Funding A Project? Don’t Get Owned

An article by on January 30, 2017

 

If someone walked up to my front door, moved me aside, and took my couch, I’d call the police. I’d be so upset that I couldn’t think for the next day, or eight. But what if the person walked up and handed me $50 just to sit on my couch?

That’s weird, right?

But let’s say that happened. The person made the offer and I accepted it with a handshake. (Yes, that’s also weird. Go with it.)

An hour rolls by and it’s dinner time. Now, that person is sitting in our living room while I’m eating dinner. What if the person wants some dinner, too? What if they insist that the $50 transaction now makes them a part owner of my couch?

I didn’t see that coming at all. And now as a part owner of my couch, they’re eyeing my food.

We’ll say that I handed them their money and asked them to leave. Oh, but wait, I didn’t know that the $50 was good for two weeks of sitting on my couch. Also, I didn’t expect for them to say to me, “I’m sorry, but I don’t want to sell my ownership stake back to you for $50.”

Before this story gets any more far-fetched, we’ll just stop it. That scenario would most likely never happen. But sometimes it does in business.

As people who create things, we get so caught up in our dreams that we seek out ways to make them happen. Most often I hear about a startup with a concept, something vague, but in their minds they just see money. (Though, the best of startups actually seek to solve problems while making money.)

The Two Paths

There are two paths I see most often. The first one of those is the do it yourself route. Whoever had the original idea sits down and builds the thing. It might not be the best, it might not be pretty, but it’s built and they own it. Sometimes it may even take a year to bring that to life. (It took me 10 years and about six versions to build my first web app, Thousand Wires. Even then it wasn’t right.)

But not everyone feels capable of building the next big social network or iOS app. The rift gets bigger as the dreamer’s skills separate from the goal at hand. That either requires the person to learn a new skill, or hire someone. They may even have a friend who can fill in the gaps for either a cut rate of pay, or an equity stake.

So either by the inability to build the thing, or impatience, the person has to bring along help.

At some point the idea of raising funds will appear. The appeal of raising funds is obvious. People make it sound like Shark Tank. You just show up and talk to someone with money about your idea and they hand you a million dollars. That does happen on occasion, but it’s not at all romantic. It’s also not something I recommend to friends and family.

A Lego Man, Stealing the Ctrl Key on a Keyboard

But Why Not? It’s Free Money!

If you look around the web, a startup closes every day. Maybe every minute. Most of them you’ll never hear about them before they close. Some of these startups had a whole lot of money.

Look at your average teenager. What if you hand them $1000 right now? They’d go nuts and buy something crazy, most likely.

“I’m not a teenager, I’m responsible!” you say.

Good. But money can mess with your head. Even some of the most solid people I know buckle when you start talking about a certain amount of money. Either they start buying sports cars, or they freeze. You may not do either of those things, I’m speaking generally.

But let’s say you do just fine. You take the money and you hire a team to build this product.

The problem is, it’s a shortcut. People readily spend more when they swipe a debit card instead of using cash. It doesn’t trigger the same part of your brain to make you feel the pain. When you have other people’s money in play, you especially don’t feel the decisions. If you have your money in the game, you care more about the small things. The small things are what make your product valuable.

Growing over the span of a few years teaches you more than growing overnight. That process will allow you to not only have better products, but it helps create the right systems. Good systems and processes bring about better products. With better products, they’re easier to sell and get people to take notice.

It’s possible to land a boatload of money, hire the perfect team, and launch your product. But by looking around, we can see how hard it is in reality. Landing a Venture Capital firm is like winning the tech lotto. Most people run a company like lotto owners.

Twitter comes to mind here. We heard for years how valuable it was, but yet nobody could figure out how they were making money. Twitter ads came into play later, but even with those it didn’t seem like they could be profitable.

When you take other people’s money, you have an immediate value. But just because you have value, it doesn’t mean your company is afloat.

Let’s say you start with a million dollars even. You hire a developer, a designer, and a marketing person. Meanwhile, it takes you three months to get that product to market.

If on day one your product sells out at iPhone rates, congratulations. But if you’re like everyone else, it’ll be a slow trickle for the first few months. It could even be a year before you finally hit the marketing angles and people respond. If it takes you three months after launch, you’re already down six months of salaries.

With a million dollars, that’s still a lot of gap. But what a lot of people do is they try to throw more money at the problem and hire a team of twenty people. If it takes you even a month to see revenue, you’re in the hole twenty times your salaries.

If that doesn’t make you nervous, I don’t know what will.

Assuming the average salary of $50,000, at 20 employees, that’s $83,333. At six months, you’re now out over half of your funding in just salaries. You would have to have quite a product to recover half of your losses. But, it seems that most startups would prefer to raise another million in funds instead.

Starting with 20 people isn’t a brilliant tactic though. But the point is that once the money is gone, it’s hard to recover. When a million dollars is gone, it’s even harder.

To make it worse, if you’ve taken other people’s money, they own at least part of your product or your company. They’re now sitting on your couch, asking for dinner.

The more money you take, the more money you throw at the product, the harder it is to recover. People point to Amazon here, who are notorious for operating at a deficit.

Operating With Debt

When you take other people’s money, they’ll want something in return. That’s most often a share in the company. It’s a loan. They want that money back with interest.

Let’s say you took the $1 million and operated for 3 years. You needed $500,000 of it to cover expenses during that time. And then you made $700,000 in profits.

$1,000,000 – $500,000 + $700,000 = $1,200,000 in the bank.

That looks great, right? Except the $1 million still belongs to your investor. If the business closed right now, you’d have $200,000 for 3 years worth of work assuming the investor didn’t take any interest with them. Assuming they didn’t (which is a huge assumption), $200k isn’t all that bad for three years of salary. You also wouldn’t likely close the doors with $200k on hand unless the writing was on the wall that there was no way out.

But what if instead you declined the $1 million. You took your time and threw your efforts at the product and hired friends and/or consultants. Maybe in that three year period of time you only brought in $200,000. Profit wise, you’re still at the same exact place you would have been with the $1 million. But the $200,000 is all yours, and at no point did you lose even 1% control of your product.

If you’ve made $200,000 in three years, could you make $200,000 in the next two? What about one if you stepped up your efforts? You have a product that sells. You have the system in place, you just need to make it more efficient and raise the volume of sales. (I’m simplifying here, go with it.) These kinds of things are unknowns, you could have made $10,000 profit over three years. Even if that’s true, you have $10k and a product that you own.

Business Loans

Raising a million dollars in funding isn’t what most people will attempt. Instead, they’ll go to the bank and ask for a line of credit. And that’s risky in a different way.

When you do that, you’re on the hook for it. If you spend the money, you have to pay it back. If the business fails, you still have to pay it back. If you took out a large amount of money, it could take you a long time to pay off, or even cause problems elsewhere. (Like with your house.)

The Best Route To Making Something

In my humble opinion, it’s best to take things in stride and build something within your means. It doesn’t have to be ugly, without form, or functionless. It just means that the growth is slower. Maybe.

But that slow growth is a good thing.

You get to look at everything a step at a time and test the waters. You’ll have to solve the problem of profitability up front, and that means you’ll have a plan. A good number of large tech companies still haven’t figured that out after 6 years in business.

You’ll be hungry, too. When you’re hungry, you work harder. You can’t just toss more money at the problem and cross your fingers.

But at the end of it, your couch, your product are yours. You don’t have to negotiate its use like a bad timeshare. And the profits, you get to decide how your business grows.

So when you’re building a site or an app, remember, you can do this. If you’re nervous and need help, send us an email.

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About David Brooks

David Brooks is a Michigan native who migrated to Orlando, Florida. David is the owner and creative director at Northward Compass. He also blogs, writes music, and writes fantasy stories in his spare time.

About Northward Compass

Founded by David Brooks in 2010, Northward Compass is a small, distributed design shop that claims Orlando, Florida as home. We specialize in dynamic, interactive, and modern web sites, applications, and games.

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