I found myself talking about “dumb money” today with an entrepreneurial friend. In our conversation, “dumb money” referred to money that came with hidden harm.
We could each tell stories of companies that were seriously affected as a result of taking “dumb money”. This one blew up (think detonation, not acceleration). That one imploded (think black hole). Another one sold for pennies (what’s the ROI on that?). And on and on.
As this article observed, entrepreneurs tie themselves with alarming frequency to investors who are actively harmful to their company. Just as the body can have a malignant tumour, companies can have malignant lines on their cap table. Start-up investors typically have tremendous power over their portfolio companies, generally over a period of many years.
So, how should an aspiring entrepreneur avoid the pitfalls of “dumb money”?
- Smart Money is money plus the promise of help that’s worth paying for. This type of money is not damaging to the entrepreneur.
- Mostly Money is mostly money. This can be called benign money and is not damaging to the entrepreneur.
- Dumb Money is money plus hidden harm. This can be referred to as Malignant Money or Cancerous money. This type of money is certainly damaging to the entrepreneur
Then they need to do their due diligence on any potential investor. Don’t assume any investor won’t be harmful. Do the diligence to prove otherwise:
- Do you trust him?
- Is he going to waste your time?
- Will he provide his pro rata in the next round? (Not so important for seed funds and angels.)
- Are his financing plans aligned with yours?
- Are his hopes for top line growth aligned with yours?
- Will he support you if the company is going sideways?
- Does he have impeccable references?
- Does he want control?
- When it comes time to sell the company, will he let you?
- Will he let you expand the option pool to hire someone great?
- Does he want to replace you as CEO?
- Will he try to merge you with a dying company from his portfolio?
- Do you want to marry him for the life of the company?
- Would he make the wrong board member?
- Is he committed to investing in startups and does he have a reputation to protect in the startup world?
- et cetera…
With all that said, I really like this advice from Venture Hacks.
Whether you raise Smart Money or Mostly Money, you should raise money as if your investors were Mostly Money. In other words, unbundle money and value-add. Get money on the best terms possible and get value-add on the best terms possible.
You can buy advice and introductions for 1/10th of the price that most investors charge. An investor will buy 15–30% of your company. An advisor or independent director will require 0.25–2.5% of your company with a vesting schedule of 2–4 years.