Editor’s Note: In the new podcast Masters of Scale, LinkedIn co-founder and Greylock partner Reid Hoffman explores his philosophy on how to scale a business — and at Entrepreneur.com, entrepreneurs are responding with their own ideas and experiences on our hub.This week, we’re discussing Hoffman’s theory: You need to raise more money than you think you need — and potentially a lot more. Listen to this week’s episode here.
We have heard our share of business pitches. Think “Shark Tank” on a very small scale. We have also consulted with a number of startups. One thing we know to be true, regardless of the entrepreneur’s efforts, is that starting a business always takes more time and more money than he or she thinks. It is just that simple. Even the most brilliant business plan will have to change. Not because of the things put in the plan, but because of those pesky things not in the plan. It is the unanticipated items that cause most startups to take longer and cost more to reach breakeven. The bottom line is that revenue never ramps as quickly as you think it will.
We will share a few of our personal experiences with you to illustrate different funding methods and some lessons learned along the way that can help you think about funding your business.
When we started our company, Whitestone Partners, we worked out of the room over our garage. We didn’t have an assistant. We already owned our computers and phones. Except for buying business cards, purchasing bookkeeping software and paying a friend $300 to help us put up a basic website, we kept our costs to a minimum.
We believed that we would be able to sell our consulting services reasonably quickly. While we didn’t anticipate being able to replace our former salaries immediately, we thought that within three to six months, we would be able to pay our bills from the business and within a year we should be paying ourselves. We were wrong.
We hadn’t factored into our plan that we were completely unknown as small business consultants and within the Richmond, Va. market. To gain credibility, we wrote a book about small business. To write the book, we interviewed more than 100 members of the small business community. This took a lot of time and more money. However, it worked.
We started selling consulting services. Within 12 months, we were paying the business’s bills from our business revenue instead of our savings account. This was tougher because our business expenses had increased due to additional marketing costs. It took us two more years to grow our business to the point where it replaced our previous salaries.
The takeaway: If you are going to live on savings, you need a big nest egg. We are eternally grateful that we did. Remember, it takes longer than you think to replace your income.
Borrowing from friends and family
Our daughter wanted to start a business selling a franchised clothing line. She needed an initial investment of about $10,000. She didn’t have it. Instead of borrowing on her credit card or going to a bank, she asked us to loan her the money. She was able to negotiate a better rate with us than the ones offered by her credit card company. She told us that she anticipated being able to repay the loan quickly, making multiple payments each month.
She has worked hard and has been growing her business. So far, she has made her loan payments without reminders. However, she has made only the minimum payments. She has been putting most of her profits back into her business to grow its inventory and to purchase some labor saving software and equipment.
The takeaway: Again, her revenue is good, but not quite as good as planned. She also didn’t expect to need the new computer, printer and inventory software. These items were not in her initial budget.
From our perspective, our experience has been positive. However, we believe we are not the norm. While we could not find any statistics on loan repayment for these types of friends and family loans, we believe that more than one friendship or family holiday has been ruined by a borrower’s failure to repay. If you are going to put relationships on the line, have a realistic plan for repayment.
Our marketing assistant, TJ, is publishing a magazine with two of his college friends. They bootstrapped the project as far as their respective wallets could take them. Then, they turned to Kickstarter. They beat the odds. Their campaign was the one in three that succeeded and their magazine, Skinny Dipper, will publish in the next couple of months.
TJ explained that they did a fairly good job of planning for the expenses related to the project, but completely missed the mark on how long it took to produce the magazine. If they had been renting space, had employees or were even dependent on the income from this project to pay their bills, they would have failed. Because they started this project as a side business, they have been able to survive, despite the delay in completing the work.
The takeaway: Delays in bringing your product to market can suck up cash and kill your business. TJ and his partners have avoided this by having another source of income and only a self-imposed deadline for publishing. Otherwise, the outcome could have been quite different. Make sure you have room in your plan and budget for reasonable delays.
Related: 5 Business-Funding ‘Rules’ to Break
We are early stage investors in Tenant Turner, a web-based lead management software for the property management industry. Tenant Turner was able to raise early seed money through a combination of local angel investors, prize money from startup competitions and a grant from a local incubator in 2014. In 2015, the Y Combinator backed Tenant Turner, giving them a bit more capital. They did a second round of angel funding in late 2015/early 2016.
It takes time to grow a great company. CEO James Barrett told us that Tenant Turner continues to grow its client base, make strategic alliances and refine the product. He explained that they are in execution mode — doing what they can to scale their business, including new support tools, better internal processes and major product improvements. Currently, the company serves hundreds of professional property management firms and investment property owners in 30 states. Barrett said, “We continue to expand our footprint.”
The takeaway: “You need to be willing to pitch to people and take constructive feedback,” Barrett advises. “You can’t keep your idea a secret and wait until the last minute.” He also suggested that identifying a lead investor who understands your industry is a good first step. You can “snowball” that relationship to find other investors. Incubators and accelerators not only help you learn but can help to connect you with other possible investors.
Starting a business is an adventure. You can try to plan for every possibility, but in the end, it always ends up costing more and taking longer to get to breakeven and beyond. Don’t get us wrong. We believe in creating a robust business plan. Just remember the stories above and have a backup plan when you have to rewrite your pro formas.