6 Disasters to Avoid in Raising Capital

My last post discussed the takeaways for entrepreneurs contained in UK mogul Felix Dennis' incisive assemblage, The Narrow Road: A Brief Guide to the Getting of Money (Viking Portfolio US, April 2011), a handbook of 88 short chapters modeled on the essays of Francis Bacon.

I'm excited about so much of the information here for entrepreneurs that I'm dipping into Dennis' collection to share his guidance on how to raise, keep, and grow capital--and avoid the disasters that take it from you.

If you need to raise money for yourself or a client, for your business, or an associate, keep these in mind:

1. Never surrender control of your business in exchange for capital. If a bank, venture capitalist, partner or other lender suggests relinquishing control of your business in exchange for the capital you need, that decision is one you will almost never be able to reverse--"no matter what promises are made at the time of the exchange..." Dennis writes. Consider the controversies facing the ownership of The New York Mets baseball team, the Wilpon family. Mets chairman Fred and CEO son Jeff Wilpon have shopped a share of the team to prospective partners in the wake of their crippling financial losses from their investments in funds controlled by convicted embezzler Bernie Madoff. Despite constant pressure from courts, media, fans, and others, the Wilpons so far have refused under any circumstances to sell a controlling share--because they cannot and will not contemplate losing stewardship and management of the franchise.
2. Avoid all high-interest loans. Whether you are considering lenders of less repute and high interest, credit cards, or other loans with scary interest rates, don't give into the temptation. As Dennis notes: "Perhaps you have read stories about people who launch a small company by taking out a dozen credit cards and juggling cash limits for a few months to obtain capital? While they make for exciting reading, such tales nearly always end tragically." For every Spike Lee who makes his first film using credit card debt and goes on to success, there are dozens who go bankrupt.
3. Understand the growth imperatives of venture capital. Dennis views venture capital organizations as a decent alternative as you seek to stake your entrepreneurial claim. But before you, or anyone you advise, accepts their loan, you must understand that venture capital firms act in predictable ways. They seek growth at all costs to ensure their investment is protected (the longer a firm's timeline to profitability, the greater the chance their investment is whittled down). They will look for chances to move from an advisory to an operational role to ensure this result, because they fear their own investors: "Venture capitalist short-termism, its eye firmly glued to the sale of the enterprise within three or four years, is the hallmark of nearly all venture capital activity." Many venture capital firms will insist on dates by which your firm will be sold, either back to yourself or to others. If this or financial targets are not met, they often attempt to step in to take control.
4. Reduce your risk exposure if you approach commercial banks. In 2011, commercial banks and related institutions are still hurting--from their catastrophic losses and the political and media whipping handed out during the economic crash--as well as from oversight by better funded and more energized regulators. If you are a serious start-up entrepreneur and want to borrow from the banking sector, endeavor to document a reassuring financial profile. Demonstrate a history of positive loan repayments. Reinforce your history as a "hard worker, frugal, steady," and ensure you have a well-documented, carefully vetted, thoroughly first-class business plan. Bring in an experienced partner, investor, or mentor (or two or three) into the picture to show off to the bank's credit committee.
5. Don't overlook friends, relatives, and business associates. Look to your network and family to stitch together your seed capital. Relatives and friends can be good sources of start-up capital--taken as a loan with staged repayment dates and interest payments, all in writing. If an elder relative is likely to have included you in a will, speak to them respectfully about getting a part of what they intended to leave you for your business. Consider present and future suppliers: "if your product is to be sold via a distributor, the distributor may be prepared to promise to pay a supplier before your company receives a penny. This helps avoid advance payments to suppliers. It's a long shot, but I've known it to work."
6. Always preserve 51 percent investment. Your end game in raising capital must always place you with a controlling share. "It's the control that counts. Period."