After 17 years in sales and marketing with AT&T, I decided it was time to strike out on my own. It was 2002 and I'd come up with a new twist on an older real estate technology. But just two years later, I'd pretty much run through all my savings trying to put it into action. I was running on fumes, and my new company needed some funding fast.
Or maybe it was even worse than that. I met my future CFO, Paul, during a charity golf event. I asked him to peek at my books, business plan, and just-finished product. He was interested in the technology but alarmed at my cash-flow situation, calmly explaining that my venture was going to "blow up" without a cash infusion. Here's how that experience, and the fundraising saga that followed, taught me a few unorthodox yet surprisingly effective ways to raise startup funding while you're under the gun.
Paul started by convincing me that we needed to prepare a "private placement memorandum" (PPM) to raise $1.4 million from local accredited investors. The cost just to prepare the PPM was $25,000—money that I didn't have anymore—so Paul became my initial investor.
After 45 individual funding presentations, we reached the critical milestone of $800,000 invested, giving us the option of depositing the investment dollars we'd accumulated to date under the terms specified in the PPM. We still wanted to completely fund the round, though, so we continued the potential investor presentations.
During this process, we met with a few people who wanted to be our "sole outside investors," offering more money to replace the commitments that we'd already acquired. While I was elated that sophisticated investors wanted to be a part of the new business, their investment term-sheets were going to hold me to my "hockey stick" projections—which meant potentially giving up substantial control and equity if my (idealistic) goals weren't met.
So instead, we completed the funding round with the local folks whom Paul and I went to church, school, or the golf course with. It was the best decision we ever made.
Having been a marginal student at a marginal university, I would've taken pretty much any job offered to me. Fortunately, I fell into a job in the mobile industry with AT&T in 1984. Over the next 17 years, the company taught me how to sell, lead a team, budget (and defend a budget), understand financial statements, manage an engineering project, and navigate relationships with an ad agency. AT&T even sent me to class for table manners and taught me how to order wine. "Ma Bell" was large enough to absorb my mistakes and small enough to celebrate my accomplishments.
Years later, it would become apparent to me that this was the best preparatory environment imaginable for a first-time entrepreneur. We are all the products of our experiences, which is where our skills come from, after all. It’s important to take an honest inventory of what you’ve learned before setting out to start your own company. Try and project complete competence and expertise and others will see through it—and probably withhold their investment.
You won’t find this piece of advice from many experts, but here it it. Although you can’t avoid the 10% penalty for early withdrawal of funds from your 401(k), you can avoid the actual tax.
It’s all in the timing: You have be both operational (preferably as an LLC) and losing money in the year when you make your withdrawal. This should be the last money you draw from your own resources before raising outside funds. The 10% penalty for early withdrawal (before age 59 and a half) will make for the cheapest money you’ll ever have access to. Using your own money before asking for someone else’s gives you street cred. It says you're all in.
Now, let's be absolutely clear: The risk of losing both your business and personal retirement savings in one shot is very, very real. So do a full gut check before proceeding with this strategy. Using other people’s money, no less than your own, comes with a price.
Try and get your initial money from friends and family first. They know you best and will generally deliver the best terms. Otherwise, you’re left with "smart money." This generally includes terms like convertible debt, anti-dilution covenants, and a host of other provisions that can dilute your ownership if you miss the "hockey stick" projections included in your business plan.
"Smart money" doesn’t believe in the accuracy of your business plan projections anyway, and neither should you. This type of investor wants to know if your business will succeed or fail—quickly. It's not "patient" money. So your best shot at success is generating revenue before raising funds from professional investors, which is why you should take their smart money last. If you do, you may be able to negotiate some of the most onerous terms away.
For Paul and I, we didn’t make our initial projections. We do, however, have 10 years of profitability behind us. Our initial friends-and-family investors have had their total cash investments returned to them as dividends—all while enjoying non-diluted ownership. And I still have the opportunity to run the company—which, of course, I love.
Randall Standard is the CEO of VoicePad, real estate’s leading mobile lead-generation and automated marketing platform.