Creating Great Disruptive Business Ideas #7 – Other People’s Money

Every potentially successful disruptive idea faces one last big challenge: can it and its creator find the necessary capital to make the investments necessary to implement that great idea.

In the beginning, everyone – including the greatest disruptive leaders – bootstraps their company or sells a limited amount of equity to friends and family. They may even take advantage of more sophisticated investment groups for “seed” funding. Either way, the sums such activities yield are relatively small and a fledgling company can burn through this financing very quickly.

The fact is, in our advanced capitalist system—even with cheaper and readily available technology—nothing significant happens without money. And when I say money, I mean huge amounts of it.

There are many reasons why raising money from well-known financiers in exchange for equity—or convertible notes—can be a smart move, despite all the difficulties in getting deals done:

• A first round of funding from well-known investors sends a signal that the successful company survived one of the greatest ordeals in business—convincing other people to give them money.
• Smart entrepreneurs make sure initial lead investors are well-known within the ecosystems and communities in which the company intends to play. Such investors bring not only capital but relationships, experience, knowledge, and insights that the leadership of the funded entity might need going forward. These marquee names help attract additional investors and propel the company toward a successful IPO.
• Rounds of early-stage funding are also key moments when a company’s value to an investor is professionally assessed, thereby answering one of the most important but difficult questions: If this company is going to make an impact, just how large and valuable will that impact be?
• Investors’ singular focus on financial returns imposes accountability and discipline on the leaders of companies they support. Even if Amazon was not profitable for many years, Bezos’ success as a CEO was due in part to his experience in finance and ability to convince his investors that he was reinvesting his profits wisely and for the long-term.

Indeed, the numbers speak for themselves: In the period from 1994 to 1996 Bezos raised $9.5 million for his fledgling company, Amazon. By May 1997 he had turned that into $483 million when the company IPO’ed. Over the course of seven years (from 2003-2010) Reid Hoffman raised $85 million for LinkedIn which went public in 2011 at a whopping market capitalization of $4,500 million!

But these examples are more the exception than the rule. What most young entrepreneurs don’t realize is these companies were already producing revenue when their founders raised their first rounds of capital. Reid Hoffman quickly grew LinkedIn to $500 million in revenue and Amazon started making revenue from day one. Without some sort of a track record, it’s virtually impossible to attract any funding, although profitability is not necessarily a requirement.

While these days everyone with a disruptive idea seems to be preparing for a Series A round of financing, the truth is that often executives of a new company will waste so much time running after venture capital (VC) and private equity (PE) firms to raise money, they lose focus and often have to close the business when nothing comes of the effort.

Going through a Series A, B, or C funding round is grueling, demoralizing, exhausting, and all-consuming. It’s a roller-coaster ride with more downs than ups. If the timing is off because the sector the company is operating in isn’t favored at the time, or if there are broader economic forces in play, even the best CEO or entrepreneur may not make any headway despite excellent efforts.

But private equity and venture capital funding are not the only options available to entrepreneurs looking to build disruptive businesses who need large amounts of funding to grow. An often better and much longer-term approach is to find a strategic partner who takes a significant stake to propel the growth of a company while providing additional benefits.

For one, investors don’t know much about running a business and are by nature risk adverse and myopic. They are also very short-term since most VC and PE firms look to sell their stake in a company within three to five years. If a founder doesn’t deliver the returns within the timeframe originally agreed to, their term will be up very quickly.

All of which can mean years of agony if an entrepreneur works with the wrong investors.

Strategic partners, on the other hand, know how to build and run a business, especially when the company they invest in is in their industry. They have a much longer-term horizon and often will slowly acquire the rest of the outstanding shares of a company over time. The biggest hurdle for most entrepreneurs, however, is the cultural fit with what are often very big, bureaucratic companies that are set in their ways and risk adverse.