Developing a Domain Into a Business - Part 2

Raising investment money is often seen as the “holy grail” of many budding entrepreneurs. After all, once you have the investment then the worlds your oyster! This couldn’t be further from the truth.

A number of years ago I had a business partner that was absolutely convinced that our company needed to go and raise some capital. I told him that he could go and try doing that if he wanted to…..and I would just grow the business. In the end he didn’t raise the capital and we still had a successful business.

I’m a bit of a cynic when it comes to raising capital. It’s the old cliché, “When you need capital you can’t get it and when you don’t need capital investors want to throw it at you.”

Let’s imagine you have one of those incredible businesses where you believe an investor would have to be crazy to not invest. A common practice for VC’s at any level is to believe your “conservative” cash flows and then add a ratchet to the shareholders agreement.

So what does this mean?

The best way to explain this is in an example. Let’s imagine an investor gives you the $100K you’re after at a $500K post money valuation. This will provide the investor with 20% equity in your business. Everyone’s happy with this position….but here’s the sting.

If you don’t meet the targets that you have specified in your business plan then they get 10% additional equity either by how much you miss the plan or how much longer it takes you to reach it.

In some extreme cases this means that the investor essentially gobbles up all of the equity or at the very least has a controlling equity position in the company. You’re now working for them and your dream of running your own business is a distant memory as they’ll often stitch you up so that you can’t leave.

The biggest problem with a ratchet is that it has the potential to drive the business in the wrong direction. For example, let’s imagine that a huge opportunity comes up but to do so you will miss your target……what do you do? If you take the opportunity you lose equity but if you don’t take the opportunity then it could be gone forever.

Another pitfall with raising capital is the classic one outlined in the movie “The Social Network”. In the movie one of the founders of Facebook didn’t realise that another class of non-dilutable shares were issued. This had the effect that with every capital raising he was diluted down to nothing while the other shareholders maintained their equity positions.

A word of advice on this one…..make sure that there is ONLY ONE class of shares with every capital raising so that all investors are on an equal footing. As soon as you introduce other classes of shares any other shareholders have the potential to feel like they are being disenfranchised. Before long you end up in the court with a disgruntled shareholder.

I’ve raised millions in venture capital and from experience the process is always at least three times longer than you think it will take. Not only that, it can be one of the most soul destroying processes that anyone can go through.
You can feel like your prostituting your business to people who ultimately don’t really care about you. They’ll say all the right words to sweet-talk you into a deal but whatever you do look what’s in writing.

My advice to 90% of businesses is that they should avoid any form of investor involvement unless they absolutely need the cash. The major reason for this is that an investor can often change the direction of the entire business because of their desire to get a particular return within a predetermined time frame.

I could go on and on about why having investors are a bad idea…..but let me now tell you a story about how they can also be outstanding.

When thought about founding ParkLogic, I didn’t need the money. What I was looking for was someone whom I could learn from and would complement my skills. After thinking about the different people I knew I approached David Gibbs and essentially handed half the business to him.

Eight years later, together we’ve built with the ParkLogic team what is largely regarded as one of the best domain management platforms in the industry. I wasn’t interested in the money that David could bring. I was interested in him. I knew that together we could build something pretty special. After working with David over these many years we've learned to appreciate each other’s skill sets and have developed a great respect for one another.

So when you think about an investment try and think broader than simply dollars in the bank. In my case, it was a skill set that I didn’t have. For you, it may be access to a particular supply chain or product to resell. The reasons for taking on investment are infinitely variable. Whatever you do, my advice is to really think before you take that step with someone else.

In the next parts in the series on developing a domain into a business I will take you through developing a financial plan.

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Michael Gilmour has been in business for over 32 years and has both a BSC in Electronics and Computer Science and an MBA. He was the former vice-chairman of the Internet Industry Association in Australia and is in demand as a speaker at Internet conferences the world over. Michael is passionate about working with online entrepreneurs to help them navigate their new ventures around the many pitfalls that all businesses face.
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