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Ten Frequent Mistakes Made by Chilean Entrepreneurs

Since we launched Magma Partners, I’ve reviewed 300+ applications for funding, the vast majority from Chile, with some from Colombia, Argentina, Mexico, USA and Uruguay.

Of those 300+, we’ve invested in seven. I’ve met some amazing entrepreneurs and have learned from many of them. But the vast majority of companies we’ve reviewed have similar problems that prevent us from investing. I’m writing this post to try to help entrepreneurs who are looking for money avoid these mistakes so that they can be more ready to accept an investment.

1. Asking for more money than they need

Most of the entrepreneurs we’ve met, including some that we have ultimately funded, make the mistake of asking for more money than they need. Many come to us asking for enough so that they can run their business with no worries for 2-3+ years, in a nice office, while spending a large marketing budget trying to get clients. But it doesn’t make sense to look for three years of financing before finding product market fit because your valuation will be low.

Raising money is a long, hard process that distracts founders from growing their business, but in an early stage company, your goal as a founder should be to raise the amount of money you need to quickly validate your company and get it to the next big milestone where you will be able to raise a larger round later.

2. Asking for money to validate the idea

This mistake goes hand in hand with mistake #1. Many entrepreneurs are asking for money before they’ve found product market fit. It’s cheaper, faster and easier to validate an idea now than ever before. you can always find a way to at least partially validate your idea. If you haven’t found product market fit yet, you should raise the least amount of money possible to validate your product market fit. As an entrepreneur, your equity should be precious. Unless you have no other options, you shouldn’t be thinking about raising more than US$10 until you’ve found and validated your niche.

We always ask entrepreneurs to show validation that the problem the they are trying to solve is real and painful before investing. I can’t count the times that I’ve heard the same “but if facebook didn’t get investment, they wouldn’t have been able to succeed.” Many entrepreneurs mistakenly believe that Facebook raised money before they had product market fit, when in fact they had nearly all of the Harvard student body using the site.

You should use all the tools at your disposal to raise a bigger round when you’ve found product market fit and need money to expand.

3. Fooled by “investors” with no skin in the game

Although some entrepreneurs have made great use of government money, the vast majority are using the money to get themselves a personal MBA in entrepreneurship at the expense of really building their business. Instead of failing cheaply and quickly, they’re failing big and slowly because government money gives entrepreneurs a no skin in the game option to start a business.

Government money isn’t bad. But if you’re going to take government money, try to operate as if you had 10% of the grant that you get so that you avoid wasting money. For example, in my first company, I wasted US$100,ooo that would have otherwise gone into my pocket developing features that nobody wanted and spending on marketing before we had product market fit. That money came directly out of my pocket. That lesson was so painful that I learned never to do it again. I fear that with government money, the lesson is closer to “oh that was bad, lets apply for another line of funding” rather than “I’ll never do that again.”

It’s great that entrepreneurs have the chance to learn these hard lessons with the help of government money. But the problem is that many burn the public money, don’t learn the lesson and keep looking for more public money. And the cycle continues.

Others who still haven’t validated their solution come to private funds asking for $2m+ valuation because they’ve gotten free or very cheap money before and don’t want to take a down round. For our purposes, any valuation where the investor, incubator or accelerator doesn’t have skin in the game isn’t a real valuation.

4. Entrepreneurs with no skin in the game

We’ve seen a high number of cases where entrepreneurs want to raise money so that they can quit their jobs and pay themselves a salary to start their businesses. This strategy is a big mistake because the entrepreneur doesn’t have any skin in the game. They’re taking no personal risk. If you don’t have skin in the game, we can’t invest in you.

That’s not to say that you must quit your job to get started. We’ve met with and funded entrepreneurs who validated their business while working a full time job and only left when they had found product market fit. This strategy is a good middle way if you’ve got the golden handcuffs of working a good corporate job.

5. Vanity Fundraising

Every day you see someone on Twitter, Techcrunch and in newspapers raising huge sums of money. So you think you should do it too. As an entrepreneur it’s easy to let your ego get in the way and try to raise $500,000 or $1m so you can be part of the big leagues. But what happens if you only need $50,000? Or don’t need money at all? I’ve seen entrepreneurs come in asking for $500,000 happily giving up 33% of their business. But they really only need $50,000 to get to a place where they could raise $500,000 at a much higher valuation later on. Don’t fall into vanity fundraising the trap!

6. Lack of Vesting

Vesting is like an insurance policy that allows cofounders to repurchase company stock at a previously agreed upon, low price if one of the founding team members leaves. We’ve seen multiple companies where founders who have left still own stock. Not only are situations like this are bad for the entrepreneurs who continue working on the business, but it also makes it difficult for us to invest.

7. “I traveled to silicon valley and decided to start a trendy startup”

We’ve seen many wantrepreneurs who went to silicon valley and NYC to “see what was going on” or “do networking like crazy” and then come back to try to launch ideas that don’t make any sense in Latin America or Chile. Instead of looking for a real problem to solve by being on the ground in the the local market, they see trendy startups in the US and try to start them in Chile, even when it doesn’t solve a real market problem. Note: we’ve seen and funded multiple clones from the US that do solve a real problem in Chile and Latin America.

8. Ideas that don’t solve real problems

Chile is filled with opportunities for entrepreneurs to solve real problems, help people and make money while doing it, but we see entrepreneurs trying to create things that don’t really solve problems that people have. They prefer to do something “innovative” or “cutting edge” rather than solve a real problem.

9. Business models that don’t make sense in Chile

In Chile 50% of households make less than $800 per month and 85% make less than $1300. Money isn’t distributed well enough to support many business models that work in the USA. For example, most small businesses can’t pay a meaningful amount of money per month to be on a yelp like platform because they don’t earn enough money to justify the investment in advertising. Take a look at your business model to make sure it makes sense in the Latin American context.

10. Chantapreneurs: Being an entrepreneur for the wrong reasons

We’ve seen entrepreneurs who are trying to start their own business for the wrong reason: to be part of the ecosystem, because being an entrepreneur is cool, because they want to be a rockstar or because they want to earn money quickly and easily. They want to start a business to show that they’re entrepreneurs, not because they want to solve a problem. We want to invest in people who are motivated to solve painful problems that affect specific niches, not people who just want to make a quick buck or be part of the ecosystem. Starting a business is hard, so if you’re goal is to “become known” by starting a business, its likely you won’t have success.

Doing things the right way

Most Chilean entrepreneurs we’ve seen are doing it the right way, but it’s very likely that the vast majority could find something on our list that they could quickly and easily start to improve. We’re going to keep writing articles on our blog with the goal of working together to improve our entrepreneurship ecosystem.

Vesting Agreements: Why they should be the first thing you do when you start a company

Vesting is an industry standard in US startups, but from what we’ve seen, the vast majority of Chilean startups and pymes do not use vesting, most of the time because they haven’t heard about it or don’t completely understand what it is.

Think of vesting as an insurance policy for you and your cofounder in case circumstances change after you start your business. When you start a business, its all sunshine and rainbows. You talk with your partner(s) about how you’re going to take over the world. Everyone is completely motivated and ready to tackle any problems that come up.

It’s been said that having a business partner is like being married, just without the sex. And we all know that while nobody wants it from the start, many marriages end. It’s the exact same with business partners.

But you need to think about the things that could go wrong.

  1. What if a cofounder isn’t the person you thought he was when you started the business?
  2. What if he gets bored with the idea?
  3. What if she leaves the country to travel or finds a better opportunity?
  4. What if she gets a job offer she just can’t pass up?
  5. What if he hooks up with your girlfriend?
  6. What if he gets married and doesn’t have the time he promised he would when he started?
  7. Or what if he just doesn’t pull his weight and you need to find another partner?

What happens to cofounder equity if any of these things happen? Without vesting, you have to rely on the good will of your partner to come to an agreement about what is fair. You’re relying on your business partner’s good faith and sense of fairness to come to an agreement. But as I’ve seen too many times to count, when money and work come into the picture, all bets are off. And its even worse if your business partner was your friend.

Let’s look at an example company that does not have vesting.

Best friends Juan and Pedro start a company. Each have 100 shares. They’re both really excited about starting the business and get to work. After three months, it’s much harder than Pedro expected and starts to come to the office less and less. Juan is still fully motivated and continues to work full time on the project.

Juan tells Pedro he needs to leave the company, as he isn’t working anymore. Pedro agrees that he isn’t working hard anymore, but says that Juan must buy the shares for $1,000,000 because that’s what his shares in the company might be valued at in three years. Pedro says no way. They have a big fight and Pedro stops working entirely. Juan keeps working on the company and Pedro still has his 100 shares, doing nothing while Juan works hard to make the business a success. Even worse former best friends Juan and Pedro don’t speak anymore becuase they both think that they were acting honorably and fairly.

What is vesting?

Vesting is simple. It protects you from all of the above situations by laying out a protocol to deal with these situations that ALL cofounders agree to BEFORE starting the business.

In practice, it gives cofounders the option to buy back each others stock at an agreed-upon low price, on a set schedule, usually over three or four years. We prefer four year vesting. Vesting, when applied equally to all cofounders, makes sure everyone plays by the same rules and avoids problems later when relationships are complicated by time, effort, ip and worst of all money.

Vesting states that if a cofounder leaves during the first year, they will sell all of their shares to their partner(s) at a previously agreed on price. If the partners stay together for a full year, 25% of the buyback options expire. This means that no matter what happens, they will each have 25% of their shares in the company. This is called a one year cliff, because you get nothing until you go over the “cliff” then 25% of your shares are vested.

For the next three years (36 months), 1/36th of the options will expire, meaning that if a cofounder leaves after 1.5 years, he would get to keep 25% of his stock (the amount vested in year 1), plus 6/36ths of the total amount.

After four full years, a cofounder can leave and all of his shares are vested. See table:

Amount Vested Monthly Cofounder

Months 0-12

0.00%

Month 12

25.00%

Month 13

27.08%

Month 14

29.17%

Month 15

31.25%

Month 16

33.33%

Month 17

35.42%

Month 18

37.50%

Month 19

39.58%

Month 20

41.67%

Month 21

43.75%

Month 22

45.83%

Month 23

47.92%

Month 24

50.00%

Month 25

52.08%

Month 26

54.17%

Month 27

56.25%

Month 28

58.33%

Month 29

60.42%

Month 30

62.50%

Month 31

64.58%

Month 32

66.67%

Month 33

68.75%

Month 34

70.83%

Month 35

72.92%

Month 36

75.00%

Month 37

77.08%

Month 38

79.17%

Month 39

81.25%

Month 40

83.33%

Month 41

85.42%

Month 42

87.50%

Month 43

89.58%

Month 44

91.67%

Month 45

93.75%

Month 46

95.83%

Month 47

97.92%

Month 48

100.00%

Vesting example

Here’s the same example with best friends Juan and Pedro from above, this time with vesting.

Best friends Juan and Pedro start a company. Each have 100 shares and agree to four year vesting with a one year cliff. They’re both really excited about starting the business and get to work. After three months, it’s much harder than Pedro expected and starts to come to the office less and less. Juan is still fully motivated and continues to work full time on the project.

Juan tells Pedro he needs to leave the company, as he isn’t working anymore. Pedro agrees that he isn’t working anymore. Per their vesting agreement, Juan must pay Pedro $10 per share, $1000, to buy back his shares.

Juan keeps working on the company, now with 200 shares, doing what he can to make the business a success. Juan and Pedro are still friends.

If Pedro had left after 18 months, he would have 25 shares from year one, and 12.5 shares for the six months that he stayed in the second year. Pedro would need to sell his remaining 62.5 shares to Juan for the agreed upon $10 per share, or $625.

With vesting you protect yourself and your cofounder from unforseen circumstances. At Magma, we believe vesting should be a required term in your operating agreement when you start your business.

Traction

One of our criteria to be able to invest in a company is that the company must have traction. There’s been lots of confusion about traction: what it means and how you can get it without spending lots of money. This post aims to help clear up the situation so that you can focus on getting traction faster, without spending large amounts of money.

Let’s start out simple. What is traction? Traction is numeric, demonstrative evidence that someone wants your product. Traction shows that you are on the right track to being able to prove that the problem you are trying to solve is real and that it’s painful enough that people will pay you to solve it for them and that your solution is the right solution.

We value traction in the following order:

  • Profit
  • Revenue
  • Users
  • Partnerships (real ones, not affiliate programs)
  • Letters of Intent
  • Offline demonstration of model
  • Traffic to a landing page/social media

We require traction because its cheaper, easier and faster to test out your business ideas now than ever before. If you are not willing or able to find some amount of traction for less than $500 of spend, you’re either not trying hard enough, doing it wrong or you are trying to solve a problem that is not painful enough that people are will to pay to solve it. Or your solution is wrong.

From an entrepreneur’s perspective, you always want to get some amount of traction before you invest your time and hard earned money into an idea. It doesn’t make sense to try to invest your time, money and ask for someone else’s time and money if you don’t know if you’re solving a real problem. You should be testing out hypotheses and validating them before taking the plunge and trying to run with an idea.

From an investor perspective, if you’re not able to at least demonstrate some amount of traction, how can we believe that you’ll be able to build a business when you have money?

So how can you do it? How can you prove that the problem is real and painful without spending any money? The easiest way is to validate your problem offline first. If you’re selling a product, sell it offline or via social media. If you’re selling a service, sell your service manually. You can also use vaporware or prototyping services, landing pages or even Google ads to validate traffic. Do something to take you one step closer to validating that the problem you are trying to solve is painful enough that people will pay you to solve it for them.

Stay tuned to our blog for more creative ways you can validate your idea for free or a small amount of money.

Magma Partners Launch and Press

As part of our launch, we were featured in a number of outlets in Chile and Latin America, most of which were in Spanish. Andes Beat and Pulso Social wrote about us in English.

The Andes Beat article, titled With two confirmed investments, Magma Partners launches the most transparent investment firm in Chile, talked about how we’re trying to bring US best practices, transparency and fair deals for both entrepreneurs and investors into the Chilean entrepreneurial ecosystem. From the article:

Created by multinational serial entrepreneurs, Magma Partners is a new fund based in Santiago that invests in high-potential startups and small businesses

Today at 7:00pm, an event will be held to mark the launch of a new Chilean-US investment fund, Magma Partners. Formed by three partners– two Chileans and one from the United States– the fund is positioned as the most promising and most transparent in Chile’s national investment landscape. Magma Partners will use the best practices of the US’s most successful funds to help solve pain-points for local entrepreneurs such as exceedingly high equity rates, lack of investment transparency, and ambiguous communication.

Transparency is paramount for Magma Partners– those who direct the fund have previously raised LatAm-based capital for their companies and have seen first-hand how the the local process can drag on for months.

The Pulso Social article, titled Magma Partners Launches in Chile With US$5 Million to Invest, highlighted how we’ll operate as a fund. From the article:

With five million dollars to spend, the team behind the fund will utilize their experiences in raising capital to ensure solid practices and policies in their investments. As mentioned, transparency is central to their approach. Sáenz explained in an interview with PulsoSocial that the Magma Partners website clearly displays all of their investment criteria and required documentation so that applicants know what to expect. “Moreover,we offer term sheets that are fair for entrepreneurs and investors,” he explained. “We aren’t trying to take control of companies but instead to help them to be successful. Our fund is 100% private capital from the three founding partners.”

Over 75 entrepreneurs, investors, business people, family and friends attended our launch event in Santiago, Chile. See a picture below from the event.

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Introducing Magma Partners

Today, we’re excited to announce our launch of our new seed stage fund, Magma Partners, the first Chilean-US fund that uses 100% private capital from the founding partners. Our goal is to invest from $25.000 to $75.000 in 6-10 high potential startups and small businesses per year for the next three years, using industry standards and best practices from the most successful funds in the United States.

When most investment groups have the word “partners” in their name, they’re referring to the partners in the fund. We’re not. We’re entrepreneurs just like you. We know what it’s like to raise money, both in Chile and abroad. We want to partner with high potential entrepreneurs to help them create successful businesses.

We’re much more than money. Entrepreneurs who receive an investment from Magma Partners can expect intensive mentorship from our network of experienced entrepreneurs both in Chile and abroad. In addition to high level connections to potential clients and business partners in Chile and abroad; access to our office for at least three months; and help raising a follow-on funding round in Chile or abroad.

Our goal is to help fill a niche in the emerging Chilean entrepreneurial ecosystem to help entrepreneurs succeed.

We’re proud to announce that we’re launching with an already solidified investment in Propiedad Fácil, a real estate portal that connects buyers, sellers and financial institutions in order to streamline the real estate market. Adrian Fisher, Propiedad Fácil’s founder, is from the US but has been living in Latin America for the past seven years. He participated in Start-Up Chile in 2012 and has continued growing his business ever since. We’re excited to help him continue to scale his company.

If you’re a high potential startup or small business in need of funding, please fill out our application form. One of us will respond within 48 hours.

Saludos,

Francisco Sáenz, Nathan Lustig, Diego Philippi

Magma Partners

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