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.