The Hard Truths About Seeking Outside Investment. If you are going to build a company with outside capital, one of the most critical decisions you will make is who will be your investor. While there are numerous arguments for why you should and shouldn’t raise capital for your business—that’s a topic for a different time—irrespective of the path, every entrepreneur should know some fundamental realities of funding structure before accepting any funding whatsoever. Funding can actually kill your venture, especially when there is a major disconnect between you and your investor. The disconnect can occur in three major categories.

1. by Faisal Hoque
founder of:
If you are going to build a
company with outside
capital, one of the most
critical decisions you will
make is who will be your
investor.
What Every Entrepreneur
Should Know Before Taking
Any Outside Investment
[Man with piggy bank: Kues via Shu6erstock]

2. Why you should and shouldn’t raise capital for your
business—that's a topic for a different time—irrespective
of the path,
Every entrepreneur should know some fundamental
realities of funding structure before accepting any
funding whatsoever.

3. Funding can actually kill your venture, especially
when there is a major disconnect between you and your
investor.
The disconnect can occur in three major categories:

4. Most funding structures in
companies are done either through
"preferred shares" or through
"convertible debt" structures, while
entrepreneurs and employees
usually hold common stock.
Misaligned Structure

5. Common stockholders are on the
bottom of the priority ladder.
In the event of liquidation, common
shareholders have rights to a
company's assets only after
preferred shareholders and other debt
holders have been paid in full.

6. Preferred stockholders have a
higher claim on the assets and
earnings than common stock.
Preferred stock generally has a
dividend that must be paid out
before dividends to common
stockholders.

7. Convertible debt (usually with high
interest) is a loan that can be
converted into equity while the
initial debt accumulates interest.
Convertible debt is like getting a
loan from a bank, but the debt
investor can usually call the loan
along with the accumulated interest
without converting to equity.

8. Often an entrepreneur's focus is on
valuation rather than focusing on the
investment structure.
Frequently, the thinking is that
high valuation gives lesser control
of the company to the investor. In
reality, it is often the funding
structure rather than the valuation
that gives you more or less control.

9. These structures create a
misaligned incentive model.
A fire sale and/or a bankruptcy
can often be in the interest of
debtors or preferred shareholders,
while it is harmful to the
common shareholders.

10. Due to the structure, the company's
strategy, execution, and long-term
prospects are often compromised.
The BOD members representing the preferred
shareholders or the debt holders, despite their
fiduciary responsibility toward all
shareholders, are likely to vote in favor of
their own interests.

11. In most cases, the investors (whether it's
a VC or an angel) know less about the
business than the entrepreneur. They
may have limited day-to-day experience
in running a venture. And they may
not know the people, customers, partners,
and the markets as well as the
entrepreneur.
Misaligned Skills

12. They often place the greatest
emphasis on financial analysis
versus operational capabilities.
While the financial details are
crucial, they do not contain enough
forward-looking information to
understand, track, and govern the
venture performance of today's
ever-changing market.

13. Vinod Khosla the famed
founder of Khosla
Ventures, at a
TechCrunch event said
that 70% to 80% of VCs
add negative value.
According to him, most
VCs "haven't done shit"
to know what to tell
startups going through
difficult times.

14. For other types of investors, such
as high net worth investors,
family offices, and private equity,
similar conclusions about their
success could be drawn.

15. In many cases, given the structure of
the funding, it is hard to avoid
investor demands.
Their advice comes with their biases,
and they often act like a dominant boss
instead of a valued partner.

16. Consider the VC fund structure: a
venture fund has a life cycle. This
short life cycle for venture funds
has negative consequences for
innovation, particularly for
innovation that focuses on solving
complex problems.
Misaligned Timeline

17. Venture funds need their investments
to pay off within the fund's life span,
which is typically between six and
seven years.
Often, they look for
investments that can generate
revenues in two to four years
and break even soon after.

18. Their ideal scenario is one in
which they sell the company for a
lot of money, or go public within
the fund's lifetime.

19. Most investors won't look favorably
on funding companies that take
years of research.
It's not that they are not interested
in innovation. Most won't fund
innovation that takes time.

20. Most VCs tend to invest
in business cycles and
trends. We have seen
how investors and VCs
acted during the dot
com bubble.
One could argue that we
may be seeing the same
mentality around social
media.

21. Investors—Your Travelling Companion?
The investors you surround yourself with make the
difference between failure and success. It's important to
be with people who believe in and support you for the
long haul.

23. Shadoka’s por.olio of offerings enables
entrepreneurship, growth, and social
impact. Our customers and partners
aspire to create sustainable value. They
are focused on repeatable and
measurable impact. We enable their
aspiraDons.
We bring together the management
frameworks, digital pla.orms, and
thought leadership for:
• Evalua@on, execu@on, and
monitoring of programs
• Scaling sales, revenue, and
profitability
• Crea@on and management of digital
communi@es and marketplaces
AboutSHADOKA
shadoka.com
Follow us @shadokaventures

24. About Me
Founder of Shadoka and other
companies. Shadoka enables
entrepreneurship, growth, and social
impact.
Formerly of GE and other global brands.
Author of several books, including
Everything Connects – How to
Transform and Lead in the Age of
Crea:vity, Innova:on and Sustainability
(McGraw Hill, 2014) and Survive to
Thrive – 27 Prac:ces of Resilient
Entrepreneurs, Innovators, And Leaders
(Mo@va@onal Press, 2015).
Follow me @faisal_hoque.
Faisalhoque.com | shadoka.com