A handshake isn’t enough: what happens when investors back out

Recently I had the opportunity to raise a small round of seed funding for my subscription sock company, NicSocks.com. The figure was about US$25 000 and I was raising it from an angel investor.

We had an aligned vision, we spent months discussing where the business was going, how we were going to move the company towards our next goal and what we would use the funds for. Everything was on track. We had a handshake agreement that I thought was as good as gold. It wasn’t and the deal fell through after months and months of work.

Here’s the first re-learned lesson from my experience:

A handshake isn’t enough. A signed contract is.

Let’s begin with three quick points on what it actually takes to get investment for your small startup.

Get your house in order
You need to have your company workings in order. At the very least have a bank account that you can use to show the investor what you’re spending your money on.

It’s a good idea to have a monthly income statement that shows money coming in and going out. This shows the investor that you’re on top of things as an entrepreneur and can be trusted with their money.

Make sure you know how things work, like your ecommerce platform for example, and that you can actually explain it. Don’t be left without an answer to a simple question. This is your business, own it and everything in it. Build the investor’s trust using your knowledge of your own business.

Have a product in the market
It’s incredibly tough to raise funding without a tangible product, website and plan. Make sure that you don’t waste your one shot sitting in front of an investor with nothing to show them but your amazing idea.

Show some traction
An idea is not a business. A product no one is buying is not investable. If you’re looking to take money from an individual (an Angel Investor) then you better make sure you’ve sold some product, made some money and have growth.

The partnership dance
Ensuring that you have an aligned vision with your potential investor is probably more important than the money you are trying to raise and the valuation you’re looking for. The chances are the investor is going to be with you for a long time and be right there with you making decisions about your company’s future.

So I spent a fair amount of time with this investor. We met for coffees, lunches and even played social football together (there’s nothing like a team sport to figure out a person’s demeanour) to see if we gelled as a potential working partnership . We did. It was great. So we moved on to the next step.

The business vision
Having a vision for your business in your head is one thing. Being able to articulate that vision clearly to an investor verbally and in document format is an entirely different prospect altogether. The latter requires writing documents, sitting down for hours and trying to predict where you think the company will be in 12 months, two years, five years and onwards. It requires documentation, planning, strategy and an idea of how you’re going to execute.

I was pushed to identify new revenue models, marketing prospects, sales channels and a variety of ways that I thought I could use the investor’s money, time and personal connections to grow my business.

Trying to raise funding is an incredible way to gain insight into your business.

I was forced to really analyse what I thought the pros and cons of my business model were; to take a really hard look at my financial projections in relation to my actual financials and see if I was dreaming or really onto something.

In the end, I had nailed down a business vision, a business plan and financial projections as well as a plan to use the funds.

Valuation and commitment
Once all of the admin and work was out of the way it was time to talk about valuation and commitment in terms of funding amount, involvement and equity I was willing to give up.

I don’t like to mince words so we got down to it. The valuation for my less-than-one-year-old company was set at R1m (±US$95 000) and I’d be giving up 25% of the company if the investor and I could hit certain milestones along the way that increased the value of the business and our bottom line. I was happy to go forward and excited to start spending the money to grow and prove a few things I needed to make the business work efficiently.

Signing and spending
I made a rookie error at this juncture. I began committing to spending money that I didn’t have in my bank account.

I committed to SEO work. I designed and ordered new stock. I started paying my team member a tiny bit of money (‘cause that’s what you’re supposed to; actually pay your staff) and made a few more commitments along the way. All of these were things that the investor and I had agreed were the way forward for NicSocks. I was doing what we had agreed to do.

A few months into spending and we still hadn’t signed a final contract and I still hadn’t received any of the funds into the NicSocks bank account. I was starting to worry that I was overcommitting myself and that my cashflow couldn’t sustain my spending.

I was right.

Stand and deliver
After many weeks of back and forth between myself and the investor’s lawyer I was at a dead end. We weren’t moving forward on the contract, I wasn’t getting meetings and things were stagnant. The money wasn’t flowing in but it was sure as shit flowing out.

And then I received a call from the investor on a Friday afternoon at 5pm.

The money wasn’t coming into my bank account. The deal wasn’t going to get done.

I had put the cart so far in front of the horse that I could barely even see where it was headed.

The good, the bad and the ugly
It’s worth stating that NicSocks has recovered from this little financial blip and I’ve come out of it with some fantastic learnings.

The good
Raising money for your company will force you to get your shit together. You’ll need everything in order from financials to business plans to stock management and everything in between. This can only be good for your business.

It’s also always a good idea to have a vision for where you’d want to go and what you’d want to spend your money on if you had the choice. Spending that money before you have it a stupid idea but knowing what you’d do if you did have it is a good plan. This entire process has opened up new revenue streams for my business and allowed me the clarity to focus on the important parts of the company and ignore the irrelevant bits.

The bad
Committing to money that you don’t have can be the kiss of death for any business. It’s simple maths: Money coming in < money going out = bye bye business. Cash flow is absolutely imperative to a young and growing business. Without money in the bank to pay for your expenses you’re in trouble and I was right there.

Fortunately this experience had opened up a new revenue model for me through the discussions with the investor so I began to hit the sales path and recover the lost investment with actual income. Real revenue is as good, if not better, than a cash injection from an investor.

The ugly
It’s hard to go through an experience that puts your business at risk. It’s ugly to have to face the workings of your business and admit that they need work. It’s shitty to realise that you put your business at risk by making some simple and avoidable mistakes.

But the truth is, going through this entire process has been a good experience for NicSocks, as well as for me as a founder. I still have a good relationship with the investor and we still meet and talk about ways to improve the business and how they can assist me in that.

Raising money can be the best and the worst thing for your business. The truth is that profit will always be valuable so push for that before you push for funding.

Image: Rocky Lubbers via Flickr.