Every entrepreneur hopes that their start-up will be funded, but the truth is that only one percent of business proposals are ever selected for start-up funding. Why is this number so low? It’s not because there are lots of worthwhile proposals and the investors are choosing the crème of the crop. The reality is most business proposals are junk propositions, not worth the disk space they take up.
The most obvious rejection is a proposal based upon nothing than an idea. Investors want proof of concept. That’s not a prototype of the gismo; it’s the proof of a working business model – and this comes down to revenue, customers, and a product. Investors don’t want entrepreneurs to experiment with their money. They want evidence the business is viable.
Many investors aren’t interested until a start-up reaches $2 million in annual sales. Many successful companies didn’t look for investors until they reached $4 million in annual sales and they reach that point after 3 or 4 years of operation. This is a sure sign to investors that the start-up’s team knows what it is doing. Funding allows them to reach $40 or $50 million within 5 or 6 more years.
With only one percent of proposals funded, there is fierce competition for funding. Entrepreneurs need to realize that while their product addresses a certain market segment; they compete against every other start-up for funding regardless of their specific industries. If you were an investor, would you fund a company with $2 million in annual sales or one with just has an idea?
Many of the professional start-up investors are moving upstream to asset management or late-stage companies. Ten years ago, a software start-up building a web-based product would get $3 to $5 million in initial funding. Now, the same project can get to the same point for less than $1 million. This can be accomplished with the private investor or even crowdfunding. As a result, venture capitalists and other investors don’t see the need to be involved in early stage start-ups and are focusing on the stages where lots of capital is needed to expand and scale up.
There are only a few types of stat-ups that truly need large amounts of capital to get started, most don’t. They do require resourcefulness on the part of the entrepreneur. If an entrepreneur wants to get funded, they have an obligation to demonstrate the worthiness of their business proposal to investors.
How can an entrepreneur create this proof of concept required by investors? The experimental start-up phase is where the entrepreneur designs and conducts a series of business experiments in order to discover the right product and business model. It’s how the product or service concept meets its business.
This process all starts with a concept plan, which outlines what they intend to do and why, and includes all the assumptions and unknowns about the business. Unlike starting with the traditional business plan, here the entrepreneur acknowledges the holes, assumptions, and issues. Next, the entrepreneur couples the concept plan with a strategy for conducting business experiments. This orchestrated and systematic process allows the entrepreneur to develop proof of concept of the business. Only then is the entrepreneur in a position to write a solid business plan, one based upon experience and facts, not guesses and wishful thinking.
Contrast this to the approach of starting with a business plan; entrepreneurs feel the start-up has to work as outlined in the plan. But most start-up business plans aren’t based upon direct experience with the customers and market. Entrepreneurs hire employees and get them to execute the plan – after all, an employee want a sense of security and admitting you don’t know what you are doing, doesn’t instill confidence. The entrepreneur may have found outside funding, in which case, the investors want steady and sure progress. So the entrepreneur seals their fate and the business plan is executed to failure.
Why is thinking of your start-up as experimental so effective? It sets the mindset that what the entrepreneur is doing right now may fail – and most likely will – after all, it is an experiment. Eventually enough knowledge and information is gathered to create the business that will succeed.
About the Author
Cynthia Kocialski is the founder of three start-ups and helps entrepreneurs transform their ideas into new businesses. Cynthia is the author of Startup from the Ground Up and Out of the Classroom Lessons in Success. Cynthia writes regularly at Start-up Entrepreneurs’ Blog and provides in her video series information on Concept Plans.