Is venture capital best for financing a start-up?

• Author: Cohan, Peter S.
• Position: PRIVATE COMPANIES

The worst possible way to finance a start-up is to take venture capital. The best? Profitable products that customers are eager to buy. Nevertheless, if venture capital is the only way, there is a time and a way to do it that will allow the business to make the best of it.

First, consider why VCs are bad news compared to the alternatives. Simply put, entrepreneurs crave control and when a start-up takes venture capital, the founder hires a boss--a boss who is in a position to fire the founder. On the other hand, if a start-up can finance itself through customer profits, generous terms from suppliers or founder's capital, the founder can retain control.

That's why start-ups seek outside equity capital only as a last resort. In raising outside capital, entrepreneurs are well-advised to sequence their capital raising with the achievement of their short-term goals. For instance, start-ups should:

* Boot strap--e.g., live off Ramen noodles and credit card borrowing--to find a business model;

* Raise money from Angel investors--wealthy individuals who write five-and six-figure checks--and friends; and

* Seek venture capital to add to the start-up's product line and expand geographically.

Making the Pitch

When making the pitch to the VCs, follow these six tips:

1. Connect emotionally with the VCs. To do this well, learn about the individuals you're pitching. Maybe they went to the same school or have the same hobby. One of the best ways to break through the emotional barrier separating a would-be borrower from the VCs--who are likely to turn you down--is to do something that makes them laugh.

2. Give a working demonstration of the product. One way to get a laugh out of potential financiers is to provide a working demonstration of the product that will amuse and delight the VCs.

3. Highlight related work success. Even if the first two items are accomplished, VCs will never invest a dime unless they perceive a winner. To that end, draw on your entire life experience to highlight passion and ability to win--this could be in sports or academics, or better yet, in starting and building new businesses. The more successes generated, the greater the VCs' fervor to invest.

4. Admit immediately what you don't know. Never try to bluff your way around a question. If you don't know, admit it right away. Inability to answer the question will not help the case--especially if it's something that should be known. But faking an answer will cause one's reputation to go...