5 mistakes most startups make when raising capital

Virtually all new businesses need capital to get off the ground and become profitable. It can put entrepreneurs in a tough spot, especially if they don’t have the cash to self-fund or meet the eligibility requirements to take out a small business loan. So, it isn’t too surprising that running out of money or failing to raise new capital is the number one reason startups fail, according to data from CB Insights.

But it isn’t all doom and gloom. Getting investors on board can be the game changer that provides much-needed capital and turns entrepreneurial dreams into reality. Convincing investors to buy into your idea takes some know-how. Being prepared, patient, and intentional in your approach can go a long way. Read on for five mistakes many startups make when raising capital.

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1. Going all in on something no one wants to buy

You may have thought up a great way to solve an interesting problem, but that doesn’t necessarily mean there’s a market for it. That’s why you need to make sure you’re building something that people want to buy — otherwise, investors will probably be reluctant to send capital your way.

This is where market research comes in. It allows entrepreneurs to zero in on consumer behavior to better understand their target audience. The U.S. Small Business Administration suggests gathering demographic information from the outset to clarify the opportunities and limitations of your business idea. How old is your target customer? What’s their financial situation like? What do they care about? Answering these questions can help clarify market demand and economic trends that might be relevant to your business. You can do this through focus groups, questionnaires and surveys, and interviews.

Competitive analysis takes it a step further, examining the strengths and weaknesses of your potential competitors. What are they doing right, where are they falling short, and how can you use this information to carve out a competitive edge?

2. Approaching investors before you’re ready

Okay, you’ve done your market research and feel confident you’ve got a solid business idea. You might be excited to get out there and start approaching potential investors but take your time: Rushing in could cost you. 

Josh Santos learned that lesson in the early days of building Noya, a climate tech company that retrofits cooling towers with carbon-capture technology. Santos and his fellow co-founder needed capital to bring the concept to life. 

“I volunteered to chase after investors and try to raise our first round of capital,” Santos told Freethink. “It was like a chicken without a head just squawking at people. It was a hard time.”

After a wall of rejections, Santos finally got his first “yes.” The only problem was that the potential investor first wanted to see scientific literature to support his business idea; having all of that information organized beforehand would have made things less stressful. So before you’re ready to approach investors, Santos says you need two critical things:

• The knowledge that people want what you’re building, and that it can actually solve important problems
• Some idea of the company’s financial structure and how it will make money

3. Lacking an investor strategy

Even if you’ve got all your ducks in a row, blindly approaching investors probably isn’t your best move. Instead, it’s wise to have a strategy of how you’ll make your pitch.

“Know which investors you’re going to reach out to — make a list, but I wouldn’t reach out to anyone on that list until you’re ready to reach out to all of them,” Santos said. “Then reach out to all of them at the same time.”

The question then comes down to which type of investors are right for your business. Harvard Business School points to venture capital (VC) firms and angel investors.

• VC firms gather money from a variety of high-net-worth investors and then invest in promising businesses on their behalf.
• Angel investors are individuals that are not part of a firm. They’re directly investing their own money in startups that appeal to them. Angels may also assume a more active role in business operations.

No matter which route you take, be sure to fine-tune your pitch and have relevant data on hand to support your ask. Drive home the ways your business idea is unique, solves a practical problem, and will generate revenue.

4. Failing to build investor FOMO

Santos emphasized the power of creating buzz around your business, which can drive a sense of FOMO among investors — also known as fear of missing out.

“Figure out ways to play investors off of each other and create this incredibly powerful FOMO effect,” he said. “Without communicating that people are investing in your round, it’s hard to maintain urgency in the eyes of investors.”

Do you have any other investors interested in your business? Sharing that with prospective investors (without violating any agreements you may have with other backers) could give you some leverage. To pull an example from corporate America, it’s kind of like getting a job offer from another company and then using that to negotiate a higher salary with your current employer. The same applies when seeking capital from investors. Building investor FOMO can help create a sense of desirability and urgency — investors will see that other folks are excited to put money into your idea, which might inspire them to do the same.

5. Treating investors like capital machines

When hunting for funding, don’t forget that investors are people just like you.

“They’re not a cold-hearted machine of a firm looking to extract value,” said Santos, whose company raised $1.2 million in roughly two years.

Much of the psychology behind startup investing comes down to how you make potential investors feel. If you approach them with a robotic pitch and treat them like an ATM, they probably won’t be inclined to back you. Instead, don’t be afraid to tell a story and connect with them on a more human level. What is it you plan to do with your next round of capital? With their help, how will you achieve your vision — and what’s in it for them?

Entrepreneurship takes hard work, whether your business requires fundraising or not. Those who are looking to raise capital will want to do their homework beforehand and lead with authenticity. Together, it could be what motivates investors to buy into your business.