No Financing vs. Bad Financing 1

Even in these tough times, as you look toward starting up, it’s still way too easy to focus on “getting financed” instead of focusing on getting financed right, getting financed well or, perhaps, getting no financing at all.

Amazing but true: Sometimes no financing at all is better than the wrong financing.

I was at the Forbes.com headquarters in New York last week, as a judge at the Forbes.com Boost Your Business contest, which includes a $100,000 prize. By the way, if you’re interested, you get to vote on this one, so click here for details on that.

On the Forbes.com site, I discovered The Right And Wrong Ways To Raise Money, written last month by Dileep Rao. He tells a story that illustrates my point:

Take it from Consumer Products Company. (I have disguised the real name to save the owner the embarrassment.) CPC was started by a young entrepreneur with a new product. He obtained his funding from a rich investor to whom he sold a controlling stake.

When the product started to take off, the majority investor took control and threw the entrepreneur out on his ear. The poor guy sued, recovering a little over $100,000 (after substantial legal fees); meanwhile, the investor unloaded the company a few years later for over $100 million.

Seems unfair, I suppose. But, just my opinion here, there are two sides to some of these stories. That $100,000 investment is a lot of money. Would you invest that much without control? If you had the money? Maybe. With the right team, the right product, the right plan . . . but maybe not. These issues aren’t all that simple.

For another view, try Choose Investors Carefully, or Not at All, on my other blog.

Dileep Rao goes on to add some additional good advice on watching this carefully:

Then there was Healthcare Company, a contract home-care provider. HC had raised nearly $400,000 of working capital from a bank and was also planning to lease $70,000 worth of computers. About a year after the original financing, my phone rang. The frantic entrepreneur explained that while he was tracking his sales targets, he needed another $70,000 to cover working capital.

When I looked at his financial statements, I found that he had used $70,000 of that original $400,000 to buy computers because Dell (nasdaq: DELL – news – people ) was not willing to lease them. I asked him if he had looked into other leasing companies–he hadn’t. HC never recovered, and the bank foreclosed on the business.

Moral: Startup capital is precious. Do not deplete your working-capital reserves until the venture is kicking off positive cash flow–chances are you will regret it.

And I want to add my own conclusion, from a more recent post on my other blog. This is a quote from William Sahlman, whose 1997 article on business plans is one of the most-often downloaded articles on the Harvard Business Review site. He was asked how his views have changed in 10 years. One of my favorite pieces of his answer was:

The best money comes from customers, not external investors.

About the Author Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry. Follow Tim on Google+ Read more »

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