When to Raise Money

Don't spend precious resources wooing early-stage investors. First build your business, then seek funding that can help you grow

By Monica Mehta

It's the ongoing irony of early-stage investing: Just when your little-engine-that-could startup desperately needs funding, sophisticated investors have no interest in parting with their money. Not for a startup, not right now. But once your company has traction, customers, and revenue, those same investors are all over it. The timing couldn't be worse...or could it be perfect?

Entrepreneurs need money the most in the beginning, when there are staffs to be hired, products to be developed, and customers to be acquired. But early-stage investors, from angels to venture capitalists, are not in the business of funding product development. That class of investor vaporized several years back, along with the IPO dreams of picklesandshoelaces.com.

So when Jeff Kozloff and Jamison Barnett, founders of Horsham (Pa.) medical market research company Verilogue, tried to raise money, they were in for a rude surprise. Investors wanted the six-month-old venture to have multiple customers in a high-growth market. They also wanted a fully operational business, a mature management structure, and experienced founders with a strong track record.

For Verilogue, these sorts of expectations were dealbreakers. To me, they're out of line with seed-stage funders' levels of investment. Think about it: A road show can eat up more than six months in the attempt to raise a few hundred thousand dollars. Wouldn't that time be better spent landing customers? And wouldn't entrepreneurs with a track record of success be able to self-fund at least the seed round?

Kozloff and Barnett were forced to stretch their own $150,000 investment, forgoing office space, employees, and salaries. They became lean, customer-focused, and fast. Within six months, they landed seven customers and had a database full of information from physicians and patients. Predictably, Verilogue now drew venture capitalists' affection. But with Verilogue on the road to profitability, the founders were no longer sure they needed outside money.

At this point, the temptation may be to steer clear of investors. But capital can help maximize growth or speed it up. And investors may also bring valuable relationships or experience to the table.

Ultimately, Kozloff and Barnett decided that a sophisticated partner could help them scale up quickly. This time, they limited their meetings to investors with experience in their industry who were willing to put in $2 million to $5 million. "There was a new sense of confidence that came from knowing that we did not need the money," says Kozloff. "It was easier to secure meetings, and we learned to qualify investors quickly and not waste time." In December 2007, Verilogue accepted $4 million from Edison Venture Fund.

By bootstrapping for as long as they did, Barnett and Kozloff managed to more than triple the amount investors were willing to ante up. They were able to choose a single backer, rather than exhausting themselves bringing together several parties. They even kept majority control of their company. In 2007, with six employees, Verilogue was named the tech startup of the year by the Eastern Technology Council. It became profitable in 2007, its first full year of operations. Now, with 25 employees, the founders say they're on track to reach $5 million in sales in 2008.

In retrospect, rejection never felt so good.

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Monica Mehta is managing principal of New York-based investment firm Seventh Capital. She can be reached at mm@seventhcapital.com