Dumb Investors: a Dumb Idea

Last Fall my son Paul dealt with a potential consulting client with a website business who wanted to bring in investors. They had half a million dollars of seed money, but it was running out. “They tell me they’re looking for someone without investing experience who won’t interfere with management and will take less equity than normal,” he told me. “In other words, they want dumb investors.”  He didn’t push his proposal. He got out of that business relationship.

"Wanting dumb investors", to use Paul’s phrase, comes up a lot. Here’s just a sampling of some email questions I’ve received that seem to indicate that same kind of thinking:

… I need capital to hire
and build the appropriate infrastructure, but I don’t want to borrow. How can I get the $ I need
(between $300k and $700k) without losing much equity? And how would you suggest I go about it?

I am about ready to start fund raising. The business will be set up
as an S corporation. The business is a gym-type operation, and the
current financials predict I will need a total of $800,000 for proper
capitalization. I personally can put in $80,000, and will manage/work
there every day putting in that oh-so-necessary sweat equity.
What percentage of a company should a person expect to give up to
receive various types of equity? Seed money? 1st round? 2nd round? etc.

… we are at a start-up stage, having developed proprietary
auction search technology and have set up to go live via our own
start-up capital in the order of $100K. Given that we can build up some
semblance of traffic, would it make sense to bypass an angel round of
financing which would provide around $500,000 in return for 50% or more
of our company in equity, and go directly to a first-stage VC round
where we can solicit $2-5 million in return for a 10-30% equity stake?

I’m amazed at how often this idea comes up. I think it’s usually disguised as wanting a good deal, or looking for a way to not "give away too much equity." I have dealt with people who assume investors are more attractive the worse the deal they negotiate.

The first question here, hidden in the mess, is whether or not you want to build the kind of business that takes outside investment. Most of the time this is a question of resources. First you develop your plan to get a good view of what’s required, then you compare what’s required to the resources you have on your own. If you can’t do it on your own, and you can’t scale it down, and you still want to do it, then you need investors.

And if you’re going to deal with investors, think of it as a long-term relationship like a marriage. Don’t look for dumb investors. Look for investors to build your company, not tear it apart. Or don’t look for investors at all.

— Tim


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