How To Set Yourself Up For The Proper App Funding
Joshua Davidson wrote this article
Let’s get this straight, getting funded is not a milestone.
I think of it more as a trade of your equity resources for a cash infusion. Some businesses need funding to get going; others don’t. It all depends on your product or service.
I have never sought investors to fund my company since I started Chop Dawg ten years ago. But this also because my business model didn’t require funding. Because of this, I was able to figure out ways to save cash reserves while bringing monthly recurring revenue that I could use later to invest.
For any app entrepreneur, I recommend that investor or no investor, that they set aside a cash reserve that they can use in the future to make targeted investments for the business. But in thinking about investing as an exchange of one resource (money) for another (equity), the first thing that I recommend that you do is come up with any additional items besides what I have on this list below.
Understanding your list of resources and how you can (or can’t) leverage them is key to deciding whether or not you should wait to seek investment. As I said in the headline, I want you to seek the proper funding for your app. That may not even involve an investor.
Your precious resources:
1) Equity if it’s worth anything to anyone. The perception of your equity’s worth is what fuels the pre-revenue stage.
2) Your credit score and history (if you’re going to get a loan)
3) Your friends and family
4) Your timing
Your app’s precious resources:
1) Number of RECURRING users + revenue per user
2) The team behind it (equity is worth it here for the right people)
3) The costs to operate the app
4) It’s timing
How much money is your app designed to make?
There are plenty of revenue sources that you can equip your app with
1) Advertisements (be careful here)
2) Selling or facilitating the sale of digital goods
3) Selling or facilitating the sale of real goods
But there are two important metrics to think about here:
1) Is the revenue that you are relying on invasive to the app experience? Advertising is an example of something that you need to tread lightly with, and it doesn’t encourage a long-term user base.
2) Is the revenue that you are generating due to app users willingly paying for products or services?
Infant Stage (Pre-Revenue, Pre-Product)
If you have an app idea that you have you have roughly sketched out and are trying to find someone to build it, there are a few things that you want to prepare for. Where you are in the process depends on whether or not you have a monetary strategy ready and if you’ve found a way to demonstrate the idea as an app.
I would recommend that you go as long as you can without the help of an investor, especially at this stage. When you receive investor funding, you have added a tremendous responsibility for yourself.
A friend of mine, Phil Kennard (Founder of a SaaS for vacation rental entrepreneurs called Futurestay) has a framework that he uses for raising capital called Proof H.E.L.P.S that has helped him raised $2M in funds that he has turned into a very profitable business.
In discussing his framework, Phil says,
“Investors are checking to see that you have done every single thing within your power to be ready to raise capital – and using that as proof that you will do every single thing within your power to survive and thrive once you’re funded. That’s the proof they want.“
It’s one thing to get funding – but this is where the work begins. Your app needs to be ready to make money when the investors write the check. Otherwise, you’ll be in for a world of hurt. You may have been able to score funding based on your idea or network alone, but that doesn’t guarantee that the investor was right to give the money to you.
There’s a tremendous responsibility in not just needing to give an investor their initial money back, but the earlier you raise, the more equity you lose.
When an idea is fresh without proof, you may be able to find someone who believes in the idea, but they’ll have no choice but to undervalue it. You haven’t proven to anyone that they’ll make their money back
On the other side of the coin, if you raise too much based on an idea that turns out to have no basis for making real money, it makes for an infinitely harder crash. This “success” in getting in at the wrong time when you don’t understand what your monetization strategy is going to work will only serve to burn cash and relationships.
You have two basic roads to take from here
You need a proof of concept, validation, and a source of preferably recurring revenue. No app is worth investing in if you don’t have some source of revenue. That doesn’t mean that your app business needs to be profitable. In fact, I highly suggest that one of your first investments is in infrastructure since nailing down the app’s operations at the beginning saves a lot of money later.
The two roads that you can take with a cash infusion are an investor or a loan. For investors, in these early stages, the angel investors are likely going to want to listen to you the most.
That doesn’t mean that anyone will bite at your idea, but angels are more likely because the stakes are personal as opposed to something that can damage a firm that handles others’ cash. Loans can seem more costly at first than giving up equity, but you end reaping a lot of long-term rewards if you can get a personal loan at fair terms.
The weight of giving up an equity percentage of your future app’s profits
I cannot emphasize this enough: the later you can raise money, the better because you’ll have more leverage and have less equity to give up.
Think of equity as a resource. So if you make a deal with an investor, it’s less of a milestone and more like you’ve negotiated selling off your resources. In the long term, things can get complicated when you bring on more investors. You’ve also given voting rights to someone that may not be a good fit for dictating the app’s direction.
You need to pick and choose your investor, because they are going to want to have a voice, and have voting rights. You need an investor that has a compatible vision for you. Also, do they have EXPERIENCE in your industry? What are they bringing to the table? That $20,000 for 25% is going to weigh you down later if you want to incentivize your team with equity later on. Be careful with your resources. You are interviewing investors for talent as much as they are interviewing you for handing over their money.
The mistake I see app entrepreneurs make is that they get too far ahead of themselves. The fact is, during the first couple of years, so many changes will need to be made with the app that it may not even be the same thing anymore. With an investor, you become less flexible with the pivots that you can make. Also, keep in mind – you’ll eventually want employees to have equity, and large equity-holders might wish to exit. Significant equity partners that make abrupt exits are people that you have to pay. A lot.
I would recommend that before seeking an investor, find a technologist that you can convince that your idea is worth working on. Pitch to the technologist first, not the investor, because they’re going to be the ones building the asset. Work something out that is fair to both of you.
So how do you launch yourself out of the infant stage?
You need some momentum to ride on. Don’t worry about a big bang for launch. What is better is ensuring that you get that steady userbase established. So what you do need is a platform in which to communicate your app’s mission and what it’s going to do for users. What is the problem and how are you trying to solve it? To use the analogy all too familiar to entrepreneurs… aim for painkillers, not vitamins. Focus on something that causes people trouble versus making something that is okay just 5% better.
Remember, with an MVP you are building something that should not fail, but it doesn’t need to be a runaway success either. So that means that you need to come up with the features that need to be in the app. The MVP is a vessel to bring users on board with your idea, make some early cash, and reinvest it right back into the product. Your userbase will become your most valuable resource, because not only can they help you make a better app that they’ll use, but they can help you find future users that are like them.
Mitigating risk in getting yourself to the revenue stage
1) If you are nontechnical, you can mitigate risk by hiring a technical team.
2) If you have no proof of concept, you need guaranteed beta users that are ready to go so you can start getting some revenue in and quick feedback. If you aren’t ready to sell yet, get some early pre-sale contracts/commitments.
3) Building a prototype of an MVP is a way to demonstrate your app concept to real people, find every perceivable weakness and showcase to an investor that you have addressed it.
Above are the initial steps that can (and should) be done during a quick 6-month timeframe. Within six months you should be able to figure out whether or not this is going to work. The personal loan does work here because you can plan a manageable monthly rate of payment that isn’t dependent on your company’s immediate revenue. With a personal loan, it’s based on your credit history.
If you’re now in the post-revenue stage
You’ll certainly get a bigger hand in the deal that you make with an investor or the bank. But think about how your revenue stream is currently working for you. Are you making steady cash or is revenue infrequent?
Understanding your revenue
1) How much?
2) How frequent?
3) Revenue sources?
4) What is your margin of error for you to make a mistake? For example, you can suffer the hit of a $2,500 marketing campaign that doesn’t work.
Do you or will you have enough money coming in that you can use to scale up the app? Is scaling dependent on a cash infusion, or are you looking for acceleration? Do you need such a boost or can it come through naturally by you making some good decisions with what you have?
Coming up with a plan on what to do with your funding
Whether you are making $1,000 per month in revenue or $20,000, you are at the point now where you need to evaluate how and how much you want to scale.
First things first, will scale too quickly harm your app business? Most likely yes, so think about how you can move incrementally. When you have the revenue, what should you do with it to reinvest?
Some choices you can make to scale incrementally:
1) Knowing your cost per user and their lifetime value will help you develop a formula for scaling. It’s simple, really – let’s say that I calculate that for every $100, I get ten users. Now, how much revenue do you bring in? And what is their lifetime value? With a cash infusion towards marketing, once you find something that works you can establish a predictable user acquisition generator.
2) How can you naturally grow based on your current users? Investing in the users who are using your app already is something you need to do. It can’t just be about your new users. Without making your current user base happy, you’ll just have a high churn rate. Your happy userbase is your ongoing asset. Invest your revenue into hiring more customer support and developers that can work to scale the platform to users’ needs. You’ll also need to invest in a server that can handle increased user growth, but also the increased activity of existing users.
3) Still mitigating risk for investors because you have the proof, BUT what you are raising needs to make sense to make projections. Understand what your projected ROI is going to be.
In the end, it comes down to this – can your app make money and build itself into an asset?
If your app has self-generating recurring revenue, be patient in how you scale. Let things play out and nurture your current user base. If you can come up with a monetary strategy that makes monthly recurring revenue even at a slight profit, there is something there worth exploring. Is it something that you can do with an investor? That’s for you to tell. If you can get a favorable loan, go with that first. While equity is a seemingly invisible number when it isn’t worth much, that’ll change with more traction and investors know it.