Should You Take Dumb Money or Smart Money?

There are two main types of money out there – smart investors’ money and dumb investors’ money.

Dumb investors (e.g., friends and family)

are not necessarily bad, since they have money and often with very good intentions. They tend to invest based on first impressions or their prior relationships with you, and they tend to invest quickly, often without performing any significant due diligence. These types of investors can be easier to convince and, if you have enough of them, you might be able to raise most of your initial capital requirements.

On the negative side, less sophisticated investors might make your life miserable by being intrusive with their questions and suggestions. Accepting too much small money means that you will have that many more phone calls and e-mails to answer. Also, if things go wrong, less sophisticated investors may be more ready to take drastic actions to recoup losses, and may end up losing close relationships with you.

Another problem is that potential investors in your next funding round may decide to pass on the deal if they think that you have too many unsophisticated investors on board.

Smart investors (VC, PE etc)

can be individuals investing from their own funds or representing the interests of clients who have placed funds with them. They invest those funds based on a deeper analysis of risks/rewards of each opportunity.

Venture capital and private equity firms with substantial resources will conduct deep and exhaustive research on all aspects of a potential investment before committing funds. Indeed, the commitment of one of these highly regarded professional firms is the highest form of validation that an entrepreneur can receive; an investment from a top VC firm can usher in a wave of co-investors and key-staff who can provide the most likely path to future success.

Bottom Line

If you plan your capital raising strategy, the first thing should do is to match your company’s funding requirements and equity story to the right types of investors. If your goals are modest—for example, starting a small service firm—friends and family investors may be sufficient.

However, if you intend to create a highly successful corporation with a significant number of staff and eventually seek an exit through an IPO, merger, or acquisition, you must be prepared to deal with highly sophisticated investors.

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