How to Ask Investors (or Family!) for Money

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1:33There's no safe like SimpliSafe. From Entrepreneur Media, this is Problem Solvers, a show in which entrepreneurs do what entrepreneurs do best, solve unexpected problems in their business. We were completely wrong. And I'm just like, it's not selling. It was like, we have to start from scratch. Watch. I'm Jason Pfeiffer, the editor-in-chief of Entrepreneur Magazine.

1:59If you want to raise money, whether that's from friends and family or institutional investors, then you need to know this. Your job isn't to just pitch them a great business. It's to lower the investor's risk. The longer the path to profit is and the riskier that path to profit is, well, you have to get paid for the risk that you take. This is Mike, who is an interesting kind of investor. My name is Mike Maples. I invest too early, way too early, and legally, ambiguously too early in startups. And what does that mean? Aside from that, it sounds very cool. Well, Mike is often credited as one of the pioneers of the seed investing movement, which he explains like this.

2:43Most people, when they invest, there's something to invest in. There's a company, it's got profits, customers, hopefully a moat, things that people talk about that make a business valuable. But I invest in companies before there's anything to invest in. And so when I invested in Lyft, well, when we invested in Lyft, it was called Zimride. And it was a different idea than what it ultimately became. When we invested in Twitter, it was called Odeo. It was a podcasting company. We invested in Twitch when it was just in TV. And so not only do we invest very early, but we invest in ideas that have a very high likelihood of making major pivots and changes along the way.

3:25And so it's a pretty wild ride, but it's one of these businesses where if you're occasionally right, the results can be really powerful. And so you end up having these outcomes that are really big. And so it's kind of a small chance at a really big outcome is kind of what the business is about. In other words, if you want to understand how investing works, how investors think, how the very earliest ideas get traction, you got to listen to Mike. He is the co-author of a book called Pattern Breakers. Definitely worth checking out. He's also the co-founder of Floodgate, a leading pre-seed and seed stage fund whose investments included Twitter long before it was known as X, Twitch, and as you just heard a second ago, Lyft.

4:10And although Mike does not invest in mom and pop shops. That is the reason that I called him because, well, originally, the reason I called him was because we just released this new issue. It's in the September, October issue of Entrepreneur Magazine called America's Favorite Mom and Pop Shops, where every year we identify 150 of the most favorite, most successful, most enduring mom and pop shops across the country, celebrate them in an issue, and then offer all sorts of insights and advice for mom and pop shops. And I wanted to understand, most people don't know the first thing about investing.

4:46And when you're at a really small scale, you are really only gonna ask for money from friends and family. And you may not know how to do that. And you may be very uncomfortable doing that. And I thought, wouldn't it be fun to ask a guy who knows this at the highest level to give advice for people at the entry level? So that's what I called Mike to do. And that's what we're gonna talk about today. Although, as you will learn, the fundamentals of talking about investing at the mom and pop level and investing at the institutional level are basically the same because it's all about not the business, but about, like I said at the very beginning, risk.

5:23So that's what we're going to get to. But wait, wait, wait. First, first, because maybe you listened to Mike explain how he is investing in entrepreneurs who barely have a company or a company that barely exists. You might be thinking, as I put to him, what you're describing for the average entrepreneur, I will tell you, and maybe you know this, when they look at it from the outside is infuriating because what they see is somebody who just had an idea get an investor, get money on an idea that may not even be a product yet. And they say, how does this person do this when I have a great idea, nobody's paying attention to me?

6:00And I wonder what you say to those people. Yeah. So first of all, I totally see where they're coming from. And I like to say that I am a rocket fuel salesman. And so my job is to go find somebody who wants to build a rocket, metaphorically, but they should not approach me if their business idea doesn't intend to achieve escape velocity. So they should not approach me to fund a normal business. They shouldn't approach me to fund a bakery or even a utility software product that doesn't have ambitions of being billion-dollar revenue. Now, people might say to me, well, that sounds kind of crazy. And there's a whole lot of businesses in the world that matter other than these breakout startups.

6:47And I say, I agree. But I also don't pretend I'm something I'm not. I say, I'm a rocket fuel salesman. You should approach me if you want to build a rocket. But like, if that's not what you want to build, we shouldn't be working together because you don't want an investor who's in it for a different set of reasons than you are. And I'm happy. I root for all founders, whether they're fit for my business or not. And I have opinions about how people who don't raise venture can still raise money and can still run a good business. But like most people don't understand the real purpose of venture capital.

7:21The purpose of venture capital is not to fund most startups. The purpose of venture capital is to fund a tiny handful of outlier startups that occur each year. Without those startups, there is no model for venture capital. You can't get paid for the risk you take if you don't find those occasionally. And so people look at it like, well, why does this guy deserve to raise venture capital when I can't? Who cares about that other person? They're either going to succeed or not succeed. You got to show up in the world and be your best self. And if your business is not meant to be to be a venture return business, that's okay.

7:57But don't wish that it was, or don't wish that that part of the capital markets was available to you because it's not even a good fit for that business. Mark said a minute ago that he doesn't invest in bakeries. And the irony is that I'm about to ask him what an owner of a bakery should do when they're looking for money. But you know what? His answers are fantastic because this conversation that you are about to hear isn't just a conversation about raising money and isn't just a conversation about who raises that money, but rather it's a conversation about business and money and how to build a business that makes money and that makes money for yourself or for other people and whoever it is that you bring on board.

8:37This is a conversation about risk. This is a conversation about growth. This is a conversation anyone should be listening to, whether you're going to raise money or not. And it's coming up after the break. All right, we're back. I'm talking with Mike Maples Jr., co-author of the book Pattern Breakers, co-founder of Floodgate, a leading pre-seed and seed stage fund about, well, all things investing and how to understand it and how to understand investors and eventually how to understand your own business model. And like I said a moment ago, he had said he doesn't invest in bakeries. So I kicked off the conversation by asking, Mike, you said you don't invest in bakeries.

9:16The irony here is that I'm now going to have you talk about investing in bakeries. And that's because what I'm excited to do is take someone with your expertise and then have you speak to folks who aren't building, frankly, the kinds of businesses that you would invest in or that the average venture capitalist would invest in. But that's fine because they're not looking for those anyway. What I want to do is imagine a bakery owner or an aspiring bakery owner who would love to open a bakery in their town, doesn't have the money to do it, and has heard that one of the ways to do this is to raise a friends and family round.

9:53Now, these are people who, in theory, they do have access to, right? They don't have the money or institutional knowledge or goals that someone like you does. But these are people who can maybe chip in and help this person get this business off the ground. But then they have a whole bunch of other questions like, OK, what exactly am I offering them in this business? And how do I make this pitch? And how do I even get into the mindset of being a fundraiser when really what I want to do is go bake my baked goods? So let's start at the very ground level for folks like that. What's your initial guidance?

10:30Sure. I've got a couple of thoughts here, but fundamentally, all businesses have something in common, and that is, in theory, they're supposed to generate profits that they can either give back to their investors, take for themselves, or reinvest back into the business. and every company one day hopefully becomes one of those, right? Including the startups that I invest in. Now, the startups that I invest in need a little bit more money up front usually because they're trying to build a scalable platform that's going to have tens of millions of users. And so there are just certain things that you have to build and get in place, certain types of talent that you have to attract, things that are going to cost that kind of money.

11:12The less that you're one of those, the more I think your bias needs to be profit first. And so the problem that a lot of startups have is they think of revenue as the thing they need to get to cover their expenses. They have it backwards. and what every business ultimately is money coming in. And so most small businesses I find would be better off prioritizing, how do I get money to come in more quickly than it's currently coming in? So that would kind of be one thought. The second thought though would be, even if you're gonna raise money from friends and family, the path to profit should be very quick, ideally, because if the longer the path to profit is and the riskier that path to profit is, well, you have to get paid for the risk that you take when you're an investor.

12:06And so if it takes a long time and it's really risky to get to profits, it's not a good investment. It's not a good bet for friends and family or acquaintances. I guess the other thought here would be... Actually, before you go on the other thought, I just want to expand upon that. So the advice then is if you're crafting, let's just continue to use the bakery as an example. that if you're crafting this bakery, then what you need isn't just that you are great at baking or even an idea for what the bakery should be, but a plan for how this bakery gets profitable quickly, because that's the thing that you want to go and show your friends and family.

12:43Is that right? Yeah, that's my opinion. And I'm glad that you asked the question because I think it's worth clarifying something about risk, right? So if you're going to ask an investor for money, we need to put ourselves in their world for a second. And all investing has to answer a specific question. How do I get paid for the risk I take? So if I buy a stock, I'm taking more risk than if I buy T-bills. And if I buy an index fund, I'm taking less risk than if I buy an individual stock. And so whenever I take more risk, I have to get paid more for that risk. Why would I take more risk to get paid the same amount of money?

13:21I wouldn't do that. That doesn't make sense. And so my risk profile, how I invest is I say, there's a small chance that this thing could be the next Twitter. But we made 600 times our money on Twitter. And so and we made 94 times our money on Twitch. And so there is a small chance that we'll do that. But the opportunity to do that is there. Now, let's take a bakery. Is there a world where I can make 500 times my money? Probably not. That's probably not what I'm in it for when I'm an investor. And so therefore, I can't afford a high chance of you going out of business because I'm not getting paid enough for the risk I'm taking.

14:01I don't have a way to make 500 times my money like I did in the case of Twitter. And so I can only justify high risk for high asymmetric upside return. So therefore, if I can't justify taking a lot of risk, how do I reduce risk? Well, one way we can reduce risk is we could be profitable. because if I'm profitable, now I'm in control of my destiny. Now I can pay back my investors. The other way that we can reduce risk is if we're not profitable now to get profitable sooner. And so those are really important factors here. One thing that I've seen work sometimes in these types of businesses is to have it be a combination of equity and a loan.

14:45So like, let's imagine I'm the bakery now. I say to the investor, I don't think you're going to make 500 times your money, but you never know. I may become the next big franchise bakery in this country. I might be the Sam Walton of bakeries. And if that happens, you deserve to benefit from the risk that you took. You deserve to profit alongside me as a shareholder, but that's not the most likely outcome. And so why don't we structured as a hybrid where you own some equity in the business, maybe not as much as a venture capitalist would, but you also have a loan that I pay back with a certain interest rate.

15:24And I may go out of business, but I'm less likely to because the covenants of the loan are, I've got to pay you back sooner and you have a claim on my profits. And so that way I can get paid for the risk that I take in two ways, right? I can get paid back on the loan and then I can also get paid on the upside if it does happen. So there are hybrid things that can happen that can work sometimes. A fundamental mental shift that you're proposing here, which I think is foreign to a lot of first-time entrepreneurs, particularly if they're not in the kind of arenas where they're going to be going out and normally raising money from venture capitalists, is what you're saying is this isn't about, I have a bakery, I need to get this bakery off the ground.

16:08I'm going around and asking people for money. This is, I have a bakery. I need to get this bakery off the ground. I need to go out and identify what the opportunity is in my business for the people who I am approaching. And then I need to understand the risk calculation that they're going to make in their heads. Even if they're unsophisticated, they may not be regular investors. It might be your mother-in-law, but natural human instinct is in some way or another, even if they don't use the language that you're using, Mike, is to start making a risk calculation. And so you have to anticipate that they're going to do that and then engage in that with them.

16:46Is that right? That's right. And you actually have to respect the fact that that's reasonable for them to believe, right? So a lot of people, they think they need to raise money because they want money. And, you know, duh, right? That's a pretty good reason to raise money. But the investor doesn't care about your desire for money. The investor cares about getting paid for the risks they take with their money. And so you have to respect their desire to get a return. It's not just about you getting the money so you can do your bakery, right? They need to get a return on that invested money because they have other ways they can invest it.

17:19Now, they may just love you for who you are as a person and not expect to make money. Congratulations. You have a benefactor, not an investor. It's nice to have benefactors. But if we're talking about investors and we're being honest about it, we need to respect the fact that they deserve a return, that they should expect one. And so when you're trying to get a return, I believe you can fundamentally be one of two things. You can either be growth first, which is what I invest in, or you can be profit first. And you can't be somewhat in between, you're one or the other. And what too many people do is they conflate the two, they cross the streams between the two, I can invest in a growth-first business because I can take the time to be patient for them to get profitable someday if they become a monopoly network effects, global, scalable company.

18:14But I have to, the growth-first investment has to be justified by getting paid for the risk that you take with a wildly asymmetric return on the back end. If you're not able to be that, then I would assert that you really want to be profit first because there is no business without customers and there is no business without profits. And ultimately, if you're not trying to be one of these scalable, massive worldwide companies, you need profits sooner than later. There's a huge cultural difference between any amount of profit and zero. Yeah. And in the case of a bakery, let's just take growth first and profit first and just turn it into some imaginary scenarios so people can visualize it.

18:58It's maybe the simplest way to do it would be it's the difference between a growth first bakery might be a bakery that pours all of its money into some form of marketing. It is just buying ads in every possible local outlet possible. It's standing on the street, handing out cupcakes, stew, whatever it can to just get as many people in the door as possible, even though because it's spending all this money on marketing, it's not actually profiting very much, if at all. Whereas a profit-first business would be different. It would be thinking about maybe slower but more sustainable growth. It would be figuring out how to increase the return on each customer so that you're not spending a whole bunch of money just trying to find tons of new customers.

19:41Am I right about that? And I'm even a little bit more primal than that. Right. Like I'm like profit first means my first customer should be profitable. So like, who's my first customer? Like before I get 10 customers, I should get my first one. And what do I really need to get one customer? Do I need a bakery or can I bake this stuff in the kitchen in my house? Right. Or can I go to a school cafeteria in the off hours and rent the school cafeteria? Period. So if you say, okay, there is no business without customers and there is no profit without profitable customers. So how do I get one profitable customer?

20:19And then once I get one, how do I get 10? And then how do I get a hundred? And you start to say, okay, as I scale my number of profitable customers, then I can start to, but like, I don't need to run Facebook ads to get one profitable customer. I only need to find one person who believes, and I probably don't even need to run Facebook ads to get 10. And so I might not even need two to get a hundred. And so like what I, the way I look at profit first is you say it literally has to be profit first. I have to, a good business is the accumulation of profitable customers over time. And so I might as well get started and get the first one.

20:57And then once I get one, I try to get 10, then I try to get 100. And I layer on the business structure to enable that. I escalate my commitments as I increase my certainty, but I don't increase my commitments until I know that I have one customer. I know that I have 10 customers. Why would I ever talk to investors before I know that? And so that's kind of what I'd recommend here. And that's pretty similar to how I look at the world in my neighborhood, but it's too many people, I call it playing house. They want the trappings of running a business. They want to have a location and they want to have the stuff that's in the location and they want to have the ability to run ads and they want to have a logo and they want to have like all the stuff that has nothing to do with profits yet.

21:48And to me, that stuff supports the profits, not the other way around. Just like revenue is not the thing you need to cover your expenses. Expenses are the thing that you should get more of to cover more profits. Right. And so you don't want to inverse the order of what matters, what comes first. That's a really wonderful perspective, because I bet that if you walked over to someone who aspires to open a bakery and you said, what is a bakery business look like? They would describe a bakery that you walk into. They describe the storefront and the glass case. But if I walk over to you and I say, what does a profitable bakery business look like?

22:31Your answer is it has customers and they're profitable. If that's the foundation, then you can put all the other stuff to the side and start with the foundation and build from there. Yeah, that's right. So I like to say that all new businesses are like a movement. And the entrepreneur has an idea about the future. Even if you're being a bakery, if you're being a good business person, there ought to be something different about what you're baking or what you're offering, regardless of what business you're in. Right. And so like the five hour energy drink doesn't have any technology in it. It's smaller than a can of Coke by a wide margin.

23:07It costs more than a can of Coke. So there are lots of ways to start a business. But ultimately, it's a movement in the sense that you have a point of view about something that the world needs that it doesn't get right now. And now we need to convince other people to buy into our point of view. And so we convince people one person at a time to join our movement. So we move people to that different future of our design, one person at a time. And as the movement accumulates, it starts to accelerate. And now all of a sudden, you start to get lots of customers. They start talking to each other. It starts to be justified to run ads.

23:45It starts to, what it takes to get the marginal customer starts to change. And the number of marginal customers you can start to get starts to change. But I like to say it's a movement. It's a movement in the sense that you move the first person and then you move the next to the next to the next. And it's the act of moving people to your point of view about what a bakery should be or whatever your business is. That is what building a business really is in my view. How would you coach someone who wants to open a bakery on how to articulate the movement that the bakery represents? So I like to say, and this might be controversial for some of your listeners, I like to say, fundamentally, you got to decide if you're going to be better or different.

24:27So I'm going to answer it through the lens of we're trying to be different, not better. So I like to say we want to force a choice and not a comparison. So if everybody in the world is selling apples, I want to be the first guy selling bananas. And I want to say, look, you may not value the advantage of bananas, but if you do, I'm the only person who has them. And so as an entrepreneur, you want to be in a situation where you can say, there's something that I and only I can deliver. And I don't need to spend any time with people who don't care about my advantage. If all you want is apples, I'm wasting my time talking to you.

25:05I need to spend all of my time, 100 % my ergs of energy, finding people who value the advantage of bananas. And I need to get all of those people to join my movement. So I think that most people think about the steps that they're undertaking to create the thing they're creating, but they don't always think enough about how do I show up in the world in such a way that I'm radically different, right? So, like, let's look at the Tesla Cybertruck. You may think it's ridiculous. I have no idea whether you like the Cybertruck, Jason, or not. For the record, I think it looks ridiculous. And I'm not I'm not even sure what I think about it.

25:45But like, here's one thing I can say. Nobody after seeing the Cybertruck says, how does that compare to a Ford F-150? And so so like what you want to do is avoid the comparison trap. Startups fail when they get compared with other things. You want to force a choice. Choose Cybertruck aesthetics or don't. Occupy the future with Elon Musk or don't. But like nobody's going to ever say, hmm, how does that compare to an F-150? When Lyft launched, nobody said, how does that compare to taxis? And so I really like businesses that try to avoid the comparison trap, because if you can be compared, you can be replaced.

26:25But if you can't be compared, you're irreplaceable and you want to be hard to compete against, right? You want to compete by avoiding competition altogether. other. And so the other advantage of being profit first and starting a movement is you attract the people who value your advantage and they co-create that future with you because they understand what you offer that the other people don't offer. They help you put a voice to that thing and then they go tell the world, they shout from the rooftops, this is awesome. This cyber truck is awesome. This bakery is awesome. This five-hour energy drink is awesome.