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Don't Marry the First Investor You Meet

How I learned the hard way that not all investors are angels.

We were high-fiving and hugging each other as if we had just won the Super Bowl. Our management finally found investors for our regional magazine company, and we were on our way to journalistic infamy. None of us thought that taking their offer was one of the biggest professional mistakes we'd ever make.

When a group of ex-journalists and I started two monthly magazine publications in Philadelphia 12 years ago, we were desperate for funds in a city lacking seasoned regional investors.

Magazines are expensive to produce and we were at a disadvantage next to publishing companies that leveraged advertisers from other publications they owned.

Banks were out of the question because we didn't have much to pledge in terms of significant personal assets.

So when a group of well-known business leaders agreed to put up only half of the $1 million we needed, we jumped on the offer without thinking twice. Beggars can't be choosers, right?

No Angels

The investor sugar daddies came from financially driven manufacturing, technology and collectibles businesses, which should have sounded alarms were it not for the cash carrot they were waving.

Unfamiliar with the publishing world, they didn't understand that it typically takes three to six months to even obtain commitments from initial advertisers. As a result, they assumed we had padded our expense numbers when we asked for $1 million.

Then came the second warning sign: Our investors -- more interested in publicity than publishing -- hosted community elites at advertiser cocktail parties and obtained media coverage for their friends and pet projects while we were running through our capital at about $100,000 a month.

About four months into the business, we were down to $200,000 and desperately needing the rest of the money we requested initially. But our investors would only put in enough to cover cost every two weeks and asked us to give up additional equity. Instead of dropping the investors, we pushed even harder for fear they would walk away.

Ticket Out

Finally, about a year and a half after we started, we found a way out of our venture. We managed to build the magazine enough to merge it with a successful publication that wanted to enter the Philadelphia market.

The investors, who owned a combination of stock and debt in the magazine, convinced the new stockholders to convert their holdings into stock in the new company. I left the magazine burned out and ready to take some time off.

Our publication went down permanently with the parent company two years later when the economy slowed down and advertisers stepped back.

What I Should Have Done

From a financial standpoint, none of the founders lost any money because we didn't put up any money. From a mental stand point, some of us swore off ever getting involved with a start-up again.

When you've got a business dream and no capital, the shadiest funding source looks tempting. But before you embrace investors without abandon, do what I should have done:

  • Run a credit check on your investors to make sure they are using their own money. If you use venture capital firms you can find out by simply asking them how much cash they have left in their fund.
  • Approach only investors that understand your industry.
  • Go to major companies in your industry for funding advice. I should have spoken to the mergers and acquisitions groups at national media companies like Time Warner (TWX) , Tribune Company (TRB) and Gannett (GCI) - Get Free Report to gauge their interest in investing in a company like mine or recommend potential investors.
  • Stick to your guns about the amount of money you need and insist investors sign personal guarantees that they will cover the full amount.

This year, I raised money for a financial service start-up by taking less money and giving up more equity just to get investors who understood the business. Lesson learned.

Marc Kramer, a serial entrepreneur, is the author of five books and is an instructor at the University of Pennsylvania's Wharton's Global Consulting Practicum, where he serves as Country Manager for Chile.