Smart vs Dumb Money: Is there an alternative?
When the time comes to raise money, many founders find themselves stumped.
Raising money is a job in itself, and it’s often hard to figure out which fundraising method is best for your company until you’re in the thick of it. Whether you’re taking on debt or working with investors, both methods can burden a company unnecessarily; especially when you want to be focusing on growth, product and your team instead!
In this article, we want to cover the difference between “smart” and “dumb” money — and a third possibility that we believe is better than both.
Smart vs dumb money
Smart money is usually described as taking money from investors, usually, business angels, who have experience building a company themselves, successfully exited, and are now trying to help founders do the same.
These angels usually have an influence on the operations and strategy of your company. If the business angel is good, then they will add a lot of value: they have the contacts, the experience and can guide you when things get tricky. Since they are invested in the company, they will care about its success and try to help you grow in the right direction.
However, there are downsides to business angels. Too much “smart money” can end up being harmful: if you have several business angels trying to help, you’ll end up spending more time debating strategies rather than making a decision. We all know that power dynamics change when more people are involved and that can harm your business.
Not only that, but if it turns out your “smart” money is more harmful than helpful, you won’t be able to fire them and get your money back. When ceding control of your business to someone else, there is always a much bigger risk since it’s a lot harder to gain that control back.
Dumb money is the opposite: investment that is really just growth capital without any real influence. These are usually corporate venture capital funds or venture capitalists who have been given money to invest and follow a systematic investment process. Investments are subject to conditions and are usually not long-term.
Dumb money is very useful in the appropriate context. For example, if you have a great leadership team, board of directors, and product-market fit, then dumb money is just what you need. The money works as extra resources to help you grow.
The difficult part of the smart vs dumb money debate is understanding which one your investor is. You often don’t know the value of an investor until you start working with them, which is why your best bet is often to assume everything is dumb money. The key is to always be aware of who you are letting into your company.
Although smart and dumb money might have different purposes, there is one thing they have in common: they both take your shares and want a return on their investment.
What if we had a new kind of “smart” money that didn’t require ceding control to others?
A new kind of smart money: revenue-based financing
There is a better kind of financing in town, and it’s called revenue-based financing.
What is it? With revenue-based financing, you raise money based on your revenue. There are various ways to approach this, but the one we want to focus on works for subscription-based companies — so SaaS companies. What if you could turn your recurring revenue customers into assets?
With revenue-based financing, also called non-dilutive financing, a lender can issue loans based on criteria that are more consistent with your business model: CAC and churn rate, to name a few. This allows you to leverage your recurring revenue into finance, while still keeping your shares. You then reimburse on a regular basis through a percentage of your revenue. Unlike debt, it doesn’t burden you as an additional, inflexible expense.
Where is the smart part? Well, first of all, you aren’t giving away control to other people — that’s smart. And also, instead of relying on business angels, you can instead hire external consultants.
Hiring an external consultant is often a smart decision: you get to pick from the entire world, rather than just a group of investors. The consultant also won’t own any shares, and so there won’t be any conflicting responsibility with his own venture firm or partners. They will bring specialised knowledge to a company, and you’ll always have the freedom to fire them.
When it comes to raising money as a founder, you’re often better off first finding the money, then finding the value. With revenue-based financing, you get to keep ownership of your company, raise money and then pick and choose who you take advice from.
So: smart or dumb money? Ideally, you want just money, and then the freedom to pick your advisors. That means staying away from financing that requires giving control or burdening your company too much with debt. Interested in revenue-based financing? Learn more about what we’re doing at Levenue.