Smart v/s Dumb Money: How do you differentiate
If you are raising money, you may encounter the phrases ‘smart’ and ‘dumb money’, as a way to describe different types of investors.
The first thing to keep in mind is that typically capital seems scarce. As an entrepreneur, you may not care who gives it to you, and you may want to take it where you can get it. So who cares.
Well not so quickly.
The difference between smart and dumb money is that smart money brings along the promise of help that is well worth it. On the other hand, dumb money carries along hidden harm.
There are ways to identify the dumb money and learn how to say, “No, but thank you for your generous offer.”
So how do you choose the right investor?
Bottom Line: Investors who want to invest money in your company should bring something other than money to the table. They need to know how best to help you grow and expand, so choose your investors the same way you choose your business partners. If money is your only parameter when choosing who you work with, you’re risking to get yourself in trouble. Some investors may want to be “silent partners”, but you’ll want to make a clear and documented agreement before you sign the papers. This will help you avoid any conflicts later when the business starts to grow.
How to Identify the Dumb Money
Review the questions below. If any answer to any of them is “Yes,” then there’s a chance you’re taking dumb money.
1. Is this investor’s lawyer a bureaucrat working by the book or a deal maker?
2. Is this his first time investing in a company that is trying to raise multiple rounds of funding?
3. Does he insist on adding a non-dilution clause in your operating agreement?
4. Is he asking for an equity stake that doesn’t correlate with the funds they’re giving you?
5. Does he insist on keeping CPAs and lawyers out of the investment discussion?
It is essential to find investors who add immediate value to your business and not just your bank account. This will set the tone for how you will continue to grow it and help establish a healthy investment culture.
How to Identify the Smart Money
Smart money brings to the table capabilities such as:
1. Coaching and mentorship (when needed).
2. Contacts and an established network in your industry to help you grow your company.
3. Contacts to other accredited financiers.
4. Challenging your assumptions and idea in a constructive manner.
5. Skill-sets that your company lacks – new media skills, financial management, operations, etc.
6. Invest the Right Money to Avoid Potential Harm
To sum up: The best smart investors give valuable help. The worst ones get into a power struggle with you. Both write deal terms to protect themselves over you. Dumb investors will often give you money on better terms, with less hassle. The onus shifts to you to keep on top of them and keep them both informed and engaged; if not you are headed for real trouble.
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