How a product is born. Part 3: Other people's money

In the previous parts, we covered the idea, the MVP and product-market fit. Suppose you have reached PMF. The product works, people use it and the business is growing. The next question is how to fund that growth.

First, understand operating income

Before talking about investment, we need to distinguish a few concepts that often get confused.

Operating profit is the result of a company's core activities after operating expenses. Revenue measures sales before those expenses are deducted. In this article, references to operating income mean a positive operating result.

Payback is the time it takes to recover the money invested in the business.

Suppose you invested 100 rubles in a project. It generates 5 rubles a month and costs 4 rubles to run. There is a positive operating result, but recovering your initial investment is still a long way off. At this stage, founders often reinvest even that small surplus in development.

In my experience, roughly three out of ten early projects have a positive operating result. The rest have yet to reach that point or are growing using outside capital. Many generate revenue, but it may be insufficient to capture their market at the required pace.

Broadly, a founder has three choices: grow using the business's profits, borrow, or raise outside capital.

The first path: use your own resources. Bootstrapping

Bootstrapping means building a business using the founders' resources and its own revenue, without outside equity capital. Profits are reinvested in the company. The owner often takes a small salary, sometimes lower than employees earn, because everything else goes into development. For better or worse, I know this personally.

For retaining control and limiting obligations to outsiders, I find this the most dependable path. Investment relationships bring extra pressure, expectations and sometimes conflict. Bootstrapping removes pressure from outside investors, although you may feel you are developing too slowly.

If the company has stable operating income and healthy profitability, borrowing on reasonable terms can be an additional way to fund growth.

At that point, investment offers may start finding you. I would still look carefully at borrowing as an alternative.

The second path for a young project: friends, family and fools

This is the familiar three Fs: friends, family and fools. These are often the people willing to back a project at its earliest stage, when there is no product, PMF or clear financial model. There is an idea and the desire to pursue it.

“Fool” describes someone who believed in you at a point when doing so required intuition or a willingness to risk money with little to calculate. To you, that person is a hero. An outside observer may see it differently.

The amounts are often small and depend on what your supporters can afford. A serious qualification follows: money invested in a first business is often lost. If you have no entrepreneurial experience, I consider that risk very high. This is my personal assessment, without claiming a universal statistic.

This path suits people with a strong belief in the project and a willingness to accept the risk.

Please explain those risks and the problems ahead honestly to anyone backing you through the three Fs.

The third path: grants and accelerators

These two tools are often confused, although they serve different purposes.

At an early stage, accelerators often provide knowledge and a useful environment first. Whether they also invest depends on the program. They help you test a hypothesis, enter a market and understand your customer. At the idea or first-MVP stage, that can help. If you already earn revenue and understand the market, their advice may be too general.

Choose an accelerator for its relevance to your business. Look for specific knowledge that fits the kind of company you are building. A promise to introduce you to investors may come with a long road to travel first.

Grants provide funding for specified purposes, with conditions attached. Amounts, timing and requirements vary considerably across government, corporate and international programs. Check the current terms of the particular competition. Blockchain projects, for example, can receive ecosystem grants for integrations.

Grants have to be spent on the agreed activities. Government programs have their own application, spending and reporting rules. If you are unsure you can use the money as required, think carefully before accepting it. Misuse can have serious consequences.

A separate category includes support regimes and innovation-project participant statuses, such as Skolkovo. Their value can include tax benefits and infrastructure. Eligibility and the actual saving depend on current program conditions and the company's status. My expectations of its startup ecosystem and investment activity are higher than what I have seen in practice. Even so, a suitable project should examine the support available.

The fourth path: angel investment

An angel is a private investor who places particular weight on the founder and their ability to work at an early stage. They assess you alongside the market and product. Several pivots on the way to a profitable model may be perfectly acceptable.

An angel's check depends on the market, stage, project's position and investor's resources. Figures from other people's stories can help you orient yourself. There is no fixed ceiling that applies to every angel round.

Angel investing carries substantial risk. These investors often enter early, when the chance of failure is high. They seek a multiple of their investment from successful companies because part of the portfolio may fail.

Finding an angel can be difficult. They receive many approaches and can be hard to reach. Approach them when you have at least a few concrete results: metrics, outcomes, first sales and a systematic way of working. Show the process and what you are doing now.

Suppose you manage to reach such an investor and meet them. If your entire pitch is, “I invented the next Facebook, Instagram or Telegram,” believe me, it sounds poor.

The fifth path: venture capital

There is plenty of mythology around venture funds. Reality is more straightforward and demanding.

Venture investment involves a high-risk ownership stake in a company. In an equity deal, the investor receives an interest in its capital. This differs fundamentally from lending. If an offer includes collateral or fixed payments, examine the debt obligations in the proposed structure separately.

The venture investor expects to earn through growth in the value of their stake and an eventual exit. One option is to sell it to a later, larger investor. Funding rounds and stage definitions help funds focus on companies of a particular size and maturity.

A simplified sequence looks like this:

• Pre-seed: an early stage with a technology or product, but few users or limited growth. Funding helps develop the project into a working business.
• Seed: the company develops its product, tests demand and demonstrates initial results. Profitability or sustained PMF may already exist, but neither is a universal requirement for every seed round.
• Series A: a move toward more systematic growth and scaling. Round size depends on the company and market.
• Series B, C and beyond: further development and scaling. Valuations can rise or fall.
• IPO: a company becomes publicly traded.

An investor entering at pre-seed can help the project reach later stages. They may eventually sell part or all of their stake to another investor. They may also remain through subsequent rounds: a new round hardly requires an early investor to exit.

Approach venture funds when you understand how additional capital will translate into growth. Each fund has its preferred stage and check size. Part of that threshold reflects the cost of managing investments: a small deal can be uneconomic for a particular fund.

Traction: building a relationship with an investor

Traction is one of the most underestimated arguments in fundraising: evidence of results and progress. Regular updates help demonstrate it before you raise money. You write to people who may never invest, encounter skepticism and occasionally arrogance. Sending reports looks easy only from the outside.

The process is simple. An investor turns you down or says it is too early. You ask permission to send updates. A month or two later, you explain how many users you have, what changed, what failed and why. Then you send another update. The investor watches how you work, handle setbacks and maintain a consistent effort. That can take a year or longer.

By the end of that year, they have seen a year of real work. A beautiful presentation merely complements the history, assuming you were lucky enough to make it beautiful. That changes the level of trust. For a venture investor assessing the team's ability to execute, it can be decisive.

Legal instruments: documenting an investment

Everything in this section depends on the jurisdiction. Before entering an investment agreement, consult a lawyer who practices in the relevant country.

One instrument used internationally is the SAFE, or Simple Agreement for Future Equity, developed by Y Combinator. It provides for money invested now to convert into shares later under specified conditions. It has no interest, debt or fixed repayment maturity.

For a Russian company, the legal structure requires separate consideration. Relevant arrangements may include share transactions, capital increases, loans and other applicable instruments. A foreign SAFE template cannot simply be transplanted into another jurisdiction. The agreement's legal treatment and repayment obligations depend on its terms and the law that applies.

An article can give you only a general understanding of these questions. Speak to a lawyer who specializes in such transactions. Believe me, this is worth paying for, even when everyone gets along and the relationship rests on trust.

What to do after closing a round

Once you have the money, there are two broad scenarios.

In the first, you work, grow, use the capital carefully and decide as the business develops whether another round is needed.

The second is common among fast-growing software companies: you start preparing the next round immediately, aiming to scale faster than the current capital allows. Some early investors may exit during later transactions. An IPO is one possible subsequent stage.

In that cycle, you need to keep demonstrating growth. If it falls short, the company has no profits of its own and the next round fails to close, options may include a down round, raising money at a lower valuation, or selling part or all of the business. A strategic buyer may value your audience or technology even if you could not monetize it.

Investment feels wonderful while everything goes well. In the real world, failure is possible and many things unfold differently from the plan. Solving business problems under additional investor pressure introduces another level of difficulty.

Investment creates obligations

Investor money brings an obligation to deliver results. You need to spend it according to the agreed plan.

An investor will rarely be your ideological partner. Usually, they want a return and have limited tolerance for losses, absent growth or broken expectations. That is understandable. You need to recognize it before the first conflict.

Let me say it once more from personal experience: investment is difficult.

If “efficiency” in your company still looks better as a word than as a working practice, it is too early to raise.

End of the series

Four parts: idea, MVP, PMF and money to develop the project.

We have traveled from “what if it works?” to “where do I find the money to scale?” Along the way, we covered:

• Why an idea needs testing before development starts.
• Why an MVP tests a hypothesis and the market's response.
• Why registrations and inquiries have yet to become sales.
• What obligations arrive alongside an investor.

Business has no guarantees. Anyone promising otherwise is either selling fantasies or talking about things they do not understand. Understanding the mechanics helps you avoid the rakes already lying on the ground with labels and instructions attached.

Your humble servant, the author of this article, has stepped on plenty of them and will probably discover a few more.

If you found something useful here, good. If you disagreed with something, good too. There is something to think about.

Thank you for reading. Go build a product.