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After more than two decades of being an entrepreneur, serving as a legal and strategic advisor to entrepreneurs and growing companies, and speaking and writing on entrepreneurial finance, I have found one recurrent theme running through all of these businesses: Capital is the lifeblood of a growing business In an environment where cash is king, no entrepreneur I have ever met or worked with seems to have enough of it. One irony is that the creativity entrepreneurs typically show in starting and building their businesses seems to fall apart when it comes to the business planning and capital-formation process. Most entrepreneurs start their search without really understanding the process and, to paraphrase the old country song, waste a lot of time and resources “lookin’ for love (money) in all the wrong places.”

Understanding the Natural Tension Between Investor and Entrepreneur

Virtually all capital-formation strategies (or, simply put, ways of raising money) revolve around balancing four critical factors: risk, reward, control and capital. You and your source of investment will each have your own ideas as to how these factors should be weighted and balanced. Once a meeting of the minds takes place on these key elements, you’ll be able to do the deal.

Risk. The venture investors want to mitigate its risk, which you can do with a strong management team, a well-written business plan and the leadership to execute the plan.

Reward. Each type of venture investor may want a different reward. Your objective is to preserve your right to a significant share of the growth in your company’s value as well as any subsequent proceeds from the sale or public offering of your business.

Control. It’s often said that the art of venture investing is “structuring the deal to have 20% of the equity with 80% of the control.” But control is an elusive goal that’s often overplayed by entrepreneurs. Venture investors have many tools to help them exercise control and mitigate risk, depending on philosophy and their lawyers’ creativity. Only you can dictate which levels and types of controls may be acceptable. Remember that higher-risk deals are likely to come with higher degrees of control.

Capital. Negotiations with the venture investor often focus on how much capital will be provided, when it will be provided, what types of securities will be purchased and at what valuation, what special rights will attach to the securities, and what mandatory returns will be built into the securities. You need to think about how much capital you really need, when you really need it, and whether there are any alternative ways of obtaining these resources.

Another way to look at how these four components must be balanced is to consider the natural tension between investors and entrepreneurs in arriving at a mutually acceptable deal structure.

There are certain key characteristics that all investors look for before committing their capital. Regardless of the economy or what industry may be in or out of favor at any given time, there are certain key components of a company that must be in place and demonstrated to the prospective source of capital in a clear and concise manner. These components include: a focused and realistic business plan (which is based on a viable, defensible business and revenue model); a strong and balanced management team that has an impressive individual and group track record; wide and deep targeted markets that are rich with customers who want and need (and can afford) the company’s products and services; and some sustainable competitive advantage, which can be supported by real barriers to entry, particularly those created by proprietary products or brands owned exclusively by the company.

Finally, there should be some sizzle to go with the steak, which may include excited and loyal customers and employees, favorable media coverage, nervous competitors who are genuinely concerned that you may be changing the industry, and a clearly defined exit strategy that allows your investors to be rewarded for taking the risks of investment within a reasonable period of time.

Understanding the Different Types of Investors

Most investors fall into at least one of three categories: emotional investors, who invest in you out of love or a relationship; strategic investors, who invest in the synergies offered by your business (based primarily on some non-financial objective, such as access to research and development, or a vendor-customer relationship—though financial return may still be a factor); and financial investors, whose primary or exclusive motivation is a return on capital and who invest in the financial rewards that your business plan (if properly executed) will produce. Your approach, plan and deal terms may vary depending on the type of investor you’re dealing with, so it’s important for you to understand the investor and its objectives well in advance. Then your goal is to meet those objectives without compromising the long-term best interests of your company and its current shareholders. Achieving that goal is challenging, but it can be easier than you might think if your team of advisers has extensive experience in meeting everyone’s objectives to get deals done properly and fairly. The more preparation, creativity and pragmatism your team shows, the more likely that the deal will get done on a timely and affordable basis and avoid the mistakes in Box B below.

Understanding the Different Sources of Capital

There are many different sources of capital—each with its own requirements and investment goals. They fall into two main categories: debt financing, which essentially means you borrow money and repay it with interest; and equity financing, where money is invested in your business in exchange for part ownership.

How Much Money Do You Really Need?

One mistake entrepreneurs often make in their search for capital is to raise too little or too much of it. They often lose credibility if, during a presentation to prospective investors, it becomes clear that they have misbudgeted or misjudged actual capital needs or have failed to explore ways to obtain the resources other than buying them. The problem of misbudgeting is problematic—if you ask for too little, the cost of capital will usually be much higher and the process more painful when you go back to the well. However, if you ask for too much (even though some experts say you can never have too much capital in an early-stage enterprise) you may turn off a prospective investor. Worse, you may cause greater dilution of your ownership that was really necessary.

One way investors protect against “overinvesting” is to invest capital in stages instead of in a lump sum. These stages (or “tranches”) are often tied to specific business-plan milestones or performance objectives, such as revenues and profits, attaining customers, recruiting team members and obtaining regulatory approvals. Breaking the investment into tranches protects the investors against capital mismanagement and waste, and protects you against premature dilution or loss of capital. You may be inclined to request that all the necessary capital be invested in a lump sum (to reduce the chances that future conditions will get in the way of receiving all the money you need), but bear in mind that there may be some real advantages in being patient and allowing for a staged investment.