Recently I’ve been debating with a number of young startup companies that are raising money in the next few months, “what is the right about of capital to raise at a startup?”
It’s a tricky question with no clear answer. There are trade offs. And it obviously depends on the kind of business you’re building. Let me assume for this discussion it’s a garden variety 2010 IT or Internet business (as opposed to something requiring capital equipment or a life sciences project). Any answer will be subjective and any real answer will just be explaining the tradeoffs to you.
On the upper end I’ve spoken openly on many occasions that I think that raising too much money too quickly can be destructive. It’s like adding rocket fuel to space ship before you’re sure that it’s pointing in the right direction for take off (or even if all of the people on board are qualified to take this into outer space). It places undue pressure early in the company’s history to “do big things” when sometimes what is warranted is more prudence. It also takes options off the table if you eventually find out that this isn’t a VC backable business. I’ve spoken about this in a post entitled, “Do you even need VC?” to which the answer for most people is “no.” If you’re interested in that topic the link also has a short video I did on the topic for Fox Business News.
But the lower end also has risks. I’ve seen too many entrepreneurs try to do things on the cheap. I know the standard line, “I want to do a small round now and raise a larger round later when we get A,B,C deal done and I can raise at a higher valuation.” If it works you’re a hero. But there are also problems / risks:
– the funding environment might change dramatically – there may never be a next round (see: March 2000, September 11, 2001 and September 2008)
– you may hit unexpected bumps in the road yourself making the next round tough
– there may be major competitive changes in the market that makes your next funding round hard (e.g. Google suddenly makes your product category free)
– you might do a great job in a great market but a competitor raises $3 million when you raised $500,000 and suddenly you have to compete with them
I’ve even heard people repeat this bullsh*t Silicon Valley mantra about “failing fast” which is horse puckey. The line goes like this, “well at least you know early that your business isn’t going to work and you didn’t have to waste 2 years and $1 million trying to bang your head against a wall.” That is so self centered it winds me up. Tell that to the person who wrote you the $50,000 of their hard earned money and entrusted you to try your best. Fail fast? How does your brother-in-law feel about that?
And how do you think the next person who’s thinking about writing you a check going to feel about that sort of cavalier attitude with their money? Fail fast = quit and give up easy = spaghetti against the wall = no clear strategy going into your business = no ability / willingness to try and pivot as market conditions change = easy way out = today’s management mantra that will be laughed at in 10 years. Who started this meme? I say define a strategy, test it up front and pivot if you’re not getting the traction you had expected. Fail fast on your own dime.
Whoops. Off topic. But seriously, if you take somebody’s hard earned money treat it and them with the respect they deserve.
So, let’s say you’ve raised $200,000 in friends and family money and you’re thinking about raising a round of $1 million and investors offer you $2 million. Should you take it? Let’s assume that the $2 million buys 25% of your company, which is the norm in an equity financing.
– obviously the starting point is to ask yourself how much money you’ll need until the next milestone. It’s best if you can raise at minimum 12 months’ cash and even better 18 months’ cash. 24 months for most tech startups is usually too much money.
– add a buffer. Your revenue will take longer to ramp then you think. There will be some unforeseen expenditures.
– that is the correct amount to raise. It should pop out of your business plan
– and don’t ask for an extra $3 million to do M&A. No good investor wants that. They can fund a deal if necessary and valid at the time you present an acquisition target to them
So let’s assume that in the above scenario $1 million gets you 15 months and $2 million gets you 2 years. What to do?
This is actually something I’ve debated a lot recently. I was at breakfast with my friend Dave Young (from DLA Piper) this morning and we debated the topic. He had the best response I’ve ever heard. He said,
“When someone’s passing the hors d’oeuvres tray you always take two”
Brilliant. I think that if you’re offered fair terms that aren’t destructively dilutive, preserve options for an exit, don’t put undue pressure on your company to do things too quickly you TAKE THE MONEY. I know you think you’re going to do a bigger round later at a higher price but the problem is that if someone offers you $2 million now it’s guaranteed. That same extra $1 million might prove very difficult to get one year from now if something fundamentally changes in the market, your company isn’t getting traction as quickly as expected or your competition makes a lot of noise in the market. Or even your investors start having their own liquidity problems!
So I came up with the corollary,
“When someone’s passing you the hors d’oeuvres tray always take two. But don’t take the whole tray.”
The whole tray is obviously unhealthy. Look, these things are judgment calls and there are no mathematical answers. Just remember that for many companies success or failure often ends up being a binary outcome. Businesses usually fail for the exact same reason – they run out of money. Don’t let that be you. If the appetizers are in front of you, take two.
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