One of the most basic decisions an entrepreneur has to make is whether to take outside capital.
When your company needs more money than you can raise by bootstrapping, this isn’t a tough decision. When you could bootstrap but want to move more quickly, then it is often a very tough decision.
For the purposes of this post, however, let’s assume you’ve decided to go ahead and raise outside money. When do you do it?
Here’s the short answer, which became crystal clear to me in the decade I worked on Wall Street:
Raise money when you can, not when you have to.
What does that mean?
It means raise money when conditions are such that investors or lenders are pitching you, rather than the other way around.
Raising money means selling a piece of your business (equity) or making a lender confident that you’ll be able to pay a loan back (debt). It’s much easier and smarter to do either in a seller’s market rather than a buyer’s market.
As with every other kind of market, capital markets go through cycles. At the peak of these cycles, such as 2007, so many investors are trying to put cash to work that money is cheap and terms are good. At the bottom of these cycles, meanwhile, such as last spring, cash is king and investors can dictate whatever terms they want.
Similarly, the attractiveness of companies as investments also goes through cycles. Nothing is more attractive to an investor than a company that doesn’t need money–because then the investor feels lucky and privileged to be invited in. Similarly, nothing is less attractive than a company that needs money desperately and is going hat in hand to anyone who will listen.
So, from the perspective of an entrepreneur, the best time to raise money is in a red-hot capital market when you don’t need it. In these periods, you should raise more money than you think you’ll ever need.
The worst time to raise money, meanwhile, is at the bottom of the cycle when you’re running low on cash. If you wait until then to start fund-raising, you have to give your whole company away to get any cash in the door.
Of course, when times are good, many entrepreneurs make a common mistake: They extrapolate the good times into the hereafter. In doing so, they base their outlook for future cash requirements on this happy scenario, instead of asking what would happen if, say, their revenue got cut in half. Thus, when the cycle turns, they get caught flat-footed…and they suddenly need money just to survive.
Raising money when you can instead of when you need to means avoiding this mistake.
Never assume that good times will continue forever–because they won’t. Instead, when everything is going smoothly, ask yourself how much cash you would need if the economy suddenly collapsed. And if someone is willing to give that money to you on reasonable terms, take it.
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