May 16, 2017
When talking to people in the tech startup scene, there’s one number everyone seems to be obsessed about: the amount of money so and so raised in the recent round. Over the years, we’ve become so accustomed to equate that number to success. This is very dangerous.
The Downside of Fundraising
- Entrepreneurs tend to forget that raising money (an act of borrowing in most cases) also comes with immense baggages — more chefs in the kitchen, interest on that borrowed money, giving up long term upside (equity)… etc
- Unfortunately, persuading someone to give you money and executing on a vision are drastically different skills. One does not guarantee another. Raising money should be a desperate act due to necessity, not something that should be boasted, or glorified as an achievement.
Let’s talk about a few acceptable reasons to raise money:
- Survival: Obviously, entrepreneurs should seek outside capital if they are on the verge of becoming homeless. However, I become alarmed when entrepreneurs tell me that they need more than $2–3k a month to “survive.” I remember when I first interviewed at YC many years ago while getting paid a SF software engineer’s salary. I made the same mistake by telling partners that the two of us would need at least $5k a month. Needless to say, we did not get in. Lesson learned: there are plenty of ways to survive with a few hundred bucks a month; learn to be frugal and be shameless.
- Efficiency: Founders are busy. Raising money is hectic and requires a lot of time and effort. Sometimes, the tradeoff of not getting the best deal this round but raise a little extra money vs. spending a little less time worrying about next round is well worth it.
- Scale: Everyone knows this one. Your company is taking off, you need more money to hire/expand product/build up infrastructure.
- Anticipating market downtrend: Timing is critical in fundraising. Will elaborate on it later in the post (“when” section).
How much? Avoid over-raising
Raising the appropriate amount of capital is an art. One of the more dangerous things a founder can do is raising too much money. It may seem counter intuitive first. Here’s why:
- Dilution: Founders raise money in stages because they represent opportunities for the company value to increase. Hence, it is highly beneficial for the founder to raise as little money as possible per round.
- Short vs. long term benefits: For a company to raise in the future rounds, founders really want a healthy valuation for the current round — as close to the true value of the company as possible. By raising too much, the current round may very well become the last round ever raised… Unless the goal is to never raise again and just become profitable. Then I’m totally for it!
- More could mean less: When it comes to management, having more resources doesn’t necessarily mean accelerated productivity and output. Sometimes, it introduces optionality, which actually hinders decision making. In my experience, hungry entrepreneurs always make the best decisions.
- Illusion of grandiose: When people see a lot of extra zeros and commas in their bank accounts, they feel great about themselves. Sometimes, way too good. I’ve seen founders who raised a lot of money start spending aimlessly on “R&D” or office perks, aka “hiring strategy.”
When to raise?
This is arguably a even more important question than what amount to raise:
- When you are ready: This is an obvious point. You want to raise when you are ready: when you know your market, when you know your team, when you know your competition, when you know your potential VCs. Once you are ready, do it ASAP.
- Understand target funds: If you are raising from a VC, understanding the fund’s schedule/stage is critical. Each fund is obviously different, but the psychology behind VC investments remain similar: 1) If you are raising from a fund that has a recent infuse of capital (they recently raised), generally speaking, they are not in a rush. They are looking at everything, and they are most likely going to want to invest an equal amount in many opportunities. A good time to get in! 2) If you are raising from a fund that’s nearing the end of its cycle, there are two possibilities: The fund is doing well: VCs can afford to be more risky and a little careless. Or the fund is losing money: VCs will become more cautious and strict about diligence. Some even stop investing all together in order to conserve that dry powder for their portfolio companies.
- Understand macro trends: Tricky, but can be extremely important. Here’s a story: I know a founder who raised a substantial round towards the end of 2015. It seemed extremely unnecessay to me at the time; the terms weren’t the best, and I thought he had at least half a year of runway left. However, everything became clearer as the VC industry took a turn for the worse in 2016 (roughly 30% less investments in 2016). If he had started his fundraising in 2016, it’s 50/50 that the company may even exist today. Instead, he became profitable in 2016 and isn’t even thinking about fundraising in the short term. Score.
How to raise?
Just a few friendly tips:
- Always give a range: Giving a range demonstrates that you’ve thought it through. Always make sure the numbers make sense, with the floor being the absolute lowest amount you need and still keep the company afloat for 12–18 months. For example, if your range is $3–5 million, be prepared to illustrate your company’s growth in the cases of 3, or 4, or 5 separately. You should not simply have one projection.
- Important docs: Executive summary (in Word), deck (in Powerpoint), financial model (in Excel)
- Resource efficiency: Demonstrating that your business is not a linear company is often the key VCs look for in meetings.
- Understand VC’s thesis: Again, important to know who you are pitching. Make sure there’s no conflict of interest. Make sure there’s a startup/VC fit.
I’m not a lawyer and I do not provide legal, business or tax advice. The accuracy, completeness, adequacy or currency of the content is not warranted or guaranteed. This post is not a substitute for the advices or services of an attorney. I recommend you consult a lawyer or other appropriate professional if you want legal, business or tax advice.