Avoid Excessive Dilution

May 28th, 2013 / Comments Off on Avoid Excessive Dilution

wsja_with_link_single-logoEntrepreneurs are always focused on raising money, but that doesn’t mean they should always be set on accepting money. There are several valid reasons for turning down funding. Here are the top three:

You should not accept money if you don’t need it. If you are doing well and have what you need to get where you are going, by all means, do not take outside money. Raising money later is better as long as you have enough cash. It’s always better to fundraise in a position of strength. Raising money is like accessing credit — if you are a good company, a lot of people want in and want to give you money, and you can be very selective. If you raise money too early, you have fewer options. So, how much do you need? We recommend 12 to 18 months runway (the longer the runway, the better).

Don’t accept onerous terms with too much dilution, or terms that give the company too low of a valuation. Generally, entrepreneurs want to maintain control and as such, are concerned about dilution. Investors are looking for a fair deal, and don’t want to overpay. So goes this complicated dance. Typically, we see seed-stage companies give away between 20% and 30% of their company for the initial round of funding. Thus, if your plan suggests a need for $1 million in funding for 18 month runway, a pre-money valuation of around plus-or-minus $4 million would yield about 20% dilution — this is right in the sweet spot.

Don’t do a deal with people who will not take you to the Promised Land. As important as it is to raise money, it’s more important to get the right people at your table. Picking the people who will help you and not hinder you is more valuable than maxing out the dollar amount. The right advisers and board members will be helpful in the good times and the bad, and supportive of you as the founding CEO. Finding that is imperative. Also check the firm’s reputation for transitioning board members. You may really like who is assigned to you in the beginning, but that person may not be who you end up with for the long term.

Now, how should you turn down money? Follow these steps:

Always treat people the way you would like someone to treat you. In general, that means with respect and dignity.

Leave the door slightly ajar. Let them know when you might expect to be fund raising again and when would be a good time for them to check in.

Honesty is important, but don’t hate on anyone. If you’ve selected another investor, and you are asked why, provide the high level reasons for your selection. Don’t get weighed down in specific details.

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