Some people think we are in a bubble right now and there’s a lot of buzz around the record amounts of capital being raised by startups. The big numbers are impressive, but any smart founder knows there are risks in raising too much too quickly.
It’s likely that you will have to give away more of the company than you’d like to, for instance, or settle for terms that are onerous. Entrepreneurs want to maintain control — they’re naturally concerned about dilution. Investors are looking for a fair deal and don’t want to overpay. Typically, seed stage companies give away between 20% and 30% of their company for the initial round of funding.
Another risk is that you may end up with partners who are not ideal. As important as it is to get money to help you grow, it’s more important to get the right people to help you grow. Picking the people who will help you the most is more valuable than getting the maximum dollar. The right advisers will be helpful in the good times and bad, and they’ll support you as the founding CEO.
Additionally, you may not have the infrastructure or capability built yet to spend the money wisely. Don’t accept money you need for a rainy day. Take money you need now, money you know exactly how to channel and money you are certain will produce a return. (A couple no-brainer basics: have a product and some market traction before raising money.)
Statistics show us that most startups fail. But, at successful startups, customers increase, the product gets better and traction builds. If a startup is working, it’s growing consistently and every day the company should be worth more than it was the day before. (For the sake of simplicity, let’s remove market conditions from the equation.)The most important thing when it comes to raising money is not the number. The just right “Goldilocks” amount is when it’s enough money to make it worth it and with a team that will help you take it home.
If you subscribe to this most basic theory (the longer you build it well, the more value it has), it makes sense to hold off on raising a big round for as long as possible. The more you establish on your own “pre-money,” the higher the valuation you can get later and less ownership you have to give up.
Of course, this is always a delicate balancing act. Bootstrapping isn’t always good enough. An influx of cash allows you to hire more people, pay more attention on product development and invest in marketing. It allows you to move much faster (and speed is like air for startups: they won’t survive without it).
Therefore, the two imperative questions become:
Can you go as far as you need to on your own?
If you are doing well and have the cash you need to get where you are going, don’t take outside money. (How much is that? We say 12 to 18 months runway, and the longer the runway the better). It’s always better to fundraise in a position of strength. Remember, raising money is like accessing credit — if you are a good company, a lot of people want in and you can be very selective.
Can you get outside financing, and at what cost?
You have to ask: “Who gets the advantage — the founders or the investors?” Investors are exchanging cash to get a percentage ownership of a company because they are excited about your potential and your company’s future. Founders are selling a piece of the company, which is illiquid for a long time, in most cases. Exits take years and IPOs can take a decade or more. But if all goes right, there will be a payday. Both investors and founders must feel the deal is fair, otherwise it will never work.