December 5, 2012
Startups go out of business for only one reason. That reason is – all together now, repeat after me – “because they run out of money.” And that raises the eternal question, “How much money do I need to raise?” You need more than you think. Raise as much as you can.
To understand how much you will require to execute your vision and get to a place where raising your next round of funding will be straightforward, you need a plan (or at least a cash flow budget). While the challenge of raising money to get your company off the ground is frustrating to be sure, it pales in comparison to the eternal anguish of raising money in distress after you’ve already started the business and are accountable to investors, customers, and employees. Building a business is hard enough, but if you’ve raised external capital, you also have to be able to (somewhat) predict what milestones you will hit by what date and how much it will cost to achieve those milestones. You need to anticipate your next raise beyond that and ensure you have sufficient runway to get there. It’s kind of like riding a unicycle while juggling pieces of broken glass.
First-time entrepreneurs obsess about the dilution caused by raising too much money too soon, whereas the advice from old hands almost always is “take as much as you can.” This is because no matter what you think will happen, it always takes longer and costs more to accomplish your goals. As my friend Steve Blank says, “No business plan survives first contact with a customer.” Imagine starting a football game saying, “On the third play of our sixth possession, we’re going to run a draw up the middle.” If you are a young company, particularly if you are pre-revenue, anticipating months or years in advance where you’ll be is farcical. Like a football game, you start with a game plan, but you must assess what is happening on the field and adjust accordingly.
On the one hand, you need to have a rational budget and predict what your milestones will be and when they will occur. On the other hand, the future is unknowable, especially if you’re still searching for a business model. So how do you manage these completely contradictory statements?
The stories of companies that failed by running out of money are legion. Have you ever heard of people who really hit it big but regretted selling too much equity too early? If so, please comment, because although I’m sure it has happened, I don’t know of any. And if they are out there, the risk is dwarfed by the possibility of running out of money.
The right amount is the amount necessary to get you to a place where you will be able to comfortably raise money at a valuation that’s at least 2x the post-money valuation of the prior round. That way, if you are diluting yourself by 25-40 percent per round, but the stock price has doubled, you’ll be gaining wealth even while your ownership percentage goes down. You need to be clear about the milestones, you need to think about how you’ll raise money again once you achieve those milestones, and you need to give yourself a margin of safety since chances are extremely high that it will take longer and cost more than you think to achieve the milestones. There are so many ways to screw up; if you’re fortunate enough to have raised money once, don’t shoot yourself in the foot by running out of money.
Unless you are certain that this is the last company you will start (does anyone ever say that?), then you should want your investors to make money. Dilution is an important issue, but don’t become preoccupied by it. Your life will be better off if you make money for your investors. It’s a blessing. Not only does it create good karma, it makes you infinitely more fundable the next time around. Fundraising is a critical success factor no matter how you look at it. Of course you always want to get the best deal you can. I’m just saying that, because startup life is so unpredictable, you will need more money than you think; and if you think money is expensive now, just wait until you are desperate for it.
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