So you have your team all lined up, you’re incorporated, you have a working alpha and you’re preparing for Beta release to get some early customers and prove that your product works.
Now you’re thinking about getting some funding to take your startup to the next stage: to expand the developer team; pay the working co-founder a basic salary; market your idea and create buzz.
*What is the best strategy for fundraising?*
I’ve been getting conflicting advice on this. *I hear it’s easier to raise money for 1 year’s worth of operations.* But I’m also being told that *it is also a good idea to fundraise for up to 2 years of operations,* because a founder shouldn’t spend all his/her time raising money. This might give you more time to reach profitability, or get to some other potential exit, such as an acquisition by another company.
*Are VCs more likely to fund your project for 1 year or 2?* Do they prefer to give you money under the assumption that there will be no more fundraising rounds, meaning they are less likely to be diluted? I’ve heard horror stories about VCs pushing startups to get lot of money in a series A, in order to put off a Series B. This is so they can lead any subsequent rounds — at a lower valuation — which benefits the VCs. But does benefit a founder?
I would really like to understand and get some tips on how founders can lay out their funding strategy before going to a VC or an Angel.
7 thoughts on “Question of the Day: Should I fundraise for 1 budget-year, or 2?”
I know that some VCs are reading this site. I would love to hear what they think on the subject.
I would love to hear what VCs think about this as well.}
I believe the best strategy in fundraising amount is to raise the right amount of money to get you past the next major valuation inflection point (with some buffer), but enough to ensure you aren’t out raising money all the time. Raising funding is a time-consuming process- sapping management time from the process of actually building product and getting revenue. So you want to raise enough money to make sure you aren’t perpetually in fundraising mode. For a venture round, I think 1 year is a good minimum. For sources of capital that are easier to close a round from (ie- angel), then the time horizon could be shorter.
The maximum amount should be balanced by when you believe the next inflection point in your companies valuation is likely to be. This could be a major product milestone, a major market event, break even, a certain size customer base, etc. If for example, your company has not launched it’s product, but within 6 months will have launched and expect immediate uptake that you can demonstrate to prospective investors, then raising 2 years of capital will be unnecessarily diluting existing shareholders (founders/employees/previous investors). The valuation with a proven product in the market will be much higher than without one at all- so you are effectively giving away shares at too low a price when you raise money that will be used on the other side of that valuation change.
If however, you are building a complex product that won’t launch for 2 years, then you really want to raise more than 2 years of money or you may find yourself having to raise money again without much change to the valuation. That isn’t a good use of management time. Another thing to consider in the amount to raise is that another downside of raising too much money is the temptation to spend it on things that aren’t absolutely necessary.}
More conflicting advice (the summary of what I have heard):
Giving/taking money for a year makes most sense, since dilution doesn’t happen to fast to the company and since investors don’t need to take too much risk. Actually, it is more like 18 months, 12 to hit your milestone, and 6 to raise the next round of funding.
On the other side, I was told that you should plan to hit your next major milestone at the tightest possible budget where you can demonstrate without a doubt that your company is worth alot, and then 2x because unknown expenses happen, and finally add 6 months to raise the money.
And it seems that if you are going to VCs it might just make sense for you to raise as much as possible, because they have already determined the percentage they are going to take. Angels would be different though.}
What Andrew said- it all depends on the valuation. If you can get 2 years’ worth of run-time without giving away too much then go for it.
If the money’s going to cost a huge chunk of the company then maybe you’re better off taking less and trying to build the valuation.}
Thanks a lot for your advice.}
I think Marc Andreessen answers your question in one of his postings on his blog entitled “How much funding is too little? Too much?
Here’s the link: http://blog.pmarca.com/2007/07/the-pmarca-guid.html
Essentially, his view is that a startup’s life is divided into two parts: (1) Before Product/Market Fit – where a startup should ideally raise at least enough money to get to Product/Market Fit; and (2) After Product/Market Fit – where a startup should ideally raise at least enough money to fully exploit the opportunity in front of it, and then to get to profitability while still fully exploiting that opportunity.
I hope this helps. It’s definitely helped me regarding my view of how much I should raise.}