It can be tempting for a startup founder to look for investors early on, especially in today’s market. Despite little revenue, companies such as Snapchat Inc. and Pinterest Inc. have grown into billion-dollar businesses over a few short years, thanks in part to cash infusions from venture-capital firms and other investors.
But what are the risks of giving up equity and bringing investors on board? How should founders decide when and how much capital they need?
On The Accelerators, a blog on the challenges and strategies for starting new businesses, experienced entrepreneurs and investors shared their tips on the right time to raise money. Edited excerpts:
Raising Money? Choose to be Humble
I encourage founders to ignore the hype and the ego stroking that comes with a big valuation and instead choose to be humble. There’s no need to raise more than you need—it’s dangerous to do so. If you raise ahead of your skis and your business can’t deliver, the fall is very painful. This is the scenario in which CEOs are fired. This is the scenario all founders must avoid.
There’s no free lunch anywhere, especially not in Silicon Valley. Investors generally exchange their capital for shares in the company—it’s a bet on the startup’s future. They therefore expect founders to create value today and every day after that. With more money invested, they believe more value can be created, which means the bar for delivering a return is raised higher than ever.
It’s crucial to raise the right amount. Obviously, you never want to be out of cash so that you are forced into a fire sale or expose a soft underbelly where someone can take advantage of your vulnerabilities. But don’t raise so much that you do stupid things, such as blowing money on fancy facilities, hiring a lot of salespeople when there’s no product or recruiting a team of engineers when you don’t know what the product is.
— Maynard Webb, founder of the Webb Investment Network and co-founder of Everwise, Los Gatos, Calif.
Do You Need the Capital?
It is true that today’s capital markets are flush with venture money, and it seems every day a new “unicorn” is born over the rainbow. You read in the news, story after story, of a wunderkind entrepreneur raising millions of dollars to transform this or disrupt that. But while fruit grows on trees, money doesn’t. It takes a lot of grit, sweat and hustle to get to the point where you have the option to raise capital. And as soon as you take on venture money, you run the risk of getting kicked out of your own garden. Once you bring on investors, it is no longer completely your company. If you are okay with the possibility of getting pushed out of your own startup and left on the sidelines, then proceed. Institutional investors invest in the company, not in you.
Additionally, ask yourself if you really need the money. Taking on capital is a big commitment. You should first figure out how big your market is, and what it will take to be the leader in the field. Sometimes, raising money causes more problems than solutions. You wouldn’t want to raise $10 million to go after a market that’s worth $1 million a year in revenue, for example. You’ll likely never reach a profitable outcome. Be conscious of what you’re raising money to accomplish, and make sure it jives.
— Richie Hecker, CEO of Traction + Scale, New York
Wait Until You’re Profitable
It’s easy to buy into the hype that securing funding should be a startup’s top priority. Many founders today look to raise capital right off the bat—as soon as they have a concept, a leadership team and a mock-up, they’re asking for investors. But when you first create a company, you won’t know exactly where the future will take you. If a startup has deep pockets at this stage, the founders will be tempted to spend the money in foolish ways. Instead of planning carefully for sustainable growth, they will throw spaghetti at the wall to see what sticks. So what if, instead, you waited until you are profitable to raise money?
Let’s say you show up to an investor’s door with an idea and nothing more, and ask for $250,000. What’s going to happen? Maybe you’ll get lucky and the investor won’t just laugh you off. If they do decide to accept your request, they’re going to set a very low valuation for your company and ask for a substantial amount of equity in return. After all, it’s just an idea—and good ideas are a dime a dozen.
But imagine that you go to an investor after turning a profit—after you have a proven idea. You’ve moved beyond prototype, you’ve done your marketing and you have paying customers. You’ve shown financial discipline in balancing costs with income to turn an actual profit. That’s something every investor wants to put money behind.
Seeking funding when you’re profitable may sound foolish, but it’s just the opposite. Not only will you be able to raise money at a higher valuation, but you’ll be able to give up less control in return for that cash.
About the Author:
Dr.Hisham M Safadi (Hisham Safadi ) BDS & MSc Leadership and Management in Health Care Practice form the University of Salford where his Master dissertation was in the effect of Emotional Intelligence on improving Dentistry care in Middle East. He was born and raised in the Emirates of Ras Al Khaimah, United Arab Emirates. Dr.Safadi had start his professional career as a dentist then turn to the field of managing medical facilities and investment management. His main interest is business start-up, leadership and mentoring. Currently he is leading several projects in Manchester that is related to enhance patient experience and improving leadership style through education.
- Patel, S. 2015. When Should Startups Set Out to Raise Money? I — Sujan Patel, vice president of marketing at When I Work, Minneapolis. WSJ. http://www.wsj.com/articles/when-should-startups-set-out-to-raise-money-1433373868, June 12, 2015.
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