Brave Tech World

September 22, 2006

    There is this myth the more money you raise from investors, the better your chances to be successful with your Startup. That is a very dangerous thing from an entrepreneur standpoint because it is not true.

    First of all, for an investor (like a VC) to give $1M or $3M to company makes almost no difference. At the end of the day he is interested in getting $50M back or zero. Sure they would prefer to give $1M and get a 50x return, but since they have hundreds of million on their account, and they must invest that money, they can't find 500 companies to invest $1M in each.

    For a Startup, it makes all the difference between getting $1M and $3M, and the surprise is that $3M might be worse than getting just $1M.

    Entrepreneurs don't get that money for free. In almost all cases they have to sell a part of the company that goes from 20 to 50%. You don't have to be a genius to figure out that selling less is better for the Entrepreneur, and getting more is better for the VC.

    Let's suppose you get two offers (Term Sheets) on the table:

    Offer 1 is for 20% of your company for $1M.

    Offer 2 is for 40% of your company for $3M.

    Which one do you take? If you are smart you say Offer 2 because it gives you a better valuation of the company. If you are greed you take Offer 1 because you are giving less of the company. But both answers are wrong.

    What you want is to get enough cash in the bank to get you to the next step in the growth of your company, increase the intrinsic valuation of the company and then raise another round of investment at a higher valution.

    Next step in growth are usually based on customer-related milestones, like, develop the Beta version, or bring the product to market, or close a multi-million dollar sales deal to a large corporation. Once those milestones are reached, your company immediately becomes more valuable. People think that their company are increasing in value in a smooth progressive way, but it is not, it increases (or decreases) in value in leaps.

    The ideal moment to raise money is just after one of those leaps (or when you are about to run out of money ). Sure you can raise money to fund the Beta version of the product, but if you can release the Beta without any funding it will increase the stakes that you keep on the next round.

    Now, the point that I'm trying to make is that the ideal amount of money you want to raise is the minimum amount necessary to take you to the next milestone on your company and not a penny more.

    If you are in the tech business, you should know upfront that the schedule is always wrong and the product will be late. Said that, if you think you need $1M to survive 12 months until you can release the product, you should raise $1.5M to add a buffer in case the project doesn't ship on schedule (and it won't), but if you raise $3M, even on a better valuation, this is just poor management and you are giving away a piece of your company for much less than it will be worth in the future.

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