Do You Really Need That Much Money Now?
July 23, 2014 | By Kevin Vela
One critical decision for any early stage startup with and abundance of funding opportunities is how much money to take. I think a lot of entrepreneurs get wide eyed, and perhaps a greedy (in a misguided way), when money starts getting thrown their way. These days, this can easily happen if the startup is particularly interesting, disruptive, or even charming. But what typically doesn’t change are early stage valuations – so I usually advise my clients to take as little money as possible early on.
Caveat – the advice changes distinctly depending on the stage of the company – this is not one-size fits all. This post is targeted towards the guys past friends and family, but not quite to Series A.
Here’s an example. (assumptions – Company has raised a small friends and family round, and is post-MVP but pre-recurring revenue) ACME Startup has just been offered $500k at a $1M pre-money valuation. That $500k is going to cost ACME 33% of the company ($500k/$1.5M = 33%). $500k is a lot of money and can provide a relief from the restless nights and ramen, but does ACME really need $500k? Perhaps ACME has full team built out and a high monthly salary burn, or is hiring seasoned employees and soon will have that high burn, or is launching a huge marketing initiative, then $500k could be justified. But oftentimes, $500k is more than ACME needs.
Let’s assume that ACME really only needs $250k. At the same $1M valuation and $250k investment, ACME has now sold 20% of the company at a post-money valuation of $1.25M. If ACME can take that $250k and get to recurring revenue, or hit some other important milestones, it’s reasonable to think that ACME ‘s valuation can double in 6 months to $2.5M. Let’s say ACME now needs another $250k. At this point in the company life cycle, that $250k will only cost ACME 9%, which means that ACME gave up an aggregate of 29% of the company over these last two rounds, instead of 33%, to raise a total of $500k. If ACME’s valuation increased by even more prior to this round, then the cost in terms of equity is even less.
(Again, I know that this is oversimplifying the process, and every raise is different. But I do see scenarios similar to the one above on a regular basis).
Thus, when you get to a point that you’re ready for your first real round, there’s a good chance that the valuation won’t be as high as you had hoped. So try to take the bare minimum of what you need, and drive up that valuation up for your next round.
Posted in Funding & Capital Raising, Startups
Kevin Vela is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, mergers & acquisitions, corporate law, capital raises, and real estate investment activities. You can see Kevin’s attorney profile HERE.