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Eran Laniado is managing director of BMN!
Raising capital keeps many startup founders busy. They approach angel investors, seek VC funds, attend conferences (hoping to randomly meet financiers), and endlessly polish their investment decks, business plans, and executive summaries.
To novice entrepreneurs, this feels logical. “With no capital, how can I progress? Money can surely help develop the product and shorten the time to market, right? Besides, everybody says that raising capital is part of the startup foundation process …”
Well, raising capital is often necessary, and VCs and angel investors have crucial roles for many ventures. However, there are situations in which looking for investors may not be beneficial.
1. Waste of time and energy
Philp Masiello, founder of 800razors and other startups, argues that raising capital is difficult and time consuming. He’s right: Preparing investment presentations and business plans, responding to investor questions and requirements, and jumping through endless hoops are all time and energy-consuming activities.
Most startups have small, busy teams trying to build a product, develop customers, and search for the right business model – all at once. Time is a scarce resource that you shouldn’t waste.
Additionally, it takes time, usually several months, for investors’ money to arrive in a startup’s bank account. You will not find investors, persuade them that you are ‘the real deal’, answer their queries and agree on investment terms overnight. The time spent on these activities may constrain product and market development efforts during that period.
Some startups can use faster fundraising routes, such as crowdfunding websites like Kickstarter (Ouya’s raising of $8.5M is a great example).
2. No real need for big capital
Steve Blank defines “startup” as “an organization in search for a business model.” It is not a small version of a large company; it is a completely different entity that doesn’t yet know what its future customers really want and what the product’s design and revenue model will be.
Eric Ries built on Blank’s approach by developing the ‘Lean Startup’ methodology, which advocates launching lean and minimalist products. These should test customer needs and the extent to which the product meets them.
Therefore, founders may realize that they should not invest in a three-person prototype development team if a single freelancer could be enough to develop a very lean version. This, of course, may significantly impact the financing needs.
3. Budgeting for the wrong things
Founders must confirm that future expenditures and investments are indeed necessary. Product developers, technology licenses, access to distribution channels, marketing initiatives, and specific intellectual property investments are often “good uses” of the capital raised.
In contrast, professional investors frown on expenses such as premature scaling (e.g., huge office spaces and too many salespeople before a product exists) and six-digit salaries for founders.
Check yourselves: Does your budget include only important items? Does it also contain “nice to have” items, or worse, totally unnecessary expenditures?
After reassessing and updating your spreadsheet, check: Do I still need external investors at this moment?
4. Valuation concerns
Experienced entrepreneurs know that raising too much capital early on can negatively impact the venture and them personally. For example, founders seeking a $600,000 investment for a startup whose pre-money value is $400,000; the post-money valuation is $1M and the investors will own 60%, leaving insufficient equity for future investors, senior employees, and the founders themselves.
However, if the founders actually need and plan to use only $200,000 in the next 9 months, they may be better off raising this smaller amount and being diluted only by 33%, keeping more equity for future allocations with lesser dilutions (of course, as Chris Dixon points out, they should also not raise less capital than needed.)
This assumes better valuations in the future as a result of progress in developing the product, team and customer base. Dermot Berkery‘s book ‘Raising Venture Capital for the Serious Entrepreneur’ elaborates on these valuation concerns.
Realizing the importance of “just-in-time” capital raising allows founders to focus initially on bootstrapping, raising minimal amounts from family and friends, or allocating small quantities of stock options (instead of cash) to freelancers. These may be better alternatives for them than raising capital from professional investors.
Eran Laniado advises multinational firms and mentors entrepreneurs. He gained corporate experience as VP of Business Development & Strategy of a NYSE traded firm and as a member on boards of directors. He writes about strategy, business models, and innovation on his blog on bmnow.com and can be followed at @EranLan.