8 Questions to Help Decide if You Should be Raising Money Now

Posted on Feb 17, 2011 | 55 comments


A year ago I blogged about one of my most common mantras that applies to sales, biz dev & fund raising alike: “Time is the Enemy of all Deals.”

When times are really good for fund raising many teams delay to maximize their valuation. Sometimes this pays off, other times it doesn’t. So how should you decide what to do?

I thought I’d try to offer a framework for thinking about the topic.

There is a natural tension between wanting to have cash in the bank now versus believing that our businesses will be more valuable in the future and therefore wanting to wait.  This conversation seems to come up very frequently these days both with portfolio companies and with entrepreneurs just looking for mentorship.

This is not a black-and-white decision, but I have a bias toward two things: 1) taking action & 2) de-risking businesses. So here’s my framework.

1. Are you in the “lean” phase?
I’m a very big believer in the “Lean Startup” principles as espoused by Steve Blank and Eric Ries. For many businesses you should keep your costs low & your capital raises low until you discover whether you are really on to a big idea where there is market demand. When you see evidence that there is this so called “product / market fit” then you may be ready for larger amounts of capital.

In the seed phase startups are typically raising between $500k-$1m in today’s market. In some circumstances this is now stretching up to $2 million.

If you are able to raise money from credible sources at a reasonable dilution percentage then I personally favor getting the round done now and building your business. These are great times for raising money the moods in funding companies is cyclical and if you miss the window it may make the future more difficult. How long is the window open? Your guess is as good as mine. I only know that … time is the enemy of all deals.

2. How much capital do I need to run my business effectively right now?
Every conversation about fund raising should start with what your current operational needs are and the stage of your business. If you’re an experienced operator who sold his/her last business and you know a priori that you want to build a really big business – I understand the desire to start with $5-10 million in capital even before you’ve proven your concept.

But this isn’t the norm. For everybody else I think the conversation starts with how much you think you’ll need for an 18 month period of time. Because times are slightly better now for fund raising I’d probably say two extra things: a) it may be worth a modest increase in your team size / activities / development IF you can raise more money to do this now & b) if you can raise more than you need right now (within reason) without too much extra dilution I would do so.

As I wrote about previously, “when the hors d’oeuvres tray is passed, take two. Eat one, put one one in your pocket.” In other words, if optimizing around a $1 million fund raise or a $1.5 million I’d raise the larger amount but spend like you raised $1 million. I do not endorse raising $5 million for a business that doesn’t yet warrant it.

3. How much dilution am I going to have to take now?
Stating the obvious, but much of the discussion will come down to the dilution you will face and the other terms you’re offered in the fund raising agreement. I like to tell entrepreneurs that the “fairway” of fund raising is 25-33% per round. So if you can take 27% dilution for $1.5 million and you’re an early stage business this is probably a fair deal.

If you’re “super hot” or “super experienced” you can end up with much less dilution – in some cases 12-15%. But this is the exception, not the rule.

So to give you a concrete example: let’s say you’re considering whether to raise $3 million vs. $5 million.  You’re offered a $9 million pre-money to raise $3 million (e.g. 25% dilution). Let’s say you brought along other investors for $2 million more at the same terms (e.g. $5 million raised at a $9 million pre-money valuation or 35.7% dilution), I would personally probably avoid the extra money because as an entrepreneur the dilution would put me out of my confort zone.

However, if you could persuade investors that you had a pragmatic plan for the capital and could push the pre-money up slightly say to $11 million pre (31% dilution) or $12m pre (29% dilution) I personally would probably take the extra money. I might create a plan to spend $4 million over a 15-18 month time horozon and keep $1 million as a buffer.

How do you push valuation? Only … ONLY … if there’s a sense of competition on the deal. You need to keep investors honest by being willing to talk with multiple parties. Respectfully, of course.

4. How many more rounds of capital will I need & what is my expected total future dilution?
Another key factor in fund raising and thinking about your dilution is how many future rounds you think you’ll need to raise. I’m not talking about your Excel spreadsheets that show you that only $4 million will get you to profitability (ha!). I’m talking about understanding the norms in the industry of what it historically takes to build a successful Internet business and where you think you fall on that spectrum given the kind of business you are.

This would weigh into my decisioning criteria if I were raising money now. You know you’ll have more dilution in the future – how much?

5. What things could I do with capital today that might improve my market positioning?
I think many entrepreneurs under-estimate the benefit that capital early helps in being able to produce product and differentiate yourself in a nascent marketplace.  Again, this is highly individualized so no generic advice can be offered. If you’re too early in a market then no amount of early additional spend on R&D makes huge sense.

But if you’re on the precipice of a big market opportunity then having more capital & resources can be critical. I recent dealt with a company that was offered $4-5 million in funding and delayed its decision for nearly 5 months for a complex set of factors. What ended up happening was a critical project was delayed that cost the company some important business. They told me that they had regrets of having not raised the capital earlier.

The result?  By waiting they probably did push up the valuation on their ultimate round slightly because valuations have gone up steadily since last year – so that’s a positive. They missed out on some very important business – that’s a much bigger negative in my opinion. The fact that the market got stronger in this period was not a factor within their control – in other words – it was lucky. If the market had gotten softer their outcome might have differed greatly. They did raise the money so for them all is working out.

6. What things might competitors do if I don’t raise capital that might impact me in the interim period?
The other thing I ask entrepreneurs to consider is what will happen to competition in a market. It is true that you should mostly concern yourself with your customers, building a great product and providing excellent service. I tell entrepreneurs to mostly ignore the competition or at least not to overly obsess on them.

But I think it would be naive to completely ignore the market & competition. When competitors raise money and you don’t the following happens (assuming all else equal on product development, which I know is not always the case):

  • they have a PR advantage both in terms of perceived momentum and also money to spend on it
  • they have a hiring advantage, both in terms of perception they’re going somewhere and in terms of dollars to allocate to people
  • they make it incrementally harder to fund raise. It’s hard for many VCs to get excited about funding a company who is going to compete with somebody who just raised $10 million from an A-list VC (although this can go the other way, also)
  • they can develop a product advantage by building with 10 developers what you have 3 people dedicated towards
  • mostly importantly they can gain a customer advantage through all of the above. They get the PR bump. They hire a team that spends more time with more customers. They evolve the product faster. It becomes a reinforcing cycle.

As I said, don’t obsess with competition, but this should at least be a factor in your decision making on when to raise funds.

7. What might future markets hold in terms of valuations?
And of course there’s another biggie – uncertainty about future fund raising. Today’s $15 million pre-money valuation might be tomorrow’s $20 million. But more likely it will be $10 million. This is not a reflection of you – it’s a reflection of market conditions. The market is over-valued in 2011 relative to norms. We’ve all seen this movie before, we just don’t know when the film will end.

Anyone who meets with me privately these days gets this advice:

The market is whack right now. Use it to your advantage. Raise now. Make sure to raise at the “high end of normal” rather than “higher than normal.” In the latter situation you’ll run into problems later when you need to raise your next round – especially if you don’t grow into your valuation.

So if what I perceive as “normal” now is that at your stage of development you would raise $2 million at an $8-10 million pre-money valuation, maybe raise $4 million at a $12-13 million. Just don’t go crazy. That way you’ll be well-positioned when things return to normal. And things ALWAYS return to normal.

8. What might future markets hold in terms of ability to raise capital?
And finally, it’s worth noting, it’s not all about valuation. Fund raising can be black-and-white. When the spigot slows, the water is gone all at once. As anyone raising money in April 2000, September 2001 or September 2008 can tell you that. Sometimes the question of “to raise now or raise later” becomes an existential question. It doesn’t feel like that in February 2011. But it’s never possible to predict when the party will end and the barman will go home.

My strongest advice is this – do what you think is at the high end of fair, but don’t “over optimize” for the perfect deal. Time is the enemy of all deals.

  • http://twitter.com/positivelypasha np mi'

    Thanks for the heads up!!!

  • http://sisyph.us/ ErikSchwartz

    Lucky me, I tried to raise money in both April 2000 and September 2008.

    I could have held the patent on changing lead to gold and it would not have gotten funded.

  • http://twitter.com/douglasbaerlein Douglas Baerlein

    Mark

    Thanks for another great and helpful post. Was interested in this part especially:

    “How do you push valuation? Only … ONLY … if there’s a sense of competition on the deal. You need to keep investors honest by being willing to talk with multiple parties. Respectfully, of course.”

    Would be interested in how you would personally describe what generating “respectful” competition between investors looks like vs. doing it in a way that is less respectful.

    Is this something you've blogged about in the past? Wasn't able to ID it in a trip to the archives.

    Thanks again.

    Doug

  • Homer119

    I have never heard an argument (except in very peculiar cases) that spoke against raising capital with a good firm at a decent dilution.

    When you got it, take it.

  • http://twitter.com/michaelyap Michael Yap

    Nice piece as always Mark. There's one thing I've been meaning to ask tho. You've repeated a number of times over the last few months about the “market being whacked”. Did you mean that investors now are more risk tolerant (i.e. more prepared to go for the longer shots, more prepared to invest in companies that don't fall under the normal portfolio or aren't a trend) or that investors are just more prepared to let the entrepreneur dictate the terms of the deal ?

    Essentially: As a business that isn't anywhere in a sexy space, doesn't fall under any of the current trends (mobile apps, social gaming, social networking, etc) but showing very good growth even in an early stage; does “the market is whacked” phenomenon apply to me ?

  • http://twitter.com/nomansland nomansland

    Above you said: “I’m not talking about your Excel spreadsheets that show you that only $4 million will get you to profitability (ha!).”

    Mark can you comment on the effect of being profitable on fundraising? I'm probably not your only reader who wonders about this. There are those occasional startups who get to profitable with less than $4M. Seems like you might have a lot of things to say about these situations.

  • http://twitter.com/derekjhopper Derek Hopper

    Thanks for sharing. I'm new, but passionate about the startup world. I'm not in a position to raise funds, but thoughts like yours are amazing to store in my mind. I'll keep these in mind when I'm in the position to raise funds.

  • Dgarrett

    A very good discussion. We are trying to raise capital to fund a startup that makes hardware products (and software) – not for the faint of heart. I have tons of experience and many successes but today's world (USA) doesn't really care. I'm working with a person in HK/PRC that has access to funds if you have any good idea –no really. Now, I want to keep our ideas here (talk to me if you want – they are substantial) but 6 months of competing with SAAS and other Internet products has me a bit shell shocked. Write me dgarrett@pivitec.com.

  • Dgarrett

    BTW . . . We just received some funding from a state of PA fund. I asked for $2m valuation and received $1.5. Maybe should have asked for more! Hey, but this fund will really help us. Ben Franklin Technicsl Partners of Northeast PA.

  • http://twitter.com/iCrowdApps Ted Kao

    Thanks Mark. Off to do a pitch later today so this is clearly important to us. I guess for the vast majority of entrepreneurs, I'll speak for myself only, we just want to be treated fairly in the process. Especially those of us new to fund raising. I'd love it if someone told me, no thanks. Its clear, direct, and doesn't beat around the bush. It annoys me a bit when I get the definitely interested and I'll follow-up for weeks and not hear anything back. Oh, and for the self funded crowd out there, we just want to get past the point of working ourselves into too much debt before we can gather the money either organically or via venture funding!

  • Dgarrett

    Guy Kawasaki's book, “Reality Check” is a good read about the “code” of these interactions. He talks – pretty bluntly – about the realities of what we face with VCs. Some good pointers.

  • Dgarrrett

    Every one is in a position to raise funds . . . You ,just need a little “startup help.” email me and I'll tell you what I know. Dgarrett@pivitec.com

  • http://twitter.com/tomasbecklin Tomas Becklin

    Timely as always! :)

  • http://bothsidesofthetable.com msuster

    Ha. Exactly. And funny how quickly it goes from sunshine to stormy weather.

  • http://bothsidesofthetable.com msuster

    First, you need to make sure you're actually meeting multiple investors. It's OK to talk subtly about having other meetings. When entrepreneurs over play this it is a turn off. The key is to be subtle. And there are many ways to use back channels to make sure others are aware that you're in the market and getting good attention.

  • http://bothsidesofthetable.com msuster

    I agree but you'd be surprised how often entrepreneurs delay fund raising in bull markets. When things are tough people grab the money.

  • Dgarrrett

    I don't see any way around expressing the financial structures of your company and your expected outcomes without using modern tools like spreadsheets. If you are really experienced, or have real experience on your team, the spreadsheets may help explain your opportunity and it's limitations. How you see the world and how well your team may respond to change is a critical skill. All forecast are wrong – it is of critical importance to realize this and cultivate the skills to see the variances early and construct actions that lead to potentially more favorable outcomes. Survival is the only option. Survival may lead to the glorious 10x your investors expect!

  • http://bothsidesofthetable.com msuster

    I believe that investors are paying prices that are too high relative to market norms and that this will not last. It happens every bull market. I believe we're in a bull market. That's what I meant.

  • http://twitter.com/iCrowdApps Ted Kao

    Cool. Thanks. I'm reading his Art of the Start right now as well. Good, practical advice. Will also check this out.

  • http://sisyph.us/ ErikSchwartz

    I resigned from Yahoo! in December 1999 to start a new company (Y! had become way to big and unwieldy). Seeded it with $250K myself, build a prototype in january 2000, showed it to some top tier VC's in February 2000, turned down some offers figuring we still had nearly $250K in the bank and we could get a much better valuation in june. VC's all said “OK, come see us when you're ready”.

    I called them up in the summer with a built product and a big and growing audience. No one was interested. They were all trying to keep what remained of their portfolios alive.

  • http://bothsidesofthetable.com msuster

    Great question. Let me say a few things:
    - if you can get to profitability – that's awesome! I've seen it happen for less than $4 million for sure.
    - I'm making the flippant remark because most VC-backed “growth” companies end up taking $10-20 million or more.
    - And every entrepreneur says “this is the last round I'll need” it almost never is.

    If you can get to profitability then life becomes much easier for you, which is awesome. Just remember that if you want to build a large, growth business (not everybody's ambition, nor should it be) there is a trade-off between growth & profits. Investors always reward growth. So there is no glory in being ramen profitable for 3 years in a row while you're competitors raised cash and are growing at 3x the rate.

  • http://bothsidesofthetable.com msuster

    Yeah, it certainly is difficult for hardware companies. I know we have some previous experience that makes us more reluctant to invest in hardware. Obviously there are still many great opportunities – but not for the feint of heart.

  • http://bothsidesofthetable.com msuster

    I agree with you, Ted. I talk about this all the time. I do tell entrepreneurs “no” all the time. I prefer to do that then to leave them hanging. I wish more VCs would do so.

  • Dgarrett

    Sometimes the timing is wrong – pre revenue vs post; mid level vs early stages. I understand that. I sure would be much better at coping if the “code” was in plain english. I was at a mjor event last week in NYC and met with a VC firm that was interested in companies a little farther along than us. He seemed really interested but I just don't know. I guess you just keep going forward and never stop believing in yourself.

  • Dgarrett

    Still, it would be good if we could actuallymake something in this country of world class. One of my efforts, Ensoniq, sold to Creative Labs in 1998 for $94m. We were producing 1m sound cards a month with lower costs and better quality than they could do in Malaca – so they bought us. Maybe Ford should be our inspiration.

  • petegrif

    Good advice.

    Marc, please correct me if I'm wrong, but the above dilution numbers don't take an option pool into account, do they?

  • http://bothsidesofthetable.com msuster

    No, they do not. Options are additional dilution.

  • http://www.Spidvid.com Jeremy Campbell

    Some articles suggest that investors are handing out money like it's Halloween candy right now, but for many entrepreneurs it's hard to even get investment meetings let alone actual term sheets. Seems like tons of investors want in a deal or none of them do. Is there any middle ground out there?

  • http://twitter.com/Joshen5252 JoshuaAnsellMcKinnon

    Good post. I have been soaking up as much as I can about raising money. Currently, one of my ventures in low tech company that we are boot strapping. We don't need lots of capital to make money. If we did raise money we could leap frog and gain tremendous market share. It is always a tough to decide to take on investors and give up equity.

  • gouravs

    Hey Mark
    I have a question, somewhat unrelated.
    If you stumble upon an Angel who gets interested, but you, as an entrepreneur, do not want to continue talking (for whatever reason), how do you get out of the situation?

    Have you ever had an experience like that?

  • gouravs

    Mark
    Thanks for another classic

    I just met a couple of angels from one of the angel groups in socal. They were talking about how there should be a 'minimum qualification' for raising money. I guess they were talking about things like proof of concept, traction, etc.

    In your opinion, do you think there is this 'minimum qualification' for a startup to look at raising money? idea, prototype, traction? esp, for the consumer web space.

  • http://twitter.com/nomansland nomansland

    DGarrett:
    To be clear, I'm describing startups with years of operating history. So the financial performance of the company lives in massive spreadsheets already. These aren't speculative models of the “some day we'll print more money than the Bernanke Fed” variety. They are rather of the “if I don't track every penny of anticipated cost and expected revenue, I'm going to have some slow-paying big account be 3 weeks late and stick us without cash for payroll.” I really do understand intimately that “Survival is the only option.” (In fact, I'm covered in the blood of all the former employees I sacrificed to the god of Live to Fight Another Day.)

  • http://twitter.com/nomansland nomansland

    Mark:

    I instinctively expect VCs will look for anything and everything they can use to discount an aspirant to funding. In our case, we turned the corner this year. We're ramen profitable but we're gaining more and more traction. We see a much bigger play than we could ever swing from gradually growing profits. So I'm finally planning on trying to raise venture. I just didn't want to do it until I didn't need it to survive.

    So I'm polishing our deck. And I just can't get past our TEAM slide. I know it's where we'll be dinged. I DON'T doubt my TEAM. All ours years together has filled each of us with memories of our own “attack ships on fire off the shoulder of Orion” and “c-beams glittering near the Tannhauser Gate.” All those moments that get lost in time when a VC glances through a deck in search of a TEAM member with a $100M exit. I don't have that. We have a self-pivoted business. One kept alive during its restructuring by loans from founders. We have very compelling clients. And finally we have the ability to say, “we make more money than we spend. Now can we have money to try to change everything in our space?”

    If a company like ours wants to go from ramen profitable to a venture-backed growth play, is their negotiating position dramatically better even with a young team? Our team would welcome some senior leadership and reinforcements. But I don't want it if it means profits (and ten years) don't materially alter our standing. Say it isn't so.

    Submitted respectfully (to whatever side of the table the sympathetic CEO sits on.)

    Best

  • http://www.digitalle.com digitalle

    @Mark. Great post Mark, there is very little such advice out there that you can access which is impartial. We are literally facing this challenge right now in that were a very small team with potentially a huge idea, ( for which we have just built a working prototype but which as a saas service has massive extensibility) so trying to work out a) how to value it and b) what kind of dilution is “fair” is a major question for us, BUT as you point out, not as important as getting the deal done.

    As a bigwig at HP once said, “the difference between a good idea and great idea is timing”…

    We'll be making some more announcements soon, so you are most welcome to follow us @digitallecom . Thanks once again, rupert Hurley, CEO, digitalle (UK)

  • Emilbb11

    This is a great point. Having read older posts and other blogs and opinions, this is a tough one. Most of the VCs expect you to have the TEAM as part of your entrepreneurial obligation. I look forward to reading Mark's response to your question.

    Personally, I think that in an environment that changes fast, where collaboration and ideas exchange is vital for both sides of the table, the VCs could consider playing a liaison role helping filling the TEAM gap by way of facilitation, and save an opportunity for the benefit of all.

  • JoeYevoli

    When raising money with competition in the market (which will almost always be the case), should you mention any fund raising your competitors have done? For example, “Company XYZ recently raised a $2M round. My company needs to raise at least $X in this round to be able to compete.”

  • Dave W Baldwin

    Like your website. I've been thinking about the “Oh there's so much money being given out hand over fist…” stuff. To me, if you figure in the law of averages, there are founders out there on their 3rd or 4th money hunt and they get it. Add in the Angels who go to parties and commit to things in the herd fashion (not knowing what it is) and you get a big sum that doesn't really show things as they are.

    So don't become fazed by all that since it can lead to taking investment from someone you regret and/or dilution matters. Looks to me like you have a product that is forward thinking and when you hit market big time is a matter of time.

    Just my 2 cents.

  • Dave W Baldwin

    For me in '08, I had the old friend from college days who was conviently MIA when he knew it was time to write the check…then would leave a message. I sent him a polite 30 day notice in latter August where I'd start expanding my money search….interesting 30 days.

    Then he calls me in October to describe all the crazy shit that was going on in the world of guessing if you would have available funds to borrow short for payroll and all that.

    I've talked him through some stuff since then, knowing (at that point in 10-08) his company had peaked and was on the downhill.

  • http://hdemott.wordpress.com Harry DeMott

    I'm digging the Blade Runner quotes. “Painful to live in fear, isn't it?” sounds like you are afraid of speaking with VC's because of your teams lack of $100M exits. Don't be. Having them is nice – but everyone who had one started without. It is no guarantee of success – and your teams lack of exits is no guarantee of your failure. If the business works, the team is great, and everything can scale – then get out there and raise your capital while everything is “whack”

  • http://hdemott.wordpress.com Harry DeMott

    Dude, if you can answer all 8 of those questions above, you're not a founder – your a damn psychic.

    How about keeping it simple:

    1. Do you have enough money in the bank to last for ______ months (pick your time period but I would say 18-24 months assuming a fairly bleak scenario – i.e. no revenue). If yes – go to #2 – if no go to #4.
    2. Does this change at all if you all of a sudden become massively successful? (more servers, more ad salespeople etc…) If yes got to #3 if no get back to work.
    3. Could you really accelerate your business with more $. Go to #4
    4. Are the ducks quacking? If yes – cut the best deal you can with the best partners you can (and here I don't just mean a brand named VC for signaling purposes – I mean the best business partner you can find – someone who is going to bring a lot more than $ to the table) and get back to work.

    simple eh?

    Actually, I really do like the post – and think it is important to be able to think through all the scenarios – it's like a hand of poker- you need to know what you have, and what you can infer about what everybody else has – and then understand what it takes to get to the end of the game – how much more $ – how many rounds – what are your pot odds at any given time – what are the real odds when looking a few rounds down the line etc….

    Very important thought processes.

    All that said, taking too much money can dilute returns to stakeholders for sure – but this is a 20/20 hindsight problem. All the talk about dilution and what is an acceptable level already assumes a successful outcome. Given the odds of this happening – I think I would err on the side of taking the money. maybe the market evolves to a point where it looks like the HY market – where there is some sort of 35% clawback mechanism for future equity raises – so if you overfund – you can get some of it back once successful assuming you give the investors some form of return.

  • philsugar

    Keeping with both sides of the table, there is even less glory if you raise money and don't grow any faster than the ramen profitable company. When you finish going through your funds: you have a screwed up cap table with no chance to profit from an exit, pissed off investors, and the need to cut all those expensive people you hired.

  • http://twitter.com/wfjackson3 Willis F Jackson III

    This seems like great advice, but you can only do what you can do. If you don't get to the point where you can raise before the thing goes to hell, then you will have to figure out a different way to make it through hell.

  • http://www.enterthegroup.com Sal Pellettieri

    Great points. I have a free site which is low cost for me to maintain and continue building, but which doesn't bring in any revenues yet because there's no advertising. I'm trying to build a user-base before I look for investors. In the meantime money is going out but nothing is coming in, is this good strategy?

  • http://twitter.com/addoway Addoway.com

    Thank you for the informative post Mark. Comes at the right time as Addoway is opening up their first round here in March.

  • http://www.aaronklein.com/ Aaron Klein

    Great story.

  • Dgarrett

    Very good. Sorry about the blood and guts part of survival . . . I didn't think of start ups with years of history. Best and good luck.

  • Andrew Beinbrink

    Mark,
    The timing of your article is ideal for where I'm at with my startup. Thanks for sharing! I like that you made it clear what the impact is on the business to raise or not to raise money and that TIME makes a significant impact!

  • http://www.victusspiritus.com/ Mark Essel

    Thanks Erik, sobering to hear the reality of market timing throwing a monkey wrench into the gears. How'd everything work out for your startups in 2000 & 2008?

  • http://www.facebook.com/jnathanevans Nathan Evans

    Great article, thanks!

  • http://sisyph.us/ ErikSchwartz

    In 2000 we limped along until the end of the year and sold the core tech (there were no outside investors, I basically broke even, which was better than the rest of my portfolio did in 2000).

    In 2008 we raised an inside bridge round, but the market was changing at the same time. The last thing you want to do is try to pivot on a bridge. It was insufficient to make the changes we needed to make given the market shifts. I'll give more details via email if you like.