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Bill Clark is the CEO of Microventures, a securities broker/dealer that uses crowdfunding to allow investors to invest between $1,000 to $10,000 in startups online. You can follow him on twitter @austinbillc.
Many startups struggle with how much money they should raise. There are a lot of factors that you need to think of, and those factors vary depending on what you’re trying to launch.
If you are a biotech startup, you may need a lot more capital than, say, a mobile app startup. There are two schools of thought when it comes to raising money for a seed stage startup: Raise as little as possible to avoid early dilution, or raise as much as you can as soon as possible.
There is no one right answer, so let’s review both scenarios to see which may be a good fit for you.
Raising a Small Round
When you are just starting out, it might be best for your startup to raise a small amount capital to get your product out to market and prove your concept before you go looking for that large capital influx.
Raising a smaller round allows you to maintain majority ownership and control potential share dilution. This is crucial for an early stage startup because the company was founded on your idea and you want to be able to execute your vision without having to get approval from the board or group of shareholders.
Another benefit is that if and when you exit, the small amount of investment raised will yield a higher return to your investor pool based on the valuation of the company or idea.
As an example, let’s say you raise $150,000 on a $1 million post-money valuation and eventually sell your company for $10 million. Your investors would see a 10x return. If you had raised $1.5 million, you would have had to sell for $100 million for your investors to see the same return.
No matter how conservative you are with estimating the amount of initial capital needed, there can be unforeseen issues that may require more cash to manage. These could be as drastic as having to change direction based on market feedback or new competition. If you don’t plan up front to allot extra money for the unexpected, then you may not be able to ride out unexpected bumps down the road.
What happens when the money runs out and the initial investment did not even allow you to go to market and prove your concept? Investors being asked for additional funding may view your business plan as risky since there might be little to show from the first investment funds. It could put you in the difficult position of explaining what the initial monies funded. Investors want traction so they can see if the business has legs. It is important your first round can support a tangible result for potential future investors.
Currently, valuations of startups are high and it is a good time to get funding. But what the landscape looks like in 12 months is anyone’s guess. Valuations could be higher or alternatively the “bubble” could deflate and send investors running.
If you raise a small round you might be thinking more about where the next dollar will come from instead of focusing your time and energy getting your concept to market and building new features. Raising capital takes an exceptional amount of time through building sell presentations and meeting with potential investors. Doing this takes away from the time you can spend on your business.
Raising a Large Round
Depending upon your level of experience, the industry and market conditions where your concept will compete, and your confidence in the idea, you may decide to raise a larger round of capital with initial investors.
You’ll be able to launch quicker. More available cash flow might allow you the time to solidly build and execute your startup rather than having to launch a quicker, less robust concept just to get first to market.
Having the funding accessible to build and execute marketing plans or add headcount for expansion is much simpler than going through another capital round to raise the necessary funds to support the growth.
A large round should mean you have enough capital for a minimum of 12 months and potentially 24 months. This allows you to put the focus more on the business and less on your future cash flow or whether the market will be right for funding.
You have to be prepared if the market landscape changes while your startup is ramping. Having that accessible capital up front just might provide enough runway for you to adjust your plan to get it back on track.
Taking a lot of money will quickly grow your organization. The more people you have going in one direction will make it that much more difficult to change direction if the market demands it.
Remember, the more money you take the more equity you are giving up. The trade-off might be worth it, but you want to be careful not to dilute your ownership too much in the early stages, especially if there is a chance for future capital rounds which will further dilute share value.
If you raise a lot of initial cash, yet need more, the expectation for future investors is to have something tangible to show for it. Let’s say you raised $1.5 million in your first round and 18 months later you are looking for another round of $2 million. Even though you have a great idea, you have just a few investors and little traction. Next round investors may not find this attractive. With large initial investments, future investors want to see serious traction, exponential growth and a clear vision of profitability in a shorter amount of time.
Regardless of how much money you plan to raise, act like you don’t have it at all. Being conservative with the money you have to work with from your initial capital investment, whether it’s a little or a lot, will bode well when future investors come knocking.
Plan for the unexpected when it comes to deciding how much to raise in the initial round, but keep your monetary goal realistic and sized right for your idea and concept. Going too big may scare away potential investors or may lengthen the whole process of getting your startup off the ground and running. In the end, you know your business better than anyone and you should be able to determine the costs of making it successful.
>> For related resources, check out our Startup Investment Tips series.
Image courtesy of Flickr, sushi♥ina
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