Fri, Mar 15, 2013
Are you familiar with the “Funding Oxymoron”? No? You better should — your personal (financial) success could depend on it.
It goes like this: Common perception is to “raise as much money as you can”. After all it makes sense. The more money you have, the longer your runway is, the more you can do, the better it feels. And yet — it’s backwards. What you actually want to do is to raise as little money as you need at as high a valuation as possible.
Let me explain.
Say your snazzy little startup raises $1 million for 20% of the company (for the sake of the argument I will not go into the finer details of pre- and post-money valuations). That means your investor believes your company is worth $5 million. Sell your company for anything less than that and your investor won’t be happy as he loses money — at least on paper. Your investor will protect himself from such scenarios through liquidation preferences and the like. And as he’s more often than not in a better position to negotiate than you, he will make sure that his insurances are solid and you have none.
In this scenario the deck is already stacked against you. If someone comes along and offers you a sweet $4 million for your just hatched company you more often than not won’t make any solid money back (due to all the legalese which your investor put into the contract). You’re forced to sell for significantly more — which might not even be possible; leaving you in nowhere-land.
Now imagine you raised $10 million for 20%. Suddenly your company is valued at $50 million. At this level your investor will seek much higher exit values — remember that VC firms seek 10x returns on their invested capital. You just put yourself in the position to create a company which you have to sell for hundreds of millions of dollars. Good luck with that.
Are you seeing it?