5 Reasons Founders Should Ask For More Money Than They Need
You have the billion dollar idea. You have the IP and the dynamic team. You will disrupt an entire industry. Now it’s time to raise the capital from your investors. So how much should you ask for? Many of the entrepreneurs that I’ve met with tend to make the same mistake: They sit down, estimate all of their startup costs and ask for exactly that amount. This can be a huge mistake.
My advice to entrepreneurs raising capital is this:
Raise twice as much money as you think you will need.
Here are my five reasons why asking for twice as much as you think you need can save you the painful experience of having to come back to your investors and ask for more money.
1) Reaching your ‘pivot point’ will usually take twice as long and cost twice as much as initially expected.
For early-stage development companies that may not yet have a final product, it is easy to underestimate the length of the sales cycle and the challenges in product or strategy implementation. There always seems to be an unquantifiable hurdle that you can’t plan for. To address this, a company should take twice the capital it thinks it needs and be prepared to take twice as long as expected. The 2x time/money formula is a conservative estimation (in err towards safety) and the actual number may be a bit less (but it will probably be pretty close).
2) You cannot time economies or markets.
There are times when people are flush with cash and other times when the cash well is dry. Even if a company is being offered more cash than it thinks it needs, it should consider taking it. The dilution in the long run is not going to matter comparably. The reality is that if execution is not perfect, then the founders are going to get much more diluted down the road than had they taken the money at the start.
3) There is no set formula if you come back to the table.
A distressed company may not be able to find another investor to write a check at a higher valuation. If the founders have to return to the original investor base and did not execute on the business plan, it could be painful for them. Whether it is a 10%, 30%, or 50% haircut all depends on the situation. If your company is going to run out of cash in 30 days, it will be more painful than if your company is going to run out of cash in 4 or 5 months.
4) If you know you are going to fall short on your execution, you need to tell your partners immediately.
Having 8 months of runway and having a concerted raise is much better than being thirty days until lights out and turning to a desperation round. Unfortunately, the latter happens more because, again, people believe it only takes just a little bit more to get to a turning point. So a founder may believe that the flipping point will only be one more month and will squeeze down more and more but something will go inevitably go wrong and that one month will usually turn into two or three months. Whether an engineer quits, or there is an issue with the product and it needs a tweak, or there is an interfacing problem, there is always a problem and that problem will need time. (Remember the 2x time/money formula)
5) Investors get diluted too.
If a company runs out of cash and an investor wrote a decent sized check on the front end, then they are going to get diluted too. If the company has to take a difficult financing, it impacts all investors.
Knowing the right formula for calculating how much operating capital to ask for is a great way to map out your startups finances and scale quickly- and skip the painful experience of having to come back to your investors after their initial investment.
Have you followed this advice in the past? Did it work out well for you or not? Please share your comments in the section below, I’m curious to hear your experiences.
Madding King III