After people's time, cash is the most important resource that a new venture has. In fact, in the book "The Lean Startup," Eric Ries asserts that "startups that succeed are those that iterate enough times before running out of resources."
But, how does one know when to raise money for your venture? What are reasonable terms to offer...or accept? What should you pay your founding team? When support organizations, like law firms and accountants, offer to extend credit to you, should you take it? Is your business even a VC-investable business?
Add your answers and personal anecdotes to these and many other FINANCE questions for entrepreneurs.
I’ve worked with hundreds of entrepreneurs during my career, many of whom were trying to raise money. I’ve observed that the wisest of these entrepreneurs understand the value of aligning with the most experienced and strategic investors possible—not worrying so much about dilution. These entrepreneurs understand that the most important factor is a large capital investment to ensure their company will have the funds to fuel their continuing growth. These entrepreneurs will also seek to leverage their investors to open doors to potential customers and strategic partners and to optimize the company’s business model. Often I see CEOs looking for “dumb” money which will pay a higher price for their investment but tend to not hold the CEO as accountable. I view this as a red flag about the insecurity of the entrepreneur who is more concerned about staying in control rather than the ultimate success of his/her company.
There are not many absolute guarantees in regards to starting companies. But one absolute is that it always takes longer to build your business and it will always take more money that you estimate you need! So plan accordingly.
How much should you raise? That's the magic question, for sure. But don't think about it in terms of how many people you'd like to hire, what size office you'd like to work in or how much you'd like to spend on marketing. Those are activities that surely will cost money but hopefully lead to some desired milestones accomplishments. And not just ordinary accomplishments but ones that provide evidence of increased viability (future success) and less risk (of crashing and burning). Which key accomplishments will allow you to argue for a higher valuation and favorable fundraising terms when you need to raise next? Those things likely relate to evidencing increased viability and decreased risk. Now you just need to figure out how many people you need and how much marketing you'll need to spend to accomplish (for example). One more thing. Don't forget to plan for surprises because things rarely play out like you expect.
I got my MBA from U.T. Austin in the late 90's when startup guru Jeff Sandefer was still teaching entrepreneurship classes there. I'll never forget his 3 rules of cash:
1) More cash is better than less cash
2) Cash sooner is better than cash later
3) And most importantly - Never run out of cash
Most startups go through tough times associated with their cash on hand - oscillating between the fear of running out and the greed of too much dilution. And when you have the opportunity to add a significant amount of funding, you really need to take a step back and plan on what expenses are truly aligned with moving your business towards a place where you don't need to incur further dilution (aka profitability).
With my previous startup, we raised over $10M across 2 venture and one debt round of funding within 2 years. We spent the money just as fast. Unfortunately, we made many investments that made us look or feel good, but didn't really tie to driving core profitability.
Among the biggest lessons learned:
- Diversifying into non-core business areas (we opened a non-profit incubator) can be an expensive distraction.
- Expanding geographically too soon (we hired a team and put an office in Berlin before we had solved US) can put pressure on an already taxed product team that has yet to figure out product market fit.
- Hired too many ancillary team members and consultants who weren't core to our success can be a big drain on resources and also a big distraction on management that has to manage them.
With my current startup, I'm trying to not make those same mistakes (Preferring to make entirely new mistakes :-) We've only raised $1.3M in our first 2 years but are already generating enterprise scale revenue. We've kept our burn down by:
- Keeping the team small and focused. We've just added our 7th team member
- Saving office expenses by working out of our CTO's condo
- Working cheap. Our founders are not paying themselves much yet.
We still have a long way to go before we ring the bell with Sensai, but at least we are focused on a smart strategy for managing our cash and dilution.
If one sits in most undergraduate and MBA courses these days, you would likely be urged to include an exit strategy in your formal business plans.
When Bill Gates dreamed of a computer on every desk, did he have an exit strategy? When Fred Smith got that famous mediocre grade on his Yale term paper about the FedEx idea, was he dreaming of the day he would sell out? Was Steve Jobs just awaiting the day he could “move on” from Apple? I don’t think so.
I have never written an “exit strategy” into any of my many business plans, some of which led to successful businesses.
Do I not place a priority on enriching my investors? Of course I do. The moment an entrepreneur accepts outside funding, providing a return to investors becomes a critical long-term goal.
“Long-term” is the concept that most matters here. Both of my two successful businesses were in fact sold for a nice return to early stage investors – the purchase prices totaled $160 million.
Throughout history, most businesses, even the giant ones of present like Wal-Mart and Microsoft, have been funded by individual investors (“angels”) and families investing on their own behalf, rather than by venture capitalists (VCs) and other organized professional investors. While VC firms look for a return within 10 years or less, angels often have a longer time frame.
When Warren Buffett buys a company or a stock, he is not trying to figure when he will get out. People who build great, lasting businesses have to be thinking further out into the future than 5 or 10 years.
Any study of returns on investment and business success indicates that the greatest, most valuable, and most durably profitable enterprises are built not just to make money, but they are built to serve a purpose.
In 1982 I met an Austin “health food nut” named John Mackey. He and his friends were in the process of building a second “Whole Foods Market” store, hoping to grow upwards from annual sales of about $10,000,000. John was obsessed with the idea that Americans’ lives would be longer and better if they ate healthy foods. He still is, as is his company, except it is bigger and better. Last year, Whole Foods Market generated $14.2 billion in sales. They have created 87,000 jobs and opened over 400 stores. That’s what I call purposeful enterprise!
I cite the example of “exit strategy” thinking, but it is only the tip of the iceberg in how entrepreneurial thinking should be integrated into today's MBA programs.
Always have a Plan B for funding. As an entrepreneur, I've had the opportunity to raise capital in different occasions and geographies and one common issue that I've seen is that until you have money in the bank and the term sheet finalised, things can change for a whole set of unforeseen reasons, even when in preliminary writing you have an agreement and your venture may be generating revenues according to the plan.
In such circumstances, having a second source of funding readily available or even being able to extend bootstrapping as part of an actionable Plan B, might be the difference between keeping your venture on the right path or having to take a detour that will cost time, focus and team demotivation.