How much capital should entrepreneurs raise in the early stages of their startup? Startup fundraising is a topic that has always fascinated me and many (smarter than me) folks have debated this topic before.
On the one hand, some people advocate that the more runway (i.e., cash) your startup has, the more time you have to experiment and the better your chances of success will be. On the other hand, well-respected venture capitalists like Fred Wilson of Union Square Ventures believe maximizing runway can minimize success.
The most recent fundraising data I have seen are from Tomasz Tunguz of RedPoint Ventures. He recently analyzed Crunchbase data from 2005-2012. He found that raising a $600-$900K Seed round would maximize your probability of raising a Series A round to 33%. In his words, “after that point, the marginal capital demonstrates diminishing returns”. While his thesis was that more runway implies better odds of success, I don’t find the data fully supporting this argument. As a matter of fact, in a separate post, he found no correlation between the size of Seed rounds and follow on Series A rounds.
In my opinion,
when it comes to startup fundraising, less is more.
Let me explain…
You can control the runway
Many folks tend to forget that. Everyone will tell you that you need at least 12, or ideally 18 months of runway. Remember, however, how much cash you have to survive depends on how much revenue you bring in and how much you spend. In my experience, more cash does not equate to success. Of course, there are exceptions, but for most startups, if you cannot produce some demonstrable milestones with a lean team over a period of 6-12 months, you may need to go back to the drawing board.
Cash is like a drug
Having more cash can give you the false illusion of security and easily de-focus you. While the lavish parties of the last bubble are now gone, here are a few data points from my world in the heart of Silicon Valley. One seed-stage startup is paying $8K / month in office rent so they can claim a coveted Palo Alto address. Another (this one post-Series A, but pre-revenue), is operating two offices, one in up-and-coming San Francisco and their headquarters down on the peninsula. Or how about the Series B, high-flying B2B software company that has a brand new shiny billboard on Highway 101, the main artery that cuts through Silicon Valley?
Fundraising is hard
Based on my personal experience, fundraising can become more than a full-time job for the CEO. Even for seed-stage financing, the fundraising process can easily take 6+ months or even longer. What is the opportunity cost of your CEO fundraising instead of selling and helping to build the business? Most entrepreneurs under-estimate the time it will take them to raise even a small round and their startup invariably suffers.
You lose control faster
Oh yes and then there is dilution. If you are an entrepreneur, you already know how the math works. The more you raise early on, the more equity you have to give up – much more than later rounds. While I certainly don’t advocate being greedy – that’s probably a topic for another post – remember that early on.
So, is there a silver bullet, may you ask? Sorry, if there is one I haven’t found it yet.
Keep this mind though; more cash for your startup is not always the answer. You can build a successful business by being scrappy early on. Here are a few examples: Google’s Seed round was an inflation-adjusted $145K in 1998, Facebook’s $630K in 2004, and more recently, Whatsapp had raised an inflation-adjusted $280K Seed round in 2009.
What has your experience been with startup fundraising? As always, I look forward to your thoughts.
Image credit: pixpoetry
Ted, you are certainly in line with the lean startup movement. A large seed round removes the necessity for a quick validation of your MVP and increases the risk of successfully delivering failure instead of pivoting early.
Hendrik thanks, very well put. I loved “successfully delivering failure” and plan to start using it.