Raising money through equity or dilutive funding, as the name indicates, dilutes your share in the business. It means every time you raise money, you give away a portion of your ownership in exchange for the proceeds. So, the question is how much money to raise and how much should you give away.
You don’t want to raise too much or too little since each of these scenarios is going to hurt you and the business.
If you raise too much money
One problem is that it will set impossibly high expectations. Also, there is a very good chance that by the second year, you will be sitting on excess cash that you raised when your company was worth considerably less and as a result you had to give away a bigger portion of the company to investors.
A company’s valuation is expected to rise each time it raises money. If not it’s a sign of a company in trouble, which makes you unattractive to investors.
If you raise too little
you put a lot of pressure on your team and operation to run everything pretty lean. That would possibly lead to a very slow rate of growth and diminishes the investors’ confidence.
Also, if the cash burn rate is high, you will end up raising money again in 6 or 10 months. One of the things that surprises founders most about fundraising is how distracting it is. When you start fundraising, everything else grinds to a halt.
The problem is not the time fundraising consumes but that it becomes the top idea in your mind. A startup can’t endure that level of distraction for long. An early stage startup grows mostly because the founders make it grow, and if the founders look away, growth usually drops sharply.
So, What’s the solution? How much money to raise
First, crunch the numbers, understand the needs and raise 12-18 months of cash each time you raise money.
Second, try your best to dilute in the neighborhood of 10% – 20% in each round. For example, if you’ve sold more than about 40% of your company total, it starts to get harder to raise a series A round, because VCs worry there will not be enough shares left to keep the founders motivated.
You should give up n% of your company which improves your average outcome enough that the (100 – n)% left is worth more than the whole company you had before.
For example, if an investor wants to buy half of your company, how much does that investment have to improve your average outcome for you to break even?
Obviously it has to double. If you trade half of your company for something that more than doubles the company’s average outcome, you’re net ahead.
In the general case, if n is the fraction of the company you’re giving up, the deal is a good one if it makes the company worth more than 1/(1 – n).
Don’t raise money unless you want it and it wants you
Such a high proportion of successful startups raise money that it might seem fundraising is one of the defining qualities of a startup. Actually it isn’t.
Rapid growth is what makes a company a startup.
Most companies in a position to grow rapidly find that (a) taking outside money helps them grow faster, and (b) their growth potential makes it easy to attract such money. It’s so common for both (a) and (b) to be true of a successful startup.
If you try to raise money before you can convince investors, you’ll not only waste your time, but also burn your reputation with those investors.