Many things about startups are about power laws — fundraising included. The best companies do attract disproportionate attention and the entrepreneurs are faced with the choice, if not pressure, of raising more. Below are five key principles on how to make the best decision.
1) Dilution Vs Runway — This is the heart of the dilemma since entrepreneurs naturally don’t want more dilution but also seek enough of a runway. One standard solution is to change the deal terms, typically by having a higher cap / valuation, to keep an acceptable dilution. The principal tension here is many investors have ownership quotas and may not want to follow below the threshold. A lesser talked about trade-off is that too much money can harm a company’s culture, effectively discouraging leanness. When considering how much money to take, our advice is to raise enough to last for 18 months. That is enough time to show results and not have to put yourself through a rodeo after having just raised.
2) Stage — There are caveats though to the 18-month norm. If you are very early stage, say pre seed or seed, it is common to raise for a shorter runway say a year. Same if you are doing an extension than a proper independent round. The converse also happens. Companies that are doing very well often get inbound interest as investors try to pre-empt the next round. So you could raise more money much earlier than 18 months, while still having enough in the bank, extending your runway even further. How to figure out the right answer? It’s an art and science that is fundamentally about balancing interests. Remember your existing investors will be tempted to push towards a higher valuation since the upround values their investment. Your new investors’ will naturally want to push towards a lower valuation so they have higher ownership. And what and how you disclose the round internally or externally adds a third major dimension to consider.
3) Disclosing — Let’s talk more about that last point. If you want to make a statement within the market, especially to discourage current or future competition, then raising the highest amount possible at the highest valuation is definitely one way. You can also keep both round size, valuation or even the fact you did the round private if your goal is to remain stealthy. Many companies choose to raise very strong rounds also, even if maintaining this info private, to boost morale and signal to potential hires. Silicon Valley especially is derided for playing the hype game, with “oversubscribed round” having almost become a standard term and some taking the position that PR should be about accomplishments not fundraising news. At Tau we take the view that fundraising is typically the biggest information available on a private company to a wider audience. So our overwhelming advice to startups is to treat it similar to what public companies do with investor days — factor in round dynamics and disclosing them very much into your strategy.
4) Investor Syndicate — What about raising more to allow more ownership from investors, or simply more investors into the round? Most VCs will tell you that a strong round is when there is a lead taking 40-60% of the round and 1-3 new firms taking the bulk of the rest. Such a traditional syndicate ensures there are enough good investors to help the company without crowding the cap table too much. The additional complexity is potentially juggling existing investors with prorata rights. If you find yourself in such a situation it’s obviously a good problem. At Tau we are advocates of the “slightly more is almost always better”, with the even bigger belief that good investors should be counsellors (not decision-makers) to help entrepreneurs think it through.
5) Venture Debt — You want to increase the round size but without further dilution or changing valuation? Raising debt is the most classic answer. At Tau we generally believe that if you are considering debt then you should go ahead and raise it. Bankers will tell you ~25% of the equity raised is the norm i.e., if you are raising $10M then another $2.5M in debt. Or you can use it to round off numbers, for instance if you are raising $16M then another $4M in debt. Remember this debt doesn’t need to be exercised, you can just pay it back within typically 24 months. The trade-off is that venture debt typically has high interest rates, often around 10%, so you should obviously figure out if that is worth the option value.
Originally published on “Data Driven Investor,” am happy to syndicate on other platforms. I am the Managing Partner and Cofounder of Tau Ventures with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). Many of my writings are at https://www.linkedin.com/in/amgarg/detail/recent-activity/posts and I would be stoked if they get people interested enough in a topic to explore in further depth. If this article had useful insights for you comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are my own.