How Much Is Too Much?

Or too little – Raising “just enough”

One of the most frequently asked question I hear is “how much money should I raise”.  Given the relatively large amount of capital that is available from Angels and VC’s many would assume the correct answer is “as much as you can”. The answer you should consider is “just enough”.

Most of you are probably familiar with the dangers of taking too little money. For a moment let’s consider the downside of taking too much funding. The negatives fall into three categories.

Ownership/Valuation – Your Company is likely to go through several funding events on the road to profitability and eventual liquidity. Your goal is to preserve the ownership for founders and employees by raising each round of financing at increasing valuations. Your interests and those of your investors are very much aligned here. But by taking too much money you may also take more dilution than necessary in the current or subsequent round. 

Poor Fiscal Discipline – Having too much money in the bank can lead to poor fiscal discipline. We have all heard or experienced this phenomenon where companies that were too well funded failed to spend wisely or conservatively. Before you raising too much money, make sure you and your investors are on the same page as to how the money will be spent. Often when investors put large amounts of money into your company their expectations are for you to spend it and grow quickly. So even if you can resist the temptation of spending the money too quickly, your investor Board members may not.

Misalignment of Interests – It’s important to have yours’ and your investor’s interests aligned. An investor’s goal is generally to return at least 4-10X the capital that is invested. By having too much money invested in the company there is the potential that your investors will want and need a much larger liquidity event than you would be satisfied with – this is the “swing for the fences” strategy which doesn’t always generate a happy outcome. 

The best way to preserve your ownership and keep your interests aligned with investors is to determine how much is “just enough”. Start by determining the key risks in your business plan and the operating metrics and milestones that track those risks. As you examine your operating plan there will be certain obvious pivot points for the business where the completion of the milestones represents a significant reduction of risk. These pivot points represent significant increases in the valuation of the company at which you can raise the next round of funding and preserve ownership stakes.

Here are some examples of pivot points…

Market

•  Completion of extensive customer interviews that validate market demand for your product or service

• Continuously improving web stats such as unique visits, page views, repeat rate, etc.

•  Commitments from key customers or partners

• Implementing a repeatable sales process and low variance of forecast to actual bookings.

Team

• Completion of the Management Team
• Key technical or sales hires

Technology

• Completion of a prototype
• First customer shipment of the product
• Achieving short and repeatable engineering release cycles

When you have determined what you believe are the pivot points for your business, you should develop a detailed operating budget that attains them. By aligning your budget with the pivot points you will now know how much money you need to raise to lower risk, create value and achieve a significantly higher valuation at the next funding event.

It’s important to get pivot points and funding events aligned. If you develop a plan that requires more money to be raised before you reach the pivot point you will not have proven enough about your business to attract new investors. You will find yourself in the middle of the funding desert without a drop of water or funding in sight!  This kind of company is often called a tweener!

On the flip side if you raise too much money, and assuming you spend it wisely, you are likely to shoot past the valuation pivot points and potentially end up as a tweener too! Raising too much money makes it more likely that you will ramp expenses and either just make the next pivot point or worse, fall short. In either of these cases you will have raised too much money and suffered more ownership dilution than you needed than if you had just considered “ how much is enough” upfront.

There are many ways to format and present budgets/milestones/pivot points. At Ridgelift we like to keep it simple. My partner Dave Newman has a favorite format (shown below) which I like as well, that analyzes the amount of financing a company should be seeking.  There clearly has to be a lot more information and analysis to back this up, but it provides a clear simple view of business on one slide.

Download business_slide.ppt

Whatever form you might choose to keep both you and your investors happy it’s important to figure out how much is “just enough”. If you’re having trouble sorting this out, drop me an email – I’m happy to help. 

 

Comments

[Vinit]

Rob,

Too often, startup people like myself have to decide along these lines. But the scary part is always "I don't want to ask $x and then, find out that it was miscalculated and should have been $x + $y"

At best, looks like I miscalculated. At worst, looks like we spent way over our initial budget/forecast.

Rather over-demand and deal with keeping ourselves focused even with "lots of cash" than under-request and deal with having to look like we spent a lot.

What would you recommend in this situation? How to go back and ask for more money (just because we were over-zealous the first time around) prior to meeting milestones?

[Vinit]

Also, when putting up powerpoints on the web, try www.slideshare.net ... great concept (I'm not affiliated, just a happy user)

[Robert]

Vinit,
Agree that deciding how much to raise is often a dilemma. I would recommend putting in a reasonable margin of error that you and your investors agree are prudent. Then pick your investors as if they were your partners, which they should be. If you fall short on your goals for the right reasons, but make good progress then they are likely to continue to support you.
The law of averages and my experience tell me, in most situations raising too much money won't solve the problem. My partner Stu has an interesting post on this and points to an informative WSJ article that seems to have data to prove that point. Check it out http://1vc.typepad.com/soaring_on_ridgelift/2006/11/get_big_fast_go.html