02 Dec Editorial: Mistakes to Avoid when Raising Capital
Almost every startup raises capital at some point and many startups do it more than once. At The Dallas Angel Network, I see startups raising capital on a daily basis and for all but the hottest new companies, it’s not easy. While raising money is a challenge, there are a few things an entrepreneur can address early on that can lessen the headache.
Initially, raising capital the first time is really exciting. Early stage companies in need of money are usually in an extreme growth mode and with a fresh capital injection, the company as well as the entrepreneurs’ lives become much more interesting. At this stage, it’s easy to think that the company, no matter how early, is worth millions. A lot of entrepreneurs are also overly concerned with losing control of their company, so they structure the investment in such a way that an investor has very little if any downside protection. The combination is an offer that is over-valued and under-structured for many potential investors to have an interest.
This combination of a high valuation and poor structure almost guarantees a tough road ahead to raise capital. Typically, when we see this combination at The Dallas Angel Network, we advise the entrepreneur to try and raise capital at the proposed terms, but should they fail, we encourage them to come back to us so we can revise the terms and valuation to something more reasonable. Inevitably, two to three months later, an exasperated entrepreneur reaches back out.
A lot of time and headache could have been saved if the entrepreneur had been more realistic about what the Company was worth and more reasonable in regards to the proposed terms. So before you embark on your capital raise, really think about what you’re offering investors and what kind of return your offer will provide. For an early stage company just starting to see its first dollars of revenue, if the return you’re offering is less than 20 times an investor’s money, think again. Of course, if your company is still pre-revenue or in the development stage, the return for an investor needs to be even higher than that.
Another mistake we see entrepreneurs make is that they intentionally don’t raise enough money. The thought by most entrepreneurs is that they’ll raise a little money now, achieve some milestones, and then raise money again when the company is worth more so as to preserve as much equity for themselves as possible. In theory this is smart, but in practice this can be a disaster, and it’s a hallmark of an entrepreneur that has never had to raise money before.
Try to raise as much money as possible, otherwise an entrepreneur is going to constantly be in capital raising mode which is a distraction from actually running the business. For an investor, anything that distracts the entrepreneur from running the business makes the business less appealing to invest in, but aside from that, a new risk has been introduced: the investor is being asked to invest in a company that will need to raise money again. This is known as financing risk and it’s a huge one for any investor to take.
All else being equal, it’s much more attractive to invest in a company that is raising enough money to get to profitability than a company that is intentionally going to have to find capital again before achieving profitability. Entrepreneurs that elect to raise all the capital they can will not only avoid the headache of raising capital again and again, but they’ll also have a more attractive offering for investors and give themselves a cushion in case things don’t go as planned.
Raising capital is incredibly time consuming to the point where it can feel like a second full time job. Going through the process and having nothing to show for it except a lot of investors who declined to write a check is deflating and potentially very harmful to your business. By making sure your valuation and terms are reasonable, and also setting a goal of raising all the money you can at once, you can take some of the pain out of the capital raising process.