The Risks in Raising Too Much Too Soon
$3 Trillion – that’s the size of the global startup economy right now. To put that figure in perspective, its larger than the GDP of some pretty decent-sized economies like the United Kingdom, Brazil and even France. It would not be wrong to say that if you ever dreamt of being an entrepreneur, now would be your time to shine.
Startups today have plenty of resources and help at their disposal. Investors, mentors, incubators, policymakers are all scouting for the best entrepreneurs to bet on and are willing to take risks with their money. A report states that Indian startups raised upwards of $7 Billion in funding between January and September 2019, spread over 603 deals.
But in the world of startups, all that glitters is not gold. The idea that some early-stage startups can raise funds without breaking much sweat is not as rosy as it seems. Entrepreneurs wrongly assume that angel or VC funding is a compulsion to kickstart growth and that they can only gain significant traction after raising money.
While it is true that startups may require external funding at some point, it is vital to not rush into this decision. Here’s why raising too much too soon can be your downfall.
Being on the Backfoot
The end goal for an investor and an entrepreneur is the same – making money. However, the point to note here is that the investor will make money only if you do, i.e., an investor gets a good return on his investment only if the startup performs well.
When a startup is new to the industry and low on traction, the investor takes on a much higher risk. Therefore, more often than not, the investor will be the one dictating terms rather than the founder. This may result in the dilution of more equity than predicted and even negotiation to a lower valuation.
Also, it is said that at least in the first couple of rounds, founders must keep in mind that they will have to give up anywhere between 15-25% shares of the company.
Capital invested at the cost of ownership will eventually put entrepreneurs on the backfoot. They might have problems raising subsequent rounds because they will not have enough equity to offer to new investors.
Extensive Use of Time and Effort
Although investors are more accessible nowadays, the entire process still takes time. Early-stage startups may spend anywhere between 4 to 6 months meeting investors and trying to close deals. And as any successful entrepreneur would tell you, time is of the essence.
If the same amount of time and effort is invested in the startup itself, the results may be much more satisfying and critical.
Once you build a solid base for yourself, the road might become slightly smoother. You might stand out more while raising funds or better, may not need them at all.
Missing Out On Key Bootstrapping Skills
Bootstrapping presents itself as one of the most significant learning opportunities for a startup. When an entrepreneur has limited resources and cash, he is forced to squeeze out maximum utility from them. Thus, entrepreneurs understand the value of every resource.
Being on a lean budget means that entrepreneurs are forced to think out of the box and rely on their creative skills. Startups are a risky proposition. Nobody knows when situations will go against you, and you will have to fight your way back up.
An entrepreneur that develops the skill of innovative thinking early on will be able to bounce back quicker. Those who have never seen what it is to work with a lean budget will face a hard time.
Additionally, if a startup chooses to bootstrap, their focus remains on customers from day one, since they are the only source of revenue. A customer-centric approach paves the way for a successful future for the company since they will always put their clients first.
Cash is Addictive
Once a startup raises funds, more often than not, there is no looking back. Instead of utilising funds efficiently and trying to churn out enough revenues to sustain the company, entrepreneurs will choose to raise external capital time and again.
Raising funds seems like a more convenient option than pushing the company towards self-sufficiency. The earlier you start raising funds, the easier it is for you to fall into this trap.
Possibility of a Down Round
A down round is when a startup raises funds at a lower valuation than the previous round. Excess cash means that startups spend money without thinking twice, thinking that it will help them increase productivity, sales and profits.
However, overindulgent spendings are mostly not met with an equivalent rise in revenues, meaning that the startup fails to achieve its targets. Therefore, when the startup raises funds again, it may have to reduce its valuation, leading to a down round.
This down round may further affect investors’ perception of them since they will now look at them as a riskier proposition.
Bottomline
Startups should ideally look for funds once they have decent traction in a growing market. You should look at your next fundable milestone and raise money accordingly, given the timeframe you expect to achieve it in. Some cushion should be kept for unexpected costs.
Any experienced investor will be able to tell if you’re trying to raise too much, too little or too soon, and they all act as big red flags in their eyes. So it is best to do your research first, understand your company, your vision and spend time getting your first set of loyal customers.
To sum it up, don’t raise funds just because you can. And a quote you should keep in mind – “Necessity is the mother of invention, not money.”
