Can You Turn $1 Into $20?
Why “Just Take The Cash” Isn’t As Simple As It Sounds
A common piece of advice from the startup industry tells founders that if an investor is offering to invest in a startup without egregious terms, they should take it most of the time, even if the money is not necessary. I think this is very dangerous advice for first time founders who have raised less than $5M, or aren’t on the “unicorn track” yet. If a founder raised a $1M pre-seed, and a new VC said they’d like to invest another $3M at a higher valuation, that brings their total raised to $4M. The difference between $1M raised and $4M raised is actually quite massive. Sure, it is $3M more dollars to put to work. But it also means that the founder just went from having $10M-$20M as a minimum exit range to a $40M-$80M minimum exit range, even though the company still hasn’t derisked anything yet.
A general rule for venture is you should be able to create 10x-20x of value for each dollar you raise by the time a liquidity event comes, at the minimum. In other words, for every $1 you raise, that should create $10-$20 in enterprise value during the time of a sale. In the example above, the founder originally set out a plan to raise $1M and allocate that amount to get to certain milestones, cross of certain “risks”, allowing them to raise the next round at a higher valuation. But since they took the standard advice of always take money when it’s available, they now need to scrap their old plans and figure out how to take $3M and create $30M+ in value with it, even though the path ahead is just as treacherous and risky as when they took $1M.
Why Is Taking LESS Better?
Why is taking LESS money better when solving hard problems on a treacherous path? It really comes down to capital strategy, execution, and risk. A founder who raised $1M on $5M post money has a much lower execution bar to clear to raise the next round. They just need to show future investors that they took that $1M and increased in the value of the company a bit. There is room for error & pivots. $5M is not a super high threshold to clear for the next round. But if the founder raised $4M on a $20M post money valuation, that’s a much higher bar to clear for the next round. If ANYTHING doesn’t go to plan, they may not be able to raise more capital and the company raises a down round (very bad) or dies (lethal) And sure, every founder thinks they are Superman with flawless execution abilities, I get it. BUT there are things they cannot control.
When building a company, there are unknowns. Unknowns market trends. Unknown competitors. Unknown technologies that pop up. Unknown pandemics. Unknown attrition numbers. Unknown unknowns! These unknowns are risks, and “risks” SHOULD be priced in, so if a team doesn’t have flawless execution due to things outside of their control, they still can keep the show going with another funding round. But it’s impossible to price risk in if a VC blows up the model by injecting more capital than was needed on day one.
Why Would a VC Want To Invest MORE Than The Plan
The issue here is that VCs don’t really get any brownie points for a $10M exit. Or even a $25M, $50M, or $100M exit. VCs are expected to bet on 10 crazy as hell founders, help them shoot for the moon, let seven of them fail along the way, get a modest return on two of them, and have one of them return the whole fund. But nowhere in their strategy does it say that they like when founders raise less, exit for less, and return less capital to the fund. Due to this, VCs are always pushing founders to raise MORE! Think BIGGER! Swing HARDER! I think the advice of “always take money when it’s on the table” lends itself incredibly well to their incentives. Sure, if you are truly on a unicorn track (and have the unit economics to support that), yeah take every penny you can get. But you don’t NEED to be on the unicorn track by default, and you can make this decision by how you decide to raise your first or second round.
Next time a VC tells you to raise more capital for one of your first rounds of capital, press them on it.
“Where would you allocate the extra funds in the biz if you were in my seat?”
“What extra expenditures am I not thinking about?”
“Am I missing an income tax rate that will cost me more than I’m expecting?”
Chances are, they are just giving you the standard advice that benefits their industry most of the time and benefits the founders a fraction of the time. They likely will tell you it’s better to have more cash on hand than less. Yes, but for every dollar you raise, you need to turn that into $10-$20 within a handful of years. If you have a scalable and repeatable way to create value, then mazel tov. If not, I’d really pause when an eager VC wants to plow millions more into your startup. Every single dollar furthers the goalpost, and unlike on a football field, the there are no limits on how far that goalpost can get ahead of you.
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Some things I’m working on right now:
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Founder or investor looking to expand your network with other founders and investors? Try out Seedscout (It runs 100% on IntroFlow).
Until next time….