To raise funds, or not to raise funds? That is the question
Framework to check if you actually need venture capital.
Framework to check if you actually need venture capital.
Stats from Crunchbase show that more than 1,900 seed and series A investment rounds happened in June–August 2020, despite it being the peak of the coronavirus. Even a pandemic couldn’t discourage entrepreneurs from seeking capital to fund their dreams.
I think it’d be fair to say that investors have been more cautious than usual as markets have softened globally as a result of COVID-19. Entrepreneurs should be able to seek the money they need to ensure the success of their business. However, many of them have trouble deciding whether it’d be a good idea in the first place…
Dealing with VCs can sometimes feel like you are embarking on a treacherous journey because you may be at a disadvantage when it comes to negotiating a good deal. However, seasoned serial entrepreneurs will tell you that it is possible to get capital as and when you need it, without sacrificing your future options. You should know precisely what you are in for before you step into the fundraising process.
Having run several companies, worked as an investor, and raised funds from prominent investors, such as Boost VC and Natalia Vodianova, I’m often asked whether it’s a good idea for budding entrepreneurs to look into VC funding.
As someone who understands the ins and outs of venture capital, I can tell you that each company has its own set of circumstances. So, if you are asking whether your business should or shouldn’t raise capital, I won’t be able to give you a yes or no answer. Instead, I recommend the following simple and practical framework to figure out what’s right for you.
Are you a low-risk/low-reward entrepreneur who wants to grow one company for 20 years? Or do you consider yourself a high risk/high reward entrepreneur who prefers to develop 4 different companies for 5 years on average in a fast-growth mode?
If you chose the first option, the answer is simple — you probably won’t need venture capital investments. You already have enough time and patience to take the company to your target profit/valuation with available resources. Who knows, you may just be able to make it right around time for your retirement!
But if you choose the second option, how long can you keep your focus on one company before switching your attention to other projects? According to my observations, it usually takes 3-7 years for entrepreneurs to move from one company to the next. If that’s your case, you’ll need funding to propel your business to success.
Are you aiming to have full financial freedom as quickly as possible, or do you want to focus on short-term investments and gradually make your way up?
If you want to be financially independent within 5-10 years, you will most likely need venture capital investment. But if you are willing to wait 20 years or more — then keep at it because you can do it without the help of VC.But you should make yourself comfortable because it is going to be a long wait!
It’s interesting to note here that there were 273 mega-rounds, i.e., fundraising of $100 million and more for tech businesses last year. So why not stake your claim in these mega-rounds that are creating more startup unicorns with bigger valuations than ever before? That could’ve been you!
It’s essential to know your market’s YoY (year over year) growth rate. These numbers will come in handy when assessing the company’s performance and estimate the future growth prospects, ultimately helping you to make investment decisions.
At the same time, you must also figure out how quickly this YoY can be commoditized and if there is a risk of competitors taking a share of your growth. Also, how fast are the multipliers growing, if the EBITDA is growing or declining and how external factors like a pandemic might affect it.
It is essential to know the answers to all of these questions to understand the opportunities available to you. This way, you’ll know when and how much capital you need to raise to make the most of your situation.
Don’t worry about either of these things just yet. The fact of the matter is that profits can be the enemy of success for a startup. This mentality can cause startups to lose the growth rate momentum and market share.
Founders often think that getting to the break-even point validates their business model. The reality is that they made thousands of times less than what they could have if they had made it to a liquidity event (exit/IPO) without the focus on profitability.
Aiming for profitability makes you complacent and less willing to take a risk. In fact, I firmly believe that you should reconsider working with investors who put too much emphasis on breaking even.
Why does this happen? Let’s start with the basics. A startup is a team of like-minded people who are after maximum capitalization (CAPITALIZATION, not profit). Consequently, any delay in this path jeopardizes the existence of the startup as a whole.
Only an inexperienced investor will bug you with the question, “So, when is break-even?”
Of course, the focus on capitalization growth, by all means, implies healthy unit economics, which means that the company will be able to make a profit when it becomes the leader of its market, with ARR from $100 million.
It’s very rare, but there are exceptions to this rule. For example, when a SaaS grows at the specified rate, increases capitalization, and also manages to get a positive EBITDA, all at the same time. But I have hardly seen this happen.
Venture capital can wait, as made evident by the fact that in 2019, the median age of companies raising funds was 2.9 years.
Raising funds isn’t easy, but examining and analyzing the above points can help entrepreneurs make sound financial decisions on when to approach investors and how much to ask for. Also, look into alternate ways of raising money, such as debt financing or crowdfunding.
Finally, encourage your team to set goals that can help minimize risk and evaluate reward potentials. And use this guide for the practical insights it offers about ways to improve your business and financial standing.