A successful startup company needs to create a sustainable growth model using paid, viral, and sticky strategies. However, before it gets there, a startup usually needs some cash investments to get things going.
Let’s say you have performed a financial analysis of your startup company and have determined that you will need $1M to keep it afloat until it can sustain itself.
When should you raise the $1M? No simple answer exists. In general, the longer you wait to raise any round of investments,
- The higher your valuation is likely to be because you have likely reached more milestones, like generating more revenue, obtaining more partners, producing more product, and so on. The higher the valuation, the less of the company you will have to “give away” to investors for a given amount of money.
- The higher risk you have of running of cash, so unscrupulous investors could take advantage of you by delaying their investment decision until you are desperate, thus forcing you to accept a lower valuation.
Some advisors will tell you to ask for all the money you need at one time because the investment-seeking process is so time-consuming that you want to do it as infrequently as possible. Get it over with at one time so you don’t have to do it again.
Some advisors will tell you to always raise more than you need because you have probably been overly optimistic in many of your predictions, and you want the cash cushion.
Some advisors will tell you to always raise less than you need (i.e., be as lean as you possibly can be) because your company’s valuation will always be higher later and you can raise less expensive money later.
Only you can make this decision. It is a delicate balance act.
What does cash flow look like?
Every startup’s cash flow looks like the following graph:
Notice that in the ideal world a successful company would burn cash at a slower rate of speed after each successive investment round; note that the slopes of subgraphs A, B, and C increase with each round. Eventually, the company sustains itself (at point C in this case) from operations without additional infusions of cash from external sources.
If the entrepreneur waits too long to raise investment round 2, line A will continue its downward trend below the horizontal zero line and the company will be out of business. If the entrepreneur doesn’t wait that long, but long enough so investors can see the company running out of cash soon, investors could just delay their decision.
Entrepreneurs have to make their own decisions.
Some prefer to bootstrap using revenues to grow their businesses; this approach maintains ownership among founders and employees, but usually means slower growth because they can be cash-strapped.
Others prefer to raise as much as possible . . . and then spend it as fast as possible, reducing the risk that a competitor will beat them to the market.
Others take a middle of the road position of raising just enough capital, and spending is judiciously.
All a matter of style.
ABOUT THE AUTHOR:
Dr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will You New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.
If you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money?
Photo of Nik Wallenda (Wonderland Walker) courtesy of Kevint3141 (Creative Commons).