Raising Too Much Too Quickly

We’re beginning to see the results of what happens when startups raise too much too quickly in the private markets and don’t perform. We’ve seen glimpses before with the blow up of Fab and Quirky. Those were extreme examples that happened very quickly (in the eyes of the public). Now we will start seeing startups miss internally set goals and have trouble raising money to continue and focus on growth (the Zenefits article in WSJ comes to mind, whether true or not). The effects may come quickly but they have been in the works for some time.

I think at any stage, raising too much money (and spending it just as quickly) before you are ready or because investors want to mark up their investment is a recipe for disaster. On the other hand, there are examples of companies raising (or having raised) a lot of money very quickly and becoming successful — namely Facebook and Uber as the most obvious examples.

The two things you need to figure out as a founder when raising is:

1) Readiness

Are you ready to raise lots of money, spend lots of money, and take your company to the next level? The answer can be not yet. Maybe the model isn’t fleshed out, maybe you aren’t retaining users like you’d like to and want to add fixes/improvements. Or maybe you realize you don’t have a venture back-able business! Crazier things have happened.There can be tons of reasons to avoid raising a lot of money. Money won’t solve most of your problems. Most times it will just exacerbate them.

2) Motivations

I’ve found that it is not uncommon that existing investors push you to raise money before you are ready. You need to understand their motivation behind trying to get you to raise more money at a higher valuation. Now this isn’t all investors (and thankfully none of my investors), but it is common enough that it needs to be something you think about. Investors mark up and down their fund depending on performance.

If your startup raises seed funding from investor X at a $5–7M valuation and then a year later you go and raise $5M at a a $30M valuation — that lead seed investor gets a 4x+ markup. This helps them raise another fund even though it is all paper gains. So it is in their best interest (i.e. back to their motivation) that you raise more and as quickly as possible (the best investors balance their need to have a well-performing fund + where a specific company is in their trajectory).

Now use this mindset for big rounds like $50M or $100M. Most times the motivation you have as a founder aligns with investors, but not always and it is something to take into account. It is hard to say no to more money at good terms, but like that season 2 Silicon Valley episode about the founder finding out that he could have said no to the amount and evaluation — you could say no.