The VC Push to Raise More Money

“You’re not raising enough money.”
It’s common to hear this from from VCs after a pitch. But is it true? Sometimes, but not always. For purposes of creating a hypothetical scenario for this post, let's say you’re asking for $500,000. You think that’s realistic, and enough to keep you going for 12-18 months. You believe you can make real progress and go back to the market to raise more if needed at that point, on a higher valuation. Perhaps you might even reach profitability (you think, but probably not because this usually takes longer than you might think). The typical VC might disagree with your approach, recommending that you seek $3M right now because "well, you're going to need it." So what should you do? Consider that the VC may be saying this to you based on their own motivations, and not what's in your best interests. And remember that any business deal is about momentum. Asking for less and then raising more = positive momentum. Conversely, asking for more and then raising less = negative momentum. The VC may be interested in what you're doing and just positioning to get a certain amount of ownership in your company. That's great! But only if they actually do the deal! Otherwise this "raise more money" advice can kill your chances at actually raising the smaller ($500k) angel round when the VC disappears. That's because negative momentum will creep in and your public attempt to raise $3M will look like failure to your potential investors, even if you have $1M in commitments. Some of them may start to feel uncomfortable and end up not investing. It's about the momentum. If you think you can make good progress on 500k, then that may be the best place to start. Of course it would be great to raise more, but if you go around saying you need a lot more money, you could harm your chances of raising an angel round. Let the market push the amount up, creating positive momentum. In situations with positive momentum, the valuation can increase with the amount of capital committed because the deal is gaining momentum rather than losing it. Above all, be transparent. Make sure the VCs understand that in the absence of a term sheet, your ask will be 500k because you have a plan and know that you can make meaningful progress given that initial raise. At the same time, clearly communicate that you would love to consider raising more if they're game to explore it. Basically, put it in their court to deliver a term sheet and signal flexibility in this situation. Don't let the "VC push to raise more money" ruin your chances at a reasonable angel round because you over-ask and then can't get there.
About David Cohen

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  • http://www.facebook.com/bhakdi Johannes Suriya Bhakdi

    inmho, the most important rule when raising money is to have a solid plan and understanding of the road ahead, and do you own math how much you need. I think for an angel round, pre-significant traction, a 24 month runway is good. This basically means: in a worst case scenario, what’s the amount of money we can continue to effectively iterate and pivot for 24 month (which is a long enough runway to be able to succeed)? If you are 4 people and you need 5k each including all other costs, that’s $20k x 24 = 480k.

    I think it’s important to have a solid and strong internal rationale for the amount of money you need, and it makes sense to look at the worst case scenario. This is a bootstrapped solution with a long runway. If you see after 3 months in users jumping on your site and throwing money at you, that’s fine – raise $3m and scale. If not, you have another 21 months to refine, iterate and maybe pivot.

    Should you raise more than this? It’s a question of the deal you get. If they offer you $1m for $6m instead of $500k for $3m, that’s free money and you should take it. If they offer you $1m for the same valuation, I would never do it. If the investors are willing to significantly raise the valuation in exchange for putting more money to work, that could be a sign that they really believe you can use more money.

    I think you are totally right, David, to point out investors mostly don’t have (just) your interest in mind, and many VCs quite frankly don’t base advice like “raise more money” on a in depth-understanding of what needs to be done. VCs tend to think they are in the business of putting as much money to work as possible with the least work, so they try to get bigger deals. That doesn’t make sense from either an asset management perspective, or from a business building perspective, but it’s mostly the reality, and I wouldn’t buy into advice like this.

    Money matters, and as a CEO, it’s important to have your own, solid and strong judgement about what you need and why. Premature scaling is one of the big dangers for startups, and “raising more” than you think you need is a warning signal. I think. :)

  • http://twitter.com/RockiesVenture Rockies Venture Club

    Excellent post – and one that I think addresses a lot of confusion among entrepreneurs.

    As I see it, there are two reasons why funding occurs in phases, rather than all at once.

    1) If the entrepreneur raised all of their funding at the beginning, they would have something like -1,000% equity, if that’s even possible to have negative equity. The company is simply not worth enough at the beginning to justify huge investment, so it needs to take place in phases. Later rounds typically (though not always) are at a higher share price than earlier rounds, so the entrepreneur gives up less equity for more money. If a VC wants to invest more than what you need, then you will likely give up more equity than you need to at cheap early investment rates.

    2) Investment phases are all about risk. While we talk about building a runway of nine to twenty four months between funding stages, what’s really important is that some major risk milestones are reached during that time. It’s not just about paying the team’s salaries, but about proving that some technical or market based hurdle can be overcome. At that point risk declines and the company increases in value for the next round. So, the best strategy is not to figure out how to survive for eighteen months, but how to get something important done that proves your concept.

    The main reasons to go for more money earlier would be if the VC saw that you couldn’t achieve the milestones you need to achieve with just $500K and could make a good case for why it would be in your best interests to go with a higher round, or if there was competitive time pressure where more money means that you can put more people on the project to get to market faster and achieve competitive advantage that way.

    I think your point about “momentum” is critical and those looking for funding need to realize that if they don’t time their funding rounds right, they won’t have the momentum to raise the next round and they will have built a bridge to nowhere.

    Peter Adams
    Rockies Venture Club

  • http://theleanstartupmachine.com Trevor Owens

    Great post David.

    Ideas that have a high degree of technical risk (as opposed to market risk) need to raise more money. I’ve seen some VCs react negatively to Lean Startup for this reason– ie. because it implies that entrepreneurs can raise less money.