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November 1, 2010

How much money should you raise?

Clearly, there is no one right answer. It depends upon the entrepreneur, his/her experience starting companies, the nature of the business, the target market, whether it is a technology or a business model play, the financing environment, and other variables.

If it is possible to get to market with a salable product and demonstrate real traction, then by all means bootstrap and only raise money if you need to do so to accelerate growth - financing for sales, account management, operations, etc. When this happens it is a rare and beautiful thing; keep the lion’s share of equity for yourself - because you can. The relative value-add of any investor in this circumstance is marginal if you know how to grow and scale a business. If not, getting a good investor or investors behind you can be extremely helpful and potentially life-changing.

In most other circumstances, where a pure bootstrap approach won’t get you there, raising enough to prove or invalidate your hypothesis is key. This generally means raising 18-24 months of operating capital, inclusive of cushion necessary to raise the next round if you have, in fact, proved the value of the idea. I generally like to budget six months for the fund-raising process. Reality is that entrepreneurs are almost always fund raising (or making similar contacts), so the six months is generally in light of a “running start” and permits enough time to process multiple term sheets and documenting the investment.

For those who think that speaking to VCs is a waste of time, they are wrong. It is only a waste of time if you go in without a clear plan and a set of clear asks; in my experience, good venture investors (and there are many) are only too happy to make connections to potential recruits and business development opportunities if they feel you are solid and that your idea is worthwhile. Plus, there is no substitute for pitching. Speaking to lots of different investors teaches you a lot about your business, and can often result in valuable ideas that can materially impact the road-map.

As a general matter, I recommend that entrepreneurs work to “keep the bar low” in early financing rounds. This preserves maximum optionality for exit and for raising from the investor of your choice in the subsequent round. If early rounds are either raised too expensively or too much capital is taken early on, it substantially increases execution risk both due to lofty expectations (“You raise at a $9mm pre and have only gotten this far…?”) or barriers to exit (if you raise $5mm on a $10mm pre from an institution early on, that $25mm exit is off the table, which could be the best decision for the entrepreneur). When the business model is validated, traction is strong and capital is needed to ramp growth into a fertile market opportunity, then by all means go for it and raise a bunch of capital at a high valuation. But just be aware of the implications for exit. There is an implicit pact between entrepreneur and venture investor that taking big dollars to aggressively ramp means not settling for the “just ok” exit. If the entrepreneur isn’t ready to sign up for this dynamic then they shouldn’t be raising that much capital at that high a valuation, otherwise they are being unfair both to themselves and their funding partners.

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