Nivi · December 29th, 2009
Chris Dixon, serial entrepreneur and seed-stage investor:
“… You should try to answer the question: what is the biggest risk your startup is facing in the upcoming year and how can you eliminate that risk? You should come up with your own answer but you should also talk to lots of smart people to get their take (yet another reason not to keep your idea secret).
“For consumer internet companies, eliminating the biggest risk almost always means getting ‘traction’ — user growth, engagement, etc. Traction is also what you want if you are targeting SMBs (small/medium businesses). For online advertising companies you probably want revenues. If you are selling to enterprises you probably want to have a handful of credible beta customers.
“The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone [emphasis added]. Building a product is only accretive in cases where there is significant technical risk — e.g. you are building a new search engine or semiconductor.”
Read the rest of Chris’ What’s the right amount of seed money to raise? Also see our post, How do we set the valuation for a seed round?
If I had to stuff my answer to this question into one sentence, I would say: “As much as possible while keeping your dilution under 20%, preferably under 15%, and, even better, under 10%.” Raising as much as possible is especially wise for founders who aren’t experienced at developing and executing operating plans.
“For consumer internet companies, eliminating the biggest risk almost always means getting ‘traction’ — user growth, engagement, etc.”
I agree with this to an extent, but if he’s referring to marketing dollars, I think there’s better use of the money.
Talking from personal experience, if one of your lead tech guys needs some sort of salary to jump on-board on a full-time basis, I’d rather find a way to get his undivided attention. There are so many free marketing tools available, and IMO you become more creative & stronger for employing those methods.
Can you explain “keeping your dilution under 20%”?
The founders and employees own at least 80% of the company *after* the financing (not necessarily vested though).
I’ve always been miffed by the phrase “raise as much as possible”. Surely there must be a balance.
For example, if your conservative projections show that you need $x for the next 12 months, but you know you can raise $x*2, should you go ahead and raise it?
What is the correct risk premium? I suspect it requires a balance between how much dilution you are prepared to take and how conservative your initial projections are.
What do you think Nivi?
I think you should more-or-less raise as much as you can while keeping your eye on dilution, liquidation preferences, control, and whether you want any investors on the board at this stage. See:
http://venturehacks-dev.mystagingwebsite.com/articles/how-much-money
Interesting approach. I like the caveats here “Raising as much as possible is especially wise for founders who aren’t experienced at developing and executing operating plans” and on your other post “(3) act like you don’t have a lot of money”, but am a bit wary of raising a lot myself. I would be interested to hear your response to a number of traditional responses against raising money:
1) “I can’t spend it effectively.” Unless you have a virtually unlimited ability to shovel money into marketing channels at an acquisition rate such that each dollar of capital can generate a positive Net Present Value return, there must exist a saturation point where you can no longer effectively use additional capital. But even for the largest markets there is an upper boundary to an effective marketing spend.
2) “If I raise more money, investor expectations increase while the business case remains constant” This is perhaps more of a political issue than a business one, but political issues absorb considerable time and effort.
3) “Excessive inventory tends to conceal problems in manufacturing. So too, excessive capital can conceal problems in R&D.” A lot of money tends to promote inefficient uses of it and tends to lead to feature creep in pursuit of the perfect product while the market marches on without you.
I would definitely welcome a longer article on this subject.
Being able to raise a money is a very high-class problem that most startups will never experience (including the startups that raise money from good investors). Don’t worry about it too much. =)
1) Before product/market fit, money is used to find fit, not for marketing channels. More money lets you run more fit experiments. After fit, more money lets you create more positive ROI channels and spend more money on them.
2) In a perfect world, you find investors who understand your hypothesis-driven approach to building startups, so you reduce the politics.
3) I know a serial entrepreneur who raises as much as he can, then puts a lot of the money into a separate bank account that requires board approval to access. It helps you act like you don’t have a lot of money. It also helps with your second concern above.
To me, the issue is that there are so many factors for internet entrepreneurs which make one year not enough to get to a good place. But yet, almost all entrepreneurs only raise for 1 year or less, and then have some expectation that they will be able to find more cash at the end of their runway.
With the economy the way it is, the chance for a second raise on mediocre or poor metrics is almost impossible. But you need to have enough runway to execute and have some time to twist/adapt in case your original assumptions prove to be incorrect.
This is why I have been telling all my startups to find a way to last 2 years assuming no revenue. Remember, this does not mean that you need to raise more necessarily; there are two levers to apply here. One is how much to raise, the other is how much you burn. So you need to look at both and figure out how much to raise, which will last you two years.
With too many me-too products, a crowded marketplace in the minds of consumers bombarded ever with new products and ever-splintering attention, and distribution being the most difficult thing to get (even more than your fund raise I believe), I guarantee you that most internet products are going to take at least 2 years to get to some good place. One year is not enough.