How to Avoid Costly Early Funding Mistakes
December 11, 2014
Note: A version of this post was originally published on Entrepreneur.
The initial funding stages for a startup can be exciting, frustrating, a lot of hard work, and above all, a whirlwind. But what entrepreneurs need to keep in mind is that what happens during those early stages can have a big impact on your company’s ability to mature and secure additional funding further down the road.
With that in mind, here are five tips to help you avoid common mistakes I see entrepreneurs get caught up in during the early funding rounds. Keeping these in mind can make your later rounds of funding go much more smoothly.
5 Tips for Avoiding Costly Early Funding Mistakes
1) Don’t Raise Too Much Money
It’s natural for first-time entrepreneurs to be hyper-focused on getting money in the bank, and really happy when it gets there. But every new CEO should remember that an initial funding round is just the first step in a long journey towards building a large, successful company. Raising too much money in the early seed/angel phase can create a difficult funding dynamic later on.
If you’ve raised a lot of money, and then spent it, the dollar amounts it took you to reach a certain point may raise questions about your leadership, product-market fit, and/or your economic model. Plus, the more you raise, the more preferred stock in relation to common stock, which might hurt a future investor’s returns (as well as impair the value of common stock held by founders and management).
2) Be Careful Not to Raise at Too High of a Valuation
Keep in mind that the goal is to bring in the right investors at the right time, not necessarily the highest valuation right away. The venture market right now is very active with lots of investors looking for the next hot company — it’s easy to be tempted into situations without thinking through possible later-stage scenarios.
A high valuation may seem a good route to take early on, but you could be saddling your company with expectations that may be difficult to realize. When you go after your next round you may not have grown into your initial valuation and may find it difficult to top. As a result, you could be looking at a flat or down round.
As it is, during the early seed/angel stages, you lack the proof points to confidently claim you have the ability to spend efficiently, which can also raise concerns about over-valuation. Rather than shoot for the moon, here’s a better idea: raise smaller amounts and perform rapid testing for proof of concept. For more thoughts on valuation, see my post “Series A Valuation: Dilution Isn’t the Only Thing that Matters.”
3) Be Selective About Who You Want Investing in Your Business
My general rule is the fewer investors, the better. Managing a large cap table can be troublesome when everyone may have different time horizons and expectations. Do you really want to deal with a cap table with 50 shareholders, 50 levels of expectations, and 50 forms of communications?
Institutional investors can be great. They can also be high maintenance. As long as you understand what you’re getting into, they can be very helpful. Alternatively, small or individual investors may be more agile, but can require time consuming hand-holding. For additional tips on selecting the right partner, see this post.
4) Choose the Right Angel Route (You Should Go Small…and Big)
The best angel group is a small one, with each individual offering a big check. To avoid a situation where you’re spending too much time answering too many different stakeholders, establish one point person who has proxy for that shareholder base.
It’s also a good idea to choose people who have experience as angel investors and who have invested in software before. Investing in software companies is not at all like investing in real estate. You want to find people who can be helpful and who understand that the process will be a slog and a lot of work.
5) Don’t Be Afraid to Fully Leverage Your Investors
The early funding stages are the time when you should learn to lean on your investors. Their purpose isn’t simply to throw money at you, but to help you make your company as successful as possible. This means asking them to open their rolodexes, make connections and introductions, and share their experiences.
The key is to set expectations early. If all you’re looking for is someone with a checkbook, look for a person who’s willing to invest with little involvement. But if you want someone who can and will be more involved, let them know what you’re looking for up front.
Don’t be scared of telling them, “I’m excited about bringing you on board. I know you have these great contacts, and I’d love it if you would connect us.”
When you’re building a business, don’t get obsessed with funding milestones — your focus should be on building a great company, your long-term vision, and creating value. By keeping the bigger picture in mind from the start, you’ll be in a better place to avoid dealing with the consequences and fallout of hasty early-stage decisions later on, which will make for a better balanced company and better peace of mind for you.
Image courtesy of Thong Vo at Unsplash