For any startup, fundraising is a crucial step. The job of fundraising is more difficult that it seems. Often, at the beginning of a venture, it’s easy to mistake fundraising with success and raise too much money. Raising too much money can do more harm than good. This post discusses the pitfalls of raising too much money at the start.
The money will get spent in the first year or so
As Notorious B.I.G. once said, “Mo’ money, mo’ problems.” This statement rings true for a startup as well. Whether you raise a million dollars, or five million dollars, the “burn rate”, that is, the rate at which you will spend it remains constant. When a new venture gets money, it will be spent on infrastructure, salaries, outsourcing software or intellectual property (trademark, patents) development etc. Having a constraint on the amount of money you can spend means that more reasonable expenditures will be undertaken. Which means you will learn how to function in a cash crunch. When you have a lot of money to fall back on, the expenditures can tend to become frivolous, and wasteful.
Raising too much money can harm valuation
As a general rule, when raising money for your startup, the more money you raise, the larger portion of your company gets owned by the investors. Normally at the first round of investment, a company may be willing to let 15-20% of the company be investor-owned. However, the more money you wish to raise, the more of your company becomes investor owned. This harms the control of founders over the company as well as it harms the future valuation of the company. When raising too much money in early rounds, the company becomes subject of high expectations as well as pressure to show huge turnovers.
Too much money makes the next round of funding harder
When you first round has been significantly well funded, you increase the valuation of your company. This means that the future rounds should be funded in a manner that is consistent with your valuation or else you lose valuation. This is a situation that you will want to avoid as investors do not want companies whose valuation decreases in future fundings. Therefore, keep initial rounds of funding only to necessary funding requirements only.
High pressure to perform well
At the start of any venture, there are many uncertainties. It’s impossible to guarantee that a new venture will perform well and how the market will react. But if you raise a lot of money right at the beginning, the pressure to perform well is really high.
Investors generally expect a 10 fold return to their investment in a venture. Raising too much money also means you’ll have to earn ten times that amount in the coming year and a half. This creates immense pressure on the venture. Also, this would mean that you spend large amount of money on marketing, which is a waste when spent in early stages.
Too much money can harm creativity
The real test of creativity is when you create with limited resource. Money creates resources and resources kill creativity. If your team is not subjected to constraints of resources in the early stages of the business, they are unlikely to develop the real skills of leadership, creativity and business.
For them money will become a solution to every problem.
So initial fundraising should be done wisely. It determines the direction that your business will take in the future. This choice is not only dependent on the magnitude of the investment itself, but also on the investor. Knowing the investor is as crucial as raising a lot of money. An investor is a partner in your business, so the choice of investor becomes as crucial as the amount of money you raise. Having some reasonable budgetary constraints in the initial stages is beneficial, as has been discussed above.
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