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When Should a Startup Raise Venture Capital?

By Crystal Goodwin and Dan Offner

StartupProgram.com

Cash is king and, as a pre-revenue company, raising venture capital is often a critical step in the success of your business. Even if you have friends and family willing to be your first angel investors, you can’t always count on friends and family to provide enough cash to get your company to the point of profitability. Startups burn through a lot of capital just getting off the ground and sustaining growth before they turn a profit, and so raising venture capital from sophisticated investors can be critical for feeding that initial burn. 

While you may know that your business is one that could benefit from venture capital funding, or even how much you want to raise, you might not know at what point you should try to fundraise.

Determining when your startup needs funding to bring your great idea to life and sustain its growth depends on both the nature of the business and your goals as its founder – there is no one right answer to this question for all startups. How you will deploy the funding, what team you will need to hire, and what other tools and resources you will need to operate and grow your business are some of the big-picture questions to ask yourself. While those are helpful starting places that you’ve probably already put some thought into, below are five other considerations when deciding if the time is right for your startup to raise venture capital.

What is my Short-Term Profitability?

One question you should ask yourself as a founder is whether your startup has potential to earn significant revenue in the short term. Here you want to evaluate the amount of revenue your startup can reach within a two-to-three-year time frame and what resources and how much capital it will take to get there. If that amount yields high returns but is only achievable through increased resources, not only is that a good indicator that it is an appropriate time to start raising venture capital, but you will also be able to show investors that there is a strategy to get them a sizable return on their investment quickly, helping you to incentivize their investment.  

Is my Business Scalable and Will Venture Capital Help?

You should also ask yourself whether your business is scalable, and if it is, whether it needs to be scaled to be successful. Not all businesses need to scale to be successful, or are even scalable, but if your business can do so because you have come up with a product or service that is highly sought after in the market and keeps your revenue increasing while keeping costs low, chances are you will need the capital to scale up. A common trait of a scalable company is that customers can be added without significant cost increases relative to the revenue generated by those potential customers. In other words, your expenses and costs will remain relatively fixed while the demand for your product and the number of customers contributing to profitability increases. If venture capital can help get you to that point quicker, or you will need venture capital to hire the resources to meet the increased demand, it is time to start raising venture capital and using it to scale. On the other hand, if your costs would increase at the same rate or faster than your revenue as you would scale, scaling that business is likely not in the startup’s best interests.  Instead, there may be inefficiencies in your current business that need to be ironed-out before scaling or finding a new commercial partnership. 

Can I Afford to Sell More of the Company?

 Another consideration for you as a founder is whether you are ready to give away control of the company. Raising venture capital requires a founder to give up a percentage of the company – unless they have anti-dilution protections (such as preemptive rights) all existing shareholders will have their ownership percentages diluted down by the new venture capital investor. If you are not ready to give up control or even a percentage of ownership in your company, then now is not the time to raise venture capital.  That said, it is important to remember that while new investors will decrease the size of your relative slice of the pie, their investment goes directly to increasing the size of the pie for everyone.

Creating Your Dream Team

When determining whether to raise venture capital, you should also consider the size and makeup of your dream team. You will want to put together a team comprised of the most talented and experienced individuals in the market, and attracting talented and experienced contractors, advisors, and employees will require you to have the cash and/or equity to compensate them. If you do not want to give up much of the equity of your company to these team members, raising venture capital can provide you the ability to pay for your dream team. While money talks and salaries matter to your team, you will likely find that a blend of cash and equity (through a stock incentive plan) will incentivize your hires while ensuring that they have a stake in the growth of the company.

Timing Your Exit

Another consideration when determining if it is a good time to raise venture capital is whether you plan to sell the business or go public in the next five-to-ten years. Not all, but a lot of startups start with the goal of being sold or acquired within five years. If the business idea you came up within your basement has immediately filled a need in the market and made the startup profitable, chances are raising venture capital isn’t necessary because you can use the excess profits to scale without diluting your ownership and introducing other investors who may have different expectations about an appropriate exit.  For example, while you may be thrilled with a $50m exit, if your latest investor is only receiving a 1x or 2x return on their investment, they may want to hold out for a bigger deal.  On the other hand, being a publicly traded corporation introduces a ton of new regulatory and administrative costs to your business and you will likely need to have some venture capital backing to even facilitate an initial public offering.

Conclusion

Raising venture capital can be a critical step in contributing to the growth, sustainability, and the success of your business. Knowing when to raise venture capital will depend on your goals as a founder as well as the nature of your startup, but the five considerations discussed above should be helpful in determining if now is the right time for your startup to raise venture capital.  Regardless of when you choose to raise your next round of financing, it is always important to vet your investors because once they own the shares, there are few ways you can force them to sell (if any). You should also try not to raise more capital than you need because it will cause extra dilution to you, and so you should try to earmark the needs and uses of potential investments prior to closing. Taking these considerations into account should help you to answer the question of when is a good time to raise venture capital for your startup.

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