Monday, June 16, 2008

Cash Is More Important Than Your Mother - Mo' Money, Mo' Problems?

People often ask me:
"Paul, how much money should I take from VCs?"
This is a difficult question, but a good problem to have. If you're at the stage where VCs are offering to fund your company, that's a very good sign. At that point, you have to figure out how much money you actually want to raise. To understand this problem better, I will paint the scenario from each side of the table. First, from the VC side:
  • More. A VC might want you to take more money because they are looking to take a larger position in your company. For example, you may have asked for $2M, but that small of an investment may not be worthwhile for a lot of VCs. VCs also want to make sure they aren't underfunding businesses. Every VC wants to give their portfolio companies the opportunity to succeed. VCs are quite savvy about how much money it takes to build a great company (we see it a lot). Entrepreneurs often underestimate how much money it will take and how long the process is.
  • Less. A VC might want you to take less money because they want to minimize their exposure. Their is always a high risk that a startup goes south and all the money is lost. You may have asked for $10M, but the VC might only want to put $2M at risk in your particular industry/space/company.
Now let's look at it from the entrepreneur side of the table:
  • More. You might want to take more money for a few reasons. First, it's a big weight that is lifted off of your shoulders. Fundraising is an arduous process, that takes an inordinate amount of the CEO's time. The less often that you have to fundraise, the better. Second, more money provides more speed. Speed and the ability to throw resources at a problem immediately are very significant competitive advantages. Finally, taking more money provides stability to the business. You are more likely to hire a superstar if he is confident that your startup will be around for a few years, instead of being unsure if it will last the week.
  • Less. You might want to take less money from VCs to keep a larger share of your company. The idea here is that you take less money in the present, and then raise more later when you can demand a higher valuation.
The VC Whisperer's opinion on this? Take as much money as you can get when it is offered to you. The golden rule should be all the reason you need: companies always need twice as much time, and three times as much cash (relative to their initial expectation).

Follow the golden rule, and take every penny that's on the table. When there is lots of money in the bank, you increase your chances of success, and you eliminate a whole set of potential problems. Cash is like oxygen for a startup. Without it, you're dead. Thus, there is no point protecting ownership in something that you don't have enough money to build.

If you remember just one thing when you're running a startup, remember this: CIMITYM - Cash Is More Important Than Your Mother.


APMarshall said...

100% agreement Paul. Assuming you are reasonably comfortable on the valuation side take as much as you can get, going back to the well is neither fun nor easy!

Taylor Davidson said...

Agree as well, although I think it's unfortunate that the capital-raising process is so inefficient: creates significant transaction costs.

If transaction costs were lower, would it make sense to raise less capital at each funding point? (by lower transaction costs I mean easier, quicker, less expensive legal fees, time for meetings with VCs, and maybe even risks to entrepreneurs for VCs negotiating changes in terms each round)

Taking too much money does tend to create perverse incentives and take entrepreneurs away from managing costs effectively, but one would hope that can be fixed by focusing on using cash efficiently.

But we've seen more companies fail because they didn't have cash to survive through inevitable delays and changes in strategies than the flip side. Things change, and it's important to be prepared for the right risks.