Share what you know with millions of people
Focus is the best place to turn what you know into remarkable content
0
Start-up Capital: Take a large round and lose the equity or go back to seed investors/bootstrap?
I am on the advisory board of a friend's start-up and he is facing a difficult decision. He has an offer to take a significant amount of funding from a VC firm. The negative: taking that money would mean a big loss of equity. The positive: the funding would give the company the capital required to make an impact in the upcoming high season of the industry it's in. The other option is to go back to his seed investors (primarily friends and family) and ask them for a bit more money to continue operations at a slower pace but with the hope that a larger round of funding can be taken later at a better price for the founder and current investors. Thoughts/suggestions?
Events
- Dos and Don'ts of Small Business Marketing May 29 @ 11 am PT
- Lead Nurturing 202: The Next Generation May 31 @ 11 am PT
- The Tricks to Paid Media June 6 @ 11 am PT
- Display Advertising for Brand Awareness June 20 @ 11 am PT
Related Activity
2 Answers
This is a really difficult decision for an entrepreneur. One thing your friend should understand - after he takes VC, it's no longer his business - it belongs to the investors. Don't be surprised if they insist on bringing in a new CEO - especially if he's a first time entrepreneur. Your friend really needs to sit down and think about why he's built this business and what he wants out of it. Does he want to play a role in something that grows large quickly? Or does he like the satisfaction of growing it himself? Is he doing it for the money, or for some other more personally fulfilling reason?
Raising VC investment is no guarantee that the company will succeed. It's also no guarantee that he's going to get much money out of the deal if it is successful. VCs need to plan an exit, and it's a lot more important to them that they return a profit to their limited partners than making sure the founder takes away money. So they'll work in terms around liquidation preferences that could mean that if the company is sold for 10X the original investment, the founder would walk away with a tiny fraction of his perceived percentage share in the company. Example: in one deal I was part of, my 10% share was diluted down to about 3% when we took a $6M round for an $11M post money valuation. But with liquidation preferences, if the company was sold for $50MM, I would have received about $750K.
I have several friends who did quite well after they raised VC. I also know a lot of companies that raised capital and are limping along but not really very successful. I personally have not had a positive experience with VCs - but that was for a host of reasons, not all directly related to the financing.
I'd strongly recommend that your friend seek advice and legal counsel from an attorney who is seasoned and well-experienced with these kinds of transactions. He needs someone to help him assess the deal being offered and understand the outcomes around different exit scenarios.
Hi Alex,
Candyce has given a really good answer here.
I was recently asked a question about raising finance and although it doesn't completely fit with your question here, your friend may find some useful information pasted below;
QUESTION: “I am seeking start up capitol to get my business up and running. All the sources I have tried say, you cannot get this capitol unless you have a history. Do you have any suggestions on how to get start up capitol?”
ANSWER: Looking at the way you spelt “Capitol” Sherry, I’m assuming that you’re from the USA. I am unaware of quite how things may differ between the UK and the US in this regard but here are some thoughts that you may find useful.
A lot depends on the type of business and the situation however the first step is to ensure that you have a good proposition for any prospective financier. Just a few weeks ago I was speaking to a commercial lending manager for a large bank. During our discussions he mentioned that despite the current economic climate, they are approving around 80% of good applications currently.
OK… So what is a “good” application..?
1) You absolutely need to have a business plan. Without one of these you pretty much have no chance and as first impressions count, I wouldn’t suggest trying your hand without a business plan expecting that you’ll get a second shot by producing one and making another appointment!
2) You need to be able to demonstrate a knowledge of the business (or proposed business), your target market and the industry that you will be operating in.
3) The cash…. How much you need, why, how long will you need it for and what you’ll be spending it on. It is important to state quite clearly how much you actually need. For example if you ask for 100k when you actually need 150k but expect that the bank won’t go that high – the chances are that a savvy commercial lending manager will see through this, you’ll look as if you don’t have a true understanding of the finance requirements of your own business – and the answer won’t be the one you’re wanting to hear!
If you’re wanting the cash for use as working capital – ask yourself “Do I need all the money in one lump sum”? If the answer is no then you can negotiate with the lender to release it in stages provided that you meet certain pre-defined milestones. This can be a more compelling business case for the lender as their risk is reduced in this instance.
In addition;
Do you have anything that you can offer as security? This reduces the risk and makes the proposition appear more appealing.
Are you contributing any of your own funds to the venture? If so – again, this makes the proposition appear more appealing because it demonstrates your own belief in your venture in that you are prepared to put your own assets on the line.
Venture Capital – Have you approached any of these organisations? With VC’s they will want to acquire some equity in the venture in return for their cash (and may want to place someone on the board) however on the upside often they come with significant experience and contacts which can help to propel your business forward. They generally are less risk averse than the banks however their costs are higher. VC’s tend to want to keep the investment in the business for a relatively short time before harvest so will want to have a clear exit strategy agreed at the outset.
Another option is Business Angels. They are similar to VC’s however tend to want to assist new business ventures for more philanthropic reasons.
I’d also suggest locating one of the government run business support agencies in your area. They are likely to have the latest information regarding grants and other funding that may be available and may also be able to assist with developing a business plan and marketing strategy if you do not already have these in place.
Good luck!
Andy.
Answer This Question