Funding 101: When Should You Raise Money?

I recently attended the FinTech India 2016 Workshop at the invitation of Village Capital as a mentor. It’s quite exciting to participate in some of these workshops because you get a chance to hang out with clever optimistic entrepreneurs who are out to change the world. Hopefully, if the rules of chemistry apply to the real world, funds will move from investors to entrepreneurs, and the wisdom of the entrepreneur will move to the investor.

Lots of entrepreneurs are young, and this is the first time they’re running a business, which means they have a lot to learn. Mentorship is also a difficult skill to acquire, which is why the Village Capital gave the mentors a great guide, which teaches mentors what to do – and what not to do. Sometimes over-eager mentors want to run the company and that’s not in anyone’s best interests.

One of the key questions founders asked was, “When should you raise money? How much should you raise? Should it be equity; debt or a grant?”

A lot of founders raise money for the wrong reasons. Some of them do it because they happen to be in the right place at the right time. Raising money gives founders a huge ego boost – it validates the fact that someone is willing to give you money in order to grow your business, and this can be quite a heady feeling.

Also, when you read about all those founders who are getting funded, you want to get bank-rolled by a big backer as well, to show the world that you’ve arrived and are on the way to becoming a serious player.

When Is Fundraising Bad

Raising money to gratify your ego is a bad move. This can come back to haunt you because you may get stuck with a bad investor who will drive your company to the ground, because he wants to run it. Unfortunately, first-time entrepreneurs are not sophisticated enough to be able to differentiate between a good investor and a bad one

When founders talk to an investor, they do their best to please them, so that he will sign a cheque. They will tweak their business plan until the investor is happy with it.

They often end up modifying the plan based on what each investor they pitch to seems to demand, and the flavour of the season. They have very little conviction in the business model they have created. This means they often end up raising too little money, or giving away too much of their company, or getting completely sidetracked because they are following the investor’s vision rather than their own.

When Is Fundraising Good

Founders need to raise as much money as they feel the company needs. This can be hard because it’s really difficult to know what the right amount is. There is no standard formula which you can use, and you need to get comfortable with this – startups are characterised by complexity, uniqueness, ambiguity, uncertainty and volatility.

Don’t go out with a begging bowl – investors need you as much as you need them, and you need to create a win-win so you can trust and respect each other – this is a long-term relationship, not a one-night stand!

You may get diametrically opposite advice, and this confuses you even more. Some people will say, “Don’t raise money from the wrong investors,” while others tell you, “Take whatever money you get, from whoever is willing to give it, whenever you get it, because beggars can’t be choosers.”

One camp feels that you shouldn’t raise too much, otherwise you will get diluted, which others believe that you should raise more than you need to create a buffer, because you never know when winter will come and funding dries up completely. The poor founder doesn’t know whom to listen to.

The Bottom Line

The bottom line is simple – “Short-term thinking hurts in the long run.” This is true in many areas of life (for example, deciding whom to marry), and applies to startups as well. While investors may have more money, they don’t have all the answers. Lots of investors could lead you down the wrong path, especially if they’re not very sophisticated themselves. You’ve got to be careful about picking investors, and just like funders do their due diligence on you, you need to do your due diligence on them as well.

Who have they funded in the past? Are the founders whom they’ve given money to happy with them? Are they the kind of guys who give you a free hand and will help you when you need it? Or will they beat you up even more when you are down and force you to do what they think is right? Are they mentors or are they micromanagers?

What about raising debt instead of equity, so that you don’t lose control of your company? This is a good option, but most bankers want predictable revenue, and most startups don’t have tangible or reliable future cash flows, as a result of which most bankers are very reluctant to lend them money.

In my opinion, the best source of funding is your customers, so focus on delighting them. If you do this, everything else will fall into place, and investors will line up to fund you!

[This post by Dr. Aniruddha Malpani first appeared on LinkedIn and has been reproduced with permission.]

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