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Building a company is no a piece of cake. A hard and testing journey, it is mired with pitfalls along the way.
We touch upon a few in this piece, more relevant to when you’re raising capital and those that have an impact when you are raising capital.
Not Maintaining Proper Paperwork and Clean Accounts
Whether your company is based on an existing, in use business model, or is a disruptively innovative model in it’s own right, the law of the land stands equally applicable.
You need to abide by the rules and regulations that exist within the legal framework, and ensure you have the right compliances in place. The smallest of lapses can have major impact; right from missing key one time requirements – having the right HR policies in place, to repeat requirements – internal audits, filing of taxes, MCA filings, etc.
It is always cheaper, less time consuming and better to get these things done early and on time, than having to deal with them retrospectively or only once they become an issue. A recent example of this was when Enforcement Directorate found a FEMA violation with Flipkart, penalties of which could have gone up to INR 1400 Cr.
Further, the threat of being on the wrong side of the law isn’t the sole reason why proper paperwork and cleaner accounting is recommended. Investors appreciate a company that has its paperwork and compliances in place, with transparent accounting. They find it easy to trust the company and management and are far likelier to invest in it as well.
Not Tracking & Maintaining Your Cap Table
Shareholding structures of a company can get quite tedious – with ESOps being granted to employees at different periods, new investors coming in at every rounds, the occasionally seen convertible debt etc. The cap table is a very crucial tool that helps maintain clarity on this bound-to-get-tedious yet critical aspect of your company.
It’s important, near critical, to maintain and track a clean and forward-looking cap table.
Ideally, you as founders want to continue to own a sizeable chunk of your company even after multiple rounds of funding and dilution. Apart from financial implications, this ensures you have enough say in the direction your company is taking.
Related Article: The Ultimate Guide To Raising Venture Debt Funding For Startups
Further, you also need to ensure you have adequate shares to dilute for new investors for subsequent rounds of fund raising.
Not Keeping Adequate Equity for ESOPS and Stock Options
A good team is a bigger asset than all the VC money you can get. If your team believes in your idea and vision and feel a like they’re a part of it, they’re much more likely to stay the course with you and help you build a world-class company.
Giving the team equity in the form of early stage equity or stock options is a great way to reward the team for their faith in you and the company. As a side advantage you end up building ownership and a sense of responsibility too.
The redbus fiasco is an example of how not to treat employees and the team. It demonstrates how shortchanging (even accidentally) your employees and team their due share can damage the reputation and value of the company and founders.
Over-sharing Information with VCs
Entrepreneurs need to share a lot of detail on their idea and their company with potential investors. While this is definitely needed, to explain, demonstrate and convince them of the value of your company, it is advisable to exercise caution too. Occasionally, entrepreneurs find themselves cornered and pushed into revealing trade secrets and the ‘magic potion’ to investors, only to find that they were never interested.
What makes this worse is that investors sometimes end up sharing these details with competitors or their portfolio companies, which obviously doesn’t help you AT all!
It’s obviously necessary to share a lot about your company with them, but its wise to recognise that you don’t need to share all details with someone who isn’t fully on board, yet.
Exercise due caution.
Raising Seed Capital Too Early
One of the biggest mistakes is raising capital too early in the growth of the company.
This can present these key problems:
a. If a first-time fund-raise is too early, you typically don’t get a fair valuation; you are left with no other option but giving out too much of equity.
This never seems like a problem at the time, but in due course, you could be left with very minor stake in a company you’ve built.
b. Funds invested never come cheap – there is always immense pressure to demonstrate the growth needed to get to the next fund-raise. Raise capital too early, and you might need to start firefighting before you’ve built a solid core. Focus on growing faster and being in an expansion mode, without the right product market fit can be catastrophic for a company.
Raising Rapid Successive Rounds of Capital
With rapid successive rounds of funding – the valuation typically gets boosted artificially.
Several people believe, with some merit, that a high valuation isn’t quite a problem as it helps the company from a PR and marketing standpoint ordinarily not a problem – this artificially high valuation poses two problems.
Firstly, it makes your company an inviable acquisition target. You’ll drive away any potential suitors without them even approaching you for the first coffee.
Acquisition possibilities aside, a high valuation only increases the pressure to get an *even* higher valuation for the next round of fund raising. God forbid you don’t quite manage this pressure very well, and have to raise at a lower valuation – this down round will do far more damage than the hype from the successive rounds of funding did good.
Raise capital when you have good reason to, when it makes business sense, when you need to and are ready to.
These are but a few examples of what you could do wrong or what could go wrong, around the time you’re raising funds. Do you agree? Any examples you know of something like this happening?
Do you have any other potentially severe gaffes to add to the list?