Capital. You need it. But raising too little, too late, or from the wrong source can cause your enterprise to choke. The middle of rapid acceleration is a terrible moment to find yourself running out of fuel!
Over the past two decades, in addition to my own journey to raise capital, I have reviewed hundreds of business plans, sat in on countless board meetings, and interviewed scores of entrepreneurs on behalf of their investors. I’ve learned that by being smart about how much you raise, when you raise it, and from whom you accept it are critical factors in successfully scaling your fledgling business.
In my experience, most entrepreneurs plan to raise enough capital for 12-18 months. But given the challenging economic climate in recent years, you should plan for a longer runway. Raising capital is distracting and you need a sufficient amount to carry you for 18-24 months without the need to keep returning to the well.
Failure to have access to adequate capital can cause performance to suffer. Investors are naturally disturbed by investments that miss their milestones in financial performance. But worse, if you don’t have the working capital on hand to execute your plan, invest in your development, and hit your revenue growth targets, you give direct competitors an opportunity to out-hustle you! While you struggle, you are in danger of being lapped by someone who is better able to continue raising capital and executing their plan.
When? Not so simple.
There are two schools of thought on timing of investment rounds. One opinion holds that entrepreneurs should raise the smallest amount of capital necessary to meet short-term need, so that future capital can be sought when the company is at a higher valuation.
That’s one trajectory. But the other opinion argues that there’s no time like the present to gather all the resources you can. “When the cookies are being handed out, you take as many cookies as you possibly can,” said one investor I interviewed for a recent book.
Your own sensitivity to risk, and your projected growth plans, will guide you toward the right choice for your unique business and situation. But here’s a tip—if your projections look like a hockey stick, better grab those cookies if they’re offered. More on that in a moment.
Arguably the most important factor among these three is the question of raising capital from appropriate sources, because the relationships you form early in your growth cycle will have the most impact on your future strategic relationships. Remember, you’re interviewing them to become proactive and supportive partners in the venture as much as they’re evaluating you as a viable investment option.
Your wish list for your ideal investor must include the following attributes:
- Domain expertise in your chosen niche (they have to “get it!”);
- Equipped with direct, relevant experience with financing challenges and opportunities, from past portfolio experiences (ideally, they’ve seen the movie before);
- Sufficiently interested in your vision for the company to stay in for the entire lifecycle of the growth cycle (nervous or impatient investors aren’t a lot of fun to work with); and
- Capable of putting in multiple rounds of financing if and when needed.
Building a dream team of institutional investors with these qualities early on can help entrepreneurs reach the performance results they aspire to reach.
Undercapitalization has its upside (see “Accept the Gift of Undercapitalization“). However, its downside carries such a strong undertow, you must be very careful to avoid putting your company at risk. An accurate long-range performance forecast is the best insurance you can invest in. Given what you know about your resources (financial, operational and human) can you extrapolate a realistic company position in the market 18-36 months hence? The credibility and accuracy of that position will depend on the critical assumptions and performance milestones you map out along the way. “Hockey stick growth models” (steep and quickly achieved trajectories) are rare, and therefore tend to raise doubts in savvy investors. (Which is why, if that’s your model and an investor is standing there with a check, I suggest you take the money.)
I am a big believer in pre-mortems—getting the smartest group of people you know in a room to whiteboard any proposition and shoot holes in it. Before you decide whether to raise a little or a lot for your next growth stage, figure out all the possible ways your plans could fail. Counter the risks you identify with tactical action plans, including go/no-go quality gates based on performance milestones. After the pre-mortem exercise, you will be much better prepared to assess how much, when, and from whom you should raise your next round of capital.
You are no doubt surrounded by people who are offering their opinions and personal perspectives. Filter those voices down to the wisest advisors—those who have learned the hard way how to do what you’re setting out to accomplish. Choose as your advisors individuals who have successfully raised your desired size and source of capital. From these strategic relationships, the right answers to how much, when, and from whom will become clear.
1. How much? To avoid potential undercapitalization at a critical moment, you need to raise sufficient capital for a viable runway.
2. When? Consult your advisors, because there are two views: either the smallest stake necessary to meet short-term needs, or as much as possible, as a hedge against future difficulty. Your unique business and situation will dictate which strategy is more appropriate for you.
3. From whom? Target investors who know your industry and its financial challenges, and who are likely willing and able to grow with you for the long term.