VC and Angel funding - How much is too much?

Marc Andreessen has a blog post about raising Venture Capital money, and the dangers of raising too little, or too much money. Marc believes you should raise as much money as you can, and then talk and act as if you raised too little. Good advice.

I have found significant differences in raising money from VCs versus Angels. Raising money typically falls into distinct stages.

Seed Stage -  Seed Stage is "idea stage" meaning pre-revenue, pre-product, and many times even pre-demo. Friends and Family normally fund the Seed Stage. Some Angels will jump in here but only if they know you, or the business, very well.

Startup Stage - At Startup Stage you have a demonstrable product, some beta users, and maybe even a little revenue. The product is not complete, the revenue model is untested, and the team is in the embryonic stage. Angels will jump in at this stage and fund between $500K and $2M. They may give you the money in several installments based on meeting milestones like shipping V1.0, converting some number of beta users into customers, or hiring your first sales person. Some VCs will do Startup Stage funding but typically only if they know you from a prior company, or the VC knows the business segment from a prior life.

First Round Funding - Most VCs want to get involved when the company has a product, a significant number of users, early adopter customers, and a proven revenue model. They like to be the first "institutional" money in the deal, and dictate the terms of the Series A investment. They want the Friends & Family and Angels to hold convertible notes with little or no conversion preferences or warrants. VCs like to invest $2M to $10M in the first round.

How much should you raise, and who should you raise it from? It really depends on the stage of your company described above. This is the single most important thing to remember when raising money, always raise as much money as you can at each stage. You will never look more attractive to investors than you do right now...regardless of stage. Huh? What do you mean? I mean, don't try to raise Seed Stage money twice. You will never look more attractive to F&F investors than you do right now. Don't try to raise Angel money in two rounds. Raise as much as you can from Angels in one round at that stage.

Raising money is very time consuming, and sometimes depressing. It takes precious time away from building your business. Put the time in to raise all the money you will need to get to the next stage, and then get back to work.

How much is too much? Yes, you can raise too much. But take Marc Andreessen's advice; raise too much and then think, talk, and act, like you raised too little. Many startups fail because they raised too much money and start acting like they have it made. They don't. I once worked for a startup that raised so much money they were making charitable donations before they were even cash flow positive. Crazy! Here are Marc's points on the danger of raising too much money;

• Dilution - raising too much money causes equity dilution at low valuation points.
• Liquidation Preferences - these preferences can significantly raise the price necessary for a profitable exit via M&A or IPO.
• Cultural Erosion - Too much money makes a startup lose that hungry attitude. As Marc says "a culture of complacency, laziness, and arrogance."
• Hiring too many people - It is easy to hire too many people when you are sitting on a pile of cash. Until you are cash flow positive the CEO should personally justify every single hire.

How much is too little? The simple answer is if you need to raise money again before you reach the next funding stage...you have raised too little. Don't stop fund raising until you have reached your goal. Accept more money over your goal if it is there at the same terms and conditions. Don't worry about giving up too much equity at an early stage. If the company is successful you will be very rich. If it isn't successful then holding 60% versus 30% won't matter anyway.

Most companies fail because they raised too little money...not because they raised too much. Of course most companies fail for reasons that have nothing to do with money. Just buy yourself some "insurance" and "run way" by raising plenty of money from all your sources at each stage.

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Comments

[Chris Ye]

Great follow up to Marc's post Don. When raising money at each stage, generally how much equity will each of these different investors expect or require? I know the answer to this question depends on the particular startup but I would like to get a general sense.

Thanks.

[DonDodge]

Chris, Every situation is different but the funding tends to fall into ranges. Friends & Family can usually raise between $100K and $300K and usually take a convertible note, so no loss of equity.

Angels will raise between $500K and $2M. They often take a convertible note too, but with warrants for additional shares or a discount on Series A shares. Again, no loss of equity, at least until they convert at Series A.

VCs want to put in $2M to $8M and usually want 50% of the company. So they will give you a pre-money value equal to the amount you raise. Sounds strange, but it usually works out that if you are raising $2M the VCs will value your company at $2M pre-money, and $4M post money so they end up with 50% of the stock. If you are raising $5M they will typically value your company at $5M pre-money. The theory is that if they trust you and your business plan enough to give you $5M, then you have probably created something that is already worth $5M.

The second and third rounds of funding take additional shares of equity so that the founders usually end up with 10% to 20%, all the other employees end up with about 15%, and the VCs end up with about 60% to 75%.

Again, every situation is different. The pre-money valuation is set by the VCs and it is an imprecise art. Competition between VCs might move the valuation up a little, but not much. At least you will feel more comfortable knowing that several VCs agreed on about the same valuation.

Good luck.