Can you raise too much cash?

Sahill MerchantThere is plenty of advice to be found on how to raise capital, who to get it from, what to use it on, and even how to structure it.

 

Yet, one of the first questions that entrepreneurs face is “how much capital should I look to raise?”

 

You look pretty stupid if you front up to a potential investor meeting without a prepared answer to, “How much are you looking to raise?”

 

I am yet to read a successful information memorandum that hasn’t clearly articulated what an investment in the company will buy the investor in terms of percentage share.

 

However, it is not an easy question to answer.

 

In the ideal world, the entrepreneur would raise just enough money to prove their concept, then, at a much higher valuation, again raise just enough money to get to the next stage of expansion, and then raise again.

 

In this way, you give away as few shares as you possibly can, since earlier investment rounds typically cost you more of your company.

 

The problem is that we don’t live in an ideal world. There are two important things to remember here:

 

  • Capital raising takes time: it is an all encompassing process that will at the very least distract the founders from getting on with the job at hand. More likely, it will suck out your soul.
  • Shit happens: while we all like to think we have mapped out the path to success, the reality is that we cannot foresee how things will eventuate and what we thought was the right amount of money might, in fact, prove not enough, or more than required.

 

What makes life even more difficult is that the amount you ask for will impact whether you get anything at all.

 

Ask for too much in the eyes of the investor, and they will interpret it as you not understanding the principles of “the lean start-up” and as being grandiose and wasteful.

 

Ask for not enough and they will think you are not realistic in terms of what it will take, and will worry about their investment being diluted down the track when you go back to the market cap in hand with an only half proven concept.

 

In many ways, you are damned if you do and damned if you don’t.

 

Two important lessons – you are wrong about your projections and don’t be greedy.

 

I tell start-ups that when planning for capital, they should halve their top line projections and double the timeframe to achieve that reduced revenue target.

 

While costs can often be accurately forecast, you will be wrong with your revenue predictions. Accept it, live with it, and then raise capital with that in mind.

 

This doesn’t mean that those are the numbers you should present to investors (who will inevitably halve whatever you provide them with anyway), but contingency capital is never a bad thing.

 

It is easier to convince an investor that a capital round has been over-subscribed and that you are going to take the higher amount to allow flexibility, than it is to admit that you haven’t secured the interest that you were looking for.

 

Taking as much cash as is on offer may mean that you give away more shares early on at a more expensive rate.

 

Don’t be greedy! If your business succeeds, you will be living the good life anyway.

 

Do a simple expected value calculation (the $ value represented by success x the probability of success), and you will see that the probability of success with additional capital is more elastic (changes more rapidly) than the $ value represented by a few more or less shares.

 

Cash is like oxygen for a growing company. If starting up a business is like diving to the depths of a vast ocean, then I would rather have a larger oxygen tank on my back, even if it means paying a slightly higher price for the diving experience.

 

You will still get lots out of the dive even if you paid a little more for it, but running out of air and suffocating while out in the deep blue is one of the worst ways to die.

 

Sahil Merchant founded Mag Nation, a retail chain specialising in mainstream and niche magazines, in 2005. Prior to this, he worked for management consultancy McKinsey & Company and spent a year working at the World Economic Forum. He recently exited Mag Nation and now advises companies on how to embed ‘consumer-centricity’ into the way they work. He writes about entrepreneurship here and Tweets here.

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