“We should be raising a $6 million round, not $12 million,” “Randy”, my co-founder, said to me. In fact, Randy was so pissed at the terms of our funding that he was threatening to quit.
“Let’s meet, so I can walk you through why we are better off with the larger amount of funding,” I said. So we arranged to meet Thursday for lunch.
I developed a spreadsheet in preparation for our meeting, so Randy could see why we were better off taking more money now instead of waiting. My goal wasn’t to trick Randy, but to educate Randy.
Randy seemed in disbelief as I showed him the various examples. Randy had never bothered to work through the math.
If you can skip a round of funding, you should.
The increase in the number of early stage funding rounds are designed to reduce investor risk. If the sequence is an angel round of ~$200,000, followed by a Series A of $2 million, that is then followed by a Series B of $10 million, you will be diluted at three instances.
If you assume 20% dilution for each round of funding, you will be diluted to 51.2% (0.8 x0.8 x 0.8) ownership by time of your Series B. That’s a lot of dilution.
But if you can find a way to skip one of those early rounds and get enough traction to get to a larger funding, then you will end up with more of the company. That’s in essence what we did.
You should figure out how much money you need to get to cash flow positive.
But round skipping has nothing to do with knowing how much funding you need.
My goodness, don’t you want to know how much money it’s going to take to get to cash flow positive? It’s even more important to know this number if you’re bootstrapping because you’re running on a very limited amount of funds.
Your initial estimate will probably be wrong. In all likelihood, you will estimate that it will take less money than it will in reality to get to cash flow positive.
Let’s say you estimate when you start your company you need $20 million to get to cash flow positive. It’s doubtful that an investor is going to give you all $20 million.
So you do your best job of estimating how much money you need to run the company for the next 18 to 24 months. And you determine what major milestones you are going to hit during that time.
Now you know how much money you want to raise for your next round.
Don’t expect your co-founders to understand how fundraising works.
One of the things that blew my mind about Randy was, despite his years of experience, he didn’t understand just how challenging it was to raise funding. One of the most obvious things that Randy didn't get was it takes an investor just as long to decide to give you $6 million as it does $12 million. And, despite my walking him through the process, he didn’t want to listen to me.
Sometimes it’s better to have another voice tell the same story. So, I set up a meeting with Marcia, our attorney who’d been through dozens of fundings, to set him straight. Marcia looked at Randy and said, ““Are you kidding? Raising $12 million in this environment (It was during the Great Recession) is fantastic! You guys did great!”
Randy said without missing a beat, “We know what we are doing! Thank you for confirming this for us Marcia.”
And that was that.