November 10th, 2021 | By: Wil Schroter
The most expensive time to raise capital is when we're most vulnerable.
This paradox is the heart and soul of where we get leveraged as Founders, particularly when we're giving up valuable equity. What we need to do in those vulnerable moments is step back and ask ourselves "Is this the best possible time to take on dilution or can we find a way forward that costs us less later?"
If we've never built a startup before, we may not even realize how important this question is. For those of us that have, we're hyper-aware of how badly we get beat up in our previous startup by not being more mindful of protecting ourselves when we were most vulnerable.
Our goal then should be identifying our moments of vulnerability and crafting a more viable path toward minimizing the cost.
More often than not, we're raising capital because we want to accelerate time. Whether we want to hire some more developers, increase marketing spend, or just have enough cash to quit our day jobs, we're trying to speed something up.
We justify that acceleration by saying things like "Well if I don't raise this money the product will never launch!" or "If I don't capture this market my competition will!" and there is some truth to that, but far less than we tend to imagine.
Our approach should be "Raising money is our last resort at this stage because it will be preposterously expensive compared to when we need it later — so what can we do to avoid raising money?" In case we forget in this moment, the majority of businesses don't raise professional capital in their formative years, so let's not pretend it's "necessary" and call it what it is "opportunistic."
While time can be expensive, Co-Founders are most certainly expensive. Think about the relative cost of adding a Co-Founder. At the time we think "Well I don't want to do this alone! Having a Co-Founder would make this work much easier, divide the labor, and spread out some of my startup costs!" And all of that is true, but it overlooks one very important thing - the cost of that help.
Often, we decide to split out equity 50/50 because in our minds it's "free" and "fair" — except when we start to play out a little math. Imagine we were to go it alone for another year, and that point had a basic version of the product, a few early customers, and some investors interested in our deal. Would we still be looking to give an equal share to someone else? Probably not.
What we're saying, then, is that we're willing to make the single most expensive equity decision we would ever make simply because we made it at the time we're most vulnerable. Our vulnerability, of not wanting to "go it alone for the next year," will cost us more than any other equity raise or company expense we'll make for the rest of our lives. In many cases, we would be better served to take the idea as far as we can, recognizing that every additional step we make could yield us a lifetime of more equity.
Raising capital too early is another sign of exploiting our own vulnerability, especially if we spend that money on things that could have been done without it. Imagine an investor that puts in $50k to our super early-stage startup. At the time it feels like all the money in the world (because we have zero) but holy cow will we likely regret it.
In the startup world, even at its most efficient, $50k doesn't get us very far. It certainly doesn't sustain salaries, it can't be used to develop a meaningful marketing campaign, and it's almost impossible to create a return on it. Instead, it usually evaporates into a tiny retainer for a few contractors, some legal fees, and that one Google campaign that we tried and it didn't work out.
The problem isn't the $50k — it's when we took it. An early $50k can cost us as much as 5-10% of our company, which will be forever a meaningful chunk, but because we took the money so early, what we'll get for it will almost certainly not be meaningful long term. When we take the money is more important than how much we take.
In our formative years, it's incredibly prudent to recognize how exponentially expensive our equity decisions are and do everything in our power to reduce our vulnerability, take our time, and hold on to that crazy valuable stock.
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Wil Schroter is the Founder + CEO @ Startups.com, a startup platform that includes Bizplan, Clarity, Fundable, Launchrock, and Zirtual. He started his first company at age 19 which grew to over $700 million in billings within 5 years (despite his involvement). After that he launched 8 more companies, the last 3 venture backed, to refine his learning of what not to do. He's a seasoned expert at starting companies and a total amateur at everything else.