How much investment does a start-up need and when? Much is said about raising too much money early on. Founders should be mindful of giving away too much of their company whilst its valuation is relatively low. Start up veterans also warn founders that raising too much can result in using cash to cover up product market fit challenges and generally blowing more cash then planned because it’s there. Whilst these cautions are valid, the consequences of not raising enough can be far more detrimental.
A text-book investment round requires a start-up to outline what they want to achieve with the money they’re raising, whether that be product market fit, customer acquisition, scale or something else. The team should carefully put together a roadmap of how this will be achieved and the money required to make it happen. If things go to plan, they get their money, deliver their results and it’s on to the next round of investment.
But, what happens when a start-up pivots or under-estimates the costs required to achieve those goals? Many startups find themselves in proverbial “no man’s land” having spent (or knowing they will spend) all their money without delivering the minimum goals required to justify the next round of investment.
This position doesn’t bode well for a start up. Savvy investors will want to dig in to the detail to understand why the goals were not met and if this is a hiccup or an inherent problem with the business. The start-up would have outgrown the valuation it raised its last round at but will almost certainly not raise further money at its intended next-round valuation. And so founders begin an awkward dance with investors that can very easily turn into a downward spiral.
The ideal scenario for start-ups is that existing investors inject more money at a fair pro-rata valuation that gives the business enough runway to deliver on its goals and make it to the next round. What that valuation looks like is heavily dependant on how supportive existing investors are as founders lose much of their negotiating power when they run out of runway. Tough investors will push for as low a valuation as possible (but rarely lower then the last round) and in many cases, founders will just have to grin and bear it.
If existing investor are not in a position to offer follow on investment or even worse, explicitly decide that they don’t want to invest even when they have the means to do so then founders need to be mindful of the downward spiral they’re about to enter. A vote of no-confidence by investors and/or a shortening runway will kill a start-up in its tracks or turn it in to “the walking dead”, moving forward by any means possible even though there’s very little chance the lifeline needed will be thrown.
It’s imperative a start-up ensures they have enough money to see them through to the next round. Raising too much is a far more recoverable problem to have then raising too little and being stuck in “no man’s land”.