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I always hear Jason Calacanis say that if there is a chance to take an extra round of funding, the founders should do this. Is that really true? Does it increase valuation somehow? For example, if I take a dollar in investment, then is the start-up valuation increased by 2 dollars? |
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Make sure you check out Fred Wilson (famous VC, funded Twitter)'s superb advice on the matter in this post of his, which addresses your main question head-on. It starts with this advice:
http://www.avc.com/a_vc/2011/01/when-they-are-throwing-money-at-you.html Don't skip the comments, there's a great discussion below his post that follows up on his points including touching on your question about valuations. |
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To illustrate pre-money and post-money valuations I will use a (very hypothetical) example: Let's say your startup is worth 100 USD. You compare it against other similar startups, you look at the sales numbers, etc. An investor does the same. After mutual negotiation, you arrive at a valuation of 100 USD, a.k.a. a pre-money valuation of 100 USD. The investor then adds 40 USD. At the time of investment, one dollar invested adds one dollar to the balance sheet. Thus right after this investment, the post-money valuation is 100 + 40 = 140 USD.
The rationale is that startups die from running out of money. Thus the thinking above goes: If you can get more money, you should do so at (almost) any cost, because it provides you more "runway" (more time to figure out a businessmodel that works, or scale an existing business model up). The downside is of course that the founders get more diluted, i.e. their ownership of the startup expressed as a percentage is reduced -- and most important, they may have to give board seats, voting power etc to the investors. |
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If your business owns a dollar it didn't have before, it's worth a dollar more. But you aren't worth any more, because that dollar bought equity: in theory, the value of your holding is just what it was before. So there are three key factors on the side of taking in money. First, in the world of startups, value is much less cut-and-dried than in established businesses, where it's essentially a function of business shape and performance. Assuming that you only take in money that recognises increasing value, this 'evidences' value growth. And yes, this is also how bubbles happen. But your start-up will create strong value, right? Second, more cash means more choices. You can use that cash to run on a little longer - so it's less likely you'll run out of cash en route to monetization. Or you can change some compromises you were making that preserved cash but cost time. Third, more investors give you more connections. And, if you've qualified your investors carefully, this will give you better access to your market - or whatever else it is you know you do/will need. There can be downsides too, of course. But that wasn't your question. |
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Two key questions:
If you have a realistic use for the money that will drive revenue and profit faster and the terms do not cause punitive dilution for your existing investors, then yes, take the money. On the other hand, if you're in a positive cash flow environment and you are already growing as fast as you can or the terms are negative for your existing investors and you - then no, don't take the money. Adding new equity capital doesn't increase your valuation per se - it's what you do with the incremental capital to drive incremental value that increases the valuation. |
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