I’ve written a lot about the positives of early stage investment and there is a ton of it around. But I’ve never seen a blog about the negative effect of raising cash from professional “smart money” investors. I want to preface this with the fact that there are tons of positives as well and it shouldn’t turn you off trying. I just want to illustrate some effects I’ve seen as my time in the space.
Raising investment will take a ton longer than your planning. I’ve seen people go for 6 months with no luck and some close an investment round in weeks. It’s so hard to predict how long it will take but it’s usually a long time. It takes a lot of time to prepare the pitch deck, the financial models and rehearses the presentation. It takes time to first find, then reach out to investors. You’ll need to book meetings which will get pushed around and then spend a few hours pitching. Say you get the deal it’ll be weeks of negotiation as well.
On the whole, it will likely take months and you have to calculate the cost of that. Could you have generated 100 more customers, improved a feature set or brokered a new partnership in that time? You need to weigh up what your opportunity cost of the whole endeavor.
You’ll Get Poor Equity Terms
The less traction you have the high the risk profile of an investment deal is. If you haven’t achieved a critical mass, you’ve got no customers or growth you’re a risky investment. Investors have two choices when dealing with risk. If the risk is too high they can choose to pass on the investment, that’s the most popular choice. The second is to up the equity ask that’s factored into the deal. It’s very common for an investor to ask for between 15-30% of a company in a seed round. That can jump if you have less traction as well. A lot of people tell me they’d rather own 70% of a million dollar company than 100% of a $0 company. That logic is true to a point but you have to understand the less you own the less you have to sell to propel yourself forward later.
Wild Term Sheets Are Around
If an investor chooses to invest they’ll present you with a term sheet which summarizes the deal. It outlines all the clauses and caveats of their investment in your company. And for the most part, they can include whatever they like in them, you can sign it and take the money or not sign it and not get your cash. Clauses like non-dilution, drag along, tag along and voting rights are common. They can be good or bad things depending on the structure of the document. But at the end of the day, your hand is somewhat forced even if there are negative clauses.
Lawyers Are Expensive
You’re going to need lots of documents and general advice. Do you have a company, a shareholders agreement or a term sheet? If not you’ll need to pay up for a lawyer to create them as they are needed in most equity deals. When you’ve got a deal in front of you from an investor you’ll want your lawyers to look over it before you sign it. More lawyer cash there but it’s worth it to avoid some of those odd clauses I mentioned above. Think about what you could do in your own company with all that cash.
You’ll Have No Leverage
In summation, traction equals leverage and power, the more you have of it the more power you have to dictate the terms of your deal. High growth startups don’t even have to search for capital, a lot of them get approached by investors who are interested already. There’s a simple solution to all the things I’ve mentioned above and that’s to focus on growing your business organically. You’ll thank me later.