Category: Entrepreneurship

Most startups should not raise money. Some exceptions include when it’s a winner take all market (like eBay), winner take most with a huge valuation boost (like Salesforce.com), or very capital intensive (like a hardware business). In this context “raise money” means the traditional large sums of money over multiple rounds approach. There’s another  approach that isn’t talked about as frequently: raising limited money to get key people formally involved.

By raising limited money you might sell 2 – 10% of the business to get key people participating instead of the traditional 20 – 40% (usually 30%) per round, not because you need the money but because you want them formally involved. You might say you could do that through board seats or advisors — you could, but it’s better if they have some skin in the game through a formal investment as well as the board/advisor participation.

The next time you want to get a person involved in the business for a long time, and you’re not raising money, consider raising money from them as a way to align interests and formalize the relationship.

What else? What are your thoughts on raising limited money to get key people formally involved?

After the post last week outlining an example value multiplier of 5 to raise VC money, an entrepreneur pointed out to me that some startups choose a middle ground between bootstrapping and raising institutional money: exclusively raising angel money. Comparing angel investors to VCs is relatively straightforward but there isn’t much talk about startups that only raise money from angels.

Only raising money from angels would be considered for a more capital-light business with the idea that there might be three rounds over five years raising amounts more modest than from VCs (e.g. $500k, $750k, and then $1 million for a total of $2.25 million). By raising money from angels it’s likely that there wouldn’t be the typical 1x participating preferred liquidity preference and that the angels wouldn’t require selling roughly 1/3rd of the company for each round (the 10-20% range would be more likely).

Let’s look at the math from purely a co-founder’s financial return for only raising angel money vs bootstrapping:

• As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
• At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
• As a co-founder that owns 40% of the business, assume you raise three rounds of angel financing (roughly one every 18 months). Assume angels buy approximately 15% of the business with each round of financing and assume the option pool grows by 5% (less hiring with less money), so multiply the ownership stake by .8 (representing the amount sold to the angels and the amount for the new option pool). Here’s the math: .4*.8*.8*.8 which equals 20.5%.
• Assume everything else is equal, which it isn’t, the value multiplier to raise angel money is 2. That is, it makes financial sense to raise angel money if the business will be significantly greater than 2 times more valuable in five years.
• A quick example: if you can build a company worth $10 million with no angels, the same company would have to be worth $20 million for the personal gain to be financially equivalent.

Raising angel money, depending on the terms, is likely to be slightly more entrepreneur-friendly than institutional money, but still requires the full commitment of a board and other fiduciary responsibilities.

What else? What are your thoughts on the value multiplier to only raise angel money?

I know some people that focus on minimizing the potential downside of an initiative, project, idea, etc. It isn’t that they have negative personalities, it’s that they worry about what could go wrong as part of their core being. They can’t turn it off, no matter how hard they try.

I know some people that focus on maximizing the potential upside of an initiative, project, idea, etc. It isn’t that they are ignorant of the challenges, it’s that they focus on the potential and inherently have blinders on to all the nuances. They often hate the details.

The world needs all types of people. Startups often do well having both types of people on the co-founding team, with a healthy give and take relationship. Someone needs to think big and maximize the upside while someone else needs to counterbalance and look for ways to minimize the downside. Dreamers and worriers go well together.

What else? What are your thoughts on maximizing the upside and minimizing the downside?