For a lot of startups, raising VC capital is essential. They can’t grow fast enough, attract the right talent and spend much on marketing and sales without raising money. However, there’s a certain type of startups that should consider not raising at all, especially post-seed stage. If you’re a startup with a way to profitability, do you really need to raise money?
I think in a lot of cases raising seed stage money actually makes sense for 2 reasons:
- It provides you with a cushion that can be incredibly important at the beginning not only financially, but also mentally and emotionally.
- It gives you some level of credibility, which is especially important if you sell to large enterprises. These large prospects want to make sure you won’t go out of business next month after signing that 3-year deal with them.
However, after the Seed stage, the benefits of raising a subsequent round are often outweighed by several disadvantages:
- If you raise more money, a successful exit becomes MUCH harder. This is something that people rarely talk about. Depending on the fund of your investors, they will require at least a 3X (most commonly a 5-10X) return on their investment within a year. I’ve never seen a deal – Series A or later – where investors did not have veto power to block an acquisition. There are many stories published and even more unpublished where the deal could work great for founders and employees, but VCs block it. Only a tiny fraction of startups ever make it to the IPO, and with all the recent IPO delays, this factor becomes even more important. Most successful exits are acquisitions, so it’s wise to plan for it.
- Liquidation preference. 99.9% of all VC-backed deals have at least 1X liquidation preference. What it means that VCs will get at least all their money back before anybody else. I personally know a lot of startups that were sold and the acquisition was celebrated in media, but because of the liquidation preference, none of the employees got anything from the deal.
- Raising money almost always means losing control. You can pretty easily get away without giving up a board seat during the Seed round, but it’s close to impossible in Series A or after. In a lot of cases the majority of the board belongs to investors after the Series A is closed. Do you want to control your own destiny or do you want your investors to do it?
- Raising money is not free. You sell your ‘blood, sweat and tears’ equity. VCs will often require a 20% — or in some cases even a 30% — minimal equity stake during Series A. Are you willing to give up this much?
- Raising money is a huge time suck. Any founder who has been through this process can attest to this. Series Seed usually takes a few weeks to complete. Series A? At least a few months. Do you want to spend this time trying to raise money or would you rather spend it building the best possible product/service and making sure your customers are happy?
- Raising money kills your creativity. When you raise money, your investors assume you’re going to spend it. When you MUST spend money, in a lot of cases you don’t spend it wisely. On the other hand, if you have certain constraints, you are always able to find creative, outside-of-the-box ways to generate the best outcome by spending as little as possible.
Of course, there can be great benefits to raising additional capital from investors. For example, companies can grow much faster with more money or beat the competition more swiftly and win the market. In 99% of cases, however, it does not happen. Raising money is over-celebrated, very distracting and makes you lose focus on what really matters: your customers. Survivorship bias dominates the VC industry. Very rarely do you read articles about companies raising a lot of money and not being able to execute on it. They die slowly and unnoticed.
There are a lot of companies that were able to build great businesses without taking any outside money. Atlassian is a great example of how you can build a multi-billion dollar company without raising anything. If companies like Atlassian can do it, why can’t you?