By Bianca Dellepiane (LION) CrowdFundBeat Guest Editor,
We all know not to raise capital unless it is strictly necessary. But, do you know what could happen if you need money and you go for the wrong funding round?
Let’s start with a brief description of the different rounds of funding available to a startup:
At the beginning, startup founders who cannot bootstrap, ask for capital to the fondly called “friends, family and fools”.
According to the crowdfunding platform Fundable, friends and family are the major funding source for all entrepreneurs. Last year they invested on average$23,000 per startup for a total of over $60 billion in new ventures.
Successful serial entrepreneur JAY ADELSON in this video, clearly explains the other “rounds” of funding. A few things may be different since this video was filmed a couple of years ago, but the essential information remains the same.
So, could an entrepreneur kill its venture by skipping the Seed round and jumping to an A round?
Yes, it is a possibility and there are several reasons why, in terms of strategy these are the most relevant three:
- THE “SMART MONEY” EFFECT
When a startup is at an early stage, raising a Seed round, which is usually formed by a large number of participants, gives it access to a broad network of mentors who can be very useful for a small, inexperienced and under-staffed company. On the other hand, A rounds are more limited in the number of participating investors and, therefore, in the hands-on help that can be provided to the startup.
- THE DANGER OF PITCHING TOO EARLY
When entrepreneurs raise Seed money they are judged mostly on their vision while, as soon as they accept Series A capital, demands switch to data showing traction, growth, potential. The real danger with pitching earlier than necessary to Series A investors is that the company probably has not hit the right milestones yet, and it does not have a good fundraising strategy. After raising aSeed round, a startup can work on demonstrating traction (customer acceptance, virality, revenue, engagement, etc.) so that it will be more likely to have a larger number of Series A investors to choose from and, as a result, a higher probability of finding the best suited one.
- THE BOARD SEAT ISSUE
There is no legal requirement for a startup to give any investor a board seat. However, professional VC firm usually make their investment contingent on a board seat.
As Steve Blanks (the man who launched the Lean Startup movement) puts it: “At the end of the day your board is not your friend. You may like them and they might like you, but they have a fiduciary duty to the shareholders, not the founders. (And they have a fiduciary responsibility to their own limited partners.) That means the board is your boss, and they have an obligation to optimize results for the company. You may be the ex-employees one day if they think you’re holding the company back.”
Therefore going directly to Series A means losing a lot of flexibility in pursuing one’s vision. If this happens too early on, it can result in confusion, frustration, loss of direction and leadership and ultimately even in the death of the startup.
In fact, listening to the stories of failed “startuppers”, many of them blame their failure on this early loss of control and divergent views between them and the investor on the Board.
In conclusion, do not rush through the funding stages and plan your fundraising strategy carefully in order to increase your chances of success.