The initial funding stages for a startup can be exciting, frustrating and a lot of hard work -- all in equal measure. But what entrepreneurs need to keep in mind is that what happens during those early stages can have a big impact on your company’s ability to mature and secure additional funding further down the road. So it is imperative you set your startup for success from the beginning.
With that in mind, here are five common mistakes I see entrepreneurs get caught up in during the early funding rounds. Learning how to avoid these can make your later rounds of funding go much more smoothly.
1. Raising too much money. It’s natural for first-time entrepreneurs to be hyper-focused on getting money in the bank and really happy when it gets there. But every new company CEO must remember that an initial funding round is just the first step in a long journey towards building a large, successful company. Raising too much money in the early seed or angel phase, can create a difficult funding dynamic later on.
The reason being, if you’ve raised a lot of money, and then spent it, the dollar amounts it took you to reach a certain point may raise questions about your leadership, product-market fit, and/or your economic model. Additionally, the more money you raise, there will be more preferred stock in relation to common stock, which might hurt a future investor’s returns (as well as impair the value of common stock held by founders and management).
2. Raising at too high of a valuation. More isn’t always better. A high valuation may seem a good route to take early on, but you could be setting yourself up for problems later. High valuations early on may set expectations for ensuing funding rounds which may be difficult to reach. You might not have grown into your valuation yet and may find it difficult to top your initial valuation, which could result in the next round being flat or a down round. There’s also the question of managing early investors’ expectations. Seed and angel investors will likely expect an appreciation of their money, while later investors could think the company’s value is inflated.
As it is, during the early seed/angel stages, you lack the proof points to confidently claim you have the ability to spend efficiently, which can also raise concerns about over-valuation. Rather than shoot for the moon, here’s a better idea: Raise smaller amounts and perform rapid testing for proof of concept.
Keep in mind, the goal is to bring in the right investors at the right time, not the highest valuation right away.
3. Not being selective about who you want investing in your business. My general rule is the fewer investors, the better. Managing a large cap table (a record of all major shareholders) can be troublesome when everyone may have different time horizons and expectations. Do you really want to deal with a cap table with 50 shareholders, 50 levels of expectations and 50 forms of communications?
Institutional investors can be great. They can also be high maintenance. But if you understand what you’re getting into, they can also be very helpful. Alternatively, small or individual investors may be more agile, but can require time consuming hand-holding.
4. Choosing the wrong angel route. The best angel group is a small one, with each individual offering a big check. To avoid a situation where you’re spending too much time answering to too many different stakeholders, establish one point person who has proxy for that shareholder base.
It’s also a good idea to choose people who have experience as angel investors and who have invested in your industry before. You want to find people who can be helpful and understand that the process will be a slog and a lot of work.
5. Not feeling comfortable fully leveraging your investors. The early funding stages are the time when you should learn to lean on your investors. Their purpose isn’t simply to throw money at you but also to help you make your company as successful as possible. This means asking them to open their rolodexes, make connections and introductions and share their experiences.
The key when “hunting” money is to set expectations early. If all you’re looking for is someone with a checkbook, look for a person who’s willing to invest with little involvement. But if you want someone who can and will be more involved, let them know what you’re looking for from them up front.
Don’t be scared of telling them, “I’m excited about bringing you onboard. I know you have these great contacts, and I’d love it if you would connect us.”
When you’re building a business, don’t get obsessed with funding milestones. Your focus should be on building a great company, your long-term vision and creating value. By keeping the bigger picture in mind from the start, you’ll be in a better place to avoid dealing with the consequences and fallout of hasty early-stage decisions later on, which will make for a better-balanced company and better peace of mind for you.