- Logan Burchett
3 Reasons You May Not Want to Fundraise
Perhaps you are a founder with a great idea or minimum viable product. Perhaps you are an entrepreneur with a small business that you want to scale.
You’re probably thinking about fundraising.
Many capital-backed startups grow to exponential heights. However, throwing gas on the fire does not always translate to a positive outcome for your startup.
We identified three prime scenarios where you may choose not to fundraise for your startup.
When you can generate sufficient cash through business operations Businesses like Forecastr may require a significant amount of development to even create a minimum viable product. However, many business models provide a product or service with relatively low startup costs and barrier to entry - for example a consulting company or an application that you developed independently. In these instances, if you can generate enough revenue to support daily operations and scale your business, you may be able to skip the fundraising process altogether. In fact, Forecastr generated cash through pre-sales before we even built a functional software. Although our business model ultimately required fundraising, pre-sale revenue reduced our burn rate and extended our cash runway to supplement funds acquired through investors. Some businesses may be able to pre-sell enough revenue to fund 100% of startup costs. If this revenue can carry operations until you can start generating cash in real-time, you may not need to fundraise. Even more, if your business is already cashflow positive, you may be able to survive -- and even scale -- on revenue alone. If you evaluate your finances and feel you do need cash to scale your business, weigh the risk within investor relationships before you pull the trigger. Risk-averse individuals may not want to fundraise their startups.
When you are risk-averse When investors give you money, they ultimately expect something in return. For example, if you raise $1M on a $4M pre-money valuation, you essentially give up 20% of your business. $1M (fundraise) ÷ [ $1M (fundraise) + $4M (valuation) ] = 20% Some investors exclusively seek a 10x or 20x return on their investment. That means you have to sell your company for at least $50M to satisfy investor expectations. You will likely need to invest significant cash to scale as quickly as possible, which may generate an exponential return, but also enables significant risk against that cash. On the other hand, many investors recognize that a lower exit value often translates to lower investment risk. Investors are people with highly diverse expectations for their money. Entrepreneurs must deeply understand (1) the scalability of their business and (2) investor expectations before entering that partnership. Check out our post “Don’t Make These 3 Mistakes in Front of Investors” to learn more about setting up these expectations. Even if you find investors who do not expect that 20x return, all investors expect a return on their investment. Do they expect a dividend? Do they expect you to grow and sell at a large valuation? Or a more reasonable valuation? Do they expect a percentage of cash flow? It’s up to you to determine the nitty-gritty behind those expectations before entering the relationship. Once you fundraise, you are no longer the sole owner of your business. You also need to ask yourself, am I comfortable with relinquishing ownership in return for potentially higher growth? Just as investors possess a variety of expectations for return, investors also possess a wide range of expectations on involvement in your business. Forecastr has experienced great investor relationships. Our investors largely remain hands-off, but provide excellent guidance and mentorship when needed, which creates a great fit for our business. However, we know many founders with highly strained investor relationships. Founders must thoroughly vet investors before entering a partnership for this reason. When you accept investor money, you relinquish ownership and enter a relationship where that investor is part of your team in some way. Just like hiring an employee, you both need to understand the expectations for the role each party will play, beyond the financial statement. In the same vein of investor expectations, we arrive at our final reason why you may not want to fundraise for your startup.
When the opportunity isn’t big enough We mentioned at the beginning of this article that certain business models may be able to generate enough revenue to operate and scale without fundraising. Often, lifestyle businesses aim to sustain a certain level of income without exponential growth. Many service-based businesses fall into this category. You may be able to generate plenty of cash to pay your employees and yourself a very comfortable salary, but your business model may not lend itself to raising money. For example, if you believe your revenue will top out at $1M-$2M a year, you may be able to acquire wealth, but that may not translate to a positive investor outcome. Founders with these types of businesses may feel the need to fundraise and throw cash toward sales and marketing to generate growth. However, if you do not understand the scalability of your business, those investors may expect a 10x return that you cannot deliver. Your $2M revenue may fail to satisfy expectations or even cause them to lose money on the investment. If your total addressable market simply isn’t big enough, fundraising for your startup will only lead to undue pressure on you as a founder to avoid catastrophic disappointment. Many founders aspire to scale their business to lower annual revenue targets, and be cash flow positive. In these instances, founders may prefer to follow a smoother path toward a small to midsize business without investor backing.
After reading, do you think you should fundraise for your startup? If so, you can learn more about cash-planning behind the fundraise in our article “Three Fundraising Finance Mistakes that Founders Make.” If you need a little help behind the scenes, Forecastr can help you project and manage your finances to button up those investor expectations before the fundraise.