As the popular saying goes, “There’s no such thing as a free lunch” and more so when it comes to the hypercompetitive world of venture capital. But the idea of free money is irresistible - especially if a VC backed competitor can kick your company out, in a race to market.
So inevitably, the biggest question all founders face when considering the future of their startup is - Should you pursue external funding? When is the right time to do it?
Since the gravity of this decision might seem intimidating to some, this blog is meant to assist you with that process.
To raise or not to raise?
Funding determines the direction of a startup, right from the moment of its inception to its company’s IPO.
To build an investor base suitable for your startup, you must understand the extent of their incentives and it is not just limited to money - it's also a whole bunch of expectations and timelines.
Here are some consequences connected to raising funds which you must consider before pursuing investors:
Dilution of equity -
Investors will expect a seat at the table in exchange for laying their skin in the game. Every time your startup receives external funding, you have to part with some equity in exchange for the investment.
Now, there are two ways this could go - one, you can sell equity as investor compensation, grow your business and eventually, own a small part of a large, successful company.
The other way is - if the value of your startup declines after an investment has been made, you might want to dissolve or sell the company. Due to protective guidelines meant for investors, you will be obligated to pay them back first, using the money from the sale. This might end up leaving you with nothing.
Loss of control -
Giving up equity as investor compensation implies you losing control of your company. Investors and VCs are only concerned with how fast you can make them money and the return on their investment. There is no such thing as a free lunch – so, money that comes into your business brings a lot of expectations and timelines with it.
It is important to wait until you've nailed the product - market fit before seeking funding. If you choose to approach an investor before you bring in healthy profits, then you stand the risk of losing certain share of your company - because, nobody wants to bet on a risky business without collateral.
All businesses do not require outside funding - service-based businesses do not require large amounts of money to run operations successfully. Expenses are usually limited to salaries, rent and logistics.
So, if your company is a service providing business, you can easily run your operations based on customer sales without having to seek outside funding.
Avoid early-stage funding if you can.
Every founder fantasizes about getting millions of dollars in funds just like all the unicorns we have heard of (Byju’s, Swiggy, etc.). The odds of this occurring are quite slim because, all these big players win by grabbing the largest possible market share and the only way to do that is by pumping large amounts of money into the business. Even if you have access to funding; availing it in the early stages of your startup will only limit your growth potential.
Founders should let startups withstand the initial stage of inflow and understand the business better; before approaching investors. By being profitable and gaining traction, you can increase the valuation at which you raise money.
Although it is wise to steer clear of early-stage funding, it might be difficult for some startups to rely on self-financing. So, how do startups manage to survive and run their business profitably without external funding?
It means to reduce any or all external debt and equity financing from investors or third-party companies. Costs can be cut back by making simple adjustments - avoid hiring workforce when you can do the job yourself, refrain from stocking up on inventory and choose freelancers over in-house consultants. These changes will go a long way in reducing your spending and regulating cash flow.
Bootstrapping teaches you how to think on your feet and make the most of every available resource to intercept a problem. It helps you realize skills you may not know you even had. Counterintuitively, it attracts the right kind of people who share your passion and vision and are willing to make sacrifices to boost the company’s growth.
When should you seek funding?
Early stage funding might restrict your growth but - relying on a VC with a certified business model, at the later stages of your company’s development; is most likely to result in success.
So, how can you decide when to seek funds for your startup?
The best time would be when your business has an authentic customer base bringing in substantial sales. Testimonials from your customers and clients will drive investors to have faith in your ability to earn considerable returns on their investments.
A well-established business model will prove that your idea can be transformed into a viable product. Include financial models that show estimated costs, sales, and revenue including your profit margins. This will serve as proof that your business will make money eventually.
The upside to receiving funding -
Bootstrapping might help you retain control of your company but in the longer run it is likely to delay your growth. The problem with slow growth is that it lets your competitors swoop in and take away your market share.
As your business grows and sales increase; you will be required to purchase assets, ensure smooth cash flow, and restructure debt. To accomplish these things, you need money. If you can cover your business’ daily running costs, then external funding is the solution you need to grow.
Key takeaways -
Assess if your startup requires money injection at the present stage
Bear in mind that you must part with equity in exchange for funds
Rely on bootstrapping to run your business, at least in the initial stages
Establish a decent customer base and a business plan before seeking funding
However you plan to expand your business, funding can help you take advantage of new opportunities and turn your ambitions into a reality by hiring new staff, increasing sales, and expanding your services/product range.
An injection of capital - be it debt or equity, from private or institutional sources - can drive a company to new heights, or at least carry it if the business hits a rough patch. Many financing alternatives exist for small enterprises, and entrepreneurs should not be afraid to use them.
Can every startup succeed without funding? Of course not. The question is, can yours? Reconsider your proposed business plan and all the available resources; you'll be surprised at what you can accomplish.