Saturday, 2nd December 2023

When should a startup raise money?

Now make no mistake, motives can be a slippery thing. Unless the proposed venture is clearly illegal, I wouldn’t go so far as to declare anyone’s motives to be good or bad.


Wrong question, Padawan.

The people that ask me this question almost never like the answer, which is typically “I don’t know”. It’s mostly true. Not only because I do not consider myself an expert on fundraising, but as far as I know, there’s no scientific way to model these things. Some entrepreneurs are able to raise money off the back of a powerpoint deck simply because of what they look and sound like, where they grew up, or what school they attended. Other entrepreneurs, with ventures that already have revenue, struggle to even get a second investor meeting, because they don’t match the patterns that many investors use to filter which ventures they’ll decide to get behind.

Over time, I’ve noticed that “I don’t know” is not a particularly useful response. So I’ve recently adopted a Socratic approach, and will now typically reply the “when should we raise” question with “why do you want to raise?” It turns out that while it might be hard to pronounce a startup ripe to raise, getting an entrepreneur to question their motives for raising are a much more useful heuristic.

Now make no mistake, motives can be a slippery thing. Unless the proposed venture is clearly illegal, I wouldn’t go so far as to declare anyone’s motives to be good or bad. But if I were to put myself in an investor’s shoes, however, and I often encourage would-be fundraisers to do this themselves, would I be enthusiastic about giving money to a first-time entrepreneur who simply has a great idea they would like try out — with other people’s money? Or one who’s raising so they can quit their day job and need a safety net? Would you happily fund someone who’s looking to improve their lifestyle and move to Banana Island?

It is unlikely that a sane founder would admit these motives to an investor. However, deep down, they probably acknowledge them to be true. Then there’s also a whole bucket of startup founders who want to raise money because they actually think that raising money is what startups do. Don’t even get me started with those ones.

Obviously, startups don’t exist to raise money. Investors put money in startups not out of the goodness of their hearts, but because they expect to make it back, and many times over. Believing something other than that is being incredibly naive. If you don’t have any inkling of how your venture will probably lead to a future situation in which said monies will be returned to the investors, collecting it is a really, really bad idea.

Startups are ventures that are created in search of repeatable business models that can scale rapidly. Anything that happens before the point of discovering this model is technically research. It is true that savvy entrepreneurs can find people willing to fund at the super early stages of a startup’s lifecycle, even if the entire thing is still a few hasty scribbles on a table napkin. This is also why startup incubators exist. But pragmatic entrepreneurs know that most funders with big monies will only come in at the point where they can demonstrate that their startup has created an actual product with willing and ready-to-pay users (and prefer it to existing alternatives, if any), as well as a market that is large enough to make the prospect of a return on the investment tenable.

Some entrepreneurs will emerge from the above Socratic process re-affirmed and better armed to negotiate with potential investors. Others will realise that they have no business raising money till they have come to better grips with the opportunity they seek to exploit and have charted at least a logical, if not immediately certain, path to profit.

In the end, there’s no golden prescriptive for these things. I can think of a couple scenarios when it might be a good time for a startup to raise, sans business model. If an investor of sound mind and of their own volition is offering you money, and the price in equity and lost sleep seems right, you should probably take it. And there are entrepreneurs who can raise money from a tweet, because they are geniuses to whom natural laws do not apply or because they’ve done this for so long that they clearly have a knack for it.

Many companies are unprofitable, years after raising money. Until they achieve enough scale are they finally able to turn on the revenue tap and become cashflow positive. It’s worked for some. For example, Facebook, who’s profit growth is currently outpacing Google’s. Others, like Twitter, haven’t been so lucky. And there’s also the unthinkable alternative that has served many a founder well. A little something called bootstrapping. Not everyone has to raise money. Countless successful startups never needed to.