Congratulations, you made it! You raised some FFF funding, government grants, and prizes from a startup competition and you were able to get your startup to $7-15K MRR. Your team is incredible, your direction is clear, and you can take on the world.

Now it's just a question of money.

Thanks to startup pop culture, your first thought is to go and raise an equity round from business angel groups or possibly an early stage VC. Then finally get your picture on the local newspaper or even on Techcrunch with a title like "The next X of Y just got funded!"

Finally, you can go around town with your funding medal, your astonishing valuation, and a lot of cash in the bank. What's not to celebrate?

But have you ever thought about the hidden cost of your funding?

Here are the real costs:

1. You signed a deal to push your startup to the limit, to kill it if necessary, in the name of the god of growth. You are not in charge anymore, growth is.
2. You gave up an insane amount of money
3. You lost an insane amount of time

Let me explain each point.

Equity round = expiration date

Unfortunately, only a really small group of founders realize the true cost of raising growth capital through an equity round: Selling equity at the seed stage means agreeing to generate growth in an unsustainable way.

You will have to deploy that capital fast over an agreed period of time. The end of that period is your startup's expiration date. From the moment you sign that term sheet, your startup has a death day.

The reason seed investors force startups to spend their money fast is that your interests and theirs are not aligned. Success for a seed investor means you raising the next round at a crazy valuation. That can be achieved only with astonishing growth.

Meanwhile, your goal as an entrepreneur should be to build a great business, not the next round or the next valuation. You will never find a seed investor that will tell you: "Don't spend your money too fast, take your time to understand the dynamics of your business or find the perfect person to hire." Instead, you will hear them say, "Deploy that capital as fast as you can and show me that hockey stick."

The consequence of this is that you'll have to deploy that money as fast as you can, wasting a lot of cash because you don't really know what you're doing. After 10 months of crazy spending and with only 9 months of cash left in the bank, you'll have to get back on the fundraising wheel, pitching to the next pusher of growth. If he likes what he sees, you're safe. You'll get your next injection of steroids (capital) with an extended expiration date (yep, each round is just a way to postpone it) and go back to pump up your burn rate.

Unfortunately, your growth might not be impressive enough or the market may have shifted so your sector is no longer "hot". In this case, your VC already knows there won't be anyone after him, you won't get your round, and you'll be left alone in the cockpit of your startup with its unsustainable structure racing towards a wall as fast as it can.

Is this really the dream you had when you raised your seed round?

Startups who can't raise the next round and are unable to quickly change their structure from unsustainable to sustainable, die. The few that are capable of surviving (they're able to switch to a sustainable business) are just postponing their expiration date.

Again, when you raise equity capital you have an expiration date.

The next expiration date comes several years down the road (max 10 years, more likely 4-5) when the investors show up at your door asking for their money back because it's their turn to return the money to their investors.

If in the meanwhile you were able to put aside enough cash for them to be satisfied, you can pay them back and keep running your business. If the cash you can offer them is not enough they'll sell your company and liquidate the assets and you can't do anything about it.

It's sad but they will take your baby and sell it to the highest bidder.

If you want to read more about this, here or here.

Giving up an insane amount of money

"Sure, only 46% of companies that raised a seed round raised a series A, but those are the losers. I'm cool and I will for sure raise my next round."

I agree with you, you are cool, that's why you're reading my post. But let's run a bit of math here.

Here's some shocking news for you: valuations in the VC world are based on the opportunity and the amount of cash you're generating (e.g.: MRR). The opportunity can give you a different multiple for your actual cash.

Assuming that you have $15K MRR and your annualized revenue is $180K, if you want to raise $350K your situation will look like this:

Now, let's assume you're not going to die, that you'll have an amazing success story with several rounds of financing and you'll have a successful exit at $500 M after a series B round. Let's see the cost of that early equity.

The median dilution after a B round for the seed investors is 32%.

As you can see, using equity as a way to finance your startup not only makes you lose control of your destiny, but on top of that it's extremely expensive. You give up millions to let someone else decide your destiny.

This scenario is even crazier if you think that waiting a bit could save you a lot of money. As we said the valuations are connected to the amount of revenue that you're generating. If your startup is growing at 10% month over month, it means that in 6 months your business will go from $15K MRR to $26K.

Look at how different the scenario becomes if you manage to hold on for 6 months before closing your seed round:

The situation is even more impressive if you look at the value of the equity that the founders can save:

An insane amount of time

Unfortunately, no matter how much I searched, this is the only point that I'm unable to backup up with data. There is no research (that I could find) about the average amount of time that CEOs have to spend preparing their pitch deck and BP and on the road pitching in order to raise each round.

In my experience, on average startups that are successful at raising their seed round spend as much as 6 months between all the meetings and having the money in their bank account. Six months for a business that is 12/18 months old is almost ½ of the lifetime of the startup spent on something that doesn't have any impact on the product or customer.

The craziest part about it is that the majority of startups can't raise money and this loss of focus is deadly for them. I'm positive that if most startups that are unsuccessful in raising funding would focus on their business instead of fundraising, they could build a sustainable and durable business.

This is what it really means to do an equity seed round. The reality is difficult, even in a positive situation with a successful exit. It's insane that you have to give up hundreds of thousands of dollars just because there are no alternatives to equity rounds or bootstrapping, or are there?

A different way

The good news is that there are alternatives, and that you can skip equity rounds at least for the seed stage. More on this in my next post.

source: Medium