If I Had a Million Dollars (What to Do With all The Money Your Startup Raises?)
…after my first round of startup financing.
I love that song from the Bare Naked Ladies. If I had a million dollars does not, however, refer to personal wealth in this case. It refers to the successful conclusion of a startup’s first seed round of financing.
Securing a good capital infusion is kind of like a mixed bag of good and bad. Many founders have to fight the urge to upgrade their offices, lease that crazy wild sports car they figured they would get when they ‘made it’ and hire a bunch of staff while others use the funds wisely to scale up their business.
I know a CEO of a failed startup although technically he still has the doors open but he has no employees. He had a great idea and seemed to be on track to live the American dream until he secured his first round of money. He went way over budget on a website and hired 5 C-level employees. As his mentor, I advised against it but he ignored my advice. See ya later!
It was not only financially unfeasible but the level of work was not sufficient to warrant that caliber of staffing. Within 6 months his funds had dwindled to next to nothing and when he looked to his investors they looked the other way. They had been watching what he was doing with their money and they were not amused. The staff, unable to work for shares, soon left.
Just as you, the founder, had done when starting out, everything had to be scaled. You need to consider the frugal versus efficient use of the funding. Planning can help with your burn-rate and financial coaching can help you spend the money wisely but you need to focus on your reasons for raising the money. Unlike the resource industry that seems like they raise money to raise money you need to produce a tangible and measurable result.
From my experience about 25% of startups actually use their raised funds prudently. Founders who have bootstrapped the business from the beginning using their own money usually have a different focus when spending investors’ money. There are a lot of lessons learned from bootstrapping the best of which is that money runs out sooner than expected.
Scaling a tech startup by hiring more programmers or maybe a marketing person makes good sense. The biggest expense of any startup should be in talent followed by marketing people. The theory is with the seed capital the founder can hire people to take a bit of the load off him and allow him better use of his time. It makes sense to me to have professionals create the pitchdecks, schedule meetings and all the milieu activities anyway. Now would be a good time to get all the accounting in place so there is a solid footing for the future.
A good ‘best practice’ is to put the ‘use of funds’ description in any circular or business plan the company distributes so there is clarity after the money is raised. It’s a good reminder for the founder and will allow the investor to sleep a little better.
One of the problems I have encountered after Round A is investor hesitation. Well, let’s call it like it is — pressure! Investors in early rounds may not be that experienced. After all, the first rounds are usually just penny stocks so it has an ease of entry. Pressure from investors can make the founder grow too fast, make bad decisions or hire staff too quickly.
After the initial seed round the founder has been getting used to the fact that bootstrapping is out the window. He’s created a company complete with working prototypes, staff, investors, meeting upon meetings, interviews and more. He is creating a buzz but he needs more money. Round B is required.
One hopes that the first round investors are happy with our founder and his results so that they are willing to invest more money into the startup. But as my partner reminded me today, it’s easy to get financing when you can tell investors your company did 200% increase over each of the last two years. When you consider the first year had $200k in revenues and the second year did $600k those numbers make a good story. It gets difficult to keep the buzz going when revenues are at $2MM and the third year produces ‘only’ a 30% increase. Thirty percent sounds phenomenal but the story to investors is the company failed to increase by 200% — ahghg!
Capital raised from Round B would probably be best used to increase production and staff. With this round though, the staff won’t be a receptionist that came with the first round. We’re looking at PR staff and business development professionals. It’s now expansion time and long range planning with good people in place to make large scaling a reality.
After the second round the CEO is still driving the bus but is certainly expected to be doing less of the operational stuff. He has a business that is getting noticed he can’t falter now so those 10 hours days he was used to in the first round have increased to 12 hours just to keep up with developments.
If he’s reached the Round C of financing he is riding the wave. He has survived, probably in spite of himself and the company has a cadre of investors who continue to capitalize his dream. The Board has now told him that he needs a professional CFO and there may even have been suggestions that he replace himself with a senior guy.
When the financing pours in based on the faith of others it’s time to take stock of everything and make sure the startup (now probably 3 or more years old) succeeds or moves to a liquidity event. The CEO has replaced the daily operations of the startup with a President and has a carefully selected team behind him. His operations are covered, PR is handled and Investor Relations continue telling the story to the investors.
The founder has reached a pivotal point in the management of the startup. He is now a leader! The journey is only beginning.
Gary is a Partner at Equifaira Partners Inc. — Liquidity Event Planners in Vancouver
Originally published at www.equities.com.