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THIS WILL BE THE FIRST in a series of posts on fundamental questions entrepreneurs face when they raise venture capital or angel funding. The hope is that in reviewing the basics will help when you are planning your fund raise.
The subject came up in a conversation with an entrepreneur wanting to raise seed capital to finance the formation of three investment funds. While this is not your typical entrepreneurial endeavor and involves no high technology product, the basic questions the entrepreneur faces are the same.
After working through projections about how much money the effort was going to require and nailing down costs as best he could, the entrepreneur had a big number and was getting push back from potential investors.
Here are the questions I posed and what the responses were.
First, did he need to raise all three funds to have a successful business? The answer was that raising the first fund would give him a viable business.
Second, what would it cost to set up and raise the first fund? Here, the number dropped from millions to substantially less than one million.
Third, would the effort to raise the second and third funds be substantially hampered by raising the funds sequentially instead of all at once.? The answer was no.
I was trying to find the real amount the entrepreneur needed to launch his business to help him decide how much money to ask investors for. The two underlying dynamics here are that 1) investors do not like to part with money they do not have to and 2) seed investment is the most expensive money to raise.
While it is nice to have a big bank of money when you are starting out, if you raise more than you need you pay a heavy price for it. Because the money is more costly, you give up more ownership than if you deferred raising some of the money until later, when you have some success and can sell your company's equity at a more favorable price.
If a viable approach here is to raise money for the first fund only, start the fund and then raise money for the second and third funds later when the business can show some success, management (the entrepreneur) is likely to be left owning more of the economic value of his venture. The risk, of this approach is that the money will be hard to find later because of lack of success or reasons beyond the entrepreneur's control. And, of course, you have to spend more time looking for money.
In this case, raising a smaller amount to jump start the first fund also answered the questions the entrepreneur was already fielding from the family offices he had targeted.. And, it also brought his amount down to an amount that would be easier to fund from family offices and angel investors, his primary investor focus for the fund raise.
The image above is part of a mosaic found in Pompeii. Happy Halloween to all.
The venture moola blog comes to you from Atlanta, Georgia. Find it at readjanus.com. Copyright Clinton Richardson.
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