The Optimum Financing Strategy for Angel Investors and Entrepreneurs
Designing the optimum financing strategy requires future knowledge of several variables. Even worse, some of the variables are not controllable, or even knowable.
For example, almost every plan that was based on closing a tech financing in late 2000 failed. Even early-stage, angel financings did not complete because the public equity market crash decimated tech investors' confidence.
This type of unpredictable event gives credence to the adage of "raise all the money you can when you can because you never know what's going to happen" (and people said that long before September 11, 2001).
But assuming stable macro-economic conditions, there is usually an optimum financing strategy.
The most important, reasonably 'knowable', factor in designing the optimum financing strategy is to determine when the company will achieve a significant, value increasing, milestone.
The optimum strategy is to raise only as much money as you really need to get through the value increasing milestone, plus enough to fund the company through the completion of the next round, with a reasonable buffer for unexpected delays.
This strategy is optimum for several reasons, it:
- only dilutes the company as much as necessary at the lower valuations,
- requires the minimum amount of time to close the first financing,
- requires the minimum total amount of time to finance the company (assuming the team develops a good investor communication program, including regular investor e-mails and CEO Updates.)
The reasons this incremental financing strategy requires less management time overall include:
- investors willingness to say "Yes" more quickly to a smaller sized investment at the earlier, riskiest stages.
- investors increased likelihood of writing a check after they have gotten to know a company better, through regular email communication, occasional phone calls and visits.
- investor psychology which affects everyone (even the pros) which make it much easier to pay twice as much per share the second time if you've already had a gain on your first round (even though it's unrealized).
Many larger funds will argue with this strategy because their structures make it difficult for them to write smaller checks. These funds will often want to invest more than the company really needs early on when the price is most attractive. Unless the company really needs all of the money to execute on the value increasing milestones, this is also generally a bad thing for the company's culture and DNA.