Startup Syntax: Raising Reality

Understand equity dilution from raising capital. Explore bootstrapping benefits in capital constrained markets and strategic timing for seeking investment.

TLDR

To raise or not to raise. The allure of vast VC funding can veil the cost of dilution. Bootstrapping may be a stronger path, delaying the ask until proof of concept takes form and revenue is solid.

Headlines

Headlines all too often read: “XYZ Startup Raises another round to expand its XYZ offering.” We see this narrative again and again, founders touting their ability to charm their way into investors' pockets. It sets the tone for new founders: the only way to be a successful founder is to raise millions, even billions, and perhaps one day trillions of dollars. But does that really signal a great founder?

Think about the economics. The more you raise, the more you get diluted, and the same goes for your investors. The higher your valuation the further you push the goal line to success.

Example

Imagine two people start XYZ Startup. They each own half of it, like having two equal slices of a pie. Let's say the whole pie is represented by 1 million pieces (shares). Each founder has 500,000 pieces.

The First Offering (Seed Funding):

To grow their company, they need money. So, they decide to sell a small part of their future pie to investors for $1 million. They offer 200,000 new pieces of pie.

• Now, there are more total pieces of pie (1.2 million).

• The original founders still have their 500,000 pieces each, but now those pieces represent a smaller part of the whole pie (about 41.67% each).

• The investors now own 200,000 pieces (about 16.67% of the pie).

This shrinking of the original owners' share is called dilution. They still own the same number of pieces, but their ownership percentage is less because there are more total pieces.

The Second Offering (Series A Funding):

Later, to grow even more, XYZ Startup needs more money. They sell another 300,000 new pieces of pie to new investors.

• Now, there are even more total pieces (1.5 million).

• The original founders still hold 500,000 pieces each, but their part of the total pie shrinks again (to about 33.33% each).

• The first investors still have their 200,000 pieces (now about 13.33%).

• The new investors own 300,000 pieces (20%).

The Simple Truth:

Every time the company sells more pieces of the pie (issues more shares) to get money, the original owners end up owning a smaller percentage of the entire pie. Even if the company becomes very valuable, their individual slice, while potentially worth more in total value, is smaller in proportion to the whole.

This example shows that while raising money is often necessary for growth, founders need to understand that it comes at the cost of giving up a portion of their ownership in the company.

Bootstrapping

Depending on where in the world you are building, your access to early stage capital may be limited and you may have no choice but to bootstrap. This is more common in emerging markets, where investors tend to be more risk averse.

There are pros and cons to bootstrapping. If you can bootstrap your way to your first raise and bring in some revenue, you are much more attractive to investors and may be able to get better terms than if you were to raise with an idea on a napkin. You have the added benefit of less dilution.

The con is you may not be in a position to bootstrap and the idea will die without funding.

Summary

Sometimes it is not a question of whether you should raise, but when. Of course, this is not a one-size-fits-all solution. Here are some questions to ask: What is your runway? What is your burn rate? Are you bringing in revenue? Can you wait to onboard more customers, bring in more revenue, show more traction? If yes, it may be beneficial to raise less and later rather than more and sooner.

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