 |
|
Concept Stage:
Financing: When $500,000
costs you more than $5 million.
By
Dave Mackie
Managing Partner, seedstage.com |
|
Financing for
your concept takes you to the seed stage and represents the first significant investment
in your company. At this point, you have 1) sweat equity, which means the work and
time you have invested so far, 2) a product you can demonstrate, or at least give
a feel for, and 3) your business plan.
Why
It's Important
The probability that someone
will give you enough money in a single round of financing to completely build a company
is low. Therefore money is typically raised in stages and the most expensive money
is raised first.
How It
Works
Let's say you need $500,000
to get to the next stage, which is when you will start selling your product. Your
potential investor is going to ask you what your company is worth, called a pre-money
valuation. You estimate $2 million, based on all your work and time. Your investor
agrees and gives you the money. Presto. He owns 20% of your company. You keep 80%.
| Pre-money valuation
(your sweat equity) |
$2,000,000
|
80%
|
| Financing (your
investor) |
500,000
|
20%
|
|
| Post-money valuation |
$2,500,000
|
100%
|
Before the next round of financing,
the aim is to increase the value of the company by two- to three times. If you are
successful, then the next round of financing will cost you less. For example, you
then will have a product, so assume you estimate the pre-money valuation to be $7.5
million and you ask for $5 million from the venture capitalists. With a post-money
valuation of $12.5 million, you're giving up only 40% of your company to get $5 million
v. giving up 20% of your company to get $500,000 in the first round. |
|
| DO: |
|
- Remember that raising
money is expensive and will take longer than you think.
- Ask for enough money
to get to the next stage with two months' safety.
|
|
| DON'T: |
|
- Raise too much money
early on.
- Don't over-value
your early financings so that you set yourself up for a "down round" where
the company is devalued on subsequent financings.
- Have unrealistic
targets - if you don't do what you said you were going to do in a given stage, the
cost of additional financing will skyrocket.
|
|
|
|
|