Jacques Mattheij

Technology, Coding and Business

The hidden cost of funding

When you are running a successful start-up company and you have the choice between attracting outside capital and growing organically there are lots of things to consider.

One thing many people presented with this choice will fail to notice is that the simple act of going after funding (even if successful) has costs associated with it that you will need to recover in the funding round itself. And if the funding round is not successful then you will be in a worse position than if you had never attempted to find funding in the first place!

The Ideal

The most comfortable spot to be in when you are looking for funding is to let the investors come to you (that is, of course a luxury situation, and in practice you’ll be the one knocking on doors).

This will have a number of upsides:

  • you don’t need to spend time on finding out who is interested

  • you can focus on your company and growing it instead, so your bottom line will be higher

  • you will be in a better position to negotiate

The alternative likely means that you will spend significant time on pitching various investors that are going to be more skeptical simply because you come to them. That time is likely going to be spent by the executives and they will not be available to do what they do best (running the company) while this all takes place. So if your executives are any good at all you’ll find that their reduced attention to the company will likely show up in the books as a dip. (If it doesn’t I’d suggest an extended holiday).

Make a budget

If you’re going to look for funding you should budget the cost of this effort just like you would budget the cost of anything else, and most importantly you should not exceed that budget. If you fail to do this you might end up in the situation where not getting funded means the end of your business. This would hollow out your negotiation position to nothing at all, or if the other party or parties decide to walk away from it will cost you the company.

Recover that investment

And you should factor in recouping the investment made in the funding round from that same funding round. In other words, it makes no sense to lose $100K in turnover in order to pick up a $100K investment.

You’d need to raise a significantly larger amount of money than what it will cost you and your team to raise that money in the first place otherwise it may be a net loss.

Of course, any venture capital company or other investor will attempt to differentiate themselves from the pack by saying that they contribute more than just capital, but if the capital brought is not a substantial multiple of what you invested trying to raise that capital then it doesn’t really matter what they contribute over and beyond that, you’ve just caused a set-back, and diluted to boot.

So, the amount of time that you can invest in finding funding is determined by the amount of funding that you intend to raise increased with the cost to the business of the reduced attention by executives, multiplied by the chance that you will actually raise that amount.

If the investment you have to make (and which you need to recover) is increasing the amount to raise by too much it may be better to wait until the risk to the company can be reduced or the amounts can be increased (because of the company being worth more) to make it worth your time.