Funding Question: Raise Money and Scale or Stay Small and Sell Early?

Business Startups Wealth

Tech start-ups are raising more “quick hit” financing rounds than ever before, according to NewYork-based capital venture data intelligence provider CB Insights. The firm labels financing rounds that are raised back-to-back within a year “quick hits”.

CB Insights claims the number of “quick hits” may reach 496 in 2014, an increase of 35% year-over-year. In the first 9 months of this year, they have already seen more back-to-back “quick hit” financing rounds than in each of the 3 previous years.

Are tech start ups raising as much money as they can, taking advantage of an easy financing market created by investors? Or are they burning faster through their cash because they are not spending frugally? Or are they not generating enough revenue or no revenue at all?

There are pros and cons of raising lots of money and scaling the business over a longer period of time or staying small, raising no or very little capital and selling early. AOL acquired TechCrunch for about $30 million, five years after Michael Arrington founded the company.

Arrington reportedly owned 80% of the company when he sold TechCrunch because he never raised any venture capital, mainly because it wasn’t option at that time. That means that when everything was set and done Arrington walked away with $24 million before taxes.

Arianna Huffington and her two partners sold their start up The Huffington Post, to AOL six years after it was founded for $315 million. Each partner owned different percentages of the stock. Apparently Arianna Huffington took home an estimated $18 million.

The Bleacher Report acquisition by Turner is another situation where the founders build a large company and exited with a relatively small amount due to their diluted stakes.

The Bleacher Report sold for a little more than $200 million five years after it was founded. But between the four founders and more than $40 million raised, their stakes were diluted to 5-10%. That means each founder walked away with about $10 million after the sale.

Raising a lot of money at a high valuation has its benefits. It can mean overtaking competitors, which are prevalent in early stages (GroupMe had to battle Fast Society before selling to Skype, Foursquare had to beat Gowalla, etc). It can also make a difference in hiring.

It’s easier to attract engineers and other talent when you have brand-name investors tied to your business and you can offer attractive salaries. It is also worth noting that most entrepreneurs only get one shot at a startup.

If they fail, it’s the end of the road. But if they’re able to get an exit under their belts quickly, more opportunities present themselves later. Investors are eager to back founders who have successful track records. And obtaining personal wealth means a different, sometimes bigger mindset the next time around.

It’s important to note that while smaller exits may benefit entrepreneurs, it doesn’t always benefit investors. Some entrepreneurs believe that in general they would only raise venture capital if they absolutely had to.

Most entrepreneurs would raise it opportunistically based on market conditions to take as little dilution as possible. And they would spend that VC money the same way they spend their own money in business – extremely frugally.

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