It is not uncommon for a startup to raise less than the full amount of capital they set out to raise originally. This has some obvious implications, but there are also some less obvious ones that I see many startup founders missing.
When an investor commits, they are committing with the expectation that the startup will raise all (or at least substantially all of the round.) This is partly why investors will often wait to sign and/or wire their capital until they see the inevitability of a critical mass of commitments for all (or substantially all) of the round.
The first reason is pretty obvious.
Getting your entire round committed is a form of validation for an investor. If you struggle to fill your round then that is a signal of a kind and investors would prefer to sit it out until whatever isn’t right gets fixed.
The second reason is a bit more subtle — if you don’t fill your round then you are less likely to reach whatever milestone will be required to raise your next round. Since a lot of founders don’t have a particularly clear idea of just what milestone they would need to achieve in order to justify their next raise, they often don’t see the worry here. But investors see it clear as day. And it’s Danger Ville, particularly in the earliest stages.
Let’s double-click on that.
Say you go out to raise $2M at a $10M post-money valuation. After 8 months of trying your damndest to raise the $2M, you settle for $1.2M and call it good. Luckily (you think) all but one of your investors are all willing to sign and wire, despite the shortfall in your fundraise. So you part ways with the holdout investor and close the round with $1.1M.
Why did that one investor hold out? Probably because he believed you when you said you were raising $2M at $10M post. He looked at the deck, the financials and the growth story you were pitching and came to the conclusion that there was a reasonable probability that you could be successful in getting to a next round. Remember, one of the greatest risks to your earliest investors is that you just aren’t able to raise a next round.
One reason for the holdout might be your prospects for a next round of funding. Imagine that the holdout investor could see that if you had $2M in capital you could build a business that could earn a 3x increase in valuation, which would go a long way toward ensuring you raise your next round. But to do that, you would need enough fuel and runway to grow the business to the point that the next set of investors would agree that your business could justify that 3x valuation, i.e., a $30M valuation.
A 3x valuation increase is quite excellent. So maybe you don’t need to get to a $30M valuation to raise. Maybe 2x the valuation is enough. A 2x valuation increase is still pretty ok. Ish. Less than 2x is certainly not what investors are hoping for (in most cases anyway.) So 2x is roughly the floor of what a VC is looking for to indicate that the company is making great progress.
But let’s say you can get to 2x. That would mean that you’d only need to convince your next investors that you’re worth a paltry $20M valuation. But can you? What would have to be true between now and then? What metrics milestone would you need to hit? How long will it take you to get there? How much will that cost?
What if you don’t have the runway and resources to get to $20M? The holdout investor would be right to weigh the fact that you’re only raising 1.2M to achieve the same metric that you pitched it would take $2M to reach.
But all things considered, the metrics you would need to hit to justify a $30M valuation will be materially higher than the metrics required for a $20M valuation. And the resources you need to achieve those metrics (especially runway) will be greater. And reaching a $20M milestone will require significantly higher metrics than you have at the time of the $10M valuation. Is $1.2M the right number to get there? Maybe. Maybe not. Regardless, you didn’t pitch that and your modeling probably doesn’t support that either. All this means that your future is significantly riskier than it would be if you raised the full $2M. So the holdout… holds out.
In my next post, I’ll share what I think you should do about all this.
