Thread by @epaley

A portfolio CEO recently asked for advice about an unsolicited offer from a good VC:

Facts:

💳 $20M/year run rate & doubling annually
🏦 Has $10M (most of the capital it’s ever raised) in the bank
💰 VC offer is $25M on a $150M pre-money valuation

What should they do?

/1

More context:

💨 The company leads its space
🔥 Current burn is ~$200K/month
📈 Planned to ramp up to a $500K monthly burn rate, irrespective of investment
🔭 Founder believes it possible to hit $50M ARR in < 18 months.

My advice was to REJECT the offer.

Here’s why:

/2

The biggest barrier to scale at a startup isn’t capital, it’s time & attention to design and run experiments testing the core tenets of the business.

Even doubling the burn rate, this founder had enough capital to operate for two years. Where would they spend the new money?

/3

My question to him was, “If you do actually achieve the $50M ARR in 15-18 months with the capital on hand, why wouldn’t you be able to raise more money then?”

/4

There’s a danger in being too opportunistic. An unsolicited offer from a VC at a high price is flattering.

It’s tempting to rationalize the offer saying it will save you the headache of running a funding process down the line. Still, my advice remains the same.

/5

Until you have built an engine that can reliably turn a $1 into $2, or in this case, $1M/month invested into $2M/month returned, don’t meaningfully scale your burn rate.

/6

There’s an argument that having more money on hand can be helpful in the case of macro shocks or other external factors. Possibly, but I believe when things go wrong, you’d prefer not to have the burdens of unnecessary capital.

Why?

/7

VCs won’t let you spend the money over five years!

With $25M, you’ll be pressured to spend on questionable growth strategies whether the engine works well or not. Monthly burn will go from $200K to >$1M. Despite best intentions, you won’t buy time, you’ll just spend faster.

/8

A company’s burn rate over time does more to determine its dilution than the valuation it negotiates at a financing event. And nothing increases burn rate faster than easy capital that comes with an outsized valuation. techcrunch.com/2018/07/20/red…

/9

🌧️ Imagine the rainy day arrives and growth slows.

Would you rather:

A) Have a $1-2M/month burn rate that requires you to fundraise even more money at a debatable valuation, saddled with a weaker metrics and a bad economy? or...

/10

B) The ability to pivot to profitability & flexibility to potentially sell the company for $200M+? Remember, if the startup raises at a $175M post, then any exit short of 3X, $500M would be considered a disappointing to investors, and may be blocked or at least discouraged.

/11

Option B is clearly the winning play if you’re concerned about potential downturns. And If you’re successful, there will always be an opportunity to raise more money. Don’t get seduced by “Vanity Capital.”

/12

I’m sure there are plenty of VCs that would criticize this as “small ball” advice, but I can point to ~$80B in recent exit value that demonstrates that putting off big capital raises isn’t a bad idea. Take your time to build a cash-generating engine and go slow to go fast.

/13

If you've found this example helpful, I encourage you to check out my most recent op-ed at @TechCrunch making the case for why confidence, not capital, should drive acceleration at startups. techcrunch.com/2019/08/13/con…

/End