Fundraising is always the flavour of the month at startups. Pre-seed, early-stage, post-revenue, growth-stage and pre-IPO startups are constantly trying to raise money. I feel that entrepreneurs are so keen to raise capital that they inordinately focus on how to raise funds and who to raise it from, without focusing on the more important questions of when and why to raise money. While funding can accelerate growth and provide stability, raising it at the wrong time can lead to unnecessary dilution of ownership and poor financial management. Understanding when to raise funding is essential for any entrepreneur.
At the idea or pre-seed stage
Startups often need initial capital to develop a prototype, conduct market research, or validate their idea. It is important for entrepreneurs to invest some of their own money to start a venture as a measure of their passion and commitment to the idea, and this also adds credibility when the entrepreneurs subsequently approach external funding sources. If self-funding is not sufficient, raising money from friends, family, or angel investors can help cover these early costs.
For achieving product-market fit
Startups deploy the pre-seed capital for developing their product or service, which should be a solution to a problem, and for which customers are willing to pay repeatedly. Thereafter, entrepreneurs must test the product or service with potential customers to get their feedback, make corrections based on these inputs, and test the customers’ inclination to pay for this product. This critical phase is called PMF (achieving product-market fit).
For scaling up operations
Once a startup has achieved product-market fit and sees demand growing, funding may be required to scale up operations. This includes hiring employees, expanding marketing efforts, setting up robust operations and increasing production capacity. If a startup is in a highly innovative and technical industry, funding for technology or R&D will be required to refine products, improve services, and stay ahead of competition.
To enter new markets
Expanding into new geographies or customer segments requires capital for marketing, logistics, and operational setup. In my view, seeking capital to expand is the best reason to raise funds. This is known as growth capital, because it can lead to a revenue surge, which is so important for startups.
To maintain cash flow and working capital
Startups with high upfront costs and delayed revenue generation need funding to maintain cash flow. This ensures smooth operations without disrupting growth. Sometimes this can be a cause for concern, though, because this is the opposite of growth capital and essentially goes towards paying the bills, which is never a good sign.
In the next column, we will review why a startup should raise capital.
(The writer is a serial entrepreneur and best-selling author of the book ‘Failing to Succeed’; posts on X @vaitheek)