Most founders try to raise their seed rounds in one shot, but some do their fundraising over long stretches of time and across a series of (rising) valuations. For most founders in the latter group, piecemeal fundraising is out of necessity: if they can’t raise $1.5m but can raise $400k, then $400k is almost certainly better than nothing. Some founders, however, do fundraising in small increments in an effort to fight dilution, on the assumption that more capital will be available later. Unfortunately, incremental fundraising does little to combat dilution while posing significant existential risk. If you have the opportunity to raise your target seed amount in one shot at reasonable terms, then you should take it.
To make the following arguments more concrete, let’s look at a typical scenario:
Option #1: Raise $1.5m on a $5m post.
Option #2: Raise $300k now on a $3.3m post, make some progress, raise $500k on a $5.5m post, make some progress, raise $700k on an $8m post.
Targeting 20%-25% dilution for a seed round would be ideal. The dilution from option #1 is 1.5/5 = 30%, which is not great. Option #2 is more complicated. It feels like it should be less dilutive because the valuations climb pretty quickly. And it is less dilutive, but not by that much. The dilution turns out to be .3/3.3 + .5/5.5 + .7/8 = 27%.
On the surface, 27% feels a little better than 30%, but it’s not actually better because future capital is not guaranteed and because fundraising takes time.
If you optimistically assume that every time you try to raise money you’ll have a 70% chance of success, then the probability of raising 1 big round followed by a Series A is 70% * 70% (=49%), while the probability of raising 3 small rounds followed by a Series A is 70% * 70% * 70% * 70% (=24%).
Taking dilution into account, would you rather own 70% of a company that has a 49% chance at a Series A, or a 73% of a company that has a 24% shot at a Series A? The former has a much higher expected value even though the founder takes on a little bit more dilution.
But wait, there’s more! Every time you fundraise, the process sucks up a lot of founder time – time that could be spent building a product or talking with customers. If it takes 4 person-months to raise each round, and $1.5m would provide a team of 5 people with 18 months of runway (90 person-months of time), then raising a full seed round will leave you with 90 - 4 = 86 person-months to work on your product. In contrast, 3 smaller raises would leave you with 90 - (3 * 4) = 78 person-months to work on product. That’s almost 10% less time than you’d have with a single seed round, and that further reduces your chances of successfully raising a Series A.
The seed rounds of entrepreneurs-in-residence (EIRs) embody the advantages of one-time upfront fundraising. EIRs are usually founders and senior execs who have already achieved success and are looking for their next projects. A typical EIR “seed” round might be something like $6m raised on a $15m post. That’s 40% dilution! This seems crazy, but it actually makes a lot of sense for the two reasons above. In fact, it’s better not to think of $6m as a seed round, and instead of view it as a $1.5m seed round (20% dilution) and a $4.5m Series A (20% dilution) – but done simultaneously. The advantages of raising two rounds at once are that the founder minimizes their fundraising time and can instead focus on building a company, and that the money in the bank provides a lot of runway and resources to build something meaningful. The founders taking these deals are not naive newbies, but rather experienced operators who know what they’re doing.
At this point you might be thinking, “The author of this post is a VC. Of course they’d argue for a larger, higher-dilution raise instead of a series of smaller raises.” Not true.
As a seed investor that tries to invest early, it’s mathematically better for me to try to invest in the smaller 1st round of a 3-part seed than to invest in a 1-part seed. $300k can buy ~9% of a company in the first scenario mentioned above, but only 5.5% in the second scenario.
Too much dilution hurts founders, but it hurts investors, too. Contrary to popular opinion, investors are not trying to own 100% of a company – that would remove any motivation that the founding team and employees have, and investors would be left with 100% of nothing. Instead, investors are after a good return. I’d rather own 5% of a company whose value increases 100x than 10% of a company whose value increases 15X. A company that is over-diluted will have a much harder time getting to 100X because it might run out of equity to sell after a Series B while its competitors are able to raise large Series Cs and beyond.
The advice in this post is independent of market conditions. I do think it’s even more valuable to have a war chest when the fundraising market is uncertain. But, whether or not the fundraising climate is founder-friendly, erring on the side of more capital and more runway is a prudent bet. (In 2014, when the climate was more founder-friendly, I wrote another post about the lower-than-expected cost of more seed capital in Fatal Pinches, Seed Follow-On Rates, and Estimated Marginal Dilution.)
This entire post is based on one key premise: the most dangerous risk for any startup is existential risk. One more time: the most dangerous risk for any startup is existential risk. If you have money but no product-market fit, you can keep iterating on your product. If you have money but your team is lacking, you can spend to upgrade your team. If, however, you’re out of money, it doesn’t matter how much beautiful code you have written or how many pilot projects you have lined up, because you’re done. If you accept this premise, then you’ll understand why a few extra percent of dilution is well worth reducing your existential risk by 20% or 30% or even 50%.
If you don’t have the ability raise as much money as you want, then raise whatever you can. If you have a choice about how much to raise, then remember that a little more dilution in exchange for more money in the bank is often the smarter bet in the long-term. Owning 70% of something that has a 60% chance of succeeding is much better than owning 75% of something that has a 30% chance of succeeding.