The “Hey! We Built Something, Please Fund Us!” Logical Fallacy

As someone who builds apps for start-ups, I often get questions about when to raise money. Here’s one example:

I am an experienced designer and I can handle development as well. I’m about to launch the MVP of something pretty cool & very robust, but there’s one problem… I am going to need a solid, full-time engineer to be there to monitor servers, and to take care of anything that goes wrong. Also, to continue to develop our platform and work on some of the core backend functionalities. It’s safe to say, I will not be able to handle this myself. Not even close.

So my question is: Should I find an experienced engineer now and make them a co-founder, giving up a decent portion of equity… maybe 20% or, should I go for some funding and use the capital to hire an experienced engineer which will have some early options?

I would have to know quite a bit more about this business to answer this question directly, but I do have some thoughts on the right and wrong times to raise venture funding.

tl;dr: Don’t try to raise money after you have built something and have zero users.

For early-stage companies, the two best times to raise money are 1) at the idea stage or 2) after you’ve gotten some traction and proven something… not in the middle.

The Idea Stage

In the idea stage, you raise money from a pitch deck and not a lot more. You will most likely need to have your initial co-founders locked down since, aside from your idea, your team is the only thing you are bringing to the table.

Major Con: Since you haven’t proven anything yet, you are going to give up more equity to your investor than you would in scenario #2.

Major Pro: Giving up a bit more equity can be okay since you will have cash in hand (if you are successful raising) and you will be able to use that momentum to tackle your next set of challenges. You will also have raised enough money so that you have multiple at-bats. You are exchanging equity for runway.

The Traction Stage

In scenario 2, you raise money after successfully launching your product and demonstrating product-market fit with traction. Since 2011, this strategy has been a major preference for investors (especially with software) in the Valley.

Major Con: While you give up less equity, you really have to prove something before you can raise a round. Companies like Pinterest sat down with dozens of credible investors before finally raising a serious round…and they had great growth while they were trying to raise. Once you go down the path of prove-then-raise, you are locked in until you get that traction.

[Over the past decade, the combination of 1) cheap cloud computing, storage, and hosting, 2) developer tools (AWS, Heroku, Github… etc) and distribution platforms (mobile App Stores, Hacker News, Product Hunt… etc) and 3) the spread of agile development attitudes have really empowered individuals and small teams in the developer community to work for themselves instead of working for someone else.]

Major Pro: You give up way less equity once you have proven a few of your biggest hypotheses and just need cash to scale or monetize something that’s already starting to work.

The MVP Without Traction Stage

I think raising money in between these two different stages is pretty foolish. You’ve maybe started to prove something but have a long way to go.

When an investor funds a start-up at the Idea Phase, the entrepreneur and the investor are seeing the same world: potential. When an investor funds a start-up at the Traction Stage, the entrepreneur and the investor are seeing the same world: cold, hard facts about either product-market fit or revenue.

In the middle, when the start-up has a half-built product but no traction or product-market fit, the entrepreneur still sees potential but the investor only sees a product without a market. They are simply not on the same page and a start-up funded at this stage will rarely see favorable terms.

I call this the “Hey! We built something, please fund us!” Logical Fallacy.

Bottom Line: If you have been properly discovering needs and developing a perspective about the world (based on testable assumptions), then you will have both potential users to test your MVP and you will be able to immediately test those assumptions upon completion of your MVP. If you think your capitalization needs to build such an MVP are larger than what you are willing to personally invest, then you might want to raise money at the Idea Stage instead of finding yourself begging for money when you end up at the “Hey! We built something, please fund us!” stage.

For the entrepreneurs, at what stage is your start-up now and how are you going to move to the next one?

For everyone else, what idea are you sitting on that you’ve been meaning to get built?