Tech Bubble Capital: A Take on Mark Suster’s Advice for Startup Fundraising

June 28, 2011 by

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Recently there has been a lot of talk about the impending tech bubble and its potential impact on the tech capital markets. Mark Suster from GRP Partners went public via his blog, Both Sides of the Table, on June 22nd in his post titled “On Bubbles … And Why We’ll Be Just Fine” to express his thoughts about the upcoming tech bubble and how it has affected start-up company valuations and the price of venture funding. In this blog post Mark predicts that the current tech bubble will burst sometime in the next 6 weeks to 18 months. He advises entrepreneurs to start planning for the capital thinning that will occur in the next couple of months or years by implementing a more aggressive outside financing strategy while capital is easier to access and less expensive due to the higher valuations. He recommends raising outside funding at “the top end of normal,” but not to exceed normal financing, as it could become a major impediment in trying to attain future financing down the road.

Mark’s advice is good and practical since it optimizes the price and attainability of venture funding; however, it is a riskier strategy as well because the company raises capital that it has yet to earmark, which can lead to a false impression of its budget position and irrational spending and decision-making. Thus, companies should evaluate their future capital needs during the forecasted capital shortage period, forecast the cost and their ability to attain this capital in a tight market and compare this risk against the risk of raising the capital early. Regardless, any company that decides to raise capital early should make sure that this growth capital is restricted to growth activities by implementing accounting controls that prevent it from being accessed for other expenditures. This will ensure that the capital is not wasted.

If you are interested in learning more about the tech bubble, I highly recommend reading Scott Maxwell’s blog and The Economist’s recent debate between Ben Horowitz and Steve Blank on whether or not we are in the midst of a new tech bubble. Similarly, if you are reading this post to help you better understand how to position your company for a market exit, then I also recommend reading my recent article on how to account for antitrust risk when evaluating market exit opportunities.

  • http://bothsidesofthetable.com msuster

    So exactly which bit of what I argued is “riskier?” Your argument doesn’t make it clear. I said:
    - people shouldn’t raise too much more than they need. it’s wasteful
    - people shouldn’t hold off on fund raising & try to “over optimize” as this is risky if markets correct. Strike iron while it’s in the fire
    - raise at a higher price than normal if you can. but not TOO high because then the next round will be more difficult if markets correct.

    So please point out which bit of this you either: disagree with or find risky???

    • Bhickie

      Mark,

      Thanks for your comment.

      As I stated in my post, I do not disagree with your recommendations about bubble
      financing strategy. In fact, I think that it is a good recommendation. I was merely trying to point out that there is more inherent risk in this strategy than I felt was given credence in your post. The “striking the iron while it is hot” mentality assumes that you are able to accurately forecast how much capital your company will need earlier than you normally would.

      As with any forecast, increasing the forecast time horizon leads to an increase in uncertainty and a decrease in forecasting accuracy. In the case of startups and expansion stage companies, this increase in uncertainty is also compounded by the number of changes that companies undergo during these stages in the development process. This means that although a company may attempt to only raise a little more capital than it needs, their lack of ability to forecast accurately into the future will lead to more funds not being properly earmarked in the budget if the forecast is high. The excess funds that would then become available and un-earmarked in the budget could end up being utilized on non-growth related investments and could ultimately end up as waste at the cost of additional ownership dilution. Thus, this additional risk needs to be accounted for in determining how much capital your company wants to raise in the midst of the bubble to hedge against future capital raising constraints that may become reality when the bubble bursts.

      Brandon

      • http://bothsidesofthetable.com msuster

        Wow. That is utter gobblygook. I find that when people can’t explain their arguments in simple English perhaps they are not strong arguments.

        If anybody thinks that “forecasting ability” has any correlation with fund raising success rates they are kidding themselves. Forecasting accuracy has nothing to do with successful financing nor ability to execute at a startup. Zero.

        • Bhickie

          Mark,In plain English, all I am saying is if you cannot accurately assess your financial needs, due to trying to fundraise too far in advance, then you run a higher risk of raising excess funds that you have not allocated towards growth initiatives and these funds could easily be wasted on non-strategic spending.  Wasted and/or misappropriated investor dollars come at a high price, increased ownership dilution and potential red flags to future investor prospects.Brandon

  • Bhickie

    Mark,

    In plain English, all I am saying is if you cannot accurately assess your financial needs, due to trying to fundraise too far in advance, then you run a higher risk of raising excess funds that you have not allocated towards growth initiatives and these funds could easily be wasted on non-strategic spending.  Wasted and/or misappropriated investor dollars come at a high price, increased ownership dilution and potential red flags to future investor prospects.

    Brandon