Sramana Mitra: If an entrepreneur takes $6.5 million in seed, how much ownership does he have left in the company?
Preeti Rathi: Entrepreneurs have to be careful about making sure that they manage the valuation from that perspective. It isn’t really a good idea to give up so much of the company that it actually will make rates for the next round really difficult. Because if the entrepreneurs don’t really have enough skin in the game, the VC’s also don’t really want to invest in the next round. So if you’re taking in so much money early on, you better have an idea that will lead to higher cap and higher valuation so that money doesn’t lead to really giving up ownership completely.
Sramana Mitra: Yes, I’m not at all a fan of this kind of bloated seed rounds. That’s totally not what we practice in 1Mby1M philosophy and methodology. We try to advise our entrepreneurs to take small amounts of money and build more in a capital efficient way and pay attention to their own ownership.
Because the other side of the flipped coin is, even though everybody’s chasing unicorns, the vast majority of exits happen at the sub $60 million range. So if you raise $20 million, you don’t really make money out of a $2,000,000 exit. So you got to manage all that in the early stage. If you’ve reached the inflection point already, then you have more degrees of freedom to take more money and still be okay.
But if you start chasing lots of money without reaching any of those milestones, that doesn’t necessarily always turn out well. It could be you work for seven to eight years and make no money as an entrepreneur and create no personal wealth at all.
Preeti Rathi: That’s a wise advice. It’s extremely important to figure out where do you expect this company to be when it grows up? What kind of exit do you expect for the company? If it’s an idea, do you think it will get to a $100 million exit? You’re absolutely right. Staying lean, taking in small amounts of money is absolutely the right way to move forward.
But if you believe it’s a large market, velocity is important at that point. At that point, you can think about raising bigger rounds. You’re basically calling the traditional series A a seed. So the valuation also has appropriately gone up for those kinds of companies. But it’s important not to just say, “This company raised such a big round, so I need to go raise.” The right thought process is how big do you expect the company to be. So raise the money according to that, so that you do make good profits at the end.
Sramana Mitra: I’m sure you would resonate with this. All entrepreneurs think that their companies are going to be billion-dollar companies. That’s kind of the entrepreneur mindset. But one of the things we do extensively in the 1Mby1M methodology is create really deep bottom-up TAM models, really deep positioning, and deep segmentation to really understand what is the TAM and how big a company can you build.
Very often, when we go through that exercise using our tools, we come up with numbers that aren’t as large. Let’s say you don’t have the rigor to go to that exercise. There are lots of investors out there right now who don’t necessarily have that kind of rigor. So between an entrepreneur who doesn’t have the rigor and VC’s who don’t have the rigor, you could end up with a lot of money upfront without the market going forward.
You think in terms of 30,000 foot level and you can think that, “Yes, I’m going to build a humongous company.” So you have this artificial conviction with no real validation. That creates a lot of carcasses all over the place.
Preeti Rathi: Absolutely. By the way, even if you’re going after large markets, the idea always is, you stay really lean and burn as much low cash as possible until you hit product-market fit. Until you have product-market fit, staying lean is extremely important. Once you have the product market fit, then you can say, “Okay. I’m going to go pour in money and get this going in a big way.”
Sramana Mitra: Also product-market fit determines and shows you what is going to be the size of the market. Product market fit tells you what your positioning needs to be. What is the segment that’s going to adapt your product with velocity? That may not be this billion-dollar market. That may be a $500 million to $700 million market or even smaller in which you have to accordingly tailor your strategy or funding strategy and all that. But what we’re discussing is very poorly understood and very poorly executed in the industry.
Preeti Rathi: Absolutely.
Sramana Mitra: That was a very good conversation. Thank you for your time.