In my post, How Much Capital You Should Raise: VC’s Perspective, I listed a number of factors that VCs consider when deciding how much capital to invest in a company. However, there is another element: more capital generally makes managers less capital efficient.

For extreme examples we can all look back to the internet boom. Companies were able to raise tremendous amounts of capital during the boom and, as a result, they spent a lot of money. Visions of extravagant offices come to mind.  In contrast, examples of increased efficiency from increased cash constraints can be found in the strategies of the leveraged buyout firms which very often increase management efficiency by layering debt obligations onto companies.

At a high level, this shouldn’t be surprising. If you find twenty dollars in a pair of jeans, you might buy something that you otherwise would have foregone. It’s the wealth effect in action and it can erode discipline. In contrast, people generally work harder and are more creative when times are tough.

However if too little cash is invested, opportunities will inevitably be missed. Critical technologies will not be developed and sales people who would have reached out to key customers will not be hired. Even worse, the company could face a greater risk of bankruptcy.

Ultimately, while this is a concern for the VC, it is not the concern that typically wins the day. VCs will try to avoid making a company too cash rich, but often won’t push investment sizes down to levels that would mitigate the company's ability to execute or remain solvent.

Comments

[Kevin Spidel]

This is dead on. See Seesmic for an example and compare to 12seconds.tv. Major funding vs. bootstrapped.