The danger of over capitalizing your shopify app

The danger of over capitalizing your shopify app

Classic founder hearsay is to raise as much as you can, especially when its in front of you.

2021 was an interesting year in the shopify ecosystem.

We saw lots of apps raising $20M, $30M, some even more.

To onlookers and employees, it's exciting. But there's so much risk in rounds like this.

I get it, the business is growing nicely, and investors are excited about the prospects. Maybe you even get term sheets without working on a fundraising deck.

But as a founder you gotta think about capitalization structure early if you have a shot at achieving the outcome you want for yourself, your team, and your investors.

A few rules of thumb:

  • For investors to approve and be happy with an acquisition, the exit value should be roughly 3X the last valuation
  • Additionally, you should  be striving to sell for 10X the total capital raised in the business

If any of these are not true, you run a ton of risk.

Let's walk through an example. Imagine you're at $10M revenue and get an offer to sell for $100M. 10X seems reasonable these days.

Without more info, it's impossible to know if this is a good deal for anyone.

If the business raised $0 and bootstrapped, this is a home run. If the business raised $20M over several rounds of funding and the most recent valuation was $100M, this really is a horrible outcome.

In the latter case, investors won't be thrilled but will likely make some small return. Founders may make a small amount, but employee stock options are likely "underwater".

Strategy around capitalization needs to happen early. Yes - you should be building for the moon, and hope there's a $1B outcome for you, but its also important that you have realistic paths at each stage.

My personal recommendation is to raise a pre-seed round of say, $500K, and use that to build a real business, with revenues growing month over month. Once you cross $1M, if you see a path to $10M, absolutely go for a series A.

The opportunity to raise venture is there for any business scaling quickly and where the growth data is crystal clear there is massive potential.

But raising that venture round before things are crystal clear, make it damn near impossible to get off that track.

If you do decide to "go for it", be smart about valuations in each round. Just because you can get a $10M valuation at seed, doesn't mean that's the right thing to do. A valuation thats too high for the stage will be incredibly difficult to grow into unless you're growing like crazy (call it 2-3X revenue growth year over year after $1M ARR).

So be strategic early about how you approach capitalization for the business.

In my experience, we had several offers to sell along the way for $60M, $80M etc as we grew. We couldn't, because we had raised $10M and needed a much bigger outcome to get all stakeholders what they needed.