Vinod Kholsa is a legend for a reason, look at returns he has gotten on the fund he is running by himself. (via Infectious Greed)

I know rounds of <1$M in the seed phase is getting more and more popular especially for web 2.0 startups that launches via the Techcrunch method. (recently profiled by business 2.0 as a how to pull out. . . only if it was that easy I would be “independently wealthy” by now.) All things equal, I would not have raised $50M in 24 month at my last startup and settled for a more gradual $15M over 2 years. And probably a round of $1M or so for seed. All the reasons to do so has been blogged to death (less dilution, more discipline, smaller egos, more control etc.) But these is a negative side to all of this that no one is talking about. . . that is

1) Raising $1M versus $5M doesnt mean your pre-money stays the same. This is the screwed up part. For $5M you are probably giving up 35%-45% of your company. For $1M you are probably giving up 15%-25% for the company. The scale is not even close to linear. You have to make the choice whether that extra $4M is worth another 20% in dilution . . .

2) This is the part that I hate the most. Putting in less money means VC’s are taking less risk. This is not the case for entreprenuers. Quiting a job and relying on your wife’s salaries to feed the kids is extremely risky when you only have 12 months of burn in the company bank account. Put it another way, VC’s only have variable cost when they invest in the startup, entrepreneurs have a huge fixed cost they have to cover before the rewards are worthy. For each dollar a VC invests, there is an dollar he/she could lose. The entrepreneur, on the other hand, is not just betting with sweat equity but with his career, family, (and baby food?) VC’s can now dull out investments in smaller chunks pending milestones and market condition. (this is a huge risk mitigator for them)

The other positive externality for VC’s is that any entrepreneur that is doing this must be extremely committed/confident of his concept or financially independent w/ a succesfull startup under his/her belt. Which helps with positive self-selection.

3) The last point has to do with recruiting. How do you recruit employees when all you have is 1M bucks in the bank? Its really really hard to do so unless you give inflated titles and/or inflated equity (and perhaps that would not work either). And of course the equity comes out of the employee pool which dilutes the common share holders (founders) and not VC’s (remember, the pool is usually allocated BEFORE an investment so the dilution is to founder/employees not VC’s). In which case, the dilution you hoped to save by raising a little money might go down the drain.

Good news of course is that its easier to start and scale a company than ever. So easy, infact, that people can do it as a side gig until certain milestones are met and negotiation leverage returns to the entrepreneur not the VC.