For entrepreneurs, cash is a tool.

In a basic sense, taking a VC's money is a way to buy runway, expand your team, and pay yourself a decent wage. But in a more strategic sense, taking cash presents a unique opportunity to develop a relationship with a new advisor. That can be tricky. You don't want to take the wrong person's money--especially at the wrong price.

That point--that "smart money" is becoming increasingly important--was drilled home Thursday at the PreMoney conference in San Francisco, a 500 Startups-sponsored event for the investment community in San Francisco and Silicon Valley.   

Jeff Clavier, the founder and managing partner of SoftTech VC, talked about some of the basic tenets of what entrepreneurs should be looking for in an investor:

  • an investment portfolio that is in some way related to the general thesis of the entrepreneur's company
  • a partner who can provide value or connections and, maybe most interestingly,
  • a check that really reflects your value and what you need--and no more. 

That last point is an important distinction that probably doesn't get addressed often enough. Fred Wilson, one of the afternoon's speakers, addressed the issue head-on in a blog post today. He wrote:

We recommend that entrepreneurs keep the funding amounts small in the early rounds when the valuations are lower and then scale up the amounts in the later rounds when it is a lot more clear how money can create value and when the valuations will be higher... 

Understand what your investors are optimizing for. Many are optimizing for putting a lot of money out so they can get to their next fund and raise even more. It's a big money game of asset allocation. When you team up with VCs who are playing that game, you are playing that game. There are VCs out there who play a different game. If you want to play that different game, please knock on our door.

In other words, you may enounter the opportunity to take on a chunk of capital early on, because plenty of investors are throwing out big sums in order to incentivize VCs to put in even bigger rounds later on. But that doesn't always pay off for the entrepreneurs, for two fairly simple reasons. First, the founder's equity gets massively diluted early on. And second, it also forces the entrepreneur to "go big" in order to achieve the type of exit that would satisfy investors.

David Karp of Tumblr, Wilson says, is an example of how to raise money correctly:

David Karp raised $600k, then $4mm, then 5mm, then $25mm, then $80mm (or something like that). And at the time of the sale to Yahoo!, he owned a very nice stake in the business even though he had raised well north of $100mm. He did that by keeping his rounds small in the early days and only scaling them when he had to and the valuations offered were much higher.

In other words, there's nothing wrong with bootstrapping whenever possible and taking on a lower valuation in order to retain equity and room to grow.  And that's not necessarily going to push VCs away, either. Union Square Ventures, Fred Wilson's firm, invests small rounds at small valuations.

"We lose a lot of deals to firms who aren't committed to any of those things," he writes. "But that's life."