Most ventures raise external funding to accelerate their business to the next level. As an early-stage startup, you might want to raise funds to validate your value proposition. If the venture has reached Product-Market-Fit (PMF), you want to invest in Sales, Marketing, and experienced executives to accelerate growth.
Regardless of the stage, determining exactly how much you should raise is necessary before approaching external investors.
The general rule is that you're in an ideal position to consider raising capital when:
Reasons to begin fundraising:
If you have existing investors already on your cap table, give them an early heads up if you will not close a round before the cash runs out. Negotiate a bridge round with the ones with deep pockets that will buy you at least another 3-6 months. In most cases, bridge funding comes in the form of a Convertible Loan Note (CLN) with an attractive discount on the next round (15-25% depending on how far out you are from closing) and a valuation cap that would usually be a 30-50% up-lift from your last round post-money valuation.
How much capital should you raise?
Here's the simple answer: Raise as much money as is needed to reach the next phase of your company's growth. There's no magic formula, but you can assess a few aspects of your business to give you a good starting point. As funding is time-consuming, you also don’t want to be back chasing investors right after closing a round.
Alex Iskold, Managing Director at Techstars, recommends presenting the following formula to investors:
“We need to achieve milestone X. To get there, we need Y people, and we need Z capital. We believe it will take us W months to get there.”
Raise enough money to last for 12-18 months: Forecast growth over at least the next 18 months when raising capital for your growth business. VCs refer to this as the "runway" – the amount of time the company can keep operating before it runs out of money. The longer runway, the higher margin for error.
Investors will typically look at:
1. The milestones needed to reach the next round of funding.
2. The resources needed to accomplish those milestones.
3. How long it will take to execute the milestones.
Here are three factors in evaluation:
Milestones are key events or actions in a project or business journey that marks a critical stage of progress. These milestones can be anything from your first repeat customer to completing a prototype. The money you raise is a means to achieve defined company goals, so the amount you raise must be bound to those estimations about what you need to spend to accomplish those goals.
The runway is the amount of time you need to fund company operations.
If you have $400,000 in funds and it costs $50,000 a month to run your business, you have eight months of runway. Aim to raise enough money to cover the next 12-18 months. If you just started, keep the company bootstrapped as long as possible and avoid unnecessary expenses like expensive offices. Keep lean!
Define your milestones and estimate the business's monthly operating costs. Some of the things that you need to consider when calculating how much it costs to run your business and move forward to the next milestone:
Once you have calculated the business total monthly spend on the above items, then multiply it by the number of months it will take to level up to your next milestone.
There will be demand for your startup if you can prove traction! If there is much dry powder and the general investment sentiment is positive, you are in a great position to defend a strong valuation, and the opposite is also true. Your job is to create as many lead investors as possible, driving up demand for your shares and negotiating the best deals for you and your co-founders!
A high valuation might feel like a great win on the day you close, but it can set you up for failure at the next funding round if you don't execute the promised growth numbers! A win/win between founders and investors on valuation and terms tends to bring the most successful long-term.
Remember that the amount of money you raise in each round will impact your future valuation—research valuations of other companies in your sector and hypotheses concerning the industry's growth. Don’t raise more money than you think is needed, but at the same time, be sure to have some buffer if the future's uncertain. Don’t be overoptimistic on your own sales forecast and allow for scenarios where you only achieve 50% of the target. You want to balance being “capital efficient” and being prepared for tough times ahead.
You can also compare your sales and burn-rate numbers with other companies in your industry or niche that are valued and assumptions about the industry's growth. Remember that every company is a unique case, and you can’t compare a valuation between a venture started by a serial founder with successful exits and a first-time entrepreneur with no experience. The risk profiles are very different for different founding teams, and as a first-timer, you must demonstrate real sales traction before you can command high valuations.
Before fundraising, it is important to define your parameters for valuation/dilution and terms that you consider acceptable versus those you would deem too much from an investor. The majority of founders give up around 15-20% of their equity at the Seed stage, another 20-25% during the Series A round, and 15-20% at the Series B round.
Again, the better you execute your plan (i.e., generate sales and keep your expenses under control), the less dilution you will experience. This is simply because your company will be worth substantially more if you hit or even outperform your targets at each funding stage.
Things you can do to prepare before you start to raise capital:
Obtain advice from other founders and experienced advisers: Find people who have made the growth journey themselves, understand your business model, the market opportunity, and, most notably, have connections with investors. They will challenge you to improve your plan and tell you about all the pitfalls and the importance of being prepared before pitching.
Ask your lawyer or advisor to prepare for investor due diligence: Find an attorney who understands venture and fundraising with experience helping companies with M&A and exits. They will advise you on everything from getting shareholders’ agreement and equity structure to patent and trademark filings. They will help you negotiate the legal parts, from the term sheets down to the definitive investment and stock purchase agreements, and all the things you, as a founder, will be on the hook for if the VC gets their way.
Collect the data: It is crucial to have the correct data to back up your business's assumptions, growth, and potential. Investors need to trust that you have done your homework and run your business on data. Whenever possible, you must show data and evidence when making claims. One such area is market sizing, or Total Addressable Market (TAM). Avoid large estimated market numbers and what % you might win over time. Instead, do a simple bottom-up calculation of how many customers you have, how many more you can reasonably sell to, and the Annual Contract Value.
Crunch the numbers: Investors will dissect your numbers in follow-up meetings once you have made an impressive pitch. You have to be able to back up your spending costs, estimated runway, and funding needs with underlying Unit Economics and KPIs. There is no other way than to build a proper financial model (Excel/Google sheets), with an 18 months Profit & Loss (P&L) and cash flow projection with realistic sales assumptions. You can, of course, project years 2-4, but focus on explaining how the company will reach its next milestone.
Prepare the pitch: Before you start fundraising, you need to build a convincing pitch deck! It should focus on showcasing your product, the problem you are solving, sharing your business model and monetization strategy, and introducing the team.
Talk with other founders:
Target the right investors: To increase the chances of raising capital, target investors who have experience investing in your industry and have shown an interest in founders with similar backgrounds and missions.
Read our blog on Meeting and Engaging with the right investor.