Hopefully you are reading this before you decide how much to raise. If you’ve already decided and communicated how much you are raising, you might be getting the obvious follow-up question: “Why is that the right amount?” It’s a very simple and justifiable question for the investor to ask but it is commonly met with a host of unacceptable responses, including things like:
- It lets us continue to operate for 9 months
- It allows us to hire a lead architect, an inside sales rep and a marketing person. And we badly need these positions
- That amount will only cause us to give up 25% equity in the company, which feels right for this early phase
- It’s the most we think we’ll be able to raise given our current traction
- We’ve seen a lot of other startups in a similar stage as us raise that amount of money successfully
- We have an experienced advisor that told us that was the right amount for now
I could add several more but you get the idea. To every one of these answers, my response is “So what, why do I care?” What investors want to know is the resulting strategic milestones the funding allows you to reach that help secure viability (elimination of risks, increased traction, etc) and keep you on your path to achieving the stated vision. If those things will happen within 9 months and require a lead architect, an inside sales rep and a marketing person to accomplish, great. But don’t put the cart before the horse. Your answers to “so what, why do I care” should become your explanations for why a specific amount of money is the right amount.
By the way, you might have to ask yourself the “so what” question multiple times in succession to get to the real answer. Here’s an example:
- “It allows us to hire a lead architect”
- answered by “so what, why do I care?”
- “Because that allows us to implement a true multi-tenant SaaS architecture for the V2.0 of our product, expected to be released in 9 months”
- answered by “so what, why do I care?”
- “Because that will reduce our average hosting cost per customer by 40%, improve our gross margins from 70% to 90% and improve our average customer lifetime value from $50K to $85K. We get to sustainable profitability six months quicker this way. BINGO!
By the way, you’ll never get scrutinized if your new funds will be used to acquire a bunch of customers. Just don’t fall into the trap of conveying some nice round number for convenience (see related post titled “When is Achieving a Certain Number of Customers a Meaningful Milestone?”) and be prepared to back the goal up with the ways you will go about doing that. The short reply to the magic question might be something like “We will use the money to acquire our next 350 paying customers, which brings $8,500 in new monthly recurring revenue and gets us to cash flow breakeven. We will accomplish this by doing A, B and C.” If A, B and C are also somewhat high-level actions, make sure to have the next level of detail for each.
Now for a specific issue to consider with regards to how much runway (time) you should buy yourself with the amount of funds raised. It stems from the fact that the value of your company (valuation) doesn’t increase in a straight line, even if your business results steadily improve. What typically happens along the way are other events that provide jumps/spikes in your valuation. Maybe you land a big strategic partner that gives you significant leverage or maybe you complete the multi-tenant re-architecture for the benefits described in the example above. These things give your valuation a sudden spike. And since every fundraising round has the consequence of diluting your equity, why raise money just before one of these spikes when you could raise just after?
Since predicting the timing of these spikes is not precise, raise enough to get you safely past the anticipated milestones just in case. How much past is a judgment call based on your level of certainty for achieving the milestone events. Also realize that raising so much money that you can get through 2-3 expected valuation spikes could easily backfire because of the near-term dilution. As a general rule, you want to raise the least amount of money to safely get to the next step up in valuation. Then raise the least amount of money to do it again or until you’re self-sustaining. I say “as a general rule” because you wouldn’t want to raise money every 3 months. There are also exceptions for businesses that have excessive capital requirements to get going or business opportunities that are highly competitive and in a “land grab” mode. But hopefully you get the idea.