How Much Should I Raise and When

“Having more capital gives you more flexibility, but can be costly at early stages.” 

Some believe that the answer to the question, “how much money should I raise? is “as much as you can.” But while we would all want to have unlimited capital to grow our companies, these decisions have implications on our ownership and the growth path of the business. So how do we determine how much to raise?

The Considerations

There are several considerations that need to be taken into account as you think about fundraising:

• The Cost of Capital. Venture capital is very expensive – meaning that you have to give up big pieces of your company to get it. Young start-up companies raise money before they have created much measurable or meaningful value, removed much of the risk, answered key questions about how big the market really is, defined how much market demand there is, proved if the product even works, or confirmed if the product has a concrete fit in the marketplace. As a result, the capital is priced with a high degree of risk assumed. Given that it is so expensive, you really don’t want to take any more money than you need.
• Control. With more investment comes the debate over control of the company. Generally, once you give up a majority of the ownership (i.e., equity) in the company, you have effectively given up the ability to control the company. This must be a consideration.
• Investor’s Desire for Ownership. When making an investment, investors assess the amount of risk involved, how long it will take the company to reach liquidity, and how much effort the investors will have to contribute to help the company succeed and scale. Those inputs then lead to a rough calculation of the amount of ownership that makes the investment worth making versus other opportunities. Generally speaking, the earlier an investment is, the more ownership an investor needs to justify the risk, effort, etc. Quality/experience of the team/entrepreneur, clear market analogs, and other factors can reduce that ownership need to some degree. So when an investor says they need such-and-such ownership (or they need to put $X amount of capital to work), it’s tied to their assessment of the risk and the reward.
• Aligning Interests. Experienced investors will be able to triangulate to what is fair for their effort while balancing the need to incentivize founders, management and employees for the risks and the extraordinary efforts required in building a valuable business.
• Accepting More Money. if an investor is willing to give you an above-market valuation that allows you to raise more capital than you need without taking more dilution, it’s worthy of serious consideration. But even here, it’s not always a slam dunk.
• Higher Scrutiny. With more money usually come more investment terms and more due diligence. The more money involved, the more more diligence to make sure that their money isn’t going to be misused.
• Your Readiness. Be honest about whether you are ready to use someone else’s money. Do you have a plan? Have you recruited staff or put in place systems or processes to grow? Doing this before and not during or after raising money is a welcome step for investors.
• Lack of Discipline of Extra Money. We need to look no further than the .com era to understand that when companies have extra money that they don’t need or have not planned for, they tend to spend without the rigor of a more capital constrained environment. This can come to life in the form of financial laxity, lack of focus, overspending by the management team and the general fear with overfunding a company is that it will be tempted to expand faster than it can absorb employees into the culture, integrate new systems, or expand real-estate needs without substantially disrupting the efficient operations of the company.

Basic Approach

Given all of these factors, the basic premise is that you should raise the sum of three amounts:

• Amount Need for Key Milestone Achievement. as much money as your company needs to achieve the milestones you believe necessary to reach a significant inflection point in the value of the business.
• Add for Six Months. at least six months to the amount of money you need for your next milestone to include time to go fundraising.
• Amount for a Buffer. Build buffer for the inevitable mistake or two in either your estimations or execution –usually one to two quarters.

It’s important to have a realistic plan and a clear view of the meaningful milestones and resources needed to deliver on that plan. If you plan wisely, you will have a pretty specific amount of capital you know you need. Here are some considerations in doing so:

• Ask for a Specific Amount – Not a Range. As an investor, it’s a big red flag during a pitch when the entrepreneur asks for a range of money (i.e.: “we are raising $5-$10M) vs. a specific amount, leaves the dollar amount open-ended, or says “How much do you think I will need?” If you can’t answer the question, you don’t really have any business running a startup.
• What is a Milestone. A milestone is a quantifiable achievement, be it in terms of product development, team expansion, or market adoption of your company’s value proposition. Examples of milestones:
  • shipping commercial product’
  • acquiring a critical mass of customers or users to prove product/market fit
  • filling out the core leadership team with “A” players.
• Basis of a Financial Plan. A detailed plan and budget should yield answers to the three critical questions needed to determine the funding required to hit key milestones:
  • What resources (people, equipment, services, etc.) are needed to deliver the milestones?
  • How much time, given those resources, is needed to deliver the milestones?
  • How much capital is needed to fund those resources for that period of time?

Once you have arrived at answers to those questions, you should have a reasonably specific capital need figured out, and should be precise about raising that amount of money. Tied to this cash need is an implied understanding of your company’s milestones. Your financial plan will likely be a series of chronologically organized milestones. The investor will rely on your ability to communicate this on your financial plan for the investor to then make a decision on whether your accurately understand your cash needs or not. An investor will likely want to talk to you about the importance of each milestone of them to get a feeling for which ones are the key ones to focus on to determine if your business is going to ‘take off’.

• Build in Some Buffer – and Communicate That to Investors. Building in some extra cash for contingencies shows management maturity. It’s the nature of the beast and acknowledging that you will not execute flawlessly will be well received by investors. Your exact calculations may have said that you needed 100K to launch your product, but an experienced investor may have seen various companies like yours and seen that there are usually mistakes done along the way that consume cash without quantifiable progress towards the agreed milestone (you may have learned something, but you may be delayed in your launch because of some screw up).
• Comfort for Investors. Investors want to make sure your business is going somewhere before putting all their money in, so it’s likely they’ll want to come in early to give you enough cash to achieve something plus a little extra to help you fund-raise after, but also to see how you achieve the milestone before putting in more. So, perhaps this Angel may opt for funding you through month 10 with your requirement of 100K plus a few more for fund-raising. This would get you through your product’s launch and give you a couple of months to see how it goes in terms of market traction (all the time you will be speaking to new potential investors) so that you can have something strong to talk about for fundraising purposes.
• Creates Credibility. Investors (and even employees) want to see that sees that you have a plan to hit a milestone and that you can execute against that plan. This reduces investment risk and proves if your company has any traction.

Timing

The best time to go fund raising, is just before of after the successful completion of a key or series of key milestones.

• Before. For example, right before a key milestone, you can woo new investors with the promise of how successful you will be at the completion of the milestone. Basically you convince them that if they don’t get into your company by investing now, that they won’t have a chance after you’ve achieved the milestone because many others will also be interested and the competition will be stiff (remember, investors don’t want to lose out on potentially hot deals).
• After. Shortly after achieving a key milestone is also a good time to try and convince investors because you’ve effectively accomplished a major thing (like launching a product), which de-risks the investment for them, but they can still get in the company before it ‘takes off’.

The worst time to go fundraising is when your last major milestone has grown stale and the next one is too far away to be de-risked.

In conclusion, raise as much as you can but understanding your monthly cash burn and map out your company’s important timelines and the cash you will realistically require to achieve them. Then have an engaging conversation with your potential investors as to how much they think you need based on their experience.Tying everyone’s perspective around a clear plan with set milestones provides a strong foundation for moving forward.