"How much money should I raise for my startup?"
It’s a great question and one I get asked all the time. This is a pretty challenging topic for many entrepreneurs, and there is a lot of good and not so good advice floating around out there.
So let's assume you believe your company can grow to $50-$100+ million in sales and you're taking the VC route.
Fortunately there is actually a pretty formulaic answer. The amount of capital you should raise should be enough to:
Fund the milestones you believe necessary to reach a significant inflection point in the value of the business. Achieving these milestones significantly reduces one or more key risks, creates more insight into the potential scale of the business, and demonstrates the execution abilities of the leadership team.
Example milestones could include i) shipping commercial product, ii) acquiring a critical mass of customers or users to prove product/market fit and various business model assumptions, or iii) filling out the core leadership team with “A” players.
Build buffer for the inevitable mistake or two in either your estimations or execution –usually one to two quarters. More is always nice, but remember this is very expensive capital.
Bankroll the company during the ensuing fundraising process. If you have correctly defined the milestones and achieved them, raising your next round of capital should be straight-forward and take 4-8 weeks to get to a “yes.” If it’s longer than that, to some degree you had the milestones wrong or you didn’t execute well. So call it another quarter’s worth of capital.
Now to get more specific and less formulaic.
How much to raise is a balance of 3 factors:
1. Milestone funding. Typically VC funding is based on achieving identified milestones. Milestones in this context are valuation-enhancing events. One can be cash flow breakeven. But certain things need to happen to enable this milestone so you need to break this down further. What will happen to enable you to reach this milestone? How long will it take? Typically milestone funding means funding from one Series (A) to another Series (B). Here are some examples of milestones you might be able to use:
Proof that the initial team is able to attract talent – key hires are C- ad VP- level professionals, which will drive your growth further. Every startup will eventually need a functioning management team consisting of CEO, CTO, COO, VP Sales, VP Marketing, and possibly some others depending on what you’re building.
Proof that ecosystem agrees with your ideas – bringing respected industry advisors or partnerships on board
Proof that there is market – $1 MM annually
Proof that you can manage your finances – cash-flow positive operation
Proof that you can scale – $10 MM annually
Proof that the market is big! – $25 MM annually and beyond
With Milestone Funding you will raise only as much as you need to hit your next milestones (plus a little more for cushion). I wrote about milestones for raising cash and how they affect your valuation here.
Essentially you want to set yourself up to achieve your next milestone with any money raised. You do not want to have to raise money when you fail to achieve those milestones. That will be hard, expensive and likely a down-round.
If you've identified breakeven as a milestone, what comes next?. Do you think you will raise money after that? If you do, you can possibly demand a higher valuation than other comparable companies because you’re profitable. But what every investor will be trying to determine is what will be the exit – how much of a return will they get?
If you don’t think you’ll raise any more money then you will want to get as much now as you can so you can still have money in the bank to grow even faster by making acquisitions, opening new office locations, etc. At that point it becomes about scaling and size – moving from a $20 MM valuation to $200 MM, for instance.
2. Available funds. How much do you think you can raise? More isn’t always better but you want to know how much is available to you – and use this number as a parameter to help set your milestone targets. And more $$ = substantial de-risk and/or faster growth, if you do it right.
3. Dilution. How much you raise early will impact how much equity you have later in the game. Milestone funding prevents unnecessary dilution and it allows you to get the highest possible value for each round.
Let's look at an example. Say you're an early stage company doing a little over $1 MM in annual revenue looking to raise a Series A. Should you ask for $1.5 MM or $4 MM? It's probably better NOT to ask for $1.5 MM – you likely don’t have enough cushion, in my opinion. At least round it up to $2 MM or $2.5 MM.
If you’re giving up between 20% and 30% of the company, at those levels your valuation will be $8 MM to $10 MM post-money – very doable. Maybe even a little small.
However if the funds are available you can just as easily ask for $4 MM. The valuation would be $20 MM post-money. Harder to justify but if the funds are available it's doable. Besides, it's the VCs who are setting the value, not you.
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Let me know what you think about how much money to raise by reaching out to me directly at firstname.lastname@example.org.