Are you at the point where you are thinking about how to figure out how much capital to raise?
Knowing how much you need and should ask for in a fundraising round is a critical part of being a founder. There is both art and science to it. Though go too far off base and you could be caught out, with serious repercussions.
Your ask and ability to explain your reasoning is going to be one of the most important factors when you are out there fundraising and pitching investors. It isn’t about the numbers as much as what it reveals about your knowledge, experience and how much time and effort you’ve invested in learning and consulting fundraising experts on this key element.
The Ultimate Guide To Pitch Decks
Here is the content that we will cover in this post. Let’s get started.
As with most other things you’ll buy and sell, comparables can play a big role.
One of the things you absolutely must know and should demonstrate in your pitch deck is how much other startups in your space have been raising at this stage recently.
For example, if one of your competitors raised $9M in a Seed round four months ago, that can be a good starting point. You may be able to justify a substantially bigger raise. Though if you are asking for significantly less, that can be a red flag. It will at least create more questions in your prospective investors’ minds. You don’t need any more of those. Are you not as good? Why do you think you are worthless than them?
Look at the three to five most comparable and most recent raises. You may add and deduct based on a few factors to get a sense of the range you should be in. Just don’t undersell yourself.
How much runway do you need to survive until another fundraising round may be possible?
Y Combinator offers a super simple (probably over-simplified) formula for raising your first round. That is multiplying the cost of 5 engineers by the number of months of funding you are planning to cover. So, if you’ll need 5 engineers, at a cost of $15,000 per month, before raising a new round 18 months down the road, you’ll need $1.35M.
Typically, you’ll be raising enough to get you through 12 to 18 months, before raising another round.
However, the coronavirus pandemic could be significantly changing that. You may need to reevaluate and raise more now, with the expectation it could be much longer before you’ll bring more capital in on palatable terms.
Cost Of The Next Milestone
The purpose of a fundraising round is to get you to the next major milestone in your business. How much will that cost?
Besides paying your team for long enough to get results, are there hard costs associated with achieving that milestone? Like producing prototypes, manufacturing, materials, equipment, marketing, and just time to make it work?
Whether it is proving you can actually make what you want to, achieving product-market fit or scaling to the next level, what will it really cost to get you to the point where you are eligible to raise or exit at the next milestone?
Funding & Capital Market Trends
If you are wondering how to figure out how much capital to raise remember that things do change. They are always changing. Do not underestimate this.
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This is specifically true when it comes to the economy and financial markets. Fortunately, we have more data than ever before. We can see the patterns in advance, and play the short and long game much better.
Capital markets go through significant phases. In recent years they’ve been throwing money at any startup that pops their head up with a pitch deck. They’ve been fueling a hyperactive M&A market and the IPO market.
While it is believed that funds still have enormous amounts of capital to deploy, and many say they are looking at the big picture and are standing by their startups to keep helping them through any current crises and volatility, it is likely we’ll see some changes in the coronavirus pandemic and its aftermath.
Most won’t say they believe a new downturn could be anywhere near as bad as the Great Recession of 2008. Though, that doesn’t mean they won’t start to write smaller checks, be more conservative in valuations, tougher in due diligence, and prefer startups with cash flow and profitability.
In this scenario, there will be a lot more startups and funds chasing less and harder to get capital on rougher terms.
This will change again. If not in months, at least in a few years.
The key is raising enough money to ride out any freeze. This is one of those times when it may be wiser to raise more than you need, in order to ensure your ability to survive and grow and take advantage of opportunities.
Add A Financial Cushion To Your Projections
If you are a new entrepreneur, you’ll quickly find out that everything costs more than you thought, and takes longer to get done than you planned.
That’s okay. Provided you’ve got the extra money to fall back on.
Some have suggested that when thinking about how to figure out how much capital to raise you need to add as much as 50% on top of your raise to ensure you are covered for these issues. So, if your math so far has brought you to a $1M Seed round figure, you really want to raise at least $1.5M.
Positioning Your Ask
Note that the amount you think you need isn’t necessarily the same as your ask. That is key when thinking how to figure out how much capital to raise.
If you want to get traction quickly and to have an oversubscribed round, you may want to start low, and add on to that.
There may also be scenarios in which you really want to land larger investors and partners and will need to expand your ask to be a good fit for the size of checks they write.
Remember that storytelling plays a key role in fundraising and you will need capital to scale things up. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.
In the video below I cover in detail how determine the amount to raise in your financing round which you may find interesting.
FULL TRANSCRIPTION OF THE VIDEO:
Hello, everyone. This is Alejandro Cremades, and today we’re going to be talking about how to determine the amount to raise in your financing round. Coming up with the amount that you’re going to be raising in your financing round, whether it’s a Seed, Series A, Series B, or whatever that is, is really an art. But there are different methods that you can actually use to come up with that amount. With that being said, let’s get into it.
First, are the key figures that you need to know. On the firsthand, what you’re going to see is the monthly burn that you have. You need to understand how much cash you are burning every month, meaning how much you’re in the red every month that you’re operating.
For the most part, if you’re at an early stage, you’re going to be talking about staff and also the rent. Those are the two biggest expenses that you’re going to have. Then you can add in there the software that you’re using and any other types of subscriptions that are adding up every month to your monthly bill. That is the monthly burn, and that is a number that you need to really have a clear grasp on.
The other figure that you want to keep in mind is the cost of getting to your next milestone. That is without counting with your existing revenues, and only counting with your monthly burn. How many months or how much is it going to cost you. Maybe your next milestone is in 12 months or in 18 or 24 months. How much money is that without counting with revenues? That is a critical figure that you need to know.
Then you have the key strategic considerations. Obviously, on the firsthand, it’s going to be all about dilution. How much equity are you going to be giving away? The rule of thumb in every financing round is that you’re not diluting the equity ownership by more than 20% or 25%.
You want to always keep it under those figures so that you are not overdiluting yourself, and you can continue to mature the business; because, remember that if you’re really building and executing a hypergrowth business, you’re probably having to go to different financing cycles, and on every financing cycle, you’re going to experience some type of dilution.
With that being said, you really need to have a clear understanding of what the dilution is going to be, what is going to be the potential valuation of the business for that amount that you’re raising, and so forth.
The other thing is the control and the flexibility. Obviously, the more dilution, the less control that you and your co-founders are going to have. For that reason, you want to make sure that also, you’re thinking about the potential player that is going to come in or that investor that is going to come in and perhaps is going to share control, vote, and voice with you at a board level with the business.
Then you want to think about investment levels. There are great people out there such as Chris Dixon from Marc Andreessen, and he says that whatever you want to raise, you want to add on top of that 50% more just as a buffer.
Now, you’re going to have different scenarios. You’re going to have the Idealist Scenario, where everything is falling into place. You’re getting the exact amount that you need to execute.
You’re going to have the Worst-Case Scenario, which you need to prepare for, where you are not raising enough to reach your milestones in 18-24 months. Maybe you’re just raising for 12 months, and that’s okay, but you’re going to have to figure out how you’re going to go out to market right away.
Then, you’re going to have the Realistic Scenario, which is more on the conservative side. Maybe you’re going to shoot a bit lower. Instead of going for the 24 months, maybe you just go for the 12 right away.
Again, you’re going to have different scenarios, and you need to be able to walk the investor through what you’re capable of doing. For example, if you give me $5 million, I can do between this, and this, and that. If you give me $10 million, I can do a bit more and accelerate by this and that.
So, basically, what you’re showcasing to the investor is that by raising more money, you can still deploy in a very good way and in a very productive way that money. But in essence, what you’re doing is accelerating even farther whatever you were set out to accomplish.
In some instances, you might see the investor, where you’re asking him for five to accomplish x or to accomplish y, and they give you double because they want to go faster on the execution side.
In the end, remember that there are going to be two types of valuations. You’re going to have the founder valuation, which is what you think that the business is worth, and then you’re going to have the market valuation, which is what the market is paying you.
At the end of the day, when it comes down to putting that valuation in place and determining the amount that you’re raising, you need to keep in mind the following things:
1) How much money you need to achieve for your goals.
2) The type of investor, whether it’s an angel, a VC, a family and friends, etc.
3) Your prior success as an entrepreneur.
4) The going rate for similar companies.
5) The growth rate of related sectors and marketplaces.
6) How likely it is that your startup will reach profitability.
7) The level of revenue currently or potentially generated by the business.
8) The team that you have around you.
9) Customer acquisition and distribution of your company.
10) Lastly, you want to make sure that you have a financial forecast that is really not only guiding you to understand what potentially that’s going to be in terms of the amount to raise, but also that you can present to the investor.
The forecast is where you’re putting all those monthly expenses, whatever it’s going to cost you, whatever hires that you’re planning to make, whatever revenue that you’re expecting like projected income expenses. You’re going to be putting it all into three to five years.
It depends on the investor that you’re going to be seeing. Some may want to see three years of forecast. Others may want to see five years of forecast. But essentially, what you’re doing with the financial forecast is going to be the following:
1) Show the financial viability of your startup.
2) Identify potential risks.
3) Provide a clear understanding of future financial needs.
4) Allow future comparisons between forecast and business operations.
5) Show financial responsibility on your part.
Hopefully, this provided some guidance as you’re thinking about determining the amount that you raise with your round. There are some nice benchmarks for SaaS companies, such as the ones that we provide on our platform on the fundraising training: AlejandroCremades.com/Fundraising-Training.
If you like this video, make sure that you hit the Like button; make sure that you comment, and that you also subscribe so that you don’t miss out on any of the future videos that we’re going to be launching.
Going back to the fundraising training where you’re going to be able to see all these frameworks and how to raise money, what valuation, and so forth. There, we have live trainings, agreements, templates, and hundreds of founders all over the world helping each other. Essentially, it’s a program where we help founders every step of the way in the fundraising journey from A all the way to Z. Hopefully, you like this video and thank you so much for watching.