How Much Capital Should You Raise?
When you are going out to fund-raise, you need to decide how much capital to raise. When we ask this question of founders, a typical answer is:
"We need to build X features in our product, and we need to hire Y people to make it happen. So, our burn would be Z, and we need a buffer of W months. So here is the amount we are raising."
But this answer isn't great, and isn't likely to excite prospective investors. The reason (and what we ourselves will be thinking) is:
No one wants to fund your burn.
Rather, investors are looking to fund a company to a milestone. And, in reality, there are two kinds of milestones for every company --profitability and next round of funding.
Profitability is a possible goal, but isn't typically the goal venture-backed companies are looking for. Instead, startups and VCs are in the fast-growth game, and that can often proceed at the expense of profitability. That's why 99 percent of the time when disciplined investors evaluate whether to put money into your business, they'll be asking:
What milestones do you need to achieve to get to the next financing?
In other words, a pre-seed investor will be asking you what it will take for you to get to the seed round. Then, a seed investor will ask what it will take take to get to series A. A series A investor will want to know what is needed for series B, and so on.
The lesson here is that investors think in terms of the specific milestones your company will need to achieve to receive the next round of financing. And those milestones mean either revenue or customer growth or some other kind of growth target. You will be given money to demonstrate that your business has potential, and that it is worthy of investors' putting yet more money in.
The things investors typically consider are:
1. What milestones you'll need to achieve for the next round of funding
2. What resources you'll need to achieve the milestones
3. How long it will take you to achieve the milestones
With that in mind, a much better answer to how much money you want to raise is:
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.
Your prospective investors are going to react much more positively to this kind of ask.
The discussion then, will revolve around whether your prospective investors believe that yours are the right milestones, and whether you will be able to achieve them quickly enough. This is where your financial model and business plan will come in. You'll need to demonstrate that you correctly modeled-out your costs, but more important, that you correctly modeled-out the growth of your key metrics.
So, whether your goal is revenue, or number of customers or something else, those prospective investors will want to understand how you are going to grow. Here is the most important thing:
You aren't building a financial model to check some check box for investors. You are building it for yourself to operate your business.
Putting together a financial model, and putting a plan in place isn't some kind of side exercise to get funding. It is the core exercise that every founder needs to go through in an ongoing manner. The financial model is the operating plan for the business. On this note, I love this advice on financial models from Kevin O'Brien, CEO of GreatHorn (Techstars '15)
Build a real financial model. We exist in a moment when everything about starting a business is easier than it was a decade ago: You don’t need the same capital to stand up hardware that you once did, and there are more ways to capitalize your business than I can ever recall. As a result, it’s sometimes easy to get seduced by the artifacts of company building: hiring big teams, renting fancy offices, spending a lot of time talking to investors and to the press.
And that's not the way to proceed, O'Brien cautions. Instead, he continues:
Dollars raised are a tool. Dollars returned are the business. The hard work of acquiring, delighting and building out an ultimately profitable customer base is where your true north should be. Everything else, even investment, is a means to that end.
So, once you build a solid model, you should know exactly how much money you'll need to raise. Your investors will know that you did the work, that you will operate the business responsibly. And at that point, they will be a lot more likely to write you a check.
Alex Iskold is the managing director of Techstars in New York City. Previously Iskold was founder/CEO of GetGlue (acquired by i.tv), founder/CEO of Information Laboratory (acquired by IBM) and chief architect at DataSynapse (acquired by TIBCO). An engineer by training, Iskold has deep passion and appreciation for startups, digital products and elegant code. He likes running, yoga, complex systems, Murakami books and red wine -- not necessarily in that order and not necessarily all together. He actively blogs about startups and venture capital at http://alexiskold.net.