How Much Capital should we Raise?
Posted by rbpasker on August 17, 2007
Raising capital for a startup is a difficult process. How to do it well is probably one of the most frequently asked questions. Even the most prolific CEO will only raise money 10 or 15 times in a career, while professional investors (AKA VCs), on the other side of the table, do it every day, all day, and work in an office full of people who also do it all day, ever day, so its no wonder founders and CEOs are always looking for good advice.
There have been numerous treatments of this topic, but I would like to focus on one blog entry by Don Dodge (albeit on a different topic, which I’ll cover separately), because he makes a number of very good points that are worth exploring further.
1. “the key is to have several VCs or investors competing for the deal”
This is indeed a key point, and not just because it provides a better bidding situation for the company. There are a many tactics used by VCs to bump competing VCs from a deal, and fund raisers need to have two or more horses in the race, right down to the wire. One tactic is to provide a very favorable term sheet “subject to due diligence” early in the process and get the CEO to drop other VCs. Then, after the lengthy due diligence process, the VC says “the company is not as far as we thought it was”, and proposes new, onerous terms, such a lower valuation or a full ratchet. If you don’t have other VCs in the wings, you might have to either take the deal or restart discussions.
2. “Companies fail because they run out of cash…they usually don’t fail when they have too much cash in the bank.”
Every startup starts out with no money, until someone puts money in. That money can come on day one from the founders, from angels, from VCs, or from a spin-off. Nevertheless, the money gets invested throughout the life of the company because investors believe in the company vision or because they agree to the risk/reward. Once existing or new investors lose faith in the company (for whatever reason, see #3 below), the money dries up and the company eventually either turns a profit, gets sold, or runs out of cash. Undercommit and overdeliver on your (mutually agreed upon) milestones, and you’ll keep the investors happy, and you won’t run out of cash.
3. “How much money should I take? … My simple answer is a little more than you need to reach the next milestone.“
What should that “next milestone” be? As you are talking to potential investors, listen very carefully to those who turn you down (if they have the guts to do so at all), because often times they will implicitly tell you what milestones you need to reach in order to get back in the door at the valuation you are proposing. I call these “fundable milestones.”
Some of the most common milestones are: product maturity (beta, production, some set of features), revenue/spending/hiring targets, CPC/CPM/CPA, uniques/adoption rates, or marquee customers. These targets could also be expressed as a rate, e.g., “50% increase in uniques per quarter.”
So the answer to “how much money?” is, then, more than enough to achieve the milestones that will get you back in the investor’s door at a valuation that you are willing to accept. Give yourself some buffer (3-6 months of operations, depending on how close to the edge you’re willing to go), but don’t raise much more. You don’t want to be running out of cash with your next fundable milestone still ahead.