How Much Do I Raise for My Startup?
Getting as much cash as possible sounds like a plausible strategy for a startup during a round. In practice, it’s a totally wrong path to take.
A couple of years ago I participated in a founder’s bootcamp where one unfortunate guy made a huge impact on everyone with his pitch deck — in a bad way.
I can’t even remember what his startup was about, that’s how bad the pitch was, but the bottom line was that founder described it as a venture with PAYING customers.
The founder also proclaimed that business already generated about $700,000 annually. At the same time, he was actively raising and offered 10% of his company’s shares in exchange for — ta-ta-dam — $50,000 check.
To us, he sounded either desperate, or ridiculous, or like an outright liar. I mean, if you have a business that generates 700K — what’s the point of inviting a stranger that might move your business to the next level or might end up totally destroying it for what, — one check?
I totally forgot about this founder, until a month ago when I met one of my classmates from that course.
He said he was, — no surprise — raising his round, but — no surprise again — investors weren’t very responsive. I politely asked him to provide me some details of his recent venture.
I’m asking for $1,5 mln in exchange for 10%, he said.
No, we don’t have a product yet, but in this field just building an MVP takes over $2 million. Investors with experience would know that.
Sure enough, his round was a failure.
However, this attitude is common among founders (even those who have whizzed through their seed round — and, perhaps, especially among them). The attitude of the first founder in my story is pretty routine too.
I have an explanation for that: Often it’s because founders aren’t really sure how to evaluate their company and how much they really need. If you’re one of them I hope this article will resolve this issue.
Simple math vs art collectors
So, how do you calculate how much you need for growth and what portion of your company you will be willing to offer in exchange? For this, we have to walk through (really fast) start-up evaluation methods.
If you already have customers, a history of raised rounds, revenue and cashflow, calculating company’s valuation is a piece of cake.
It gets murkier when you’re on pre-revenue stage. Basically, there’re two approaches for figuring out how much a company without customers or revenue might cost.
The first one says: put whatever price tag you feel like. Adopters of this approach proclaim that startups are like art — if someone is willing to pay what an artist is asking for, this a fair price tag.
However, going totally wild with evaluation. If you decide to follow these tactics, use at the very least, industry benchmarks — you can use Startup Valuation Nest website to get an idea.
The second approach for evaluation is more math-based and pretty straightforward. It says: take the time you’ve spent developing your product (“sweat”);
- then calculate market price of your efforts and split it in 2 (ex. you’re a Python developer, you’ve worked on an app for a year, market’s average compensation for this position is $120,000 = 120,00/2 = your sweat price is $60,000 );
- do the same for a co-founder if you have any (ex, you got another $60,000);
- add cash that you have brought in (ex, $40,000 each = $80,000);
- add rough evaluation of your idea (if it’s not a longevity pill or a cancer treatment it should probably be under $100,000);
here you go — your company evaluation is $300,000
Now it’s time to calculate how much you can raise. It’s considered to be a common practice not to offer more than 15% in a round.
So, rough calculation will give you not very impressive but much more realistic numbers: you can probably count on raising up to $45,000 during your seed round. But most probably you wouldn’t want to delude your ownership so early on, so
it makes sense to offer 10% instead in exchange for $30,000.
(Well, isn’t it about the same amount early-stage accelerators promise to invest in you if you really impress them? Now at least you know the magic behind these numbers).
Burn rate factor
So, the job’s done, right? We put $30K in our pitch deck and go hit investors. Not exactly. One of the first questions you’re going to be asked: “What activities are you going to invest the funds into?” And “How long you’re going to last with this $30K?”
Meaning, the next calculation you should do is to figure out your probable burn rate and runaway.
For instance, you’ve written a business plan and it shows that you’re going to burn $30K in 9–10 months. You’re going to spend these funds on the early hire (reasonable), some user testing (reasonable) and administrative (sounds good).
This is a plausible plan that means, you’ll be focusing on growth, start generating first revenue, and in the same time would be busy working on establishing connections with potential investors for the next round.
Most probably, you will not be able to last so long, so there would be a credit line (somewhere around the 6th month) or a grant or a crowdfunding campaign.
But, here you go — a plausible plan that presumes that your raise rate meets expectation, your burn rate doesn’t raise red flags and your time to the next round is well within average limits (308 days, to be precise).
I know what you think:
But wait, my product is really disruptive, it will change the way travel/ticketing/insurance/food delivery…. Industry works. It will open a totally new perspective and unveil new markets, in the same time contributing to global economic growth and sustainability.
Fine, let’s presume you’re telling the truth. Let’s even
imagine that you’ve stumbled upon an investor who is eager to give you $2 mln to create your “VR Facebook + PayPal+Uber”.
Where does it leave you? It might be something counterintuitive but with big investment comes big responsibilities. What investors actually expect from you if they give you a lot, is the following: you have to grow like crazy spending invested funds on hire.
Active hire means you’re turning into a slow corporate monster in less than 6 months after your birth. You’re losing velocity, agility, hunger and the corporate culture you’ve been leveraging upon to come up with this amazing idea of yours.
It usually ends up in losing control (if not financial, but actual) over the company and it starts stirring in the direction that you’ve never expected it to.
Bottom line? A founder is totally burned out, co-founders-best-buddies-in-the-beginning-of-this-story turn into lifetime enemies, investors are disappointed, customers don’t get what they’ve hoped to.
But why would investors want you to do all these? Why can’t they invest and wait a couple of years while you’re building your team, your product and your customer base?
For different reasons, actually. Partly, because that’s what VENTURE investment is about: invest to trigger aggressive growth. Else they could have put money on saving account or buy financial derivatives.
Partly, because fast growth needs more investment and prompting it, they make you need them in return. And as Paul Graham point out, “partly, because the portfolio effect means they favour kill-or-cure strategy”.
Meaning, your precious company is only a part of a big pool for them. VCs don’t need too much involvement. They need Darwin’s “natural selection” in its most crude form: turn into a “unicorn” or die.
So, here’s for modesty and responsibility in raising. And for understanding that startup business is not different from any other forms of entrepreneurship at least in this respect.
Knowing your financials is the key. Making decisions based on your knowing of these financials is the key. And the only way, not to end up like a Thanksgiving turkey: stuffed, but dead.