“How much are you asking for?”
“How long will it last you?”
Two questions that you will hear from investors when raising a round of funding.
Those may seem like simple enough questions, right?
Over the past few years I have had the opportunity to work closely with a number of startups from stages ranging from pre-product to scaling.
Everyone wants to know how much money they should raise.
If you raise too much, your valuation will be too high.
Valuations for a company in early stages (i.e. have little to no revenue) are mostly based on the percentage the VC wants to own. Many early stage investors will want 20% to 25%. That means you raise $5 million for a $15 million to $20 million valuation.
What’s bad about a valuation that is too high? A couple of things:
- The valuation for following rounds will likely include some component of revenue. That likely means you need to have aggressive revenue targets and if it takes longer than you expect to hit those revenue numbers you may need to do a down round. Check out this list of down rounds. There are some companies that you probably think are awesome, like Soundcloud, for example. Their valuation is less than the total they raised. Stay smart. Don’t be them.
- There’s no such thing as a war chest with VC money. You will spend all of it. Within 18 to 24 months. VCs invest in working capital. Not in 10 year government bonds. They will put pressure on you to spend all of it as fast as possible. Hire this executive and that one. Hire a team of 20 devs to build new features, pay top dollar for them plus recruiter fees since you cannot recruit that fast. Then half of the new people you hired won’t work out because you didn’t take the time to truly evaluate their fit. And you just wasted a good portion of what you raised and a bunch of time. Get it? And then what? You spent it all, didn’t hit revenue numbers and no one wants to invest in you again.
But if you raise too little, you probably won’t make it to your next milestone. Then no one will invest in you again and your company disappears.
Here you have to be like Goldie Locks and raise the amount that is just right.
But the amount that is “just right” is different for every company. It is not one size fits all. It depends on a number of factors, like type of business, location (and talent location), industry, length of sales cycles, etc. How do you know what is the amount of money that is just right for you?
The good news is that there are a couple of rules that you can follow to help you figure out just how much to raise.
- Raise By Milestone
- 18 to 24 months
Raising By Milestones
Raising by milestones can be great for very early stage companies. Pre-product or pre-launch phase startups can gain a lot of value by using this calculation method for how much they need to raise.
How does it work?
If you are raising an angel round of funding and you do not have a product yet, all you have are PowerPoint slides or maybe a light demo, raising to your first milestone might work for you.
How do you create milestones?
You break down stages of your business into parts that can be measured and reflect progress in your business.
Best practices for creating milestones for your startup:
- Use stages or phases to describe where your business is. For example, Beta stage: User testing.
- You can have multiple milestones per stage. For example, Enterprise Stage: Build Enterprise specific feature X, Sign one enterprise client.
- Use dates or Date Ranges. Dates not only help you to measure what has happened but also help you to stay on track. For example, you can make sure you work towards filling your pipeline with enough prospects to be able to sign 50 clients by the end of the quarter.
- Include number of clients/customers/users, revenue targets and / or other defining metrics.
- Use a horizontal line to show time. You can have concurrent things taking place, just create additional rows to show that they are happening at the same time.
- Indicate which milestones have been completed.
Things to avoid when creating a milestone slide?
- Using non-measurable milestones, like “launch successful PR campaign.” What does that mean? To make this a measurable milestone you could change this to something like “Closed $50 thousand in Annual Recurring Revenue from new customers generated by PR campaign.”
- Using number of employees as a milestone. I.e. “100 customer support employees” is not a milestone for an investor deck. Why would an investor invest in you because you were able to hire employees?
When deciding what to include on your milestone slide, ask yourself “is this something that directly shows how well my business is doing?” if the answer is “No” than do not add it to the milestones slide.
How can you use milestones for fundraising? Once you are close to completing a milestone or have just completed a milestone this is a great time to raise. If you have milestones that truly reflect progress in your business and you show prospective investors they will be very interested in listening to what you have to say.
Even if your milestones change over time, or even between milestones, that’s ok. Businesses, especially young businesses, evolve. It’s a good thing.
Here is an example milestone slide for a subscription business:
Raising By Time: 18 to 24 Months
To be fair, you need to incorporate milestones here as well. But more because you need to show progress in your business than for any other reason.
Remember it will likely take a minimum of three months from fundraising to cash in the bank but it will most likely take six months. Plan for at least six months from the start of fundraising to cash on hand. Always monitor your cash on hand and net burn.
Use your bank statements to calculate net burn. Each statement will show you the beginning balance and ending balance.Take the beginning balance and subtract the ending balance and voila! You have your net burn. Do this for each of the previous months that your company existed and enter all of the info in a spreadsheet.
The nice thing is that the default period for bank statements is a calendar month, unlike your credit card. (PS, you can request that your credit card company change the billing cycle to a particular date. This can help with cash flow.)
How do you get started on figuring out exactly how much to raise?
First: Start with revenue. Create a revenue plan for what you would like to achieve.
- How much Monthly Recurring Revenue do you want to have in twelve months? No, seriously. Start by backing into that amount to see what it would take.
- What is your average annual recurring revenue per client?
- How many clients do you need to get to this magical MRR number?
- How many clients can a salesperson close in 12 months if they have enough qualified leads?
- Don’t forget to account for churn and some late collections.
Here is a simple B2B SaaS revenue model you can use for projecting your burn.
Second: Figure what resources you need to support this plan.
- How many client service people can support one client?
- How much will bookkeeping cost?
- What other employees will you need to hire?
- What do marketing expenses look like?
Third: Revise. Go back over the plan and really look at what you have, answering the following questions:
- Can we hire enough people and in time to support this plan?
- What is the ramp up time for a new sales rep?
- Can we comfortably get this many clients per month?
- Can we reasonably absorb this many clients per month?
- How long will it take to collect cash from clients?
I hope this has helped get you closer to understanding just how much money you should raise for your next round of funding. Remember if you cannot raise as much as you want, put together a lighter plan where you earn less revenue or grow slower. As soon as you are consistently winning clients (and keeping churn low) investors will flock.
For more insight or help managing B2B SaaS startup’s finances contact me at me (at) katiebronnenkant.com.