As mentioned in my most recent essay, I have seen too many plans this year where there’s a multi-billion dollar revenue projection accompanied by an initial ask for only $500K. You don’t want to give the impression you are raising just enough money to get yourself in trouble and nowhere nearly enough to accomplish the ambitious mission.
Obviously the more you raise now, the more you are betting against yourself. You are selling your equity at what should theoretically be a low point in its value. You are accepting more dilution than may ultimately be necessary. If, on the other hand, you raise just enough to get out of the starting gate and achieve a first milestone, you are making an all-in bet that you will be able to find the next round money at an increased valuation based on your startup’s performance. I’ve been successful with both approaches; but my decisions were based on complex circumstances in every case and included some level of reasoning alongside the gut instinct.
Investors may prefer that you take more money now. Their dollars enjoy having companions, and there’s perceived safety in being surrounded by a nice cushion against the unknown. One might argue that overfunding today can move your next round further into the future where your valuation curve may preserve the equity you hoped to maintain in the riskier just-in-time method. There’s also always someone advising you that when money is available you should take it; you just never know what internal or external economic perturbations may mean that money in hand today is out of sight when you really need it later. It is generally true that it’s easier to raise more money than less. A big idea is more attractive and creates hope of moving the needle for investors from all categories. Once you convince your lead investors, others will tend to pile on. It’s a clubby mentality.
At this point, I must remind you that part of your decision is how much can you personally raise? If you are a first-time entrepreneur unknown by practicing tech investors, you may have a relatively low ceiling on what you can scare up from your family and personal friends. Whether you are fresh out of a highly regarded school where you had a 4.0 GPA or fresh out of a distinguished corporate career, you may have had no opportunity to make yourself known among those who write checks for ideas like yours. Frankly, your best bet may be to hitch on as an early hire for a startup led by a serial entrepreneur who has an investor following. If you earn your way into a key role in a venture that has a successful exit, and if you demonstrate your talents to the investors who profit from that deal, you’ll get your turn at bat. Marissa Mayer is sitting in the original Google office working on her next big idea. She can probably raise $500M in seed money with little effort; see if she’s hiring before you attempt what may be an impossible task on your own. According to numerous articles I have read, the median age of successful entrepreneurs is around 40. Those over 55 have better odds than those under 35. You don’t have to knock it out of the park in your 20’s. Have a little patience as you build your following.
The flip side of that is those who can easily raise too much money. All the rules are different in the biomedical space, and, if you have something that appeals to doctors, you may well be able to raise more money than you can deploy efficiently. But, you can raise it at a valuation that is high enough to protect you against excessive dilution. These high valuations are necessary because of the enormous costs of bringing a biomed product to market, particularly if it requires FDA approval. You have to leave room to raise tens or maybe hundreds of millions of dollars to execute your plan, but for those that work, the upside more than takes care of the money at risk. The caution here is to make sure that the use of proceeds does not outpace what would be considered prudent business. Capital raised typically doesn’t sit around without being put to work relatively quickly. It’s important to have someone who knows how to say “no” to expenditures that veer toward the realm of a science project.
Beyond these general observations about raising money, let’s now focus on the hard work of the actual calculations that should inform your decision as to the amount you need. You will have a spreadsheet wizard on your team and the ability to generate a classic hockey stick revenue projection and an up-and-to-the-right quadrant chart that shows you killing the competition. You will have a lovely deck. All those are givens. Everyone can predict expenses with some accuracy. No one can anticipate buyer behavior or regulatory complications. One company I know has no competition in its market, but its potential customers have all cobbled together home-brew systems to accomplish the same objective and have no intention of replacing their babies with something from the outside, no matter how much better it may be. The result is sales cycles far longer than anyone anticipated in the business model. That doesn’t mean the company will fail; it probably does mean that it will take much more money than planned to wait out this protracted sales situation.
It’s important to stress test a business model against such contingencies as just described. Try doubling your sales cost, or tripling the time to closing, just to see what are the quantitative results. You may find your capital requirements are 5X what was planned. Your task is to test not only these variables but all the key assumptions in the model to determine to which ones the outcomes are most sensitive. There’s a notion in venture investing that your return is maximized by focusing on your winners and ignoring your losers. But, if you as the entrepreneur want to be one of those winners, you will be well served to identify and focus on your most vulnerable points and dealing with them early on. You won’t get the opportunity to move up to the winners classification if you don’t plan properly to handle the most precarious unknowns in your core business model.
A venture capital investor told me long ago that he had come to distrust automated spreadsheets presented to him because there were too easy to prepare and always looked pristine. He preferred the old-fashioned pencil on accounting paper, which pretty much guaranteed that every cell had some thought behind it and that any glossing up of the picture was too much trouble to do on a whim to show the desired outcome. I don’t think he realized how valuable the modern computerized spreadsheet would become as an easy way to test a wide range of assumptions and to support far more dynamic methods of planning than were previously possible. If you are not using the latest tools with this in mind, shame on you.
What then is the answer to how much money you should raise? It’s a blend of what’s possible, what’s timely, and what best de-risks the business for all concerned. Whatever you decide, just please don’t pitch something that on first impression looks implausible to a seasoned investor. Make sure your ask matches investor psychology, and back it up with stress-tested projections.