How Much Money Should You Raise From Venture Investors?
When pitching investors, remember that your ask is like porridge; it follows the goldilocks ratio and has to be just right. Asking for too much or too little funding will raise red flags with investors and cause you to lose credibility. So the question remains: what is the appropriate amount of funding founders should request? This is a difficult question to answer. Luckily, there is a formula you can use to answer it. This framework helps founders position their fundraising targets and avoid red flags with investors. Here are some common red flags for venture investors:
Red Flag #1: Ask isn’t tied to specific fundable milestones.
Red Flag #2: Round prices equity too high or too low.
Red Flag #3: Ask doesn’t align with fundable milestones.
Red Flag #4: Use of funds highlights features, not benefits.
Red Flag #5: Using the wrong term to describe your round.
Red Flag #1: Ask isn’t tied to specific fundable milestones.
Founders commonly frame their ask as an extension of runway (e.g. $1M buys my company 12 more months). Don’t do this. Founders need to remember that time is not a fundable milestone. The prospect of buying you more time does not get investors excited. Instead, factor in the priorities and interests of your audience by framing your ask as a means of reaching near-term value inflection points. Inflection points don’t always have to be tied to short term liquidity (e.g. getting to cashflow break-even so you don’t have to raise again). Below are examples of specific fundable milestones which could be inflection points that trigger future rounds:
5 large enterprise customers each with ACV of $100k
$2M in ARR
20 land-and-expand contracts worth $10M in future annual contract value
FDA regulatory clearance to get to market
Red Flag #2: Round prices equity too high or too low.
You should price your round in a way that gives both founders and investors meaningful ownership. Investors want to see founders supported, rewarded, and aligned to continue creating future enterprise value. If your ask offers too much equity and over-dilutes founder ownership, the round will leave you with insufficient skin-in-the-game. Investors will be concerned that you’ll be less motivated as a result. On the other hand, if your ask offers investors too little equity, the investors won’t have enough skin-in-the-game to achieve meaningful or target returns on their investment. Founders can use the “20% ratio” as a good rule of thumb for pricing equity. The “20% ratio” states that your valuation is roughly 5x the amount you’re raising. Using the “20% ratio”, if you’re raising $2M this round, then your company’s post-money valuation should be roughly $10M. Keep in mind though, the “20% ratio” is generally only relevant for earlier stage startups and rounds.
Red Flag #3: Ask doesn’t align with fundable milestones.
Once you’ve identified your fundable milestones for investment, the next step is to determine how much cash you’ll need to reach the inflection points. Accurately projecting revenue/expenses is not a clean or simple exercise for founders. While this blog post doesn’t cover financial techniques for projection, these Inc and Forbes posts can help guide you. After you’ve determined a reasonably accurate picture of your company’s future financial health, the next step is to determine how much additional cash you’ll need to reach your stated milestones. Founders should give themselves extra cushion here. Add 3-6 additional months of capital to your total funding requested. The goal of framing your company’s ask is to achieve fundable milestones with enough cash left to raise the next round.
Red Flag #4: Use of funds highlights features, not benefits.
Similar to customers, investors buy benefits, not features. Features, in this case, are the things that you are going to do with the money you raise; benefits are the outcomes that will come from those actions. When describing your plan for how you’ll allocate investor funds, be sure to make the distinction. Your “use of funds” slide should not highlight features because features fail to describe the bottom-line benefit to investors. An example of an incorrect “use of funds” slide would be one that allocates funds for hiring 3 salespeople, 5 developers, and 2 customer service reps. Remember, when you’re calculating “use of funds”, everything needs to align and support how you’re going to achieve your fundable goals. Hiring 3 salespeople is not a fundable goal. However, incurring the additional revenue they will generate is a fundable goal. Benefit-oriented goals like this will resonate with your investors and you should make every effort to include them in “use of funds” slides.
Red Flag #5: Using the wrong term to describe your round.
When describing the round you’re raising, be sure to use the correct terminology. From Pre-Seed to Series E, investors have preconceived notions of what characterizes one round from another. You’ll lose credibility with investors if you do not know the appropriate term for the round you’re raising. For example, calling your round a “Series A” round is only appropriate if your company has already raised a “Seed” round. The same is true of “Seed” rounds if your company is actually just raising friends-and-family money. If your company’s current fundraising round is in between say “Seed” and “Series A”, founders can use sub-stages to describe incremental rounds. Examples of this include terms like “Seed-Plus”, “Seed I”, or “Seed II”. Founders characterize their rounds in this way to avoid “burning a letter” by prematurely jumping round or stage. The term you use to describe your round sets serious expectations for investors and changes the optics of the deal. If you want to dive deeper into terminology and how it impacts fundraising strategy, here’s a relevant Hackernoon article.
Next Steps:
After you correctly frame your fundraising ask, what’s next? Check out this #DreamitDose and accompanying blog post on the most important question you should be asking investors after you pitch.
By Elliot Levy, Healthtech Associate at Dreamit Ventures
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