Correctly and competently determining how much money to raise in a fundraising round continues to be a problematic point for many founders. Raise too much money, and you sacrifice equity and harm future valuation, raise too little, and you won’t have enough runway until your next fundraising round.
So, when thinking about how much seed capital to raise, founders might be left with adages such as raising just enough to cover “18 months of runway”. Usually, these crude strategies aren’t good enough. For most businesses, far more detailed, milestone-led, and needs-based approach is needed when calculating how much to raise in a seed round. Every business is unique, so cash targets for seed rounds should be specific to you and your business.
What does this mean in practice? While it is right to regard every business as unique, there are three prevailing considerations which should guide how much every business should raise: the company milestones, burn rate and valuation.
The importance of milestones, and how to set them effectively
Milestones are quantifiable achievements which mean you have reached significant inflection points in the growth (and thereby value) of a company – either in product development, team growth, or market adoption of a product or service, and a financial plan will probably be a sequence of these chronologically organised milestones. As opposed to a ‘goal’ (e.g. create a successful company with a £2m turnover in the next 5 years), milestones are subsets of an overarching goal (e.g. a product launch).
Reaching each milestone should consequently significantly reduce one or more key risks, generate more insight into the potential scale of the company, and indicate the execution capabilities of the leadership team.
This execution is judged by specific milestones and their related deliverables: what needs to be achieved to claim the milestone was reached (for example, £x MGR, with Y new users), time frames (was the milestone delivered on time?), and budget (was it delivered with the amount of money allocated to it). Arming yourself with a good execution record is not only invaluable when it comes to pitching to investors and selling yourself as a capable entrepreneur, but also when the time arrives to determine how much to raise, as you’ll have a clearer idea of what is required to achieve milestones.
As a founder, you should start by establishing an appropriate timeline by calculating your financial projections and including the intended milestones. From this point, you can break it down into digestible chunks of investment for investors. Specifically, they will be looking for the following details from your pitch:
- The essential assets (people, equipment, services etc.) needed to deliver the milestones
- The time, given those resources, that is required to deliver the milestones
- The amount of capital needed to fund those assets for that period of time
These considerations will give you a reasonably accurate calculation regarding capital required.
What about your burn rate?
Your business costs money to run. Like coal in a train’s steam engine; the faster you funnel it in the quicker it might go, but for a shorter duration. When working out the amount of capital you need to raise, you should start by looking at the cash you need to sustain your monthly burn rate, then add projected additional costs – such as any employees you look to hire, marketing costs, development spend etc. – and run the numbers afresh. Then multiply that by the number of months you think you’ll need to reach your next big milestone (and consequently, next funding round), and factor in a buffer for the inevitable unforeseen obstacles, typically an additional 6 months worth of burn rate.
Investors might disagree with your calculations. For example, they might disagree that your burn rate will carry you to Milestone 3, and suggest that it will take you longer than anticipated and only take you to Milestone 2. So be prepared to be challenged, and take the opportunity to learn from, and negotiate with, seasoned investors.
Every investor will have different key areas of interest to them when evaluating your business. For some, it’s the idea and vision. For a lot of others, it might be the team (particularly in early rounds), and for the rest, it might be the revenue currently being generated, the clients, or the intellectual property (IP). The whole canvas of the company, from financials to the idea, and from the team to the IP, it all needs to be factored into your raise. It paints a far more compelling picture, providing you with the ability to respond coherently and impressively when asked questions such as why is your burn rate so high in month 12? Why is your valuation X? Where do you expect your revenue to be in 6 months? How does your IP differ from your competitors? What are you doing to protect your IP?
The valuation of your company will also be a driver behind the money that you’ll raise (and ultimately, how much you should be asking for). However, more often than not in early rounds, it’s back calculated from how much money you think you need (through considerations such as milestones and burn rate) and what you think the lowest amount of equity you can give away is.
For an established business, valuation is relatively straightforward. It is based on the market value of the company using verifiable metrics and assets, such as revenue, profits and customers. However, for startups, it becomes more difficult to assess the worth of the business.
There is fluidity in startup valuations, and it’s a subjective figure based on the right combination of factors – “black magic, hard math, market dynamics, investor return calculations, entrepreneurial hubris” as David S. Rose puts it. Only by striking the right balance of these, will you end up with a number that lies between the founder valuation (how much you believe your business is worth) and the market valuation (how much your business is worth to investors when taking investment risks into evaluation).
Generally, there will be some negotiation with investors, but the agreed value typically reflects a number of considerations, including but not limited to:
- The number of current customers
- Total revenues
- Revenue growth curve
- The business model
- The market niche
- The IP value
- The type of investor
- The going rate of similar companies
- The growth rate of associated sectors/industries
- Your team
There are a variety of different valuation methods you can utilise to calculate your startup valuation. We’ve created the ‘Art of Startup Valuation’ guide for early-stage and pre-revenue startups – check it out to consider how much your business might be worth.
Considering the equity you want to give away is a further consideration in valuation. The general rule of thumb for seed rounds is that founders should target giving away between 10% and 20% equity.
The Goldilocks Principle
At the end of the day, you need to raise just enough (plus a comfortable buffer) to pass the starting gate and reach the initial milestone(s). You’re backing yourself to raise another round at an increased valuation based on your startup’s achievements.
The more money you raise in your first seed round, the more you are essentially betting against yourself as you are selling your equity at what should be, an assumedly lower point in its value. You end up accepting more dilution than what could be necessary. More money also brings more investment terms and due diligence to ensure that money isn’t misused. Many investors (particularly VC’s) consider overfunding startups can result in financial laxity, a shortfall in focus, and overspending; tempting founders to expand faster than it can integrate new employees, systems and operations.
Moreover, a high implied post-capital valuation can put a lot of pressure on a startup if things don’t run as expected and then later need to raise further money as it increases the chance of the next round being a down-round, or new investors avoiding the deal in the future as it’s too costly.
Coming up short in your fundraising is arguably worse than raising too much, as it will always cost you even more than the original money.
In conclusion, it is imperative to present a realistic plan and a clear view of the significant milestones and resources required to deliver that plan. By calculating it wisely, you will have a relatively specific sum of money you know you need, and then you can make room for setbacks. Regardless of whether you raise a little or a lot of money, being conservative with your initial investment objectives will bode well for later rounds of funding.
Daniel Ritsema, Co-Founder and Managing Director of Cranes Drinks
Raised: £410,000 – (Seed = £190,000 & Series A = £220,000)
In 2016 we completed our first round of crowdfunding on Seedrs. The business was valued at just under £1 million and we provided a detailed investor pack with projected growth and sales, as well as what we planned to do with the money and a five-year plan. Our target was £95,000 and we successfully raised £190,000.
As to how much you raise, it really depends on what you’re looking to raise funds for – we had just taken on a non-exec director, we had increased production costs and we wanted to leave our gardening jobs in order to focus solely on growing the business. We did a cashflow forecast, but of course, there was an element of guestimate work at the beginning, the newer the business, the harder it is to analyse how much you need or what you’re predicted to sell.
Once you have estimated funds required, times the amount by 1.2, as chances are that’s the figure it will actually end up to be – even the biggest corporates overspend on budgets. Don’t think ‘We need £90,000 and that’s exactly how much we’re going to raise’. In our case, we needed that extra amount in the first round, as we were able to invest in a rebrand and it made all the difference with getting our product into supermarkets.
By our second round of crowdfunding in 2018, we had been successfully selling for a year and a half and we could produce bigger batches [of cider] so we could reduce the cost of production. Our business valuation increased to just under £3 million, partly because we had secured a national deal with Asda. We were raising funds for working capital and marketing, to support sales with our national launch in Asda. We had a target of £150,000 and we successfully raised £220,000.