When you are going out to fundraise you need to decide how much capital to raise.
A typical answer we hear looks something like this:
“We need to build X features in our product, and we need to hire Y people to make it happen. So our burn would be Z and we need a buffer of W months, so here is the amount we are raising.”
This typical answer isn’t great, and isn’t likely to excite prospective investors.
No one wants to fund your burn.
Investors are looking to fund a company to a milestone. In reality, there are two kinds of milestones for every company – profitability, or next round of funding.
Profitability is possible, but isn’t typical for venture-backed companies. Startups and VCs are in the fast growth game often at the expense of profitability. The public companies, on the other hand, are in the game to generate profits (Not always, but more often than not).
In reality, when disciplined investors evaluate whether to put money into your business, they ask – what milestones do you need to achieve to get to the next financing? That is, the pre-seed investor asks what it would take to get to seed round. A seed investor asks what it would take to get to series A, a series A investor wants to know what is needed for series B, and so on.
Investors think of specific milestones the company needs to achieve in order to receive the next round of financing.
The milestones are either revenue or customer or another kind of growth target. You are given money to demonstrate that the business has potential and is worthy of putting more money in.
The things investors typically consider:
1. What milestones do you need to achieve for the next round of funding?
2. What resources do you need to achieve the milestones?
3. How long will it take you to achieve the milestones?
So a better answer to how much money you want to raise is this:
We need to achieve milestone X. To get there, we need Y people, and we need Z capital. We believe it will take us W months to get there.
The investors are going to react much more positively to this kind of ask.
The discussion then, revolves around whether investors believe that these are the right milestones, and whether you will be able to achieve them quickly enough.
This is where financial model & business plan comes in. You need to demonstrate that you correctly modeled out your costs, but more importantly, that you correctly modeled out the growth of your key metrics.
Whether it is revenue, or number of customers, or something else, prospective investors want to understand how are you going to grow.
And here is the most important thing:
You aren’t building a financial model to check some box for investors. You are building it for yourself to operate your business.
Putting together a financial model, and having a plan in place isn’t some kind of side exercise to get funding. It is the core exercise that every founder needs to go through in an ongoing manner. The financial model is the operating plan for the business.
I love this advice on financial models from Kevin O’Brien, CEO of GreatHorn (Techstars ’15)
Build a real financial model. We exist in a moment when everything about starting a business is easier than it was a decade ago: you don’t need the same capital to stand up hardware that you once did, and there are more ways to capitalize your business than I can ever recall. As a result, it’s sometimes easy to get seduced by the artifacts of company building: hiring big teams, renting fancy offices, spending a lot of time talking to investors and to the press.
Dollars raised are a tool. Dollars returned are the business. The hard work of acquiring, delighting, and building out an ultimately profitable customer base is where your true north should be — everything else, even investment, is a means to that end.
Once you build a solid model, you know exactly how much you need to raise. Investors know that you did the work, that you will operate the business responsibly, and will be a lot more likely to give you a check.