How to decide how much money you need to raise for an early-stage startup
This is the second installment of a four-part series which aims to help early-stage startups navigate their way through a fundraise. Click here to read the first part.
A key question for entrepreneurs is the quantum of funding to seek from investors. The minimum amount that needs to be raised depends on the cash requirements of the business for the next 12-24 months. A slight buffer could be included. However, it is capped by the limitations of the stage at which the business finds itself.
If you have a business that is yet to be operationalised, do not expect to raise $10 million. While there are exceptions to this rule, chances are such anomalous funding only happens with serial entrepreneurs who have already returned significant capital to their earlier investors or very experienced founding teams that can hit the ground running in a particular industry very quickly.
Also, keep in mind if you go out to raise a smaller round and see a lot of investor interest, you can always increase the size of the round. It is better to over-deliver on the fundraise.
Skipping stages is hard. It is easier to raise an angel round followed by pre-Series A and Series A, instead of jumping directly to Series A. At each stage, the sophistication of investors increases. They find comfort in investors who have invested in the past. It also gives them the confidence that the entrepreneur is able to take outside money, use it wisely and deliver returns.
Early angel investors also become great references for future institutional investors. Institutional investors often have a ticket size and stage preference.
As an entrepreneur, it is your responsibility to research the investor in advance to check whether their fund matches what you are seeking. If you seek out investors randomly, the results would also be random. Worse still, you will end up wasting everyone’s time in the process.
Early-stage investors often make decisions based on only two or three key areas of focus. Most early-stage startups do not have a proven business model. As a result, it is difficult to predict future revenues and cash flows with any certainty.
Early-stage investors focus a lot more on the team and market. These are probably easier to evaluate and the understanding is that if it is a solid team playing in a good market, even if they get the product wrong a couple of times, they can always pivot and build on what they have.
As an entrepreneur, you must focus on building your team, understanding and going after the right market, finding product-market fit and more importantly, first identifying the problem you are going to solve.
I have often heard from entrepreneurs that they can do everything and therefore they don’t really need a team. While you might be able to do everything, you need to ask yourself a couple of questions. Can you really do everything in the best possible way or would it be better to bring in experts for certain functions? Is doing a particular task the best use of your time or could you “outsource” it to a co-founder and focus on more critical aspects of your business?
When founders sometimes bring in co-founders, they are concerned about equity dilution. In the long run, a good set of co-founders will more than compensate with the value they build.
Also, creating an equitable shareholding is essential to build trust among the co-founders and also later with investors.
Having co-founders also reduces the risk for investors as they know that there is backup management lined up in case the founder is not performing his or her duties for whatever reason. Entrepreneurs should also seriously consider adding advisors and building an independent board of directors.
The author is a former investment banker, an advisor in the technology sector and currently works as a strategy professional in the telecom industry. The views and ideas expressed are personal.