How Much To Raise
You’ve bootstrapped your company to the point where you can look back and be very proud of what you have achieved. But now you need to fundraise as you realise that in order to achieve significant growth you will need an injection of additional capital.
It is important to have a good grasp of how much capital you need to raise for this round (and in subsequent rounds) as raising too much too early (generally at a lower valuation) will result in giving up an unjustifiably large portion of your company.
So, the big question remains: how much should you raise?
The final amount will be determined by several factors, including the time to reach your next milestone, runway, valuation, and ownership.
Your Financial Model is Your Starting Point
Building a financial model is the first and by far the most critical undertaking for a startup and relates to collating actual and projected financial performance to forecast your company’s funding requirements and cash flows over the next few years.
Your model will lay the foundation for many of your decisions – both current and future – and will play a significant role in determining when and how much to raise.
Not only does this help you as a founder understand the path that lies ahead, but knowing that you understand your business and the market in which you operate is an important consideration for investors. No investor is going to part with their money and invests in a company where there is no clear, or at least a well thought out, route to profitability. Investors know that forecasting income and expenses are not a perfect science, but it is imperative that you demonstrate to investors that you have a solid understanding of the factors that are most likely to have an impact on your financial viability.
A financial model is also not a static concept, it will evolve as your business grows. Your model will require constant updating to ensure that your banked progress (good or bad) is taken into account. If you expect to start generating a certain amount of revenue 6 months out but fail to reach this milestone, how does that filter through your model? And how does that affect the amount you need to raise in your next round to ensure you can reach your next milestone?
Knowing how much capital you need to raise and being able to clearly articulate and justify that amount to investors, along with the milestone/s you intend to reach using that capital, is critical to a successful fundraise.
In determining how much to raise, there are three primary schools of thought, all of which have their own unique pros and cons:
1) Raise only as much as you need to reach your next milestone
If you are confident in your projections and are sticking to the idea of giving away as little equity as possible, then this is the advice you’ll probably choose to follow. Crucial to this approach is accurately determining your burn rate to ascertain how long your runway is.
By burn rate, we mean the rate at which a company spends the funds raised during a round to finance overhead expenses – before it starts generating a positive cash flow from operations – and is generally expressed as an amount per month(e.g. $20,000 per month). Runway, on the other hand, is defined as the length of time a company can keep operating at its current burn rate until it is out of funds, and is generally expressed in terms of a number of months (e.g. 5.5 months).
If you believe that you will reach your next milestone, with a resultant increase in valuation, then only raise what you need and not a pence more. You can then do a follow-on raise at a higher valuation to fund your business until your next milestone.
2) Raise as much as you need to reach your next milestone, plus a buffer
Fundraising is not a perfect science and the probability that you have perfectly projected your company’s future financial performance is exceedingly low. You need to be honest with yourself here too, and admit that no matter how much time and effort you put into your model, you may get it wrong when calculating your expected burn rate and runway.
This approach to fundraising incorporates a buffer for reality. Calculate how much runway you require to reach your next milestone (i.e. your raise amount), and then plan to raise that amount in addition to a small buffer. Consider raising a buffer equivalent to an additional 6 months’ runway. Yes, this does mean that you will be giving up more equity earlier than you would have preferred, but the consequences of running out of money before reaching your next milestone outweigh that extra bit of dilution.
3) Raise twice as much as you need to reach your next milestone
There are several reasons informing the “raise twice as much as you need” approach.
The first is that by raising double upfront, the additional cash in the company’s coffers can help you achieve a cashflow positive position without having to go back and raise another round. The obvious benefit here is that there should be no further dilution down the line unless you want to raise more to undertake significant investment. Countering this first reason, however, is the simple fact that by raising more money early, you are selling your equity at what should reasonably be its lowest value.
Secondly, fundraising is time-consuming and often takes the team’s focus away from their important day-to-day activities. The extra funding raised upfront provides your team with some extra breathing room, allowing them to focus on their actual jobs chasing the milestones that have been set.
A Simple Equation
Let’s look at a simple calculation that can help answer the question of whether you should accept more money if it is offered.
If an investor offers you £x for 10% (n) of your company, the deal is in your favour if the receipt and use of the £x results in your remaining holding (1 – n) exceeding the pre-money valuation of the company. In this case, n = 0.1 and 1/(1 – n) = 1/(1 – 0.1) = 1/0.9 = 1.111. If this deal can increase your remaining stake by more than 11.1%, let’s say 15%, you will be better off as your remaining 90% stake will now be worth 0.9 x 1.15 = 1.035.
The above is a simple calculation, and there are of course other important factors to take into consideration.
The “most expensive” equity a startup will sell is that which is sold early on while the company valuation is still low. Giving up significant equity early not only reduces your future gains but also brings with it more onerous investment terms and increased due diligence. Furthermore, a high implied post-capital valuation (due to you raising more than you needed) can put a lot of pressure on you to deliver. If things don’t go according to plan and you are forced into doing another raise, the chance of the next round being a down-round substantially increases.
Raise Amount vs Current Valuation
Floww occasionally receives funding round information submitted by startups’ stating that the expected raise amounts for their current, open funding rounds are more than their companies’ pre-money valuations. This is generally due to a misunderstanding of the term “pre-money valuation”.
The Pre-Money Valuation is the enterprise value that has been set for a company ahead of a new funding round and the valuation should not typically – unless under specific, extenuating circumstances – be less than the raised amount.
As an example, using a pre-money valuation of £2,000,000 and an expected raise amount of £500,000:
- Pre-raise: Valuation = £2,000,000 (current shareholders = 100%)
- Post-raise: Valuation = £2,500,000 (current shareholders = 80% + new shareholders = 20%)
- The current shareholders maintain a significant controlling interest in the company.
If we were to keep the pre-money valuation at £2,000,000, but adjust the raise amount to £2,500,000:
- Pre-raise: Valuation = £2,000,000 (current shareholders = 100%)
- Post-raise: Valuation = £4,500,000 (current shareholders = 44.4% + new shareholder = 55.6%)
You can therefore see that raising an amount more than your valuation would result in the new shareholder/s owning a majority stake of the company.
As you set out on your fundraising journey, we trust that these insights will be a useful and valuable guide. Floww has a range of guides and templates, covering a broad range of topics, that you can access for free.
We look forward to supporting you on your fundraising journey! We also have a dedicated Customer Success team standing by at the ready to answer any questions you may have along the way.
