Erez Lahav
Every startup gets to the point where it needs to raise capital. In the early and growth stages alike, the principles of the game are clear to everyone: more capital is worth a longer runway, faster growth, happy investors, and a better position towards raising the next round of financing, hopefully at a higher valuation.
Founders are tightening their investors’ deck, plugging in the current numbers, projections, tech roadmap, team’s slide, competition landscape, market size and everything it takes to go out and start pitching to investors;sharpening the pitch and ready to go.
On the other side of the table (or Zoom), at the VC side, there is us. We hear the founders’ story and do our best to properly evaluate the opportunity.
Founders mostly pitch well, answering questions through out the meeting and then, just before we get to the end of the deck, there is the final slide about the ask.How much you are looking to raise and at what valuation.
I must admit that this is never a simple question with an unequivocal answer, and this is the reason I encourage founders to spend more time and thought around it.
We ask, why areyou raising 20 million and not 15 or 10?
"The market is hot now…”, “Our competitors have raised more…", "Talent is expensive…" "We made a plan for the next 5 years and we need 20 million…" All are wrong answers.
In short, too much reliance on intuition and general atmosphere and not an informed, calculated decision based on data. The timing and amount you raise should be derived from the plan, budget, and milestones. Building a startup is a marathon, it should not be handledwitha single sprint at a time. The round size will certainly affect the next round, the growth stage, and is as crucial to the success of the company as every other factor you consider in the business. Global market conditions are changing, and it is likely that,during its lifetime,a startup will go through at least one or two cycles of crisis in the public market that directly affect the appetite for investment in the private market and consequently, the funding climate. Therefore, the atmosphere in the market at the time of the round is important but even more important is the understanding that the run is a long run, and the round size today should also make sense in a retroactive perspective when approaching the next round.
"Building a startup is a marathon, it should not be handled with a single sprint at a time."
Entrepreneurs who, in 2021, raised more money than they needed through inflated valuations, not only were unnecessarily diluted, but might face flat or lower rounds in 2022. A scenario that can lead to a negative trend in the future, an image of failure and difficulty in raising another financing round from VCs and considerable investors. It is important to note that unnecessarily inflated rounds do not always result from the excessive appetite of the entrepreneurs but are often fueled by the desire of the existing investors of the company to record a value bump-up in the books in order to increase their fund’s performance.
So, what should you consider when planning the round size?
First, there is no need to plan 5 years ahead; in terms of a startup,that is an eternity. A good plan should be for two years ahead with planning for an additional round towards the end of those two years.
The plan should reflect the achievement of significant milestones during these two years; at very early stages, these are milestones that are related to product, technology, regulations, design partners initially, and in more advanced stages it is mainly numbers, revenue, and infrastructure for rapid growth. Plan the hiring required to reach the milestones and hence the budget needed for it. Of course, add a little more for extra security for mistakes and trials along the way. There is no point in raising a sum of money that you will not be able to deploy in the next two years or you will succeed but not in the right way but out of pressure to use it. The latter will lead you exactly to the place you do not want, underperforming on the promises, excessive dilution, and a higher chance of a failed follow-on round.
Today more than ever we realize that the biggest and fastest funding is not necessarily right for startups that raise money. The minimum required to achieve the goals up to the next milestone and up to the next funding round, plus a little reserve, can serve you much better in the long run.
