How to calculate if, and what, you actually need to raise
The road to closing a fundraising round is dark and full of secrets. Or at least, it can feel that way.
With nearly €73 billion in European venture capital invested in 2021 (Q1-Q3) alone, startups are frothing at the mouth to get a piece of the pie. And as major players like Sequoia and Tiger Global continue to dominate entire rounds, founders seem willing to push the envelope on how much they can raise.
Headlines are full of record-breaking fundraises and unprecedented valuations, but sometimes the numbers make you wonder. Why did Prague-based Rossum raise a $100 million series A? Why did Bunq need a $228 million series A? And if Sorare is worth $4.3 billion, why do they need a capital injection of $680 million in the form of a series B?
And, perhaps the most important question: why are founders giving away so much equity if their companies are that successful?
One of the biggest mistakes we see founders make is raising how much they think they can raise, rather than what they actually need. Sometimes they raise too little because they’re not confident they can raise more. As a result, they struggle to meet their milestones and may need to raise another round sooner than expected.
To avoid this, some founders will try to raise more than they need because they want enough runway for unexpected costs. Even if they’re able to justify the padded numbers to investors, it can inflate the valuation, which can cause problems when raising later rounds.
If you take the time to calculate how much funding you really need before raising, you will have an easier time explaining why to investors, and a better chance at scaling successfully.
So how do you calculate what you really need? You’ll almost always look at three factors: talent, product, and marketing.
Evaluating costs at the ideation and early stages of a company is challenging because you don’t have much data (if any at all).
In this case, market research will be your best friend. Learn about what has (and hasn’t) worked in your industry, what skill sets you need in early employees, and what your total addressable market really is. This may include answering questions like:
- What problem does my solution solve first and foremost?
- Who has the skills to build the solution?
- Who needs my solution right now?
- How many of these potential users are out there?
- How do I reach potential customers as well as talent?
- Who are my competitors?
- Who has tried to build a solution like this but failed? Why?
The answers to these questions will help tell the story about the company you want to build. And as you paint this picture for yourself, you’ll also have a better idea of what your potential costs will be:
- Talent: Do you know anyone who can help you solve this problem? How much do you need to compensate them?
- Product: What does the minimum viable product look like? Now that you have the who to make it, what else do you need?
- Marketing: How will you reach your first users?
You only have to do a few calculations, but these can be crucial for your raise. For example, if you need €150,000 to build your MVP, then ask for €150,000 with your evidence for why you need that amount of capital. Asking for less (or more) can lead to problems down the line.
Once you’ve calculated your bare minimum costs, you can approach friends, family, and angel investors. There are some early seed venture capital funds, but be wary of how much equity to give away. Don’t exchange more than 10% at this stage.
Pre-seed investors want to know that you not only have an idea, but also the discipline to understand your market as much as possible. A road map or business plan can help you clarify your process, but investors expect those things to change as your business grows.
If you’re generating revenue, then you have some solid data to examine and leverage. You should know how much you can expect to bring in on a monthly basis, as well as the costs associated with operations and production.
If you don’t already track your expenses, this is a good time to get that in order! Break down your costs, from supplies to staffing, accounting to subscriptions, and everything in between. And if you’re not comfortable working with numbers, a financial or business expert may be a good investment. (Your accountant won’t be as helpful with crafting a story based on your numbers.)
Your finances should illustrate how you have handled your finances up to this point, and then explain what you need to break even and grow the company. Again, be sure to look at the three major factors that will tell the story of your growth potential:
- Talent: What are you spending now? How much do you need to spend in order to recruit the next necessary hires?
- Product: Do you have your minimum viable product? If so, do you need to make any improvements?
- Marketing: How much do you want to grow your customer base? How will you do it?
Investors expect that you need funds for at least one of these three factors because these will be the driving factors for building a successful company. If you want to raise money for an office space, you need to evaluate your priorities.
Your goal at this stage is to break even and grow as lean as possible. You might hear about seed rounds reaching €10 million, but these are outliers — typically you should really only need up to €2 million at this point. When raising from investors, expect to give up around 20% of your equity.
If you don’t want to dilute yourself and can prove you have a sustainable revenue model, revenue-based financing (RBF) may be a better alternative. RBF gives you the capital you need without sacrificing equity. Instead, you pay back the investor in installments based on how much revenue you generate.
In other words, you get the capital you need while still retaining ownership of your business. And, ideally, you’ll never have to fundraise again. But if you choose to go the VC route, RBF can be a beneficial source of funds to get you to the next stage.
At this point, you will constantly have to decide how to allocate capital, including which investments to make and which to postpone. You will probably not be making a profit yet, but should see a route to be breaking even, and possibly generating profit. The next milestone you’re aiming for is scaling.
Look again at your numbers:
- What milestones have we already reached?
- What targets need to be met before we reach our next milestone?
- Who do I need on my team in order to achieve those targets?
- How will we build our MVP?
- How will we source clients?
- How much revenue are you generating?
- What are the targets you need to reach in order to unlock your next milestone?
- Who do you need on your team to achieve those targets?
It’s tempting to create a budget wishlist that includes every tool and talent that could make your expansion possible. But you need to consider what you actually need, versus what you want. Again, look at your three major factors:
- Talent: What skills are you lacking? Who can take your company and product to the next level? Do you have the capacity to handle your expected growth?
- Product: What improvements need to be made? Are they functional or cosmetic?
- Marketing: How is your current customer base growing? Do you need to boost retention efforts?
It may also be tempting to include a lot of padding on top of your calculated needs; however, if you can’t properly justify the cushion, investors may be hesitant to support you.
Just like previous rounds, you will need to explain how you intend to use the budget in order to scale to the next stage of profitability. It may even be helpful to revisit the same questions you asked yourself during the ideation phase. As your company grows, make sure you aren’t holding onto outdated visions for your product, or that you haven’t lost sight of the real goal.
And keep in mind that RBF can still be a viable option for your company if you don’t want to give away equity in exchange for capital. With every fundraising round, expect to give away a total of 10 to 20% of your equity when approaching investors.
Often founders are on the verge of being profitable, but choose to raise another round — and dilute themselves — in order to reach their next milestones. Sometimes they raise just because they can, and big rounds get big press.
But the goal of raising should be to reach a break-even point and become profitable. You don’t want to keep giving away equity in order to stay afloat. And in order to reach the break-even point, you need to generate revenue, which means you need to develop a product that people are willing to pay to use.
Building a successful business isn’t easy. But if you focus on creating a stellar product with the right team, you can raise what you need until you become self-sustainable.