Ask an Investor: How do I deploy Series A capital?

finance

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I’ve completed my fundraise, how do I deploy my Series A capital ?

The ideal answer to how you deploy capital begins before you even meet with investors. Instead of starting with the mindset “We are burning $x/month, we should probably raise x * 18 = $yMM.” consider developing a solid plan for capital deployment.

To increase your chances to make it to your next fundraise, you should be thinking about how deploying this capital can increase the overall value of the company at least two times greater than the post money of your last round. Having a plan is key. Working with your CEO, your newly hired head of finance is the individual who is best tasked with coming up with this plan.

The plan

There exist good and bad financial plans and projections. A bad ProForma models out all the costs for the next five years in excruciating detail and shows revenue appearing as if by magic on the top line.

When you’re raising your series A, the assumption is that you’ve hit product-market fit.

Good ProFormas come from the knowledge that revenue is incredibly important to assess with some degree of accuracy, that customers are acquired, and revenue is generated as a direct and indirect effect of spending funds on sales and marketing. (No — if you just build it, they will not appear).

Revenue and its relationship to costs are the core of your financial projections and predictions. Outside of core development costs, move a cost down, and revenue should go down. Move a cost up, revenue goes up.

I can’t say it enough: be very wary of having cost models divorced from your pipeline and company building activities. It is far too easy to start spending funds on resources that won’t affect the top line, now or tomorrow. Beyond losing credibility with your potential investors, you may not make it to your next round.

Update your assumptions

While it may sound intuitive, models should be continually updated. As you learn more about the nature of your business, you will arrive at better approximations of costs. Your projections should develop to reflect your increased knowledge.

You will likely discover, as you build your company, that some underlying assumptions about how your business grows turn out to be false.
 

Use all new insights as an opportunity to update your revenue forecasting ability. Early on, you’ll likely have some magic numbers in your forecast.

An example: Early on, you know you roughly add five new customers a month, but don’t have a good idea of what the source is. Through customer interviews, you determine the source to be your content marketing. Incorporate that into your model. Get rid of the magic number and replace it with an acquisition number linked to a spend on content marketing. Your new numbers are expense-driven – no longer magic, and thus defensible!

Good financial models are not just for investors; they are invaluable tools for helping you plan strategically and anticipate where funds will be needed.

Once you have funding

Treat every dollar as if it’s your last. Fight very hard to not become intellectually lazy around even minor spends. In a healthy startup, every dollar spent should be seen not just for its amount but for its opportunity cost.

Another example: You can burn through a lot of capital buying new computer equipment for everyone after a fundraise. I should know. I’ve done precisely that. It’s straightforward logic to fall prey to: faster computers will make everyone more productive.

Yet, it’s unclear if this is really a defensible decision. Though the outcome is measurable: one or more months less of burn. Time you could have used to drive further customer adoption, in turn building a better traction base for a Series B.

The same can be said for beer flowing on Fridays and ping pong tables. Some amount of ‘team building’ purchases makes sense, but think long and hard about how much you want to spend. The trade-off for these purchases is shortening your runway.

A couple of months later

Course corrections happen. Pivots happen. You will likely discover, as you build your company, that some underlying assumptions about how your business grows turn out to be false. You are running a startup after all.

Maybe you planned to automate the entire post-sales enablement and thus were going to hire a dev team to execute this plan. Then you realized that what you actually need are three to five customer success members. With this in mind, do you still need that dev team? Before triggering the spend, model it out financially. Incorporate your insights into your plan before making any decisions (but you are already doing that, right?).

Oddly enough, legal fees post-financing is the number one source of -1000 percent variances I see.

The terminology for the difference between the number you forecasted and the actual number spent is called a variance. There is almost always a variance between budget and actuals, no matter the size of the enterprise. The degree, or size, of the variance is what matters. If it’s a couple of points (0 to 3 percent), no sweat. Totally normal for most line items.

When you get into the five percent to 15 percent range, you will want to discuss this at your next board meeting. It likely means a shift in your business that’s worth a longer discussion. It may be well-understood and expected, but it will stand out in your financials.

Any variance larger than that begins to fall into the “I better call my lead investor now” category. Something clearly went off the rails in the last financial period that deviated significantly from plan. The best case scenario is that this was an unplanned expenditure that was agreed to by the board before it was made.

Oddly enough, legal fees post-financing is the number one source of -1000 percent variances I see. Everyone agrees they need to be paid. After all, our legal counsel was key in bringing a financing to a successful completion, yet no one seems to plan ahead to pay them!

Regardless, it’s best practice to give your board members and investors a heads up on these significant unexpected costs.

Likewise, if you have large positive variance (you made more money or spent less than expected), feel free to call up your investors with the good news!

In summary, develop a real plan, execute against it, and continuously refine it when new information comes in.


Sarah’s take

Sarah Marion

I can’t overstate the importance of Christian’s comment to link your costs and revenues when you’re building out your financial model. When you’re raising your series A, the assumption is that you’ve hit product-market fit and now it’s time to add fuel to an already burning fire. To break it down to basics, I typically build financial models by breaking them down into four key steps:
 

  • Pull together your historical financials to understand your cost structure and revenue growth levers. It’s not enough to download your Freshbooks or Bench history! Make sure your sales lead and CTO are communicating how their sales funnels and employee hours are converting into revenue.
  • Explicitly lay out your revenue and expense assumptions before starting your P&L. Build from the bottom up. If you’re building an outbound sales machine, what percentage of inbound leads (or outbound qualification calls) convert into SQLs, what percentage of SQLs convert into demos, and what percentage of demos are closed?

    By comparing with historical sales productivity data, you’ll be able to gauge how many salespeople to onboard. Add an understanding of how long it takes to close deals, and you can forecast when to hire those salespeople to get them fully ramped, and what your monthly recurring revenue (MRR) looks like.

  • Build out the P&L and make sure you’re setting yourself up for success. Is your growth rate compelling enough to raise a series B? Are you reaching the revenue numbers you’ll need to hit to raise that next round by the time you want to start fundraising? Are you accounting for unexpected logo churn? Have you planned to add customer success reps to hit your upsell targets?
  • Check in every quarter. Get comfortable comparing and communicating your results vs. your plan to yourself, to your management team, and to your board.

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Photo via Unsplash

Christian Lassonde

Christian Lassonde

Christian Lassonde is the founder and managing partner of Impression Ventures, a venture capital firm focused on investing and leading deals in FinTech companies raising late seed to early Series A rounds. Her is a former founder, having built and sold Virtual Greats, a luxury online IP rights broker, and Millions of Us, a digital agency. Christian spent a decade in San Francisco building software for Second Life, LucasArts and Electronic Arts and selling solutions to Sony, Nike, Warner Brothers, General Motors, Coke, Intel and many more Fortune 500 companies. You can follow Christian on Twitter at @classonde