Welcome to a BetaKit weekly series designed to help startups and entrepreneurs. Each week, investors Roger Chabra and Katherine Hague tackle the tough questions facing founders today. Have a question you would like answered? Tweet them with the #askaninvestor hashtag, or email them here.
When you set out to raise money, you will likely do so with a specific business objective in mind. That objective might be building your MVP, finding product-market fit, hitting a revenue milestone, entering a new market, or launching or a new product. You need to budget enough time to do one of two things: get to a point with the money you raise where you can sustain the company indefinitely on revenue, or show enough progress to attract new investment dollars.
The number of months you have before you run out of cash is called your runway. Your runway is calculated by taking your monthly burn (monthly revenue minus expenses) and dividing the amount of cash you have in the bank by that number. As your company’s revenue grows (or if your expenses decrease), your runway increases. The most powerful position you can be in when raising money is one where you are either cash flow positive already, or where you could easily go from negative to break-even or positive cash-flows by making small adjustments to how you operate the business.
The more money you raise, the more limited your exit opportunities will be.
There’s a great online tool built by Y Combinator founding partner Trevor Blackwell called the Startup Growth Calculator. It’s built to help startups determine how much money they need to raise to reach break even — or profitability. Once you reach break even, you have infinite runway and can control your own funding destiny.
If you are not in a cash flow positive position, and don’t foresee the company reaching a cash flow positive position with the money from this round of financing, it is better to err on the side of caution when budgeting how much you need to get to the next inflection point.
Venture Hacks suggests that you raise as much money as possible so long as you are able to maintain control. Don’t lose sight of what your liquidation preference would be in the case of an exit. That said, the more money you raise, the more limited your exit opportunities will be. If you would rather maintain your exit options, Venture Hacks suggests you raise at least enough money to run two experiments — hopefully moving you towards your next major business milestone. I am personally partial to this option over raising as much as possible, having seen a lot of companies ruined by raising too much at too high a valuation early on.
If you need a more concrete benchmark for budgeting your fundraising, a common rule of thumb accepted by most investors is to raise at least enough capital to last 18 months. That said, remember that you will need to budget six months for the next fundraising itself. So at the 12-month mark, you’ll be back on the fundraising trail, meaning that you would only have 12 months to reach the required inflection point.
When a company fails to hit the milestones needed to raise their next round before running out of capital, they will often try to raise what is called a bridge round. Bridge rounds are short-term loans that are used when a company secures permanent financing. Because entrepreneurs are usually at a negotiating disadvantage when raising bridge rounds, these rounds tend to come with very unfavourable terms, often forcing an entrepreneur to give up more equity, and in some cases, forcing a down round – which can result in very punitive dilution for early shareholders. Bridge rounds are to be avoided, and are one of the reasons why estimating how much cash you need to reach your next funding milestone is so important.
Roger’s take:
As a startup CEO, you have three primary jobs:
- 1. Ensuring your company is setting, and executing on, an appropriate strategy
- 2. Hiring and retaining A-level talent across your organization
- 3. Making sure your company has the money to execute on your strategy
In my experience, all three of these activities are consistently on the minds of the best startup CEOs over the course of their work weeks (and work weekends!).
Of course, the amount of time you dedicate to each of the above activities will ebb and flow based on the current needs of your business. However, the important point here is that fundraising should always be on your mind. If you are truly building a world-changing, disruptive company, you will need financing, and lots of it.
You may not be in the process of actually pitching for money in earnest, but you certainly should always be thinking about it, even if it is in the back of your mind some weeks. We’ve talked a lot in this series about building relationships with funders early on, well ahead of you actually needing a cheque from someone. Internalize that you are always fundraising in some form or another, and building these relationships will become innate and automatic as you go about your work day.
Don’t be stuck to the playbook that you have to wait 12 months or 18 months to actually accept money.
Katherine lays out a good framework for thinking about how many months to wait in between the time that fundraising becomes your central activity. I would add that it is important for founders to be opportunistic and flexible about when they take money. As she mentioned, the best time to raise money is when you are profitable or are flush with existing cash. The best time to raise, from a terms and valuation perspective, is when you don’t actually need the cash. Ironic, but very true in practice.
If you have spent time building up relationships with potential investors in between funding rounds, you may receive unsolicited interest from them to invest. This is a great position to be in. Recognize that this will only be real interest if you truly have an ongoing relationship with this investor.
Don’t be stuck to the playbook that you have to wait 12 months or 18 months to actually accept money. You are at war with your competitors, and access to capital can be an important differentiator and accelerator. Just be sure that you have a solid opportunistic reason for taking the money. Perhaps it could be to acquire a competitor or complementary company, expand to the Asian market, or power R&D for a new product line. There is some merit to just having more money as a “war chest” in case you need it, but you’ll sleep much better at night if you have a laid-out plan for actually spending the money that is diluting your precious ownership stake.
As you think about planning your next fundraising round, it’s important to keep in mind seasonality and economic cycles. The business world slows during the summer and winter holidays, and despite the fact that you smart founders continue to work your butts off during these times, investors may not. So if your funding timeline takes you through the summer or December, be sure to leave enough time for lack of or delayed response from investors.
On top of seasonality, the greater business economic situation should also weigh into our timing. We’ve talked before in this column about financing becoming much more scarce during economic downturns or crashes. If you feel like the economy or tech sector is overheated, you may want to strike while the iron is hot and pad your coffers to weather a downturn.
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