The correct amount of money to raise for your startup is “as much as you need to hit the milestones to raise your next round of funding.” It isn’t rocket science, and yet, the vast majority of founders I talk to are very fuzzy about exactly how much money that is, and there are a lot of misconceptions about how you figure out how much you need to raise.
To be a startup on the VC treadmill is a staged de-risking of a business proposition. In other words: Right now, your company is very risky indeed because certain parts of your business are unknown. This is why you need to put together a minimum viable product (which is neither minimum, nor viable, nor a product) to test out part of your business model. Once those things are tested and proven, the risk of the business goes down, and you can raise your next round of funding to take on the next part of the journey.
The first mistake a lot of founders make is to try to raise enough money for a certain amount of runway, measured in months or years. That makes some sense, but investors are not interested in keeping your startup afloat for the next 18 or 24 months. They’re interested in keeping you alive for long enough to deliver certain milestones, which in turn are a proxy of risk reduction.
Let’s take a deep dive into how you can best design your startup’s journey through the various stages of funding — and detail just how much you need to raise at each stage.
Milestone-driven fundraising
The best way to think about how much you need to raise for this round is to consider what you need to accomplish to raise your next round. That means considering the specific milestones that you must hit to prove that your company is moving in the right direction. These milestones might include:
- Launching a product to market (product de-risking).
- Solving a hard technical challenge (technical de-risking).
- Getting Federal Communications, Food and Drug Administration or other regulatory approvals (regulatory de-risking).
- Hitting revenue milestones, such as annual (ARR) or monthly (MRR) recurring revenues (financial de-risking).
- Decreasing your sales cycle times (especially relevant for large-account B2B startups).
- Keeping your active users active, especially focusing on the DAU to MAU ratio (user engagement de-risking).
- Finding your first X customers (product-market fit de-risking).
- Determining (or reducing) your customer acquisition cost (marketing de-risking).
- Hiring key staff members (resource or knowledge de-risking).
- Reducing churn of your existing customers (net revenue retention, or NRR, de-risking).
- Increasing spending from your existing customers (lifetime value, or LTV, de-risking).
- Increasing the money-per-transaction spend of your existing customers (average revenue per unit, or ARPU, de-risking).
- Improve your viral coefficient per customer (marketing de-risking).
- Managing your burn rate (financial de-risking).
- Improving activation rates (de-risking your onboarding process).
- Keeping customers happy by measuring and improving your net promoter score (NPS).
- And many, many, many more.
Exactly which of these metrics are important and which can be ignored depends heavily on the specific business model and industry you are in, but thinking into the future can be helpful. The best pitch decks we see are ones that have a laser-like focus on a handful of these metrics and zero in on obtaining and improving some of these metrics.
When you are at the earliest stages of a company, it’s likely you’re just looking to get some simple version of your product to market and onboard your first five (for B2B) or one hundred (B2C) customers so you can get some early customer feedback. Later, as you’re moving from the initial launch to looking for a sustainable business model, the focus shifts toward revenue generation. This is where the CAC-to-LTV arbitration ratio becomes crucial. Get new customers, increase the value of existing customers, keep your existing customers and increase virality from new and existing customers. Lather, rinse, repeat.
Selecting the right metrics and goals
Once you’ve chosen four to five metrics you want to focus on, you need to set some targets for them. These targets should be specific, measurable, achievable, relevant and time-bound (often referred to as SMART goals). So, for an imaginary startup, we might come up with the following set of goals:
- Beta launch: By June 2023, we launch the initial beta version of our product to a limited audience. The beta version should test whether customers get actual value from our product and allow us to receive initial user feedback.
- Premium launch: By November 2023, we launch a paid version of our product to a limited audience. At this time, the free version will become available to all customers.
- User acquisition: By January 2024, we want to have 300 customers on the platform. By March 2024, we want to have 900 customers on the platform.
- Revenue: By March 2024, we want to have at least 100 paying customers on the platform in order to start testing our pricing model. The initial goal is to charge $29 per month per customer.
The above are all clear, measurable goals. The way the goals are designed means that there’s no doubt whether a goal has been achieved, and it means we can use these to measure whether we’re on schedule.
Crucially, looking at the list above, you can make a qualified guess as to whether you’ll be able to raise your next round of funding if you do hit those milestones. A platform in-market with 900 users, 100 of which are paying customers at $29 per month, means a $34,800 ARR. You can start guessing at how long customers will stay on the platform and calculate your lifetime value per customer. These metrics together tell a story of the company.
Are these metrics and milestones enough to raise your next round of funding? If the answer is in the affirmative, then you know what you need to do. If not, it’s back to the drawing board. Do you need more revenue? More customers? Is there another aspect of the business that needs to be de-risked? Add that to the list of milestones.
Figuring out how much to raise
Once you know the metrics and goals, involve the entire team to figure out what actually needs to be done to hit those milestones. This is where your development team will ask for development and research resources. Your operations team will ask for logistics, customer support and other operational resources. Your sales and/or marketing teams will need people — and money for the people to spend to get their jobs done. In a very small team (say it’s just you and a co-founder), these “teams” will be the same people again and again, but in any case, every business unit has different needs for resources — both human and financial — so think carefully.
Remember that some resources can be switched on and off within seconds, while others can take weeks or even months to source. For example, you can spin up as many AWS instances as you need to run the business in a day, but hiring the right developers, operations and marketing folks can take a lot longer.
The resource needs all go into your master timeline planning tool, which should include hiring timelines, costs associated with hiring and any other resources you need. Here, it’s very important to ask everyone to be honest with themselves and with you. It’s crucial to get as accurate of a plan as you possibly can. This is not the right time to try to impress anyone with how quickly you hope you can hire or how effective you are at churning out code. At the same time, we’re not asking people to be super conservative and pad the time estimates — what we want is as honest and as accurate an estimate as we can possibly get. This master timeline feeds into your operating plan, and from there, you have a timeline and a financial picture of what needs to happen over the next period of time.
Now, remember that people are notoriously optimistic, even when they are asked to be realistic. If your operating plan says that you can hit all of the milestones within 18 months and with $3 million of investment, think about what would happen if hiring is slower than expected, the staff is more expensive than expected, or if the legal costs are higher, the outsourced resources are slower, or the customer acquisition cost is higher than estimated. At this point, add 30%-50% to your budget. That doesn’t mean that the budget increases; if the development team says 18 months and $1.8 million, that is what they have to work with. But it does mean that if things go wrong (oh, and they will), you aren’t immediately up Schitt’s Creek without Alexis Rose’s acerbic wit.
So, your plan shows $3 million and 18 months. That means you’re raising $4 million to give yourself some wiggle room for when things go wrong.
Sense-checking the plan
As I mentioned above, you’re raising money for certain milestones, not for a particular stretch of time. Some companies surprise themselves by being able to hit all the milestones in their 18-month plan in just a year. Great; time to raise another round. Sometimes, it turns out that things take way longer, or you might discover that the milestones themselves are wonky. Some may be very (maybe even too) easy to hit, and others may turn out to be impossible to achieve. If you think you can still raise money, then go ahead and top up the coffers at that point; go through the same planning process again, figure out the set of milestones you need to hit to raise your next round, and take it from there.
If the plan turns out to be wrong and you come up short, at risk of running out of cash, you’ll have to play the bridge-round game. It’s not a fun game, and bridge rounds are notorious for putting founders in difficult situations. Finding yourself in a situation where you have to raise money to make it to your next funding milestones means you have no leverage in negotiations. Even worse, a lot of founders underestimate how much money they need for their bridge. We occasionally see second and third and fourth Series A extensions happen. That’s a sign of spectacularly poor founders who are unable to get their company to where it needs to be to hit the next stage of growth.
“That round is not a bridge, it’s a pier,” Axel Bichara, GP at Baukunst, joked at a recent event, highlighting that raising money just to extend a company’s runway, without having clear milestones and goals attached to it, is a recipe for disaster.
Once you have your fundraising amount and your plan, checking that it makes sense is the final step. As you hire more marketing folks and ramp up marketing spend, does the number of new customers increase accordingly? That’s a trick question — usually, the mistake is in the other direction: exponential growth in customers without adequate marketing spend. The same goes for product development — it takes time to spool up developers, so increasing your team from two to six developers doesn’t mean a 3x increase in productivity overnight.
The other thing to look out for is one-off expenses that happen regularly. There may be recruitment expenses, legal expenses, insurance, taxes, design and trademarking expenses, payment processing fees, equipment costs, maintenance costs, accounting and IT infrastructure costs, etc. Getting a good consultant who does fractional CFO work (i.e., can take on the CFO role for a period of time — here’s a good guide to fractional CFOs) can help ensure that you don’t overlook something obvious and can help benchmark your financial plans against what they are seeing at other startups at your stage and in your industry.
If the plan is internally coherent based on times and finances, and you’ve baked in some extra leeway, congratulations, you have a better estimate of what you need to raise than most. Round up to a reasonable number and stick that number in your “ask and use of funds” slide of your pitch deck.
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