venture money

Venture Money & How to Raise It

The Google search history of many earlier-stage companies likely includes this phrase: “how to raise venture capital.” While there’s certainly no shortage of relevant information on the internet, it can be daunting to create a sound strategy based on self-conducted research.

Based on many conversations with earlier-stage companies – and knowing that finding venture money is always top-of-mind for these ambitious startups – I’ve created a high-level framework that I would use to devise my own fundraising strategy if I were just starting out. No two new companies are identical, of course, but these general concepts should apply in some way to founders without much fundraising experience.

Come up with a plan

When I say “plan,” I mean more than big-picture goals. Do you have a detailed financial plan? Be sure to nail down the basics, beginning with a three-year financial pro forma. I find a dynamic three-statement financial model to be most useful when creating a pro forma because it will calculate changes to your cash balance as you tweak your fundraising strategy and calibrate your revenue projections.

Understand the assumptions that drive your model

Do you know your most important KPI‘s (Key Performance Indicators) that drive your business?  Trace every dollar of projected revenue backwards to certain actions or assumptions that drive it.  Once you have this list, be sure to incorporate them, in their own section, into your financial model so that they can be rapidly changed. Examples of KPIs might include, but are definitely not limited to, average annual contract value, number of deals closed per quarter per sales representative, number of sales representatives in a given month, customer acquisition cost, and churn rate.  Your business viability is dependent on them. 

Identify your key venture funding milestones

I suggest fundraising based upon anticipated milestones which are expected to trigger valuation inflection points. Using your pro forma, map out the various points in time at which you plan to achieve a key milestone. Try to map it as precisely as you can (e.g., down to the quarter or even down to the month). The milestone might be a product launch, a certain revenue run rate, expansion from 1 to 3 markets, version 2.0, 100k users, or something entirely different.

Feel the burn

Then, calculate the net cash burn required to reach your identified milestones. Equipped with this information, create a realistic fundraising plan that will enable you to operate for twelve to eighteen months between fundraising rounds – and be sure to build in a buffer! It inevitably takes longer to raise than you think. Lead venture capital firms could take anywhere from six to twelve weeks to reach a term sheet and, potentially, another month after that to close the investment and wire funds. Include some padding so you are not setting yourself up to be in a position of cash weakness during a raise.  

As an example, say the date is currently 01/01/2017 and you’ve identified these two milestone estimates: (1) initial product launch on 06/01/2017 and (2) $100k trailing 12-month (TTM) revenue on 06/01/2018. Assume also that you’ve calculated the estimated total cash burn to reach milestone 1 (+ 2 months) to equal $250k, and milestone 2 (+ 2 months) to equal $750k. And your current cash balance is largely depleted. One possible near-term fundraising plan could be to go out to raise $250k now to fund through milestone 1, and raise the next $750k shortly after milestone 1 is achieved to fund the business through milestone 2.

Know when the price is right

Understand the framework for how the market may value you at these inflection points, or future “milestone” dates. Your goal should be to raise the money you need at each point you’ve identified in your plan, while minimizing your dilution exposure with respect to your stage of business at a point in time.  Expect an appropriate amount of dilution at each fundraise: not too much, but also not too little.  

For example: Let’s say that you run a B2B SaaS business and have read research that the market typically likes to use revenue multiples between 4-10x TTM revenue to value your business (hypothetically).  

Based on your research, you should anticipate the future and think twice before aggressively negotiating for a valuation in your 2017 round that could match or exceed the valuations that the market will likely bear for your business in your 2018 round {e.g. 4 x (TTM Revenue) to 10 x (TTM Revenue) being your theoretical range based on your research}. Doing so could place unnecessary strain on your future fundraising process and potentially position the business for a “down round”.

Stratify the venture capital market

Build your investor wish list, beginning with who you think might be the most valuable partners to your business at each funding stage. Once you have your list, understand that venture capital investors are not all alike in check size, industry, stage of business, market traction, preferred geography, culture, role (e.g., lead vs. passive), and so on. Determine which is a target for each of your planned rounds and get to know them early.

Be open, honest, and responsive to investor inquiries

One thing VCs don’t like is the notion that someone is not being forthright with them.  Be open, genuine, and concise. Identify your challenges and weaknesses upfront. Share with the VC your strategy for resolving those challenges.  It will build trust and help illuminate issues earlier in the process.