In general, the job of any founder (or CFO as the business matures) is to ensure the lowest possible cost of capital while appropriately accounting for risk and capitalizing on strategic opportunities. Stated differently, you want to produce a solid return on investment. It is surprisingly easy for early-stage founders to view their businesses in more abstract terms. Rather than thinking in terms of risk-adjusted rate of return, many founders think in absolute terms: “either my business succeeds or fails, period.”
While there can be some short-term benefit (especially in the early days) to the myopic view of succeeding at all costs, it can also lead to your continuing to pour valuable time and resources into a poorly developed plan or product. You will tend to make better decisions and have more success in fundraising if you can think like an investor in evaluating capital and its potential uses within your business.
How Much Money To Raise
As I’ve written about in the past, too much money can be bad for early-stage companies (check out the blog post, Too Much Money Can Doom A Startup). It can lead to expensive, bad decisions – especially for product-oriented companies without an established PMF.
Early on in a company, your goal should be to raise the least amount of capital required to reach a target benchmark while also allowing for appropriate uncertainty and risk. This doesn’t mean you shouldn’t be ambitious in your target benchmarks. Be ambitious, but also be deliberate and calculated in determining how much money is required. In other words, how much capital does it take to get to your next benchmark when you allow for additional cushion in case it takes longer or costs more than you think (which it will)?
Even the most prudent and experienced founders can quickly turn into spendaholics when given too much money. So before you set out to fundraise, make sure you know how much money you actually need. Remember, this is costly capital.
Here are some questions to ask yourself:
- What is the next reasonable milestone that I need to achieve to increase the value of my business?
- Product validation or proven PMF?
- A certain number of users added?
- A proven, scalable customer acquisition strategy?
- Do I know exactly how I would deploy capital if I had it?
- X$ to product development vs marketing, etc?
- If I’m wrong about my assumptions, how much additional capital would be needed to course correct?
Use of Capital
As stated above, you need to ensure you have a clear plan for deploying the capital you raise. Investors want to know that you have a plan for their money and that you’ve done your due diligence to ensure those plans have a good chance of producing a return. So write out your objectives and vet them with your mentors or other founders before approaching investors. You should also build out a formal budget for the capital (the later the stage and larger the round, the more detailed the budgeted use of proceeds should be).
Return on Invested Capital
Return on invested capital (ROIC) is a calculation used to assess a company’s efficiency at allocating capital to profitable ends. This is often hard to project on early investments in a business. However, you should have a clear idea of how the capital you deploy will produce a return on that investment.
To make this easier, imagine yourself in the investor’s position. They are about to give you money and they’re betting that either 1) you’ll pay it back with interest as promised (if debt) or 2) you’re going to use the capital to make the business significantly more valuable (if equity). So you should feel very confident articulating to your investors how your planned use of the money will produce significant value for the company, thereby helping to justify their betting on you.
A simple example is in customer acquisition investments. Let’s say every customer you sign up for a SaaS product is worth an average of $500 a year in high margin revenue. Additionally, you project the average lifetime of a customer to be at least 5 years ($2,500 LTV). Now let’s assume you’ve proven you can effectively leverage digital marketing to acquire new customers for $300 each. Given your market research, this is just the tip of the iceberg and there is still a lot of room to increase your spending on digital marketing before you “tap out” that pipeline of new customers. In this example, it is easy to make a strong case to capital providers that your using their money to invest in more digital marketing is a good return on invested capital.
Who to Raise Money From
There is no right or wrong answer to this question, especially in the unpredictable and chaotic early days. However, there are some general rules of thumb. Again, this is not an exhaustive review of all scenarios but more an illustration to help you understand the proper use of the various financing options available to you based on the maturity stage of the business. Since every situation is unique, it is best to consult with your trusted mentors and advisors who have significant experience with capital fundraising appropriate to your business stage. For more information, check out our other blog posts on fundraising.
Stage | Idea Stage | Product Market Fit | Proven Customer Acquisition Funnel | Growth / Expansion |
Source | Angel Investors VC | VC | VC Non-Bank Lenders | VC Private Equity Non-Bank Lenders Banks |
Type | Preferred Equity / Convertible Notes | Preferred Equity / Convertible Notes | Preferred Equity / Debt | Preferred Equity / Debt |
Size of Round | $ | $$ | $$S | $$$ |
