How to plan your funding rounds

December 18, 2016

Having had this conversation a couple of times during the last few weeks, I think it might be worth elaborating here:

When companies raise money, they have to think not only about how much they want to raise at which valuation but also the sequencing of their funding rounds.

Let me explain: I recently sat down with a startup which was putting together their first round of funding in the form of a $250k angel round. Their plan called for a follow-on seed round of about $750k to $1M within 9 to 12 months.

Now here lies the problem: As every entrepreneur who ever raised capital will tell you – it takes time. Even if you have funders lined up, until you have all your ducks in a row and the paperwork sorted, months can go by.

If your financing rounds are stacked too close to each other you will:

a) find yourself spending a good chunk of your time doing nothing but fundraising, and
b) typically won’t have enough time to create sufficient traction to demonstrate progress (and thus justify your next round and the higher valuation).

To make things worse: point a reinforces point b.

A good rule of thumb is to raise enough capital to give yourself an 18-month runway (and 24 if you have to stretch it). This is usually enough time to create momentum to carry you from round to round and demonstrate the increased value of your venture. And on the other hand, it is a reasonable enough amount of cash that investors don’t get gun-shy.

When you raise your round you already have to think about what comes after the round (which might be another round or profitability). This view heavily influences how you think about valuation and the amount of money you will raise. Sequencing matters a lot when raising capital.

And this leads me to the next question:

How to value my startup?

One of the most vexing problems for anyone raising equity-based funding (typically Series Seed and onward) is the question of valuation. I get this question all the time from the founders I work with: “We are going to raise money from investors; how shall we value our company?”

Your typical startup doesn’t have any hard numbers to go by – you are pre-revenue and pre-profit. Mature businesses are typically valued at a multiple of their revenue; with the multiple depending on your industry.

For startups, that approach doesn’t work. Sometimes you can look at comparable funding rounds – company X looks a lot like you and raised $Y million on a $Z million valuation.

Truth be told – determining your valuation is insanely easy and requires quite literally only 4th-grade math:

How big of a check do you want — divided by — the ownership percentage — equals — the value of company.

(Michael Dearing from Harrison Metal brought this to my attention.)

It’s truly as simple as that. If you’re raising $3M and you want to give up 30% of your total equity for that investment, your valuation is $7M pre / $10M post money (if you’re unclear about the distinction of pre and post money valuations, read this article).

Simple as that.

With all this being said – good luck with the fundraising!