How much money should you raise?

An example of a cheque.

The best answer to this question, as you’d probably guess is “Depends!”

The most common answer I hear is, “As much as you can” – which I’m not sure is the right answer, for at least two reasons. If you raise far more than you actually require,

  • you’ll be diluting more of your company at a price lower than you need to
  • you run the risk of developing a wide range of bad habits starting with mistaking raising money with running a successful business

Entrepreneurship literature suggests too much money can be as much (or greater) a cause for business failure as not enough money. Of course the same literature suggests that under-capitalization is the primary cause of slow to no growth of startups.

Better minds than mine have grappled with this issue, in a variety of manners. However most of them are set in the context of the US of A.  I provide links to several at the end of this post.

Whether you raise money, in what manner and how much will depend on

Nature of business – is it a service business, that is better boot-strapped? Web design, IT services, most consulting businesses all fall into this category. Does it require significant capital expenditure or up front investment – multi-location courier service or restaurant, manufacturing or high tech businesses fall into this latter category. Of course a slew of businesses fall in between these two – which would put them in the sweet spot for formal fund raising.

Nature of capital – are only friends, family or fools going to fund your business – most businesses would fall into this category – particularly service businesses that are going to stay small or local.  If you are already profitable or revenue making and are looking for capital to grow, you’re likely better off with debt. Of course in the Indian context debt may be non-trivial to access, despite a pile of money being available. Or do you need equity capital – as offered by angels or venture capitalists?

Assuming that you are a fundable business, I’d suggest asking the following three questions to determine how much money you should raise in your seed, angel or a series A round.

  • How much are you likely to spend over the next 18 months for your business plan?
  • Do you intend to raise another round and If so how many rounds do you anticipate?
  • How much of your business will you be diluting in both the first round and subsequent rounds?

Fred Wilson’s advice to US startupsis largely applicable in the Indian context too with a couple of caveats. He advises

  • raise enough for 12-18 months of business – in India I’d recommend at least 18 months
  • try not to dilute more than 10-20% – in India this might have to be as high as 25% percent

Can you raise too little money? Absolutely. Two things to keep in mind are

  • Things take much longer than you anticipate – the product ship, the first customer, incoming payments  In India a rule of thumb would be
  • It easily could take six months from the time you start your fundraising to when the money hits your bank

Good hunting!

What is the right amount of money to raise at a startup – Mark Suster
How much money to raise? – Fred Wilson
How much money should you raise from an early stage investor? – Seedcamp
How much should we raise? – Venturehacks

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Valuation 101 – for startups looking to raise their first round

maths

A recurring topic in conversations with young entrepreneurs and journalists across India has been that of startup valuations. Despite all the writing that’s out there, innumerable forums and meet ups, some questions – often very basic ones – persist. The questions themselves vary in actual phrasing from

How do VCs or angels value startups?
How much should I raise?
How much should I dilute? 

And each time as I’ve attempted to answer the questions raised, I’ve found us going back to the basics of What does valuation entail – what are its components and the math behind it. 

Note: In India, when people talk of valuation, they are usually talking of post-money valuation and the dilution refers to the percentage the investor owns, after their money is invested.

At the risk of oversimplification, all fund raising and valuation – regardless of fundraising round (angel, seed, Series A) – breaks down to three variables, which from the entrepreneurs’ perspective looks like:

I believe my company is worth so much today (pre-money) pV
I intend to raise so much money-  A
You sir investor will now own D% of my company

The reality though is more like this

Amount  (how much money you absolutely need to raise?) A
Dilution (% you’re prepared to give & investor’s ready to accept for A)  D%
Valuation (what the company’s worth post the investment (post-money)) V

Math dictates that the post-money valuation is Post-money valuation

(for the curious, pre-money valuation is obviously pV = V-A)

Valuation_triangle

In this scenario, the valuation (V) is an artifact of how much money you absolutely need to raise (A) and how much ownership (D) you are prepared to give up (or how little the investor is prepared to accept). Once you fix any of  these two variables the third is automatically fixed. So it’s important to understand which of the variables are really in  your control and what degree of flexibility you have in them.

Amount So how much should you raise? Any kind of serious fund raising can easily take you six months between first discussion and the money hitting your bank. So it’s a good rule of thumb to raise money for 18 months of operation, so that you can focus on running your business for at least a year without having to worry about raising money. You’d need this money to cover the operational expense of running your business over the 18 months and any capital expense or investment that you’d make in the business. For a startup that’s not raised any outside (of friends & family) money, based on your business plan this amount may vary from as little as Rs. 45-50 lakhs ($65K) to say 1.5-2 Crores ($250K). So this fixes one variable (A) in the valuation triangle. Of course if you plan to start an airline (Indigo) or overnight delivery (FedEx) or semiconductor firm, you’ll need a lot more money to start with, but most of us can start with $60-100K.

Dilution Particularly for any first round (seed or angels) the investor likely would expect to get 20-25% of the equity. Depending on where your business is at – concept, prototype, early customer traction, they may go as low as 15% or want as high as 30%. This is largely a matter of the maturity or stage of your business, the perceived de-risking done and the line of business you are in.

Comparables (what other companies in your line of business, in your geography got valued at) are relevant as is your revenue, margins, free cash flow but treat them as rough guidelines rather than definitive stakes in the ground. Sure, your market size and share, your business plan, your product or service state all matters – but usually, in the Indian context valuation is not absolute but a direct output of answering the two questions.

  1. How much money do I need to raise in this round?
  2. How much ownership am I prepared to dilute

So for instance, if you seek to raise Rs. 60 Lakhs (Rs 6 million) and desire to dilute no more than 25%, then your post-money valuation is

Valuation

Just as easily for the same money, if you have dilute more – your valuation could change without any real material change in your business. Depends how desperate you are and how greedy or generous the investor is. The table below shows the effect of A and D on valuations.

Valuation options

Reality rarely is this clean. Happy hunting.

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