I often hear founders say they are raising money to increase their runway by 18 to 24 months. In a sense, that is accurate, but only from the startup’s point of view. However, that’s not what an investor is looking for. Your company surviving for another year and a half is not the goal of a fundraise; that’s a side effect at best. It’s probably a decent guess for how long the next stage of the company will take, but only because 18 to 24 months is typically the time horizon you can semi-reliably predict.
But what happens at the end of those 18 months?
Instead, founders should communicate to investors what a round of funding unlocks. That’s expressed in milestones, not in time. The goal is to transform the company sufficiently that you can do something that you cannot do at this moment.
How much to raise?
How do you know how much money you need to raise? It’s a tricky question, but it’s a critical aspect of your startup journey. Establishing a clear and realistic fundraising target requires careful consideration with one goal in mind: What hoops do you need to jump through in order to be able to raise your next round of funding.
For startups, I like to think about funding rounds as a process of staged de-risking. At the earliest stages of your company, an investor might not give you $40 million but could later on. Therefore, you should be asking yourself what would be true for your future $40 million company that isn’t true today. Often, this is about the amount of risk inherent in your business.
Before you have a product, you are extremely high risk. As you release the product and start onboarding your first customers, the risk decreases. When you have a reliable and repeatable way of attracting and retaining customers, the risk decreases further. If you’re able to increase the value extraction per customer (usually by increasing a customer’s lifetime value, either by decreasing churn or increasing total spend), your risk reduces even further.
Note that all of these things take time: Developing software takes time, improving top-of-funnel takes time, and growing customer spend takes time. But time isn’t inherently a factor. In other words, software isn’t magically going to develop itself over time. Your marketing isn’t going to get better over time. It takes effort and focused, directional work to improve.
For your fundraise, then, the “correct” amount to raise is the amount of money it will take to hit the milestones that will unlock your next round of funding.
Begin by analyzing your startup’s financial needs through the creation of a detailed budget. Break down your expenses into categories, such as product development, marketing, staffing and the infrastructure you need to hit those milestones. Assess how these costs will evolve over time and determine the runway needed to reach key milestones, such as product launches or market expansions. Of course, your projections will absolutely be incorrect (it’s the nature of the beast), so be sure to factor in contingency plans for unexpected expenses or delays.
What are the fundraising milestones?
To figure out which targets to set for your fundraise, you’ll need to think about which risk factors are preventing you from raising a bigger round now. A funding-round-driven approach to de-risking your startup is to create a system where you are addressing the known unknowns and exploring the pitfalls along the way.
Ultimately, you’ll be answering a series of questions that gradually home in on a repeatable business model:
- Is the problem we are solving real?
- Are people willing to pay to have the problem solved (i.e., competitive landscape)?
- Is the solution we are proposing even possible (is this a hard tech problem)?
- Is the product we are developing a reasonable implementation of our proposed solution?
- Can we find any customers that are experiencing this problem?
- Can we get any of these customers to pay anything at all for our product?
- Can we get these customers to pay more for our product than it costs us to deliver it?
- Can we find a reliable set of sources for more customers (i.e., top of funnel)?
- Can we defend our product and solution in the market (i.e., is there a moat/competitive advantage)?
- Can we hang onto our customers once we acquire them (churn prevention)?
This somewhat simplified list takes your startup from “is this business even viable?” — at which point it is extremely high risk — all the way through to “can we operate this business at scale and at a profit?” Some of the questions on this list are hard to answer absolutely; often, answers come gradually. Every business can probably find at least one customer for what it is selling, but can you find 10? 100? A million? As the scale of the operation grows, the cumulative risk of a company decreases. If you have 10,000 customers and you have a clear top of funnel and a reasonable customer acquisition cost, it’s easy to raise money because you have a relatively clear path to hitting your 100,000-customer milestone.
Once you’ve identified the milestones you need to hit to raise your next round of funding, you simply work back from there: How long will it take? What resources do you need? How much will it cost? These milestones, along with the price tag, make up your “ask” slide.
For a lot of these gradual-growth milestones, the timeline to hit them typically falls in the 18- to 24-month timeline; but what you’re really doing is raising enough funds to deploy the resources to hit those milestones. If you estimate that it’ll take 18 months but it actually takes 20, who cares? If you guessed it would take you 18 months, but you get a huge tailwind and you can do it in nine? Great. Ultimately, you’re unlikely to be shouted out of the boardroom if you’re able to hit your milestones.
Having clear KPIs that show progress toward the metrics you believe in (and, importantly, your board and future investors believe in) will unlock your next round of funding. And that’s far more reassuring to an investor than you raising money to help you get through a period of time.