Hopefully, you remember the classic TV show Taxi and its despicably lovable character, Louie DePalma. In one memorable episode, the unforgettable Jim Ignatowski accidentally burns down Louie’s apartment. Jim’s wealthy father sends Louie a signed blank check to cover the damages and Louie faces the question that every high-tech entrepreneur faces: How much money should I ask for?” (Trust me, you’ll like the rest of this post more if you spend the 4 minutes to watch the clip!)
It’s a classic strategic question asked by every entrepreneur that I’ve ever worked with. And it is obviously a good question to spend some time thinking through because the amount you ask for reveals how much logic and business savvy you have in your bloodstream. By the way, you will always be wrong in the eyes of at least half the experts you ask.
I certainly can’t answer your specific “how much” question in a single 1,000 word blog post. But I will suggest there are only three main buckets in which to place your answer generally. Once you’ve placed your trust in one of these buckets, then you can get to work on your specific amount:
- “raise no money now, keep bootstrapping” (~20% of deals should do this)
- “raise only what you need to get the current job done” (~70% of deals should do this)
- “go big or go home” (~10% of deals should do this)
Understanding the value of your business is a major factor in raising money. Remember, that investors typically obtain ownership in your company in exchange for their investment. If, like some that show up at my door, you are only part-time at your venture and the product isn’t quite built and you have no prior experience in a market, your business is not going to be worth more than $1 million in all likelihood. If you were successful at raising $2 million, the new investors would own 2/3 of your business. You probably don’t want that and believe me, THEY don’t want that. These early-development stage companies should continue to bootstrap until they have created some value. It’s also possible that your company may fall into this category and not be so early-stage. If you’re just beginning to find your way in a market, or have discovered some traction after a strategic pivot, grinding it out for another 12 months at less than optimal cash positions may be the right path. Developing a proven business model, even the earliest stages of one, is a sign that it may make sense to raise some outside cash.
Raising capital when you shouldn’t is extremely frustrating. Most experienced investors understand that they may not be the final investors in your company. If more money is needed later, those later investors will get to set the rules and those rules may not be friendly to earlier investors. This awareness adds to their reluctance to invest so early and, rather than ask for more onerous terms from you, they simply decline to invest. And you are likely to spend a lot of wasted time and face a lot “no’s”. The smart founder knows the difference between dogged persistence and foolhardiness.
If you’ve decided that raising money NOW is the only way to go, I find that a majority of early stage companies should probably be raising a moderate, specific inflection-point-inducing amount of capital (#2 above). This is true whether your company has no revenue or millions in revenue. And this is really where the Louie DePalma conundrum takes hold: How much to ask for? Here is how I typically go about helping my clients figure out how much to raise.
I take the founders best assumptions and projections for 2 years after I’ve begged them to be as objective and cold-calculating as their entrepreneurial minds will allow! Then we spend about 4 hours talking about a much more modest set of assumptions for both revenue and expenses. Then you add up the shortfall and add 6 more months of burn rate to get your total. Now stand back and stare at the number and assess what that number means for ownership in regard to the current value of the company. Evaluate what that number means in terms of milestones you’ll achieve and what timeframe is targeted for them. Be sure to tie these…amount, milestones, timeframe…together in your investor pitch as you start to consider whom to approach and it should yield a rational and credible amount of cash to seek. Yes I know…you hear that devil on your shoulder saying “go big or go home” and you’re afraid you’ll regret, like Louie, not listening to that voice when he discovers $200,000 was possible. (To be clear…if you are offered a larger amount of money…consider it and its implications, of course. What I’m talking about here is what you go out there asking for).
Trying to raise a distractingly large amount of money…say enough to pay for operating shortfalls AND enough to pay for a new round of product development AND get through regulatory approvals AND begin making product in quantities AND launch the sales effort on that new product…is a “go big or go home” strategy. I do not advise this strategy in most cases, especially in the past 5 years or so. The funding climate and valuations have not warranted it. If your company has gotten to 1) rapid revenue growth (10-20% per month?) and 2) operational normalcy (i.e., predictable margins) and 3) you are facing a very large market opportunity for which you’ve placed yourself at the forefront in your industry and 4) the external funding winds are in your favor then a “raise as much as you need to get you to an exit” strategy may be worth considering. I’ve often heard this strategy espoused by very respectable people who understand well the dynamic in raising capital. They say it this way, “You’re not raising enough money.” Maybe you set out to raise $500,000 and they say “you should try to raise all $4 million you need for your plan.” There are times when this could be true, but usually, I find that founders are blinded by the flattering nature of this comment. “Yeah, I deserve to raise more.”
As I said at the beginning of this post, what your company should specifically raise can’t be handled by the advice in a single blog post. You should seek out some objective advisors who can help guide you first to the right “high level strategy” and then within it, figure out the detailed strategy. I’d also suggest that you create a strategy for each…that is, know what you would do with a bootstrap, middle-of-the-road or go big strategy amount of money. Don’t present each scenario, pick your preference. But do be prepared to discuss each with investors. Or, at your own peril, follow Louie’s lead, just stick a finger in the air and ask for a number between “whoa” and “meh”.
Check out these other posts on starting and financing your venture