Updated: Nov 13, 2020
Many entrepreneurs ask "how much to raise?” However, it is not one question to ask, but rather, three:
What are the goals for this funding round, and how long will it take achieve them?
How much are startups (at similar stage and in the same industry) raising?
What is the investment policy of your target investors?
It turns out that there is not a single answer to each of these questions. Fine tuning is required to match the scope of the investors you are targeting.
In this article, I discuss the process of building the financial plan for your startup. I take into consideration target investors and similar startups’ track record as a guide in setting goals and schedule that align with your target investors' goals.
Define your purpose: Why do you raise capital?
The first action you take is to define a meaningful milestone for this round, such that will justify - or eliminate the need fo - the next funding round:
A technical achievement
A marketing achievement
Revenue and operational maturity
Accelerated growth requiring significant resources
We will now prepare work-plans for each major domain within our startup, from R&D to marketing and sales, each such work-plan will detail the people, equipment, investments, offices, and all other inputs required for operation.
Each such plan will be the responsibility of an executive who will take care of its implementation. Does the founding team include the required expertise? And if not, has a future CEO been identified? Is she available for work, would she identify with the venture?
Technological manpower is often the most expensive component in early stage technology companies, and meticulous planning of the resources needed is required by the R&D manager.
How many developers will we need? In what roles? What is the average salary for each role? When and how much will we need to recruit for each position? Is it possible or desirable to outsource some of the tasks at hand? If we do outsource, what are the efforts required for integration and supervision?
Marketing and Sales plan:
Here the costs are divided between the internal sales and marketing team, outsourced teams, advertising expenses and other marketing activities.
Similar to R&D, the marketing manager should not only commit to inputs but also to tangible measurable, results: How much the marketing efforts he has planned cost, and how much would they yield?
Manpower is a major expense with peculiar characteristics:
Hiring decisions are somewhat detached from sales volume, as they are discretionary. Further, they tend to be rigid: It takes time and money to recruit and train, and while success rate is never absolute, it is difficult (and sometimes harmful) to lay off.
Further, Investors tend to look for headcount and measure it against growth, sales, and profit, as a proxy to the organizational culture of the company.
This means a Human Resource table must be maintained separately, concentrating allocations from development, marketing, headquarters, and when required - production.
Forecasts and dependencies
Each work-plan will be laid out in a dedicated table within your master spreadsheet.
While including the relevant expenditure they will crucially include measurable goals, which will be translated into tangible achievements, for example:
How long and what resources will it take to release version 1.0?
How many salespeople do we plan to work within how many months, to generate $X in revenue? ...
Naturally, there will be dependencies between the various plans: for instance, there is no point in launching an aggressive sales campaign long before a production version is ready for release.
Infrastructures, and Operational Plan
HQ Operational plan
What are the costs of setting up and maintaining a website?
What are the cost of office space, complete with insurance, taxes, electricity and other anticipated expense?
Which officials are expected to be at headquarters?
All these will be listed in the table for “General and Administration" that will add the expenses of consultants, bookkeeping, accountants, and lawyers.
Some businesses require physical infrastructures for manufacturing, for delivery, for equipment and merchandize storage.
Now, oftentimes physical infrastructures have the annoying tendency to be built for purpose (think about a production line, with dedicated machines, environment control, and workflows embedded in bricks and mortar).
Infrastructures must be planned in advanced, with machinery and equipment procured, if not made to order. The location has to be approved by authorities, it carries rates and utility bills, and what's more: it starts to deteriorate the moment it is built - wear and tear play here, as well as the technology useful life.
Set aside amortization, there are immediate cash flow implications to building infrastructures with an initial cash outflow - and running them, incurring repeat expenses.
Infrastructure Set up should be managed separately. Because of its project management implications (separate budgets, risks). Sums will be then drawn to the master spreadsheet.
Similarly, technology projects, specifically in the hardware domain, tend to require high and risky initial expenses (R&D, engineering, tooling, testing, certification, etc.), and then subside to maintenance mode. If you are into a hardware project, you’d better separate the initial phase from long term production, for clarity and control.
Sadly, these expenses would be deemed none recoverable - should the project fail, investors will rarely recuperate much of them, if at all.
When manufactured physical products are involved, and once tooling and other non recurring expenses are paid, unit economics will come into play:
Bill of materials (Raw materials, components, sub assemblies) need be sourced, stored , and handled; labor has to be accounted for.
Products will have to be inspected, packaged, shipped - each activity carrying its own costs, sometimes many months before sales proceeds enter the coffers of the company.
Payment schedule and risks add to the required working capital.
SaaS: Acquisition Costs
SaaS products seldom sell themselves: marketing and growth activities tend to gobble important sums, dwarfing the R&D costs of earlier stages.
When SaaS companies enter their growth phase, the cost of user acquisition compare - together with operational costs (servers, support personnel, etc) - compares with “old economy” manufacturing cost - as it is derived of the growing number of users, cross and up sales, and user attrition (Churn).
Marketing & Sales Plan
The sales plan sets revenue goals for the period we cover in our plan. It delineates quotas and targets, enabling monitoring and assessment of speculative assumptions (planning) - and realistic data (reports).
Further, it accounts for all the related expenses associated with bringing the anticipated revenue: Advertising, Affiliation, distribution, and revenue share are pre sale and post sale expenses that impact your fixed cost and contribution margins.
It is crucial that this plan is prepared by a seasoned executive, well immersed in the target market and vertical: How long do sale cycle last, typically for this class of products? How many people get to decide and influence decision making on the customer side? What are the initial chances of closing and how do they improve as customer move down the marketing and sales funnel?
These factors impact the initial revenue forecast, and its progressively better precision - providing proof for any aggressive growth prediction your vision leads to.
All work-plans prepared are managed on their respective tables, linked to the financial plan table - accounting for revenue, expenses, and operational profit or loss.
Importantly, as entrepreneurs, you are not only interested in the profit of the company. You should be focused on the cashflow, which must leave you with a positive cash balance at all times: As a startup company, you will not be able to produce much of collateral against increasing debt.
Letting cash balance to decline to zero can be lethal to startup companies, and must be avoided at all cost. Further, continuing operations with negative cash balance is of the rare occasions where debtors and suppliers might have legitimate demands against directors in the company.
One of the means to prevent such occurrence is to maintain a sufficient cushion, calculated in such manner cash balance does never go below zero. The calculation accounts for remaining cash to suffice for two consecutive quarters without additional revenue. Enough time to dissolve the company and pay remaining commitments to employees, suppliers - without the need to harm your partners more than necessary. Entrepreneurs do fail, but the way they manage failure impact the willingness of past and new collaborators.
Calculating the Investment amount
I provide here the formula calculating the investment amount required to never allow cash reserve to go below the reserve amount in the example above:
Where sumif sums all anticipated losses.
Cash balance going below the reserve amount would be a signal to shut down the company.
Who raised, and how much?
Now that you have laid an ambitious plan, all that remains is just call investors, and they will pour their wallets’ content on you. Right?
Well… Just a minute here...
We might not find an investor who is interested, and has the expertise in our domain.
They may not have the amount requested at the moment, and they may not invest that high - or that low.
They may prefer younger companies, or more mature ones.
So, what’s to be done?
Lay Of The Land
First, do your research: Which startups did raise funds and which of those are
In the same space
Similar market potential and structure
Similar type of founders
Active in the same geographies
You may search using filters on Crunchbase
Or look it up on Startupnationcentral
Since data in these data bases were inserted by humans, fallible creatures as they may be, they cannot be regarded as clean of interests or bias. Further, the information may be lacking or less than up to date.
Do your research: Cross examine with other sources, such as:
Press releases by the companies or by investors
VC website portfolio section
Connection to anyone who can, and would provide insights and impressions
This research will form in your mind an understanding of the environment and timing you are trying to raise funds in:
Which companies have raised capital in the same stage as yours?
Where do they come from, and what geographies and markets are they targeting?
What size are they?
Who are the founders, which of them share characteristics with your team?
Speaking of which, do your team need reinforcement?
And the most pertinent to this discussion: How much did they raise?תיאום ציפיות
Let us get back to the financial plan you have prepared. Is the required investment amount within the range you have discovered? If so, you are good to proceed to the next step.
If not, you are bound to a reality check: Go back to revise your plan, adjust budgeting, rethink your growth plan, your product, or your go to market strategy till your numbers fall in the range.
You may probably have to adjust your pitch, until you lock in on a lead investor. Once found, their preference will crystalize your plan, budget, goals, projections - and the valuation that emerges from them.
Who invested, how much, and why?
Once you understand the sum you are trying to raise, what phase you are at, who are you going to be compared to, you can now turn to research your favorite target investors. The criteria vary, but some ideas are:
Did they invest in your domain?
Do they have stakes in direct competitors?
Are they involved with synergetic companies?
Do they bring added value, except from cash?
Are they pure financial investors, or are they strategic to you?
Are they targeting the same segment?
In what stage do they enter, and how long will they support invested startups?
Do they lead or follow investment rounds?
What is their ticket size, is it in your range?
These searches can be done in the previously mention Crunchbase and Startupnation finder, but there are other publicly available databases, among them signal, by Nfx fund, where you can not only look for active investors, but also contact them, present your pitch, get recommendations:
Another well known list is Eden Shochat’s list:
The criteria we set in the previous sections will help us limit our search from thousands prospective investors to a manageable number.
How many are “manageable”? Is a question with no answer set in stone. However, given the nature of the process (how many touch points until an investment decision is taken, the low probability of investment for each particular investor in your particular startup), it is sensible to start with a cohort of a few dozens.
“We see hundreds of startups, examine carefully some 60-80 opportunities, and eventually invest in 2 to 4 companies each year. Therefore, naturally there is quite a lot of excellent startups we did not invest in”
A brief calculation can demonstrate the point:
A VC sees hundreds startups per year, invest in a handful. This means normally the ratio is 1:100. The flip coin of this assertion is that as a startup, you need, on average, meet a hundred investors to close your 1st deal.
Experience shows, on the other hand, that the more focused your offering, the more defined your target market and segment, and the better you understand your relative position in the startup eco-system - the smaller the number of relevant investors you’ll find, and at the same time their likelihood to engage in an investment will rise.
In this post I tried to show a method to define the amount you need to raise for your startup, taking into account similar and sometimes competing companies, investors appetites and trends.
This is only but a part of the considerations you take while preparing for an investment round, but I do hope I managed to give useful clues.
The author serves a business development consultants to technology startups. Among the services TheRoad provides is preparing startups to capital investments.
The information and views in this post are not to be regarded as consulting, and the reader may rely on and use any of it at their own risk.
TheRoad: Technology startup consulting and mentoring