Fundraising and Financials, Part II of II

In the previous post, I looked at how problematic it is to decide on the size and timing of fund raising, in particular for the seed stage.  A company can’t typically raise all the money it needs at the very beginning (nor should it), and it also can’t be constantly engaged in “the next round” for in some perpetual fund raising cycle.

A good compromise is “sufficient capital to reach a convincing milestone plus at least 6 months buffer”.  Let’s break that down:

         “A convincing milestone” can be anything which interests additional investors to come on board.  For A-Round investors, it could be a finished product (if the technology was hard to develop), existing and growing revenue (if market validation was hard to develop), a growing user base (if there’s a lot of competition for the users’ time), etc.  Really anything that proves that your company is special (as opposed simply to how you claim it is special).  This varies widely, for a dot-com a finished and live website probably isn’t impressive, for example.

         “A 6 months buffer” is important since no one (excluding some outliers from boom periods) get a check for millions after their first pitch.  The reality is your first pitch is a win if you get invited to a 2nd pitch with the other partners.  And that’s a win if you involved in due diligence, and so on.  A round can be fast (2 months), but the reality is that you need to plan for it taking at least 6 months (9 months is smarter).  Pitches, evaluation, internal discussion, another pitch, another internal discussion, term sheet preparation, term sheet analysis, due diligence preparation, due diligence analysis, due diligence questions and feedback and further preparation, investment contracts, your attorneys’ feedback, other attorneys’ feedback, etc… you get the picture – it always takes longer than you expect and the less runway you have, the more desperate you become and the less negotiating power you enjoy at the table.

A good example would be an SAAS company that does [insert earth shattering technology here] for [insert largest growing demographic here].  In this example, the founders are three recent university graduates bootstrapping their idea from a CompSci project into a real company.  5T€/Month takes care of a small office, telephone, web server and hosting, etc.  Another few thousand for attorneys’ costs, travel, misc.  .  Finally, the two founders need to live, so at a about 4T€ brutto X 3 plus some interns for another 1T€, we have expenses of about 20T€/month.  When the company starts ramping up, it’ll be closing to 35T€ when they hire a few more people, need a slightly bigger office, servers which can handle the expected loads, a bit of marketing, etc.

For such a company, being able to demonstrate paying customers over several months would be a pretty convincing story for investors, especially when these are showing good growth.  The assumptions are that the company will launch in 4 months, so if it takes a month to find its feet and then start generating revenue.  Three months later the company can talk to an investor, point back, and say “look at the revenue we are generating; it may be small, but it is growing; with another investment, we could jump start it into another order of magnitude by doing [insert strategy here]”.

Although the founders are probably talking with VCs the entire time, when the can say the above is when they first start to become seriously on the VC radar.  In this example, that is in month 8 (4 Months development, 1 month “live” but not yet significant, 3 months proven traction).

When you consider that the decision + Term Sheet negotiations + Closing will take 6-9 months, this means the company has to have a total of at least 14 months runway and 17 months would be smarter.  In the SAAS example above, this corresponds to an initial capital need of 280T€ to 340T€.  If we were talking about a company with closer to 45T€/Mo. Burn, then the initial capital would be 630T€ to 756T€.  Which do you think is easier for the three recent graduates to raise?