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How To Define The Investment Amount You Need To Raise

There are several factors that determine how much money you need to raise for your venture. If you managed to bootstrap and build initial traction, then the first and most important factor is how much money you need in order to reach your next milestone.

1. Secure Your Runway To Reach Your Next Milestone

If you manage to get to profitability from your first fundraising round, then you wouldn’t be rushed to raise money in the near future unless you decide to do so. This is a great goal to have because if you fail to reach profitability after your first funding round, then raising another round would be a matter of life and death. If macroeconomic conditions negatively affect the investment environment, this could turn out to be a big problem for your startup.

Moreover, funding is much easier (and cheaper) to get once you don’t need it desperately. Reaching profitability just after one round showcases that you are moving your business in the right direction, and subsequent investors would be happy to pay a premium (i.e. to give you more money for a lower share of your business) to get in on the action.

The exact amount you need in order to reach profitability, of course, varies from business to business. For example, if you know your burn-through rate and your revenue growth rate, then you can assume relatively safely how much runway you need to cover in order to become a self-sustaining business.

If your project is very early stage, however, extrapolating how much time you would need until profitability becomes harder. In this case, you should try to get at least 12 to 18 months of runway covered. This would give you enough time to validate your ideas and even to iterate once or twice in case your first attempts at finding product-market fit don’t work out.

So, if you have a team of 5 people working full-time with an average gross salary of $10k per month (your founding team and first employees need to be experienced and motivated, and developers are expensive), this means you’d need $50k per month or a total of $600k for one year or $900k for 18 months. Account for marketing, office rent if needed and other general expenses, and you should have a solid estimate of the amount you need to give your business a good chance of success.

If getting enough money to become profitable isn’t possible, then you should at least aim to reach the next milestone that would make it easier to fundraise another round. For example, this could be using a smaller pre-seed investment in order to produce an MVP and to successfully validate your solution. Afterward, you might need a seed round to finetune your business plan and figure out unit economics (the efficiency phase), so that you are well-positioned for scaling-up, for which you might need growth capital.

2. What Share Are You Selling?

Second, you need to divide what share of your business you are willing to sell in order to get the desired amount. Most funding rounds require between 10% and 20% of dilution, and it’s typically good to try to avoid giving up more than 25%. The reason is that you’d usually have to repeat the fundraising process a couple of times and offering too much early on would make further rounds a bit more difficult to close.

So, if you want to get $600k for 20%, this suggests a $2.4M pre-money and $3M post-money valuation. The question is if you are able to justify such a valuation.

If you have a financial history, you can argue for a multiple on your earnings. If you don’t, however, then it’s a good idea to compare your business to other startups in your industry that were able to close a similar funding round. For example, Y Combinator offers $125k for 7% of the business to all of their startups, which suggests a $1.6M pre-money valuation. This could be a very good benchmark for pre-seed investments.

In summary, in order to define the amount you need to raise, you need to know two things:

  • What is your burn-through rate, and how much time do you need in order to reach profitability or your next milestone.
  • What’s the valuation of your venture, and what percentage are you willing to part with? If you can make a convincing argument that your startup is worth a higher amount, you can part with a lower percentage for the funding amount you need.

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