Chapter 4. Structuring Your Raise
Now it’s time to take what you have learned so far about how financing works and start putting together a plan for your company.
In this chapter we will cover how you determine when is the best time to raise. We will go through what needs to get factored into the decision of how much to raise. And finally, we will determine the best legal structure for conducting your raise.
Timing Your Raise
The decision to raise may be precipitated by a number of factors. Perhaps recent company growth leads you to conclude that your company is particularly attractive. Perhaps there is a particular market opportunity that you want to capture that requires more resources. These are great reasons to raise because they are all positive signals about the growth trajectory of your company, and they will put you in a strong negotiating position.
While raising simply because you are out of money is certainly a legitimate reason, it is not the best reason, and it doesn’t put you in a strong negotiating position with investors.
Let’s dive deeper into the five factors affecting when to raise.
Have at Least Six Months of Runway
Your company’s runway is the number of months of cash you have left in the bank. As much as it’s great to be idealistic about timing a funding round, there are some real limitations posed by your company’s runway.
You need to raise money before you reach the end of your runway, or else you’ll be out of money. When you’re timing a fundraise, a common rule of thumb is to leave at least six months between when you plan to start fundraising and when you expect to reach the end of your runway.
The fundraising process can take six months, and the closer you are to the end of your runway when you hit the fundraising trail, the less negotiating power you will have, because investors will know you have no other options. If your company is profitable you have an indefinite runway, and running out of money doesn’t have to factor into your fundraise, giving you more negotiating power.
If you don’t have six months of runway left, you’re in what Y Combinator founding partner Paul Graham calls “the Fatal Pitch.” Your options are to decrease your costs or increase your revenue. If increasing your revenue is an option, do this first. If not, cutting back on costs, likely by letting go of employees, is your only option. If you find yourself in this situation, realize you are here—make changes to extend your runway, and then turn your attention back to fundraising.
Understand Your Seasonality
Fitness apps do better in January, retail businesses tend to perform better in December, and dating apps do better around February. Don’t be caught off-guard by seasonal changes in your business. While you are fundraising, investors will be tracking your business metrics. You want to use that seasonality to your advantage, rather than have it work against you. You want your numbers to grow during a fundraise, not suddenly plummet. If your numbers start going down during the fundraising, you might lose leverage in the negotiation, or begin losing investor interest. Know your seasonality, and plan accordingly.
Plan Around Industry Events
Great examples are the TechCrunch Disrupt Startup Battlefield, CES, the LAUNCH Festival, and the Web Summit Pitch Competition. Presenting at one of these competitions and performing well could give you the platform and media attention you need to start a raise. Securing a spot at one of these competitions could also help you get investors to commit prior to the event, by suggesting the opportunity might go away or cost more once you gain exposure there.
Plan Around Company Milestones
Do you have a product launch coming up? Are you about to hit a particular traction milestone that will make you more appealing to investors? Do you have a major partnership you’re about to close?
You can use these milestones as ways of either kicking off a fundraising process or getting investors to commit.
Finally, holidays in the venture capital industry should factor into the timing of your raise. The venture capital world in most countries shuts down every July and August and from the US Thanksgiving holiday at the end of November until the new year. During this time, venture capitalists, and most angel investors, go on vacation and are slower to respond to email.
Starting a fundraise or trying to close a funding round during these times can be ill advised. Assuming you’ll need at least two months from when you start pitching to when you close all of your commitments, the best months to start pitching are September, October, January, February, March, April, and May.
How Much to Raise
Many experts recommend that once you’ve decided to do a fundraise, you should raise as much money as possible so long as you are able to maintain control at any cost, and don’t lose sight of what your liquidation preference would be in the case of an exit.
But remember that it’s better from a perception standpoint to set a modest funding target and exceed it than to set an ambitious target and fail to hit it—not to mention the fact that the more money you raise, the more limited your exit opportunities will be. Also, more money generally means a higher bar if you ever raise money again.
Because of this, I’d recommend that rather than raising as much as possible, you raise enough money to get your company to the next inflection point (where you either have the metrics needed to raise a new round or are profitable). A common rule of thumb is that you should raise at least enough capital to last 18 months.
The Startup Growth Calculator
The Startup Growth Calculator is a great online tool built by Trevor Blackwell, a founding partner at Y Combinator, to help startups determine how much money they need to raise to reach breakeven—or profitability. Once you reach breakeven, you have an infinite runway and can control your own funding destiny.
You do not want to be caught at the end of your funding without having hit the necessary milestones to either sustain yourself or attract new investment dollars. So, it is better to err on the side of caution when budgeting for a funding round.
Structuring a Funding Round
No matter when you decide to raise, and no matter what your target funding goal is, the third step in planning your raise is deciding how to structure the sale of the new shares. You’ll most likely be deciding between the three most popular ways to structure a funding round that we discussed in Chapter 3:
- Priced rounds
- An equity-based investment round in which there is a defined pre-money valuation
- Convertible notes
- A debt-based financing where money is given as a loan at the time the investment is made, with the expectation that it will convert to equity at a later date
- SAFEs (Simple Agreements for Future Equity)
- A simplified alternative to convertible notes
In a priced round, lead investors usually set the terms of the round. A lead investor may be an angel investor (probably one investing a fairly significant amount into the company) but more likely is an institutional investor. The lead investor will lay out these terms in a term sheet, which will be presented to the entrepreneur. On a million-dollar seed round a lead investor would usually put in at least $100,000, with half the round being ideal.
In a convertible note or SAFE round, the entrepreneur will have set an initial cap and discount that they wish to raise the round on. These numbers may be negotiated by the first investors who commit to the round, but it is a fairly simple negotiation.
Review Chapter 3 for guidance on standard valuation caps and discounts in today’s market. Ultimately, every company is different, but the market averages and best practices that we’ve covered in these chapters are a great place to start.
In this chapter we have put together an initial structure for your fundraise. We have also concluded the first section of the book, building a foundational knowledge of venture capital. Let’s review some of the core concepts covered so far.
Once you have decided when to raise, determined how much to raise, and settled on a structure for raising your round, you are ready to start preparing to pitch to investors. No matter which way you choose to structure your fundraise, the core principles of how you prepare to pitch, plan your raise, source investors, and execute your raise will remain quite similar. In the next part of the book, we will discuss how to prepare yourself to hit the fundraising trail.