The BSList: You're Raising the Wrong Amount (No. 93)
“How much should I ask for?”
Almost every single time I talk to a founder as they’re prepping their raise, this comes up—and it’s absolutely the wrong way to think about a round.
The right question is, “How much do you need?”
When you raise money, the way you should build up your ask—ideally—is the following:
“We need X amount to get to Y milestone, which we can do based on Z assumption in the model—which we’ve already proven. Y milestone should also put us in a great fundraising position because we know that’s what the next round investors will be looking for from us.”
Now, it may be the case that you’re just starting out and you haven’t really proven anything yet. In that case, an investor might decide the idea, or the team, is worth testing that assumption—but you still have to know what goal you’re trying to achieve. (i.e. “This model works if we can prove out Z assumption.”)
When you don’t anchor your pitch to what the company and its model need and how much you’ve already de-risked things, you leave yourself open to the VC’s own preferred check size. Sometimes, that’s a function of their fund size, but it could also be a take on where they are in their fund cycle, or even just how much they like you or the deal.
A lot of times, it’s a function of their perception of how competitive the deal is.
The reality is that the smaller the round, the lower the price. It’s very easy to think that the more competitive a deal you are, the higher the valuation you’ll be able to raise at. While that’s mostly true, it’s actually driven by the fact that VCs are willing to write bigger checks, which in term bumps up against the founder’s desire not to dilute, which increases the price.
In other words, if you’ve accomplished a ton, but you only want to raise $500k, you rarely get VCs to agree to give that amount to you at a valuation of $20 million. They’ll hem and haw about ownership percentage, which is probably another BSlist post I should write about, and ultimately say you need to be raising more at that price.
You know, it’s “good for the company” and not solely driven by their desire to own more.
In any case, when VCs shortchange you on round size, they either have a smaller fund and they’re hoping to buy more at a lower valuation or they see some more risk in the deal than you do.
It’s your job to eliminate those risks ahead of raising if you can, or at least address why that risk shouldn’t bring down the round size. That’s where VCs are really shortchanging founders in their communication. They’re not telling you specifically how the round size is messing up their perception of risk and return. They’re not running you through the scenarios of how this valuation or that amount of runway will affect the next raise or how they believe that a round of this size is a long trip off a short pier.
It’s a lazy pass.
Whatever the case, there have been lots and lots of instances where top-tier firms accept less than what they would normally put in when the round is really competitive or it’s just way bigger than they would normally do. That’s because, for these companies, they believe they’re better being in the deal and associated with its outcome than being out of it.
That just isn’t the case for most companies—which is why they’ll give you the excuse that something like round construction is the issue.
Sure, they might have told their LPs they would try to own 15% of every company, but if the next Stripe is in their lap, or the founder of Stripe is raising a round, they’ll settle for 3% versus zero nine times out of ten.
And that’s really the challenge for all founders: How you can assemble a fantastic enough team tackling a big enough problem with a mindblowing enough plan and pitch to make it look like the kind of can’t miss no-brainer that makes people bend over backwards to get in, regardless of round size or any other dumb pass excuse a VC might throw at you because they have to do a modicum of extra work to get there on it?
