As an analyst at an early-stage VC firm, I frequently see companies that have some initial traction but are running out of money and are fundraising under pressure.
These are often companies that did not raise enough money earlier, and now struggle to raise the next round because they did not have the resources (money) to create enough assets to attract the next investor.
Here’s how you can avoid this cycle.
1. Plan your next funding round now
First, it may seem counter-intuitive to consider your next financing round when you are focused on the present one, but consider what will happen when the money raised now runs out. Funding rounds tend to bring enough money to keep the company operating for 12 to 24 months — then what? Second, fundraising may take up 6 months, at which point the assets created need to be ready to be presentable to the next investor. In practice, this shortens a company’s runway. Finally, keep in mind that investors look for abnormal returns investing for growth — break-even is rarely interesting in that equation.
2. Establish what the next investor will judge you by
Assuming that you will be raising money again — what will be the Key Performance Indicators (KPIs) that the next investor evaluates you by? An early stage investor may be willing to invest in a vision but the next investor needs to see how — and at what speed — you are approaching that initial vision? In other words, what assets will the company need to create to be fundable? For some verticals, these KPIs or assets are more obvious, and for others less so:
- a marketplace may be judged on the number of transactions that it facilitates and how it handles liquidity;
- SaaS (Software-as-a-Service) companies tend to be judged by revenue;
- a social network can be evaluated by the number of users and how engaged they are.
Each vertical is unique, which is why you need to look for comparable KPIs and numbers for your, or related, verticals. One way of establishing industry comparables is looking at the funding history and accomplishments of the leader in your space in app store rankings, funding, press releases from earlier funding rounds, etc.
3. What resources do you need to create the assets necessary to raise the next round?
Once you have established what assets your next investor will want to see in 12 to 24 months (and you have deducted six months for fundraising), what resources do you need to create these assets? If it is a certain number of users that are the “assets,” at what stage does the product have to be to make it attractive to users? What is the acquisition cost per user? If the asset requires a certain number of customers, how long and costly is the sales cycle of each sale?
By looking forward and breaking the plan down month by month, you will have an easier time planning and, in turn, convincing investors about the plan going forward.
4. Expect Murphy’s Law and add 20 percent
Startups operate in a volatile and unpredictable space. Anything that can go wrong will go wrong, but this can be planned for. Therefore companies that are fundraising should expect things to go wrong and add a “safety margin” in the budget. By adding a 20 percent safety margin, a company can avoid the pitfall of trying to raise the next round without having the assets ready to present.
5. Keep in mind the aligned interests of entrepreneurs and existing investors
In terms of successful next round financing, the interests of the existing investor and the entrepreneur are much aligned. If the next round funding fails, the existing investor loses, which is why investors are obsessing about “fundability.”
The take away? Make sure that you raise enough money to bring the resources to create the assets that make your company fundable in the next round.
Benjamin Ratz is an analyst with Lool Ventures, an early stage venture capital firm based in Tel Aviv. He leads research and analyzes new investments for early stage ventures.