How Much Money Should I Raise For My Startup?

Ok so you’ve decided to raise a seed round for your company and you are asking yourself the question “How much money should I raise?”

Well here’s my answer: either raise twice as much as you think you need to get to Default Alive status, or twice as much as you need to significantly de-risk the business.

Let me explain:

First, let’s define Default Dead versus Default Alive. This comes from Paul Graham: Default Dead means that if you don’t change something significant in the business, you will run out of cash and die.

Default Alive is the other scenario: without changing something significant about the business you could operate indefinitely due to revenue. Default alive means you are (ramen) profitable, or could become ramen profitable by cutting down on non-critical expenses.

If you’re running a company, it’s very important to know whether you’re default dead or default alive. If you are default dead it means you are in a race against time to figure out product/market fit and scale revenue to get to a point of baseline sustainability. If you are default alive it means the company can be stable for an indeterminate amount of time based on what you’ve already accomplished.

Do one answer to the question of “How much money should I raise?” is “Raise twice as much as you think you need to get to default alive.”

I say twice as much because it’s some law of the universe that everything always takes longer and costs money money than you hope it will. I think this is due to the optimism (delusion?) that one needs to be an entrepreneur. It always takes more time and energy and money to accomplish something once you’re in it.

So if you’re looking at getting to default alive and you’re thinking “yeah, we could get there with $200,000”. I tell people to raise $400k. If you think you need $400,000 raise $800,000. If you think you need $800,000 raise $1,600,000. Another reason to double the amount is that if you need to raise more money, it will take time, and you’ll need cash to burn while you are rounding up the next group of investors.

So that’s one answer to the question of how much money to raise: twice as much money as you need to get to default alive.

An example: You’re starting an app that will make money through subscriptions. Say you need $10,000/m to be at ramen profitable which at $10/m is 1,000 subscribers.  And say you think it’ll take $100k to build the app and $25k to get the first 1,000 subscribers or $125k total. In this case I’d say raise $250k to account for the “stuff always takes longer and costs way more money” factor.

My second answer to the same question is: raise twice as much money as you need to significantly de-risk the business.

What does de-risk the business mean? This was explained to me by Gabe Zichermann, one of Kindara’s investors. I always remembered it because it stuck in my mind and it seemed so brilliant and so simple.

He said to me, “the point of a fundraise is to de-risk your business”. If you look at a valuation graph of a company, companies typically raise money to accomplish a very specific thing. When they accomplish that thing the value of the company goes up. And when the value of the company goes up, there’s more value to sell to investors. Typically at the early stages the reason the value of the company goes up is because the company has been de-risked.

This de-risking goes on and on:

Raise some money + accomplish some stuff = less risk in the company = the value of the company goes up: Raise more money on a higher valuation > Repeat

When you look at your business, there’s probably one or two things that represent the most risk for the company. Maybe you haven’t figured out customer acquisition, or monetization, or maybe you haven’t figured out your brand, or you haven’t launched the product yet. Maybe you haven’t done the engineering that you need to do to in order to launch the product.

All those discrete pieces of work (figuring out customer acquisition, etc.) significantly de-risk the business. So if you pick the biggest risk points of the business and figure out how much money you need to raise to eliminate them, you arrive at a cost to significantly de-risk the business. Then double it for reasons explained above.

How To Think About This:

Here’s how I would recommend identifying the biggest risks:

First: Start with your 10-year vision. Imagine your business 10 years in the future. How many customers will you have? How much are they going to be paying and for what? How many employees will it take to operate the business? Get a crisp picture in your mind of what you want the business to look like in 10 years and what you think it can look like in 10 years based on all your market assumptions that you have now.

Next: From that 10-year vision, go down to a 3-year vision and map it out. Then go down to a 1-year vision and map out what needs to happen over the next 12 months in order for the three-year vision to happen, as the first step towards the ten year vision.

Third: Now that you have this vision, ask yourself the question, “What are the biggest risks that could put my 10 year vision at risk?” This could be finishing the product, proving out the market size, the unknown cost of getting customers or anything else. List out all the risks and rank them. You’ll end up with the biggest few risks to the business. These are the ones you want to focus on first. You’ll use the money you raise to remove these risks from the business.

In Conclusion:

So those are my two answers to the question, “How much money should we raise?”:

My first answer is twice as much as you need to get to Default Alive status. Default alive is safe, and you won’t need more investor money, so it’ll be a lot easier to raise once you get there. And the second answer is raise twice as much money as you need to significantly de-risk the business.

This second answer might apply more in the case where you need significant capital to get to default alive. In that case you might choose to plan a couple raises between where you are and default alive status, and the money you raise will go towards removing the biggest risks to the ultimate success of the company.

Just remember to raise more than you think you’ll need!

If you have other questions about startup fundraising or building a social impact startup, please get in touch with me.

 

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