This blogpost was jointly written by Kim and Todd Saxton.
In 2013, Fred Wilson (AVC) of Union Square (US) Ventures asserted, based on their portfolio’s data, that “the amount of money a startup raised in seed and Series A funding was inversely correlated with success. “ That is, the more money a startup raises, the more likely it is to fail. Or the less money it raises, the more likely it is to succeed. At least, that’s the pattern supported by US Ventures’ data at the time.
CBInsights tested this assertion with their own data in 2013. They found “no relationship between the amount of money raised and success.” In other words, funding levels were not related to venture success or failure.
Many people assume that raising more money is better and that more success will follow raising more money. These studies suggest that it’s not about the total amount of money raised. It’s interesting that neither dataset supports the idea that more money = more success. It will take more time and data to know which is correct.
We would argue that the strategic question is not how much you can raise - it’s about raising the right money at the right time. Start with the questions: “Do you raise money at all? If so, how much and when?” Here are 3 tips for right-sizing your funding:
#1 Start by raising funds from customers through sales. We see a lot of founders rushing to raise outside funding. But once they start fundraising, it becomes an all-consuming task. Then, sales start to slow down as energy is diverted from customers. If they invested the same amount of time and energy into sales and marketing, they might be more successful. In fact, Jason Calcanis recently described a Pegasus (as opposed to a Unicorn) as a startup “that is so profitable that it is able to use its profits to soar so high, that it skips multiple rounds of funding.” One Pegasus is Calm.com - the #1 app for sleep, mediation and relaxation - that got seed funding in 2014 and then grew sales from $120,000 to $80 million in 2018 without raising any more money. Raising funding is not mandatory! If you can spend the same energy and grow sales, do that. It will put you in a better position to raise money if and when you need to.
#2 Figure out what it will cost to get through an inflection point in company value. An inflection point in valuation is when the combination of product-market fit and sales traction trigger investors’ enthusiasm, giving the startup a higher valuation. The first inflection point might come from closing the first 5 customers for an early stage B2B (business to business) startup. In fact, this may be necessary to secure your first funding. A second inflection point might be hitting $1 million in ARR (Annual Recurring Revenue) or $100,000 in MRR (Monthly Recurring Revenue). This often comes with or is followed by a good understanding of customer acquisition costs, customer lifetime value, and retention rates. A third inflection point is hitting cashflow breakeven. Startups should develop a clear sense of how much money they need to raise to hit these inflection points. If you don’t know these numbers, make some assumptions and monitor your results to see if they are right. Then, only raise the funding you actually need. Looking at Calm.com, they took no money from 2014 to 2018. For their Series A in 2018, they raised $27 million on a valuation of $250 million. They went for their Series B in 2019, raising $250 million on a valuation of $1 billion with $150 million in revenue. Those are some nice inflection points!
The Inflection Point in Calm.com’s Valuation ($milllion)
#3 Choose your investors wisely. Right-sizing your funding includes picking the right investors. In our book, The Titanic Effect, and within the Investor/Advisor Sea of the Human Ocean, we cover many details about how to choose the right investors. Sometimes startups want a high profile investor. The thinking is that these high profile investors are a sign of credibility. What you really want are investors who understand your market and business model. You want connections for future activities, including customers and business partners. You also want them to be able to provide more funding later, after one of those valuation inflection points. So deep pockets that will last beyond the first round are helpful. But most importantly, you want them to be willing to provide the right amount of funding at the right time. Too much, too early is not as helpful as you might think. Plus, you will likely give up more equity at a lower valuation than if you hold off some funding for after hitting an inflection point.
As you are getting ready to seek investors, make sure you review our posts on how to pitch your startup and what bothers investors about startup pitches. Work through if you need funding and what is the right amount of funding for your startup to hit that next inflection point. Then, you can go out there and close a round with confidence and enthusiasm!