More frequently, my team and I are seeing companies go out to raise a certain amount of capital—let’s call it $25 million—and are finding that given the changing economic environment, investors are suggesting the company consider raising a lesser amount—let’s call it $15 million.
As A Founder, What Do You Do?
The natural reaction is to be very frustrated. It’s possible that if you had raised capital six months ago, the $25 million would be sitting in your bank account now, which feels unfair. You’re allowed to take a minute to complain to your co-founders, existing investors and families.
After you’re done venting, tell yourself—while you may be unlucky because you didn’t fundraise in 2021, your number one job is to remain solvent—and, access to capital helps to ensure this is the case. Also, remind yourself that the fundraising environment of the last three years was abnormally great—not that the current environment is abnormally horrible. According to Pitchbook, the median Series B raise from 2019 to the beginning of 2022 was $25 million. In comparison, from 2016-2018, the median Series B raise was less than $15 million. That’s an approximately 75% difference in round size. Many successful companies have raised a $15 million Series B or smaller (e.g., Tesla, Flipkart, LinkedIn, Zoom, Lyft).
With this level setting in mind, it’s time to start planning: how to optimize how much capital you can raise and how to optimize what you can do with that capital. Of course, this process will be iterative as you receive investor feedback.
Optimizing The Amount Of Capital To Raise
Steps to optimize your capital raise will depend on where you are currently (i.e., you haven’t started your raise, you’re mid-raise, or you have a term sheet).
If you haven’t yet gone out to raise, take the time to really reevaluate how much you are asking for. You don’t want to lose a potential investor because you have unrealistic expectations about how much capital you can raise. In order to honestly conduct this exercise, start by throwing away your financial model that assumed a $25 million raise. If you do not start over, you will continue to anchor to your prior goals and expectations. It’s very difficult to continually revise the number of salespeople you planned to hire or to remove a facility you planned to expand. If you start with a clean spreadsheet, you can focus on what will truly drive your business forward rather than focus on what you lost because you are raising a smaller amount.
Once you rebuild your model, you can have a more specific conversation with your existing investors to understand how much capital they have available to support you. Let’s say you determine you need $15 million to run the business and continue strategic growth initiatives. If your existing investors have $5 million of capital available, then you are really looking to raise $10 million. That can be more attractive for a new investor than considering a $25 million round without knowing if the existing investors are supportive.
If you’re already mid-raise, you should likely complete the same two steps above—especially if you are getting negative feedback on the amount you are trying to raise.
Remember: It’s okay to pivot on your ask. You won’t be the first.
If you come back to potential investors with thoughtful responses about the changes in your model and projections, many will be willing to entertain the conversation from a new perspective.
If you already have a term sheet on the table, try to take the emotion out of it. Dilution is never a founder’s favorite word, but a board can always re-equitize the founders and key management over time. It may be worth it to take an extra $1 million if available even though the dilution is painful.
With a term sheet in hand, look to negotiate to allow for a second close. Many investors, particularly strategic investors, require a financial lead. Once found, it may take them longer to do their diligence and commit. If you believe you can generate additional demand for the round with a lead in place, ask to allow for a second close to bring in additional investors.
Optimizing What Your Capital Can Achieve
As you begin to better understand how much capital you need and can raise, it’s time to optimize what that capital can do. But, what are you optimizing for? And, how do you prioritize where to make investments?
The main goal will likely be to extend your cash runway as long as possible while not starving the business. A good rule of thumb is that financing should provide a company with 18 to 24 months of runway. This is typically enough time for the company to hit a meaningful milestone to increase the company’s valuation or make it much more attractive to potential investors. If the $15 million can actually buy you 24-plus months of runway, you may want to instead consider investing more in key areas, which will in turn reduce the runway slightly.
In terms of prioritizing, the key areas for investment will differ for every company, but if you are finding that each new salesperson is extremely productive and is generating a strong return on investment—that may be a great place to add. Or, if you could invest a reasonable amount of capital to meaningfully increase your gross margins, that could be another option for spending a bit more capital.
However, don’t forget to learn from the questions and reservations investors had during this fundraise. Assuming you believe these were the investors’ real gating items for not getting excited about your company, it may make sense to prioritize making progress on those initiatives and allocate capital accordingly to set yourself up for the next fundraise.
The macroenvironment is not your fault, but it is your job to acclimate and move your company forward. Be nimble enough to navigate the changing landscape. And, of course, try to remember that some of the most successful companies come from volatile times.