Almost all startups need outside capital to successfully get through hiring, finding a workspace, and generating early growth. The first time a startup takes outside capital is typically referred to as its “seed” round.
In a perfect world, the seed round would be all you need successfully launch your business. Theoretically, the capital your seed round raises should be enough for your idea to reach profitability, and in turn, self-sustainability. With an increasing amount of startups extending past Series D and E rounds, far too many businesses are setting themselves up for future complications by raising the wrong amount of capital during their seed round.
Raising the right amount of capital during your seed round significantly reduces the amount of equity you must give up by bringing on future investors during later rounds. Getting outside funding is a lot like anything else—it’s a lot easier if you just get it right the first time.
As a founder, determining exactly how much to raise can be daunting. With pretty much every startup requiring a unique amount to successfully incubate their ideas, the year-to-year averages offer almost no insight into how much your specific business should be raising. It’s impossible to quantify startups by any average; funding amounts are relative, and finding out exactly how much you should be raising is completely based on the individual needs of your business.
What Do You Need the Money For?
Always raise for a reason. Never enter a funding round without a specific need for immediate capital and a clear plan to scale with it. Determine exactly what your business needs to successfully grow and spell it out to investors. Whether it’s a team of developers or hardware prototypes, you need to give investors a promising reason to put their money into your business.
Also, try to raise at the right time. It’s extremely important to consider your overall timing when attempting to bring in outside capital. It doesn’t necessarily matter how far along your idea is in terms of becoming a purchasable product, but you, your team, and your investors should all be able to clearly identify a strong product-market somewhere within your idea. You should have a coherent vision that is easy to communicate to both investors and future team members.
And while it’s not always necessary, in some cases investors will pay special attention to companies with rapidly scaling customer acquisition rates—something that’s likely to indicate a disruption or new trend in the market.
How Long Do You Need It to Execute Your Idea?
When a group of investors is getting ready for a startup’s seed round, the main thing everyone is worried about is how long it will take for the business to reach profitability. However, getting an accurate estimate the time needed to successfully turn a startup idea into a sustainable business can prove to be quite difficult. As a founder, it’s important to consider everything: how long it will take to complete the necessary hiring, how much time you’ll need for advertising, how much time you’ll be able to spend on user testing, etc.
Don’t get bullied into giving up large amounts of equity in your business, especially if your business has a long road to profitability. As a rule of thumb, you should aim to give up no more than 25% stake to investors during your first funding round. For startups with long turnaround times, giving up low amounts of equity becomes increasingly important to provide room for investors without having to give up control of your business. If you can achieve profitability with the resources that come from your seed round, it’s possible that you may not even need future funding rounds.
Determining How Much to Raise
This is where things get especially interesting: putting a value on your business and trying to determine exactly how much money you should be trying to raise. The goal of your seed round should be to generate the money required to reach profitability without the need for future funding rounds. Early stage startup valuations are arbitrary—you can’t look towards trends and metrics to determine how much to go for during your first funding round.
All businesses are different and will require unique amounts of capital to reach profitability. On top of that, not all businesses are of the same value to investors. In order to estimate the total value of your business, you need to consider the scalability of your idea, how disruptive it is, and what share of the market you have the potential to capture.
To get started figuring out the optimal seed funding amount for your business, calculate the current rate at which you’re burning money, and what resources (typically in terms of hiring) you’ll need to scale into profitability. The best way to look at how much money you should raise during your seed round is through the total months of operation you’d like to fund.
This is where that estimate of how long you’ll need to reach profitability comes in handy. If you start with a total amount of time needed to develop your idea, it’s easy to work backward and create different time frames based on various hiring constraints.
Here’s an example: like many Silicon Valley startups, let’s say you’re building a mobile app and need to bring on a few engineers to start your project. If you’d like to be funded for 14 months with three engineers, at an average cost of $15k per month, you’re looking at $630k in developing power alone. Investors like to have options—provide a wide range of different growth scenarios by varying your hiring plans and months of funding.