By Abraham Thomas | 7 September 2023
TLDR
You should raise your next round:
1. After a major inflection point (de-risking) for the business
2. With clear avenues to deploy cash to generate growth
3. While you’re in a position of strength
4. Possibly after hitting round-specific traction milestones
5. With market and industry trends in your favour
6. While the macro funding environment is strong
7. Giving investors time to build a relationship
8. Taking customer seasonality into account
9. When you can devote >80% of your attention to the process
10. Avoiding tweener valuations if possible
Detailed Memo: When to Raise Capital
When should you raise your next round? If you’re running out of cash, you don’t have a choice in the matter; raise what you can, when you can. But if you have cash in the bank, or if you’re profitable, you have some control over when to raise, and you should plan accordingly.
You want to triangulate between the following imperatives:
1. Inflection Point
VCs love to invest – and therefore, you should try to raise – just after a major inflection point in the business. This could be traction-related (1M ARR, accelerating growth), it could be qualitative (first 3 sales in US market, success of a new GTM channel, 0-to-1 transition for a marketplace), it could be tech (removing the main bottleneck to scaling), it could be something else. Whatever it is, it must represent a significant de-risking of the business, which is what justifies the fund-raise at a higher valuation.
Playing the game in lookahead mode, you want to start thinking right now about what that inflection point (or points – could be multiple!) is and building towards that. What is the one thing that maximally de-risks the business right now? Solve that, and then make that solution / story the heart of your pitch.
2. Avenues to Deploy Cash
VCs want to invest – and you want to raise – when there is a clear and obvious opportunity to deploy the cash you raise in a way that generates strong growth with high certainty. VCs love a pitch where they give you $ and you turn it into $$$ in a predictable way.
Ideally, all other blockers have been removed (de-risked), and cash is the main limiting factor for growth. One common scenario is when you have proof of a GTM motion that works (sales team, paid acquisition, marketplace flywheel) and the ‘only’ thing left to do is scale it – this is why GTM is often used as an inflection point. But there are other scenarios.
What you don’t want to do is raise just because you’re running out of cash, or because you don’t have resources to do all the things you want to do – those are not convincing pitches for VCs. They don’t want to fund ‘more of the same’; they want to unlock the next level of growth.
Note that ‘avenues to deploy cash’ is not quite the same as ‘use of funds’. To me, ‘use of funds’ is like a budget – it lays out the functional areas where you will spend (X% on headcount, Y% on infra, Z% on marketing etc.). ‘Avenues to deploy’ is more like ‘what will I achieve with this money’: if you give me this cash, I will hit these business milestones (ARR, growth, customer base etc.). (These represent the next stage of de-risking for the business).
3. Position of Strength
You want to raise from a position of financial strength: either 12+ months of runway, or break-even profitability, or terrific growth, or even better, some combination of those. In other words, raise when you don’t need the cash. If not, you open yourself to lower valuations and all sorts of games. (This is related to the previous point around avenues to deploy cash – you want to raise because raising boosts growth, not because raising staves off insolvency.)
(The standard advice used to be to raise when you have 6 months of runway, so as to bank as much growth as possible before hitting the road, but that’s changed. In the current capital-constrained environment, 6 months doesn’t leave you enough margin of safety in case the macro environment stays soft, or fund-raising takes longer than expected.)
4. Hit Widely Accepted Milestones
Some inflection points are qualitative, but there are also some widely accepted quantitative milestones that determine round readiness. The best known one is the benchmark of USD 1M ARR, growing over 2x and preferably 3-5x year over year, to qualify for a Series A. If you have a clear line of sight to that number, plus the other pieces (qualitative inflection points, scalable GTM, unit economics, saas efficiency metrics etc.), then it’s time to start planning your raise.
For a seed round, there’s no explicit traction benchmark, but there needs to be some sort of suggestive evidence that traction is on the way – a combination of team, market, technology, insight, angle of attack – mostly qualitative signals.
For a Series B, the expectation is $3-5M ARR growing rapidly (2-3x year over year) but more importantly a scalable GTM that investors can deploy cash against – inside or enterprise sales, or paid marketing, or a network effect flywheel. At this point PMF risk should largely be mitigated and it’s all about scaling with capital.
5. Industry Trends
Industries go through warm and cold spells, and so do technologies. If there’s market momentum behind the kind of stuff you do, it’s not a bad idea to capitalize on it. It’s easier to raise money for an imperfect startup in a rising tide / thematically strong market, than it is to raise money for a fantastic startup that is swimming against the current. (Yes, a lot of this is perception, but often, perception drives reality).
Be warned, however, that you should not try to shoehorn your company into the trend du jour. That’s a really bad idea. VCs often see founders sprinkle buzzwords (crypto AI fintech ML creator data whatever) into vanilla pitches, and it rarely works. Let the trend come to you, and if it doesn’t, don’t worry about it. But if it does, try to strike while the iron is hot.
6. Macro Environment
I don’t advise trying to ‘time’ the market per se, but it’s important to be aware of the general macro and fund-raising environment. There are times when capital is abundant, and other times when it’s scarce. When capital is scarce, fund-raising takes an enormous amount of time, effort, and focus – all of which would be better spent on building the business. So if possible, avoid situations where you’re forced to raise in a capital-scarce environment (easier said than done I know).
Conversely, when capital is abundant, fund-raising is (relatively) easy, and it makes sense to seize the opportunity. Don’t over-optimize on valuation or round size. If you can get a good investor at a fair price on clean terms with a quick process, do it. And then get back to building your business. When money is on the table, take it.
7. Build Relationships
VCs like to get to know you before they invest. In the classic formulation, they like to ‘invest in lines, not dots’. This is a return to historical norms. In 2021, deals were going from first pitch to close in a matter of days, driven by FOMO. That’s no longer the case in 2022.
Nothing builds credibility like saying you’re going to do something, and then doing it. VCs who observe you doing this consistently over time are more likely to invest. It’s not a bad idea to set up the first dots before your inflection point, so that when that point arrives, they are already briefed and can move fast. (This was what happened for our Series B at Quandl – a VC tracked us for over a year, and then when we hit a major milestone for the business, they gave us a pre-emptive term sheet even though we weren’t raising).
Having said all this, the majority of your pitches will still be to investors who you’re meeting for the first time, and there’s nothing wrong with that. But if you have a few ‘dream investors’ that you want to court, try to meet them and set the stage 3-6 months in advance of your full-on fund-raising process. (Longer if it’s a late stage deal).
8. Account for Seasonality
It’s important to show momentum through your fund-raising process – you don’t want growth to slow down just as investors are doing their diligence. If your industry has a seasonal pattern – for example, if many customers plan their budgets in Nov and buy your product in in Dec or Jan – then take advantage of that when planning your fund-raising calendar. And conversely, beware of foreseeable soft patches.
Also be aware that Jul, Aug and the second half of Dec tend to be quiet times for VC deals, so don’t start your fund-raising process on Jun 30th. Investor seasonality matters too!
9. Founder Bandwidth
Fund-raising takes time, effort, and focus. It pulls you away from actually building the business.
Therefore, you should (1) spend as little time as possible on it – run a disciplined, calendar-bound process that keeps every investor in sync and moving forward – in the current market environment, I’d say 45-60 days max and (2) fund-raise when you are confident that the business can run without you for 2 months – this is a function of team and maturity.
10. Avoid Tweener Rounds
VC investment rounds tend to cluster at particular sizes / valuations: currently 2-4M for a seed round, 8-15M for a Series A, 20-30M for a Series B and so on. (The reasons are complex and structural). Assuming 15-25% dilution per round, this implies certain valuation ranges for each round, which in turn imply certain ARR ranges. The non-obvious consequence of this is that there are ‘dead zones’ for fund-raising: for example, if you’re aiming to raise 5M on 30M with 600k ARR – even though the multiple looks reasonable, there’s no ‘natural’ investor for you – too big and valuations too high for a seed fund, too small to move the needle for an A fund.
That being said, this is probably your least important consideration, especially as you move into later stage. (Many Series A investors these days are large multi-stage funds who can write first cheques at anywhere from 1M to 5M in ARR).
Further Thoughts
These imperatives are not of equal importance. I would say that inflection point, avenues to deploy cash, and position of strength are the most important. Milestones, industry and macro trends are the next tier. Relationships, founder bandwidth and seasonality are all nice-to-have but they’re not must-have. And avoiding tweeners is probably least important.
Next, it may seem like many of these criteria are beyond your control. It’s all very well to say fund-raise when the business can run without you, but what if your team just isn’t mature enough? The point of this exercise and this memo is that you should be aware of this requirement and can plan for it 6-12 months in advance. The same goes for all these imperatives – you may not have them in place right now, but you can start thinking about them so that when it comes time to fund-raise, you’ll be well placed and proactive.
Finally, you’ll notice that there’s a blurry line between pitch advice and business advice. This is to be expected. The best fund-raising strategy is always to build a good business!