One of the most common questions that a start-up gets asked is "how much money are you raising"? But how do you answer this most inevitable question during your fund raising process? While the question may seem a simple one, there are 3 types of answers we encounter and each one of them triggers a different set of signals.
1. "I-am-signaling-my-valuation" answer
Suppose you are in the Series C stage of the fundraising process and your response to this question is US$20M; here's how a VC interprets your answer: "So you are raising US$20M. In all probability, if things have gone well, you have had a 30%~40% dilution till now and are looking at another 15%~20% in this round. So that's a US$100M valuation. Ah ha!" And then the obvious, "You mentioned your revenue last year was US$3M and the forecast for next year is US$6M … That's a multiple of 33X last year's revenue and ~17X the forecasted revenue." They will then ponder about what happens in your next raise - "Do you have sufficient ammunition now to justify a ~US$200M valuation in the next round, which in all likelihood is 18-months away? Can you create a US$25M~US$30M revenue business in the next 24-months?"
You see how this simple number triggers so many questions and objections? While a seasoned entrepreneur can anticipate and proactively answer these questions, many founders do not, and their pitches can suffer as a result.
2. "I-am-raising-a-small-strategic-round" answer
Here's the entrepreneur who has completed a Series B 24-months back. The milestone that was supposed to be hit hasn't happened as yet, but the last 6~9 months finally seem to be showing a promise.
The entrepreneur: "We believe we will be ready for a proper Series C financing 6~9-months down the road, but we are looking for a strategic investor to put in a small investment of US$3M~US$4M that will help us extend the runway and leverage the recent traction. In the interim, we derive value from the partnership that your company can enable while you participate at a competitive price before the Bigger C round".
What's the corporate investor thinking at this point? "Oh…so your current set of investors are probably not willing to put up more dollars and have advised you to shop around the corporate investor community". On a related note - the institutional VCs typically believe that corporate VCs are not bothered about financial returns!
You see what the objections are going to be - Why are the insiders not backing you up if you are indeed experiencing increased traction? Not an easy answer to provide…
3. "My-round-size-is-flexible" answer
The entrepreneur has been on the fund-raising process for some time. After having gone through discussions with several tier one VCs and understood that there is not much appetite for the larger ticket size, he/she has now scaled the round down and is approaching a different set of investors. This is a huge barrier in itself. It's almost like telling the investors that you are willing to change your business plan to accommodate the size of the round, while of course the right process is the other way round.
A suggestion here may be that the entrepreneur meet investors prior to the fund raise so that he/she understands what metrics are important for them. Some investors may view companies strategically, some thematically and yet others might want to focus on growth over profitability, depending on their risk tolerance.
Hopefully the above will help entrepreneurs frame the answers correctly and prepare them better for a discussion with investors. In our next blog, we will discuss the value strategic investors bring and actions entrepreneurs should take to leverage the same.