What Kind of Funding Round Should You Raise, if Any?
A lot of the founders I talk to have at least thought about the possibility of raising money, but there's a lot of whitespace to navigate when thinking through whether or not to do it, how to go about it, and what type of of round to raise.
In this post, I'll begin pulling back thr curtain by explaining the consequences of raising money, the funding stages in a startup's lifecycle (so you know where you are), and how to determine if you should raise from Angels or VCs.
The Consequences of Raising Money
Raising money is not inherently good or inherently bad. It depends on the type of business you want to build, and the relationship you want to have with it. In some cases, bootstrapping and slow growth is absolutely the way to go. In other cases, the window of opportunity is small, and growth is more important.
1. Raising funding will change your relationship with your business
When bootstrapping, you really are your own boss (with the exception of your customers). Once you raise money, you have a fiduciary responsibility to your investors. That means you need to keep them informed, manage investor relationships, and make decisions that consider your responsibility to investors (making your company valuable). Here’s a list of things you’ll need to deal with as a founder who’s raised funding that you wouldn’t deal with if you bootstrapped:
Anxiety from external pressure to grow/succeed
Regular reporting to investors
Managing investor relationships and expectations through emails, phone calls, etc.
2. Raising funding will redefine what is considered an “acceptable outcome”
If you’re bootstrapping your business, acceptable outcomes can be things like:
Pay myself well and be profitable
Sell the company for $2MM
Get acquired by a competitor or another company we’d like to work for
However, once you accept funding, those realities change. From the perspective of an investor, investing in a startup is high risk, high reward. If they wanted to invest in something safe with more moderate returns, they’d be investing in real estate or the stock market. With an investment in a startup, most investors are thinking of 10xing their investment.
Depending on your terms or stage, this means the targeted outcome for an investor would be to create a company that can achieve at least a $20M exit.
Raising Funding is about reaching for a milestone. Raising funding is not about going full-time or paying yourself more. If you’re considering raising money, you need to have a clear sense of what you’ve already accomplished, what the next milestone, and the resources you’ll need to get there. You shouldn’t raise funding because you feel like it’s something that startups do – you should raise funding to level-up your startup.
3. Raising funding puts smart, wealthy people in your corner.
One of the best parts of raising funding is not just the capital that you can get to fund your startup, but rather the people that you’ll be partnering with to make your startup successful.
Here are some of the incredible things investors can do for over the lifecycle of your startup:
Advise you on how to grow your startup
Make introductions to partners who you couldn’t access yourself
Make introductions to other advisors and investors
Make introductions to customers
Invest in your future rounds
Help you recruit top talent
Of course, you’ll need to vet your investors and understand their strengths in order to make the most of these, but sometimes a single investor can drastically change the trajectory of your business.
4. Raising funding makes fundraising an indefinite part of your job
If you raise funding once, by no means are you required to raise additional rounds of funding. However, it’s more than likely that you’ll go on to raise venture capital to continue to grow your company towards an exit. If that’s the case, then fundraising is now a permanent part of your job. You’ll need to manage your current investors and constantly be ready to start fundraising again.
The Funding Stages in a startup’s lifecycle
When a lot of founders think about raising money for their startup, they usually immediately think of raising Venture Capital. However, “raising VC” is often an overgeneralization, as many early stage startups should be more focused on raising angel funding.
If you’re looking to raise money for your startup, different rounds that you can raise range from “Friends and Family” rounds to Series A (or later rounds).
It’s not always black and white (there may be friends and family in your angel round or seed stage investors in your Series A), but early stage funding rounds approximately break down as follows:
Most early-stage startups need to decide between whether they should raise an Angel round or a Seed round (which involves raising money from institutional investors). This is a subtle but important distinction, as it will dictate the financial instruments you can use to raise as well as the fundraising process. It's not only about the amount (you can raise $500K with either an Angel round or a Seed round), so it comes down to several other factors.
How to know if you should raise angel or VC funding
Most people think of raising venture capital first when they think of raising money. However, most early-stage startups are not ready to go the VC route. You should only go the VC route if the following apply:
You’re raising at least $500K (VCs will rarely participate in rounds smaller than this)
You’re able to raise VC funding
Factors that determine your ability to raise funding:
Network: do you have connections to VCs? Will they listen to you?
Track record: do you or members on your founding team have a track record with founding and exiting a startup previously?
Progress: can you point to substantial progress, either through early customers, product development, or tech?
If you have a really strong network with VC’s or a really strong track record (which means VCs may know about your previous accomplishments even if they don’t know who you are), then it’s probably worth jumping the gun to raising Venture Capital. If this isn’t the case, then you’ll need to demonstrate progress to warrant a valuation in the range of $4M-10M. Valuation and progress is different for every startup depending on your space. For some startups, a prototype could be enough. For others, you may need dozens of customers and $1M in annual revenue.
The best way to figure out if you have enough progress to raise VC is to talk to someone who’s in venture capital. When we were considering raising a seed round, the first thing I did was talk to a few Associates at VC firms that I was friendly with, and they quickly told me that they would need to see more progress.
Here’s a quick little flowchart that simplifies this question regarding if you should raise money, and if it should be from VCs or Angels:
Deciding to raise money is a big decision, and one that you can't turn back from once you accept someone else's money. Before diving in, make sure that you understand how it will change your relationship with your business, and be realistic about your ability to raise money and how you'll go about it.