If you’re having a difficult time deciding how much money to raise for your startup, you’re not alone. Many struggle with balancing all the factors involved in an initial raise, especially because those factors vary depending on what type of product you’re attempting to launch. Some startups simply need more capital than others. For example, a biotech startup may need a lot more capital than a mobile app startup. A good way to look at raising capital is to view it, according to David Roth, co-founder of AppFirst, via Forbes, as runway management. You don’t want any extra baggage, but you’ll need enough fuel and runway to get off the ground.
There are two opposing approaches to the first round of funding. Either your priority is to maintain majority ownership of your company by raising a small amount, or your goal is to secure a large enough amount to keep your startup running for a significant period of time. Either of these approaches could be the right choice for your startup, depending on what you want to get out of your initial capital. We’ve provided pros and cons of each below to help you decide the best approach for you and your company.
Smaller Initial Rounds
Raising a small amount of capital is beneficial when your company is in the very beginning stages, especially when you’re new to the startup industry. This path will help you focus on getting your concept to market quicker so you can prove yourself before seeking a larger influx of capital.
Advantages of raising less capital
A smaller initial round will allow your company to maintain more control over the direction of your product during its early stages. It will also control potential share dilution by delaying heavy investor involvement. This will allow you to execute your vision without having to get approval from the board or group of shareholders or alter your decisions to align with their viewpoints.
If and when you exit, the limited number of investors you involve will also see a higher return based on the valuation of your company. This will most likely result in a better relationship with these investors and make them more likely to consider participating in future rounds. For example, if a bigger raise resulted in the same post-money valuation as a smaller raise, you would need to sell your company for more in order for your investors to see the same return.
Alternatively, achieving the same valuation with a smaller first round would result in a bigger return for your investors.
Disadvantages of raising less capital
No matter how much money you initially raise, and how conservative you are with it, every startup may have unforeseen issues requiring additional capital. These issues can range from small tweaks required to stay ahead of the competition, to a complete change of direction based on market feedback; but each can be especially damaging to startups funded by smaller rounds. If your initial budget doesn’t allot enough money for the unexpected, it may mean the end for your startup.
Failing to raise enough to get your product to market not only affects your product and team, but it also impacts your relationship with your investors. Current and potential investors want to see a tangible result before they’re asked for additional capital. If you seek support from new investors, your initial investors will not appreciate seeing their ownership diluted if you have nothing to show for it. Without traction from an initial raise, your business plan may appear risky or ineffective to investors and deter them from providing additional capital. The last thing you want is to be asking for additional capital without being able to explain and prove what the first round funded.
Starting with too little funding can cause you to spend too much time figuring out how to secure additional capital when you should be putting your time and energy into getting your concept to market. Between building presentations and meeting with potential investors, raising capital requires a significant amount of time that could be better spent building and improving your product.
Larger Initial Rounds
A variety of factors can persuade you to opt for a large initial round of funding. Examples of these are your level of confidence in your idea, your experience, and industry and market conditions. If you have faith in your concept and the market allows, raising a larger amount of capital with initial investors may be the best option for you.
Advantages of raising more capital
With a large raise, you’ll be able to launch a more complete product faster than a small raise would allow. With more capital, you’ll be able to build a more complete product before you hit the market. If you opt for a faster and less robust launch so you can be first to market, you can continue to focus on improvements instead of planning another raise. Aside from the product itself, this additional funding can be used to execute marketing plans or expand your team. Any way you look at it, you’ll have a better chance of building a more impressive product in less time with a bigger initial raise.
A large round usually provides enough capital for a period of 12 to 24 months. Because the market for funding can fluctuate a great deal in two years, a large raise allows you to focus more on your product and less on future cash flow and the funding market condition. However, you shouldn’t completely ignore funding market conditions after a large round. Paying attention to changes in the funding landscape will help you choose the best timing and make the most of your next raise.
Disadvantages of raising more capital
Taking a lot of money upfront will help you grow your product, but the size of your organization will most likely increase along with it. The more people you have heading in one direction, the harder it will be to steer when the market demands a change.
It is important to keep in mind the trade-off between how much money you take in and the amount of equity you give up. Future capital rounds will further dilute share value, so you should be cognizant of how much ownership you maintain at the start.
If you ask for more funding after a big initial raise, next round investors will expect to see major traction. For example, asking for $2 million 18 months after an initial raise of $1.5 million will require you to justify your request by showing serious progress from the initial raise. Investors are more likely to turn away if you cannot provide a clear vision of how this additional funding will lead to profitability in a shorter amount of time.
How Much Capital to Raise
Whether you raise a little or a lot, being conservative with your initial investment will bode well for future rounds of funding. Future investors will be more interested in supporting your idea if they see a track record of money wisely spent, regardless of the amount.
The amount of money you raise should prepare you for the unexpected, while maintaining a realistic budget for your concept. Setting your sights too high may scare away potential investors or lengthen the process of launching your startup, while not aiming high enough may leave you without enough money to make your idea a success. No one is more likely to raise the appropriate amount for your business than you, so do your research, make room for setbacks, and confidently determine the amount you need to raise.