Funding Life Cycle of a Firm

"I don’t know where I am going, but I’m making great time"

On of my readers in Germany sent me an email the other day asking if I would describe what the funding cycle looks like…timing, amounts, valuation, etc. While there are millions of permutations of this, I’ll try to give a general framework and set of principals.

Start at the End: you need to understand what self-sufficiency looks like for your business. Until you can support yourself (CF positive), you will be reliant on the kindness of strangers and will be in perpetual fundraising mode. Your knowledge of your business model is key here.

Layout the Steps: How much capital does it take to get to self-sufficiency and what are the key milestones in the business. Some that VC’s use are:
1) getting your beta launched
2) getting the production version launched
3) getting your first "high profile" customer that others in the industry take notice
4) hitting $3-5M in sales (usually means you have figured out pricing)
5) hitting $10M in sales (usually means your direct sales force is working)
6) hitting $20M in sales (usually means you have channel down)
7) EBITDA positive
8) CF positive.

How much capital do you estimate it will take to hit these and when? Then double each amount and the time (law of 2). That is a rough estimate for your needs. I would say that you generally have a three round cycle at a minimum.  #1, #3, #4 and #6 are possible funding events (probably either #1, #4 and #6) or (#3, #4 and #6). We joke about companies running out of letters in the alphabet for rounds (Preferred Stock Series Y) because they have raised so often, but it is usually rare to go past F or G (6 or 7 rounds).

Determine Funding Sources: For each stage mentioned, it will be clear what options you have given the milestones hit and the amount needed. For amounts below $1M, bank debt, customer financing (prepaids), angel or venture are all possible. For amounts, $1-3M, angels and venture are possible and for amounts above $3-5M, you are dancing with the VC devil. Usually, you see bootstrapping and angels to get to beta or first customer, and either angels (if really capital efficient) or VC’s from there.

Set Expectations Around Valuation: Entrepreneurs are optimists by design/necessity. Unfortunately, this often leads to huge discrepancies regarding valuation expectations. You should expect:

Pre-product VC seed rounds: $1-3M pre-$ valuation for (this bumps probably to $2-6M for angel).
Beta/Initial customer: expect $4-7M pre-$ valuation (angels as high as $10M)
Revenue $3-5M: expect $7-15M depending on growth, story, sizzle, etc
Revenue $10M: expect $10-25M same caveat
Revenue $20M+: expect $30-60M same caveat

VC’s target 10x for the early stuff (including $3-5M in rev) and 3-5x for later stuff ($20M+ in revenue). So, the visibility of your growth and likely outcome will determine valuation. Can they get 5 or 10x at that valuation?

Avoid Surprises: Fundraising is only as successful as the accuracy of your capital needs estimates. In the worst case, you run out of capital either a) suddenly or b) before you have reached key milestones. In these situations, you lose all leverage in the process and it does not end well. We have CEO’s who develop hives if they have less than 1 year’s worth of runway. Assume it will take you 6 months to close on a round…give yourself 6-8 months to get it done.

Two’s Company: The optimal situation is to get three funders to the table for your process. Assume that one of them will drop out unexpectedly which will leave you with two.  This creates a built in stalking horse/forcing mechanism. Nothing like urgency/scarcity to accelerate the process.

You are  in the risk mitigation business like an insurance company. You are only as successful as you are accurate in identifying risks that get in the way of your plan. Put buffers and contingencies in place (cost reduction or other funding sources) to address surprises. And let ‘er rip…