Every third startup is launched with a budget of under $5,000, the money that usually comes from the founder's pocket. It may be enough for a start, but those looking to expand their business will eventually be seeking investment.
The only question: How much money should an early-stage startup raise?
The first answer that comes to mind is the more, the better. But it's not as easy as it sounds.
When to start fundraising
A recent study shows 95% of VC firms see the personality and experience of the fundraiser as critical factors for investing in their startup. But if you can't boast about your experience and reputation, you still have high chances.
The same study says that other key factors include the business model (74% of respondents agree with that), the startup's market (68%), and its industry (31%).
This means that you should start fundraising when you 1) researched the market and figured out your place in it; 2) identified your customers, their pains, and how you can relieve them; 3) gathered enough data to prove your business might work and why you are the best person with the best team to scale it.
The more traction you show, the less time you will waste looking for investors—they will look for you. So concentrate on improving the product as much as possible, rather than designing a perfect presentation without any metrics.
How to estimate the amount of money needed
In a perfect world, you must ask for the money required to achieve profitability. But investors understand that one round won't be enough for an early-stage startup.
That's why you should set intermediate goals for your business and raise as much money as you need to achieve them before the next round. According to YCombinator, the optimal time between rounds is 12-18 months.
Investors care about their money, that's why startups must present clear milestones for a period of 1-1.5 years and describe how they will reach them. Milestones can be a certain number of users, conversion rate, or revenue.
Good and detailed financial plan for at least one year can be helpful here. It should include your expenses and revenue based on realistic assumptions.
Say, you calculated that you need $500,000? But what will you do if product development lets you down or marketing costs will go up? Or what if a specialist you were headhunting asked for a higher salary?
To protect yourself from unplanned expenses, when fundraising, you should ask for up to 30% more than you need according to your financial plan.
Requesting too much money is a bad idea: 2 reasons
Reason 1: Overspending. Whether you raise $1 million or $2 million, you will have to spend it in the same time frame—about 12-18 months. And as practice shows, it will not be a worthwhile expenditure.
Reason 2: Risk of a "down round." The valuation of your early-stage startup depends on the amount of money you raise. If the sum turns out to be unjustified, this will mean that the valuation was inflated. And during your next round, you will have to raise money based on actual revenue and at a lower valuation, which is much more complicated.
Before raising money for an early-stage startup, you must prepare in advance: test your product, collect data, develop a business plan and set milestones for your company's next 12-18 months.
Raise 30% more money than you estimate you will need to reach your milestones.
Be conservative in your estimates and don't ask for too much money at a high valuation. It will be challenging to raise funds if your metrics show that the company is overpriced.