The art of how much to raise

In the past several weeks, I have been astonished at the size of seed rounds that founders expect to raise in their first round. My jaw hits the table when a founder blindsides me with requests to raise seed rounds of $1 million to as high as $3-4 million!*

These are the start-ups that have

  • Opened their doors for business within the previous 12-18 months.
  • Have an ARR of less than two crore rupees ($300k).

Surprised at the massive requirement of capital, we go through their financial model. Within a few minutes of looking through the model, the spreadsheet would give out a chilling fact:

The founders first decided the amount they were raising; then, they decided how to utilise the amount that is raised!

It may seem like smart scheme when pitched to novice investors, but it is a foolhardy attempt to do that to an investor with experience.

For instance, to show full utilization of the amount the founders pad certain numbers. So, a close inspection of the fund utilization plan exposes the founder’s true intentions, i.e. that they wanted a reverse calculated an ego-boosting valuation for themselves. To achieve that goal they were willing to misrepresent facts. How does a founder come back from that image?

The good news is that – there is a better way.

My advice for founders that are creating their fundraising plans is to start with a well thought out answer to a famous Peter Thiel question

What is the one thing you know to be correct but very few agree with you?

In simple words, what do you need to prove to your team, your advisors, investors, etc. to elevate their belief in your idea? Whatever you need to do to gain their confidence that is the goal of your fundraising efforts.

For example, if everyone in your inner circle does not think that your company cannot sell x number of your whacky widgets in a specified period – then that is precisely the thing you must prove! Your goal must be specific, measurable, attainable, and realistic, and time-bound so that you aren’t on a wild goose chase.

Second, estimate the time and the resources (servers, people, space, travel, etc) required to achieve your goal. Pay close attention that your estimations do not have un-utilized or under-utilized resources. In fact, I advocate allocating 20% fewer resources than your start-up needs. It forces your team to innovate, after all – scarcity is the mother of innovation!

Third, figure out the exact cost of your resources over the period of their requirements. This exercise is a crucial step. Because if you had correctly estimated the resources and the time they’re required, you will (now) have the EXACT amount you must raise to achieve your goal.  

Fourth, add 25% top of the number you had in the previous step. The extra amount is your buffer, i.e. it is the extra cushion you’ve kept to account for any mistakes you may have made in your calculations. The extra cushion gives you the breathing room to commit errors – an essential fail-safe for an early-stage startup.

Now you have the exact amount your start-up needs, not a paisa more and not a paisa less. Next, go out there and raise this amount!

This proper prior preparation will give you the confidence to answer questions about the “why” behind your fundraising efforts. Your confidence will impress your prospective investors as you come off as a professional founder instead of a novice founder who thought they could pull the wool over the eyes of a seasoned investor.

As an investor that has sat on the other side of the table for almost eight years, this level of preparation and maturity from a founder is rare. But, when I meet a prepared founder it invokes confidence that the founders will utilize my precious and expensive capital judiciously. In fact, I may be swayed to give a premium valuation to such well-prepared founders – exactly what the founder wanted but now he/she earns it with respect!

* – Oddly enough, the high expectations were from founders who spoke in millions of dollars instead of crores of rupees. It ignites the patriotic fervor residing in Vinod – a sight to watch!

How Big Hairy Audacious Numbers Hurt Founders

Yesterday, a founder was having a tough time trying to convince me on his business plan. After the umpteenth attempt, he asked out of sheer frustration, “How is it that xxx company with shitty service and many issues gets all kinds of funding but you can you not give me the initial seed capital to prove myself?”

He was right in a sense, many companies like Ola, Oyo, Swiggy, Flipkart etc. went through phases when their products/services were shitty. They had numerous consumers complaining about them on social media sites and there were questions about whether they would survive the horrible reviews. How is it then that they could raise so much money? How could they convince early investors that they will become these massive unicorns?

In my opinion, it was the founder’s ability to convince the investors on the existence of a market segment that was under served, accurately depicting (for the investor) the issues that this targeted segment is facing. Put simply, they were able to showcase the size of the target segment that could be served right away and the potential addressable size. This is usually the most difficult part for investors to believe and the least researched part by founders.

Many investor presentations have Big Hairy Audacious Numbers (BHAN) which ignite wows, oohs and aahs from family and friends, but that number does not hold up to a deeper dive. It quickly shrinks as the investor digs deeper. The easiest way to shrink the BHAN is to ask the founder which customers he will say no to and which ones simply don’t face the problem he is solving. Every founder needs to ask himself/herself the question, “which customers are too small for me and which customers am I too small for?”. Once those boundaries are set, usually the BHAN shrinks to a fraction of the original, in this case it shrunk over 90%.

Even though that sliver of the original number could be huge, it would make me, (or any other investor) doubt whether the founder clearly knows how to get the most bang for the limited budget that an early funding round provides. It also destroys the credibility of the traction that the founder has achieved until that moment because it raises questions as to whether a large chunk of the current customer base include customers that the founders don’t intend to serve!

These doubts cost the founders dearly and while they can come back with better research and understanding, it will require nothing short of a home-run to re-convince me or any other investor.

As far as the questions on the shitty services are concerned it is impossible to have 100% satisfied customers, 100% of the time. There will always be some slippages, but if the new solution is a little better than the old one and the founders demonstrate a culture of constantly evolving their venture to improve this solution, customers will forgive and continue to use their product/service. Therefore OYO, Ola, Swiggy, and Flipkart should be an inspiration and not a point of frustration for founders that are getting rejected.