Cash is King: How founders should decide their cash runway
15 March 22
15 March 22
There’s a lot to consider when looking to raise venture capital. Chris Lascelles, investor at Triple Point Ventures, gives his low-down on how to get it right
It’s a great time to be a start-up – or is it? Only a few months ago we were celebrating a golden age of venture capital with $621bn pouring into start-ups around the world. Some commentators predicted 2022 would be even bigger.
Things today are looking a bit different. Persistent inflation, interest-rate hikes and conflict in Europe have cooled public markets. And while the early-stage investment market continues apace, the effects we’ve seen in the public markets threaten to spill into the venture capital ecosystem.
Against this backdrop, now’s a great time for founders to pause and take stock. In situations of uncertainty, you can give yourself an unfair advantage by knowing when and how to look for funding, how much to look for, and what VCs will want when you do.
First things first – raising venture capital isn’t for everyone. The process can be time-consuming, as well as rewarding. Done right, you can learn about important holes in your business and receive advice and support from experienced investors who’ve seen people in your shoes before. Done wrong, fundraising is an unwelcome, never-ending distraction from running a business.
If you decide venture capital is right for you, the first thing to do is make a great deck, and ensure you know your market inside-out. When creating a deck, the priority above all else is to ensure you tell a compelling story. Assume your reader is coming to your market without prior knowledge – this forces you to explain complex ideas simply. Then, ensure your deck leaves a reader curious and intrigued.
Some people try to make decks like business plans – long and full of data and financials. Of course, this information is important, but in a fundraising deck it is more important than anything else to leave the reader with intrigue. To know whether you’ve hit the spot, ask friends to read your deck. Are they excited by the opportunity you’ve explained?
So, you’ve nailed your deck. Now what? Well, a fundraising deck is just a door opener. The best VCs don’t sit and listen to your pitch alongside your deck, Dragon’s Den style. Real venture capital meetings happen after a VC has read a deck. It’s a two-way chat, digging into you and the details around your business.
In your first pitch meeting, your job is to convey domain expertise and energy above all else. Some call this ‘vision’. What you need to do is show your understanding and excitement for the market while demonstrating you are a commercially-minded subject matter expert.
In a good pitch, a left-field question from a VC should be a rare thing. The best founders go into meetings knowing their space much better than the VC in front of them. It’s probably a warning sign if a VC knows your space much better than you. To be successful you need to know your market, your customer, and your company like the back of your hand. They will be looking for your ability here.
When you’re an expert in your market and you’ve got your deck sorted, there are two things to consider before sending emails out: the stage of your revenue and product.
While some VCs back businesses with a dribble of revenue – or even just a deck – many want to see more revenue to prove you’ve built something others actually want (35 per cent of start-ups fail because of lack of market demand – it is rarely because of product development!).
When picking your target list of VCs, it’s best to research online which funds are right for the stage of your business. Crunchbase is probably the best free place to start.
As a general rule, if you are pre-revenue and pre-product, you are a ‘pre-seed’ business. If you are post-product and have a bit of revenue (around £10-20,000 per month), you are a ‘seed’ business. If you have £1m of annualised revenue, you are ‘series A’ ready. These definitions change constantly – but this broad outline is a good place to start.
‘It’s more than transferring a pile of cash and collecting a return a few years later. It’s a process of constant communication and hard work’
Here’s another piece of pro advice: don’t pursue Series A and B funds if you want pre-seed or seed funding. Most of the time they will say no and it could close the door to a later round.
Even if they do invest in you, your investment is a drop in the ocean for that fund. They’ll see you like a call option for a later round. Then if you hit a speed bump and they don’t invest that sends a bad signal to other potential investors – potentially undoing any value they brought in the first place.
If you are a pre-seed or seed start-up, funds dedicated to your stage will have seen the growing pains you are (or will!) experience, time and time again. You will be a meaningful part of their fund, so they will give you time. And they will probably give personal as well as professional support – as they’ve seen founders going through some of the hardest (and earliest) parts of business like you.
If you are pre-series A, it’s also important not to discount friends, family and angels. Of course, not everyone has access to people willing to invest in their companies – but individuals can make quick, decisive decisions that can get the ball-rolling on your fund raise.
Once you start meeting VCs, if you have a strong pitch you may get several funds offering to back you. At that point, your choice of partner is key for your own sanity as much as it is for your company.
At the early stage, an investment is a relationship. Early-stage venture capital is about more than transferring a pile of cash into a company’s bank account and collecting a return a few years later. It’s a process of constant communication and hard work.
Good VCs are on hand when you need them, and the right friendship can be the difference between success and failure. After you’ve established a relationship and the VC has expressed an interest in investing in you, ask how they hope your partnership will work.
Most VCs want to help you in any way they can – their fund’s performance depends on you as much as your performance depends on their cash. They are normally good at opening doors, whether that’s future funding rounds, or sometimes by introducing connections that can help with product, customer support, tech or overall hiring.
More important than a laundry list of ‘value add’ items though, are two simple things. First, do you like them? Second, do you respect their approach and thinking? This is key, because if you like them, others will too.
Venture capital is a relationship world, and if you like a VC, there is a chance their peers will too. If their peers do, their black book will be strong, people will respect them professionally, and that will open doors for you.
When you are putting your deck together, the top question is “how much do I want to raise?”. There’s a lot of capital available to start-ups today, and seed rounds in 2022 are closer to the series A rounds of 2012.
So, how much is enough? This will depend on how cash hungry your business is and the stage it is at. As a very rough rule of thumb, raising up to £500,000 at pre-seed is middle of the road right now. Then you are looking at £1.5-3m at seed, and over £3-5m at series A. These numbers are heuristics and change rapidly (probably on a six-month basis).
Importantly, every business is different, and there may be good reasons to raise more or less along the way. You should though, regardless of anything, raise enough money to give you at least 18 months of flat (no growth) revenue runway. That way, you’ll have time to make mistakes and learn.
Alongside runway, it is key to raise an appropriate amount without unnecessarily diluting yourself. A general rule is to aim for round dilution of 25 per cent or less. In the current market, 20 per cent dilution is standard. Beware of any VC that tries to own 30 per cent or more of your company in a single round.
Alongside raise amount and dilution is the all-important valuation. On valuation, there’s one golden piece of advice – never suggest one to a VC. At best, you’ll get what you want. But at worst, they could think your valuation is too high or low, and decide you are either unrealistic or don’t know your market.
Given how quickly the market changes, founders are not expected to suggest a valuation. Decent VCs know where the market is and will suggest a valuation. Focus instead on dilution. You can then negotiate a valuation if you have competing term sheets from multiple VCs. Suggesting a valuation upfront risks only closing a door, and doesn’t open any.
Finally, remember that your valuation is the benchmark for your next round and, eventually, your exit. If you plan conservatively, think that your exit will be at a valuation of five to 10 times your annualised revenue (assuming you are software). For a future funding round, assume it will have a valuation ceiling of eight to 20 times your annualised revenue at that point.
What does this tell you? If you are at a £20m post-money valuation after a round, you are likely to need at least £1m of annualised revenue before you can raise another funding round at a higher valuation. And the more money you raise, at higher valuations, the more performance you need for VCs to remain supportive.
Of course, you could get better multiples than five, ten or 20. But entrepreneurs are great risk mitigators as well as great risk takers, so plan for a more difficult market. Also note that, as with fund raise amounts, valuation multiples change regularly. The above pointers apply to where we are in March 2022.
A final financial thing is to look ahead in the fund raise. Post-series A, a founding team should together have at least 30 per cent of the equity in a business, and ideally more than 35 to 40 per cent. If the founding team is getting close to this early on, you’ve raised too much money or raised at too low a valuation. You will need to be recapitalised. Investors dislike this and it can make your round hard to support. The solution? Just think ahead and raise the amount you need at a sustainable dilution level.
After you’ve completed your deck, structured your raise and got a VC interested, the final piece of the puzzle is to have a structured data room available for said VC to review. In the data room, you should include all your key company information, separated into at least four sections covering commercial, financial, legal and HR aspects of your business. The gold standard would be to have a mini-investment memorandum written in the third person for a VC.
Having the data room ready when you meet a VC makes it easy for them to take you to their investment committee (IC), and quicker for you to get the all-important “yes”.
Even in the uncertainty around us today, there has never been a better time to be a founder. Some jitters caused by current events are to be expected, but there are plenty of willing investors for great businesses, regardless of what’s going on in the world.
Picking the right moment to go looking for investment – and ensuring you’re ready before you do – can be the difference between a bumper, oversubscribed investment round and going home empty-handed.
Have the pointers above in mind, and you’ll be starting with an advantage!
Chris Lascelles is an investor at Triple Point Ventures
This article was originally published in Growth Business