What is the Right Amount of Money to Raise at a Startup?

Posted on Mar 11, 2010 | 133 comments


This is part of my ongoing series on Raising Venture Capital.

appetizersRecently I’ve been debating with a number of young startup companies that are raising money in the next few months, “what is the right amout of capital to raise at a startup?”

It’s a tricky question with no clear answer.  There are trade offs.  And it obviously depends on the kind of business you’re building.  Let me assume for this discussion it’s a garden variety 2010 IT or Internet business (as opposed to something requiring capital equipment or a life sciences project).  Any answer will be subjective and any real answer will just be explaining the tradeoffs to you.

On the upper end I’ve spoken openly on many occasions that I think that raising too much money too quickly can be destructive.  It’s like adding rocket fuel to space ship before you’re sure that it’s pointing in the right direction for take off (or even if all of the people on board are qualified to take this into outer space).  It places undue pressure early in the company’s history to “do big things” when sometimes what is warranted is more prudence.  It also takes options off the table if you eventually find out that this isn’t a VC backable business.  I’ve spoken about this in a post entitled, “Do you even need VC?” to which the answer for most people is “no.”  If you’re interested in that topic the link also has a short video I did on the topic for Fox Business News.

But the lower end also has risks.  I’ve seen too many entrepreneurs try to do things on the cheap.  I know the standard line, “I want to do a small round now and raise a larger round later when we get A,B,C deal done and I can raise at a higher valuation.”  If it works you’re a hero.  But there are also problems / risks:

- the funding environment might change dramatically – there may never be a next round (see: March 2000, September 11, 2001 and September 2008)

- you may hit unexpected bumps in the road yourself making the next round tough

- there may be major competitive changes in the market that makes your next funding round hard (e.g. Google suddenly makes your product category free)

- you might do a great job in a great market but a competitor raises $3 million when you raised $500,000 and suddenly you have to compete with them

I’ve even heard people repeat this bullsh*t Silicon Valley mantra about “failing fast” which is horse puckey.  The line goes like this, “well at least you know early that your business isn’t going to work and you didn’t have to waste 2 years and $1 million trying to bang your head against a wall.”  That is so self centered it winds me up.  Tell that to the person who wrote you the $50,000 of their hard earned money and entrusted you to try your best.  Fail fast?  How does your brother-in-law feel about that?

And how do you think the next person who’s thinking about writing you a check going to feel about that sort of cavalier attitude with their money?  Fail fast = quit and give up easy = spaghetti against the wall = no clear strategy going into your business = no ability / willingness to try and pivot as market conditions change = easy way out = today’s management mantra that will be laughed at in 10 years.  Who started this meme?  I say define a strategy, test it up front and pivot if you’re not getting the traction you had expected.  Fail fast on your own dime.

Whoops.  Off topic.  But seriously, if you take somebody’s hard earned money treat it and them with the respect they deserve.

So, let’s say you’ve raised $200,000 in friends and family money and you’re thinking about raising a round of $1 million and investors offer you $2 million.  Should you take it?  Let’s assume that the $2 million buys 25% of your company, which is the norm in an equity financing.

- obviously the starting point is to ask yourself how much money you’ll need until the next milestone. It’s best if you can raise at minimum 12 months’ cash and even better 18 months’ cash. 24 months for most tech startups is usually too much money.

- add a buffer. Your revenue will take longer to ramp then you think. There will be some unforeseen expenditures.

- that is the correct amount to raise.  It should pop out of your business plan

- and don’t ask for an extra $3 million to do M&A. No good investor wants that. They can fund a deal if necessary and valid at the time you present an acquisition target to them

So let’s assume that in the above scenario $1 million gets you 15 months and $2 million gets you 2 years. What to do?

This is actually something I’ve debated a lot recently. I was at breakfast with my friend Dave Young (from DLA Piper) this morning and we debated the topic. He had the best response I’ve ever heard. He said,

“When someone’s passing the hors d’oeuvres tray you always take two”

Brilliant.  I think that if you’re offered fair terms that aren’t destructively dilutive, preserve options for an exit, don’t put undue pressure on your company to do things too quickly you TAKE THE MONEY.  I know you think you’re going to do a bigger round later at a higher price but the problem is that if someone offers you $2 million now it’s guaranteed.  That same extra $1 million might prove very difficult to get one year from now if something fundamentally changes in the market, your company isn’t getting traction as quickly as expected or your competition makes a lot of noise in the market.  Or even your investors start having their own liquidity problems!

So I came up with the corollary,

“When someone’s passing you the hors d’oeuvres tray always take two.  But don’t take the whole tray.”

The whole tray is obviously unhealthy. Look, these things are judgment calls and there are no mathematical answers.  Just remember that for many companies success or failure often ends up being a binary outcome.  Businesses usually fail for the exact same reason – they run out of money.  Don’t let that be you.  If the appetizers are in front of you, take two.

  • http://bothsidesofthetable.com msuster

    Mostly agree. Just be careful about doing huge VC rounds too early (e.g. $10 million when you're pre revenue)

  • http://bothsidesofthetable.com msuster

    msuster at gmail dot you know what. I try my best to get back to people. Sometimes fall short. Be persistent.

  • http://reecepacheco.com reecepacheco

    Happy to have inspired you.

  • http://twitter.com/stnik Nik Souris

    you know me :) failure not an option. I was playing on your analogy of the Hors D'oeurves being “capital” and calling out that an entrepreneur needs to know when that soiree (personal money, family funding, etc) is finished your next stop has interested “investors” and/or you can sustain yourself. Basically, knowing the capital markets that will support your business and its market.

  • philsugar

    Agreed, but I'm taking your premise of determine what you realistically need…..that should be a truly conservative estimate of what it would take for you to be able to be profitable not that you have to hit break-even if you are taking it out of the park, just that you have the ability to control your own destiny and get profitable and be happy if you can take double that amount….

    This as opposed to take as much as you can.

    So given you figured out what you realistically needed, if you have a competitor that took as much as they could, don't change your funding based only on that data point. You can steal heat.

    And I've personally watched situations where there are several competitors in a market, one gets a ton of financing, another also takes a ton out of fear, and the only one left standing is the one that matched the financing to the opportunity.

    I can give concrete examples but I don't have to because…..ironically you need to look no further than the VC industry.

    You are totally right if you end up being cheap and constraining growth while somebody else really puts down the pedal you will get beat.

  • philsugar

    Customers are a great point….and I would add employees.

    When you as an entrepreneurial company screw people by “failing fast” you have pissed in the communal entrepreneurial well!

    It makes it harder to ever sell that person (whether she is a potential customer or potential employee) to work with an entrepreneurial company ever again.

  • Will P

    Speaking of raising $10M pre-revenue, what is your take on Square? They raised a giant Series A, helped by the celebrity status of the founder, for an iPhone app with a hardware dongle and a transaction processing backend.

  • http://bothsidesofthetable.com msuster

    I think I'll avoid answering that one …

  • http://www.repeatablesale.com/ Scott Barnett

    Really looking forward to your “fail fast” post – I'm surprised at the size of the nerve you hit. I'll actually take the other POV on this – while it's hard to equate “fail” with something good, I do like the simplicity of the idea – of course, it's the definition of what “fail fast” means that is important. The other side of the equation is perfectly summed up by Elie – I've seen so many people give up on a strategy before it had a chance to fully develop… boy, this topic is gonna be juicy :-)

  • http://www.cindyalvarez.com cindyalvarez

    Sure, if you deliberately incorrectly define “fail fast”, it sounds like BS.

    Fail fast DOES NOT equal “quit and give up easy = spaghetti against the wall = no clear strategy going into your business” — that's YOUR definition.

    Fail fast DOES equal “define a strategy, test it up front and pivot if you’re not getting the traction you had expected”. With emphasis on defining a hypothesis of what “not getting traction” means and a willingness to pivot quickly vs. continuing to throw good money after bad.

  • http://www.repeatablesale.com/ Scott Barnett

    Really looking forward to your “fail fast” post – I'm surprised at the size of the nerve you hit. I'll actually take the other POV on this – while it's hard to equate “fail” with something good, I do like the simplicity of the idea – of course, it's the definition of what “fail fast” means that is important. The other side of the equation is perfectly summed up by Elie – I've seen so many people give up on a strategy before it had a chance to fully develop… boy, this topic is gonna be juicy :-)

  • amurphy59

    Fail fast is not about the company failing fast it is about testing different concepts, identifying what works and what doesn't, iterating, and testing again. Too many companies start out with a new product idea or conversion funnel and focus on trying to get it to be perfect and they miss out on learning from actual customer data. I am sure there are exceptions, but I really don't know anyone out there that raises money from friends and family to start a company where the future of the company hinges solely on the success or failure of a single idea. Iterate Iterate Iterate.

  • http://www.cindyalvarez.com cindyalvarez

    Sure, if you deliberately incorrectly define “fail fast”, it sounds like BS.

    Fail fast DOES NOT equal “quit and give up easy = spaghetti against the wall = no clear strategy going into your business” — that's YOUR definition.

    Fail fast DOES equal “define a strategy, test it up front and pivot if you’re not getting the traction you had expected”. With emphasis on defining a hypothesis of what “not getting traction” means and a willingness to pivot quickly vs. continuing to throw good money after bad.

  • http://www.researchandcompare.com Alex

    Fail fast is not about the company failing fast it is about testing different concepts, identifying what works and what doesn't, iterating, and testing again. Too many companies start out with a new product idea or conversion funnel and focus on trying to get it to be perfect and they miss out on learning from actual customer data. I am sure there are exceptions, but I really don't know anyone out there that raises money from friends and family to start a company where the future of the company hinges solely on the success or failure of a single idea. Iterate Iterate Iterate.

  • http://bothsidesofthetable.com msuster

    Cindy, go and ask the average person on the street with no context what “fail fast” means in a business context and see what kind of results you get. My problem isn't with lean startup it is with the term “fail fast” and how such a cavalier term has taken hold with people who aren't in on the “insider definition.” I get pitched 20 times / week. Many young people now equate “fail fast” with “don't bother with business plans” and “launch and if it doesn't work move on to the next project.”

    So, it's not about my definition or your definition. It's about what many people out there in the market think, interpret and emulate when they hear “fail fast.”

  • http://www.cindyalvarez.com cindyalvarez

    Is this really any different than any other philosophy that's been touted over the last 10-15 years, though? There will always be incompetent/irresponsible wannabe entrepreneurs who interpret the theory du jour to mean whatever they want it to.

    The word “failure” is there for a reason – someone else said it in the comments – to counteract the supreme hubris of the Valley and make people realize that it's OK to be wrong, as long as you admit it, learn from it, and work to find the thing that WORKS. (as quickly and cheaply as possible, one hopes)

    You talked about letting down employees — well, I've worked with entrepreneurs who insisted on blindly following their idea, insisting that they have this business plan and by golly, we're going to stick to it come hell or high water… because “failure is not an option”. THAT is the attitude that needs to change.

  • http://bothsidesofthetable.com msuster

    supreme hubris of the Valley: see, “fail fast”

    failure is ok. I have no problem with it. I'm on record as saying I prefer working with second time entrepreneurs even if their first business failed. but when you come up with a tag line that says, “fail fast” you can't expect people to all know what you meant when you created it. Calling them “incompetent/irresponsible wannabe entrepreneurs who interpret the theory du jour to mean whatever they want it to” is probably not fair.

    The nice thing about working with entrepreneurs who blindly follow their idea is that if you lose faith you can change jobs. The contra where you as an employee believes and the CEO prefers to “fail fast” so he/she can move on to their next brilliant idea and make more money is a travesty.

  • http://www.cindyalvarez.com cindyalvarez

    OK, I clearly agree that if you take someone's money (whether it's VC or friends/family), it's your responsibility to try your damnedest to reduce risk, validate ideas, and generally try to make the thing work.

    You tell me you see “CEOs who prefer to “fail fast” so he/she can move on to their next brilliant idea” — honestly, I don't doubt you. There are all kinds out there! It does seem incomprehensible to me, though — wouldn't you want to at least TRY to make your company work? Try to validate your idea and reduce risk? All I'm saying is, it seems like it would take more than a provocatively phrased meme to turn a responsible person into an irresponsible one.

  • http://bothsidesofthetable.com msuster

    OK, I agree completely with your last sentence. The meme doesn't make a good person bad. But young people are impressionable. Many don't yet know right from wrong in a startup. I know because in 1999 I launched my first company. We were encouraged to spend money quickly, do a “land grab” and build many products. Sounds absurd, right? It was the mantra back then. The conventional wisdom. Goldman Sachs was an investor in my company. They were confident (as was the whole market) that we would raise a $40 million B round with less than $1 million in revenue. We were going to IPO in 12 months for North of $1 billion. What did I know? Everybody was telling me that's how things worked. And for many people that is how things worked.

    But life changed quickly. I had to fire most of my friends and colleagues to survive. 122 people to 33 in a few weeks. Leaving would have been easy. I stuck around and cleaned up the mess. We built a real company and 5 years later sold it when we were doing $14 million in recurring revenue and had $36 million in backlog. Not Google, but a result nonetheless.

    My point: young, inexperienced people who are “responsible” can be fooled into thinking that “this is how business is done.” I have had people I consider very ethical repeating some of the “fail fast, just shut the business down if it doesn't work” lines. I know Hiten and you guys are at the center of the lean startup movement and I have huge respect for everybody involved. But I think that your closeness to the issue means that you may not realize how the original message has gotten lost in the “Chinese Whispers.”

    Cindy, I'm sure if we sat down one day and compared notes our outlook on startups would be pretty similar. Lean startup is the right idea. I'm attacking the phrase, not the core principles. Thanks for sticking around and debating and keeping it professional. I appreciate it.

  • http://bothsidesofthetable.com msuster

    Cindy, go and ask the average person on the street with no context what “fail fast” means in a business context and see what kind of results you get. My problem isn't with lean startup it is with the term “fail fast” and how such a cavalier term has taken hold with people who aren't in on the “insider definition.” I get pitched 20 times / week. Many young people now equate “fail fast” with “don't bother with business plans” and “launch and if it doesn't work move on to the next project.”

    So, it's not about my definition or your definition. It's about what many people out there in the market think, interpret and emulate when they hear “fail fast.”

  • http://www.cindyalvarez.com cindyalvarez

    Is this really any different than any other philosophy that's been touted over the last 10-15 years, though? There will always be incompetent/irresponsible wannabe entrepreneurs who interpret the theory du jour to mean whatever they want it to.

    The word “failure” is there for a reason – someone else said it in the comments – to counteract the supreme hubris of the Valley and make people realize that it's OK to be wrong, as long as you admit it, learn from it, and work to find the thing that WORKS. (as quickly and cheaply as possible, one hopes)

    You talked about letting down employees — well, I've worked with entrepreneurs who insisted on blindly following their idea, insisting that they have this business plan and by golly, we're going to stick to it come hell or high water… because “failure is not an option”. THAT is the attitude that needs to change.

  • http://bothsidesofthetable.com msuster

    supreme hubris of the Valley: see, “fail fast”

    failure is ok. I have no problem with it. I'm on record as saying I prefer working with second time entrepreneurs even if their first business failed. but when you come up with a tag line that says, “fail fast” you can't expect people to all know what you meant when you created it. Calling them “incompetent/irresponsible wannabe entrepreneurs who interpret the theory du jour to mean whatever they want it to” is probably not fair.

    The nice thing about working with entrepreneurs who blindly follow their idea is that if you lose faith you can change jobs. The contra where you as an employee believes and the CEO prefers to “fail fast” so he/she can move on to their next brilliant idea and make more money is a travesty.

    If KISSMetrics launches its analytics platform and users want a different feature set then you pivot – even if 180 degrees. But if you guys suddenly said, “Eff it. Analytics is too hard – let's create a GroupOn competitor” that wouldn't be fair too Polaris and the money they've invested in you.

  • http://www.cindyalvarez.com cindyalvarez

    OK, I clearly agree that if you take someone's money (whether it's VC or friends/family), it's your responsibility to try your damnedest to reduce risk, validate ideas, and generally try to make the thing work.

    You tell me you see “CEOs who prefer to “fail fast” so he/she can move on to their next brilliant idea” — honestly, I don't doubt you. There are all kinds out there! It does seem incomprehensible to me, though — wouldn't you want to at least TRY to make your company work? Try to validate your idea and reduce risk? All I'm saying is, it seems like it would take more than a provocatively phrased meme to turn a responsible person into an irresponsible one.

  • http://bothsidesofthetable.com msuster

    OK, I agree completely with your last sentence. The meme doesn't make a good person bad. But young people are impressionable. Many don't yet know right from wrong in a startup. I know because in 1999 I launched my first company. We were encouraged to spend money quickly, do a “land grab” and build many products. Sounds absurd, right? It was the mantra back then. The conventional wisdom. Goldman Sachs was an investor in my company. They were confident (as was the whole market) that we would raise a $40 million B round with less than $1 million in revenue. We were going to IPO in 12 months for North of $1 billion. What did I know? Everybody was telling me that's how things worked. And for many people that is how things worked.

    But life changed quickly. I had to fire most of my friends and colleagues to survive. 122 people to 33 in a few weeks. Leaving would have been easy. I stuck around and cleaned up the mess. We built a real company and 5 years later sold it when we were doing $14 million in recurring revenue and had $36 million in backlog. Not Google, but a result nonetheless.

    My point: young, inexperienced people who are “responsible” can be fooled into thinking that “this is how business is done.” I have had people I consider very ethical repeating some of the “fail fast, just shut the business down if it doesn't work” lines. I know Hiten and you guys are at the center of the lean startup movement and I have huge respect for everybody involved. But I think that your closeness to the issue means that you may not realize how the original message has gotten lost in the “Chinese Whispers.”

    Cindy, I'm sure if we sat down one day and compared notes our outlook on startups would be pretty similar. Lean startup is the right idea. I'm attacking the phrase, not the core principles. Thanks for sticking around and debating and keeping it professional. I appreciate it.

  • http://markgslater.wordpress.com markslater

    the way i always understood the 'fail fast' term was through the lens of a governing feature, not from an entire company point of view. You may start out addressing SMBs where as actually there is consumer potential in what you are doing – therefore shed that SMB skin quickly – or basically have the ability to change your approach quickly – dont be cautious over glaring data suggesting the worng approach – exorcise it from the company DNA and 'pivot' quickly as you put it.

  • http://markgslater.wordpress.com/ markslater

    the way i always understood the 'fail fast' term was through the lens of a governing feature, not from an entire company point of view. You may start out addressing SMBs where as actually there is consumer potential in what you are doing – therefore shed that SMB skin quickly – or basically have the ability to change your approach quickly – dont be cautious over glaring data suggesting the worng approach – exorcise it from the company DNA and 'pivot' quickly as you put it.

  • http://twitter.com/jpdavy Joseph Davy

    I have to say that I agree with your concept from the 30,000 foot view. When I think of “fail fast”, I regard it as such: if someone gives you $500,000, it is better to waste as little of that money as possible developing a business concept that isn't going to work, so it is best to find out soon, before you've spent $500,000.

    Perhaps the mantra for 2010 will be “Fail CHEAP”. I work at a startup that has gotten a ton of recent traction. We have proven our model is scalable and attractive. It took us about 12 months to arrive at this particular model, and I wish that we could have arrived here much sooner, because we would have preserved much more investor cash. Luckily for us, we did not have the “rocket fuel” problem, so pivoting was easy and (relatively) inexpensive.

  • http://twitter.com/jpdavy Joseph Davy

    I have to say that I agree with your concept from the 30,000 foot view. When I think of “fail fast”, I regard it as such: if someone gives you $500,000, it is better to waste as little of that money as possible developing a business concept that isn't going to work, so it is best to find out soon, before you've spent $500,000.

    Perhaps the mantra for 2010 will be “Fail CHEAP”. I work at a startup that has gotten a ton of recent traction. We have proven our model is scalable and attractive. It took us about 12 months to arrive at this particular model, and I wish that we could have arrived here much sooner, because we would have preserved much more investor cash. Luckily for us, we did not have the “rocket fuel” problem, so pivoting was easy and (relatively) inexpensive.

  • http://twitter.com/jpdavy Joseph Davy

    I have to say that I agree with your concept from the 30,000 foot view. When I think of “fail fast”, I regard it as such: if someone gives you $500,000, it is better to waste as little of that money as possible developing a business concept that isn't going to work, so it is best to find out soon, before you've spent $500,000.

    Perhaps the mantra for 2010 will be “Fail CHEAP”. I work at a startup that has gotten a ton of recent traction. We have proven our model is scalable and attractive. It took us about 12 months to arrive at this particular model, and I wish that we could have arrived here much sooner, because we would have preserved much more investor cash. Luckily for us, we did not have the “rocket fuel” problem, so pivoting was easy and (relatively) inexpensive.

  • http://twitter.com/IMD_OWP IMD OWP

    There are new strategic challenges for the global firm. These challenges include: (i) market opportunities migrating to rapidly emerging economies in the East; (ii) the long shadow of the financial crisis and the rising prominence of sovereign wealth funds; and (iii) the urgent imperative to deal with climate change and to include a larger number of stakeholders in the firm's growth strategies. The < a href=”http://link.imd.ch/wjwgj”target=”_blank”>IMD OWP 2010 devotes a session to each of these challenges.

  • http://twitter.com/IMD_OWP IMD OWP

    There are new strategic challenges for the global firm. These challenges include: (i) market opportunities migrating to rapidly emerging economies in the East; (ii) the long shadow of the financial crisis and the rising prominence of sovereign wealth funds; and (iii) the urgent imperative to deal with climate change and to include a larger number of stakeholders in the firm's growth strategies. The < a href=”http://link.imd.ch/wjwgj”target=”_blank”>IMD OWP 2010 devotes a session to each of these challenges.

  • dshen

    There are two variables in runway: how much you raise and how much you burn. Each can be adjusted but many never want to adjust burn.

    However in today’s world, I see startups at seed requiring 24-30 months to get to some good place, either breakeven or having good enough metrics to land their next round. This is because of fast growth barriers in today’s ecosystem of customers both consumers and B2B. Thanks to the exponential growth of startups, you’re all competing for the same people and now everyone is your competitor because it’s now the battle for attention first, and product/service second. Growth is so slow, competition so fierce and crowded that you need more runway to grow and pivot, and a few times if necessary….

    So I tell people that 12-18 months is not enough today. You need to figure out how to survive 24-30 but they forget that they can also adjust burn to meet this requirement, and not raise double their current ask.

  • calling.BS

    Thanks, great post Mark.