Deal Size and Valuation

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No one knows exactly how much money they need to build their company, but once you’ve gotten your head wrapped around the interplay between dilution, price, and valuation, there are several best practices for backing into a target amount of money to raise.

First, you’re raising money because there’s something you want to accomplish. If you’re going to raise money, investors will want to see how accomplishing that goal will translate to increasing the value of your company.

Second, you need to estimate what it will cost to accomplish that goal.

Third, you need to determine whether you can raise enough money to more than cover your costs in achieving your goal—and do so on a valuation that doesn’t over dilute you or make it impossible to raise again.

Choosing Milestones

Every business sets different goals. We can’t tell you what to tell investors. What we can tell you is that you must create a compelling story as to how you will use your investors’ money to create meaningful progress and increase the value of your company. Chris Dixon calls these “accretive milestones.”*

At the seed stage, your goal might be to reach product-market fit. After the seed, maybe it’s to create enough revenue to reach cash-flow break-even. Or maybe it’s to grow from $1M in annually recurring revenue (ARR) to $10M in ARR. One key question to ask yourself is: if you achieve your goals, will you be able to raise your next round on a valuation twice as high as this round? Even better, can you be profitable enough to not need more VC money, in order to limit dilution of your ownership and the value of your stock?

But be careful about pegging your milestones to rumors about what venture capitalists will invest in. One well-circulated myth is that seed-stage companies need to get to $1M in ARR before raising a Series A, but Semil Shah, founder and GP at Haystack, points out that many companies raise a Series A before $1M in ARR.*

Modeling Your Costs

Once you’ve set a goal—which, should you reach it, will demonstrate meaningful progress and increase the value of your company—you need to figure out how much money it will take to accomplish that goal. Unless you have an MBA or love forecasting expenses, this is going to feel daunting, as it has to nearly every entrepreneur you’ll talk to. In fact, Sir Richard Branson, founder of the Virgin Group, didn’t know the difference between gross and net profit until he was 50 (well after he founded a media company and airline).* That doesn’t mean you should skip learning some basics of finance, however.

Your ability to reasonably forecast revenue will vary depending on stage, from damn near impossible at the early stages to slightly less impossible at the Series A round and beyond. Although you’ll need to estimate your revenue for your pitch, when determining how much to raise, it’s wise to start by assuming your company has or will have no revenue and only calculate your expenses.

​Definition​ Burn rate (or burn) is the amount of money a company loses each month after accounting for any revenue. Given that most startups do not have any income in the early stages of the company, a burn rate can simply be the amount of money a startup spends each month.

You can use your burn rate to tell how much money you need to raise in a given period—your operating runway. Your runway can be calculated as your bank balance divided by your monthly burn rate, then multiplied by the number of months you’re calculating for.

Most investors, including Fred Wilson* and Mark Suster,* recommend raising enough to sustain 18–24 months of operations; others recommend 12–24 months. There are a couple of caveats:

• Raising angel rounds, friends and family rounds, or other first money rounds might provide for only a few months of runway.

• The type of business you plan on running will have a large impact on the amount of capital needed. The variance is high enough that it’s difficult to generalize guidelines, but the difference in time required to get FDA approval for a biotech company vs. testing a consumer mobile product is likely to be pretty different.

Entrepreneurs tend to overestimate what they’re capable of accomplishing inside a period of time, so make sure you’re being realistic. Ask yourself what meaningful progress you believe you could demonstrate inside of 12–24 months, and then list the people you believe you’d need to hire in order to do that.

If you’re completely new to spreadsheets and financial models at the seed stage, you can back into a burn rate by estimating the cost of key hires using broad figures ($100K per employee outside the Bay Area and NYC and $200K inside NYC and the Bay Area) or specific figures (using compensation data like AngelList provides).

As early as the seed stage, you should consider contracting with an external CFO to help with basic financial planning and analysis (referred to as FP&A). This person will help you build a model that you can easily plug new hires and corresponding salaries into, in addition to accounting for things like health care, taxes, and more.

Going High or Low

​controversy​ An abundance of nuanced and seemingly conflicting advice exists on why founders should raise more money than they think they need and how raising too much can actually be damaging.* It turns out there’s a Goldilocks zone for how much you raise. It’s probably more than your first pass at covering expenses for your team, but it’s probably not double that figure.

At some point, you’re certain to run into this platitude: “No founder ever wishes they took less money.” The idea here is that founders almost always fail to account for some kind of big expense that blindsides them along the way. For example, you’re likely to make a bad hire, have to fire them, give them severance, hire a recruiter, and spend months finding a replacement. Or maybe someone on your team will start sharing images owned by Getty and you’ll get a bill for copyright violation.

Mark Suster lists several reasons why raising too much money can hurt,* and we’ve included a couple key reasons here:

• Money burns a hole in your pocket. Few entrepreneurs have the discipline to raise a pile of cash and not spend it. Whether you choose to raise $2M or $10M for an 18-to-24–month period, you’re likely to spend it.

• Lack of money can create discipline. Consider the $2M vs. $10M scenario further. In the former, you’ll be forced to make more thoughtful decisions about what to spend your money on because you won’t have enough to do everything you want. This will act as a forcing function for thoughtful conversations about prioritizing only the highest-leverage work.

One nuance to keep in mind when determining how much to raise is how you communicate this to investors. We’ll bring this up again in our section on meeting with investors, but when providing investors a target raise number, giving a lower number than what you actually hope to raise makes you appear closer to achieving your goals, which can help create a sense of urgency by making the investor think they have less time to get in on the round. That said, especially if you’re new to fundraising, you probably can’t get as much as you think.

Picking a Valuation

With achievable milestones set, costs modeled out, and a target number to raise, you must determine how much of your company you’re willing to sell in exchange for that amount of money, keeping in mind the effects of dilution.

Paul Graham encourages companies not to sell more than 15% in what he calls “phase 1 (‘a few tens of thousands from something like Y Combinator or individual angels’)” and no more than 25% in “phase 2 (‘raise a few hundred thousand to a few million to build the company’),” for a total of no more than 40% before the Series A.* A general rule of thumb is that companies should expect to sell around 20–25% at the seed stage.

The next step is to assess the viability of the deal you’d like to make. Just because you want to raise $1M on a $6M post-money valuation does not guarantee you’ll be able to do so. You need to learn to look at your company the way an investor will, and our favorite system for this comes from Leo Polovets.* He calls startups “risk bundles.” Can the founders work well together, hire a team, manage a team, ship a product, get people to pay for the product, and get people to pay for the product in a scalable and profitable way? Each of these things is a risk, and for every subsequent “yes,” in that line of questioning, an investor has a reason to increase the valuation of your company.

Benchmarks for typical valuations vary from year to year depending on the funding climate (see Mark Suster’s bear vs. bull market ranges*). This makes reliable data hard to come by. In 2014, Polovets published the ranges* he saw for B2B SaaS startups.

• Pre-product or alpha version of a product. $3M–$10M; notable, strong teams raising on the high end

• Beta version of product. $6M–$9M; $1K–$20K in monthly revenue

• Post-launch. $7M–$14M; $25K–$100K in monthly revenue; unrepeatable sales process

• Mature product. $15M+ (Series A likely); $100K+ in monthly revenue; repeatable sales process

It’s also worth checking out “Pricing A Follow-On Venture Investment”, Fred Wilson’s piece on how Union Square Ventures thinks about pricing a follow-on investment.

​contribute​ If you have or have seen more recent or comprehensive data, please let us know so we can include it here.

Just because you can raise on a high valuation, however, doesn’t mean you should. The deal you put together today, whether it’s a pre-seed, seed, or Series A, will have implications on whether you can raise money again in the future. For example, if you somehow raise $2M on a $20M post-money, you need to create enough value to be able to raise money at a much higher valuation than that $20M valuation in the next round—this is called clearing the valuation hurdle. Founders often underestimate how hard it is to get a company off the ground. If you’re committed to taking venture capital, you should plan ahead and seek a valuation that is reasonable, one that’s tied to reality, and one that sets you up for success in your next round.

Whatever valuation you choose, you’ll bring it to the negotiation table when you meet with investors to set the terms of the deal.

Figure: Bay Area Pre-Money Valuations (Series Seed)

Source: Silicon Valley Bank and PitchBook Data*

Figure: Bay Area Pre-Money Valuations (Series A)

Source: Silicon Valley Bank and PitchBook Data*