• Strategy
June 11, 2024
If so, you probably already know that there are two headline numbers: the amount you are raising and the valuation at which you are raising.
For example, you may hear of a company raising $7 million at a pre-money valuation of $25 million. This means that the company’s existing equity is valued at $25 million before $7 million of cash is added to the company’s balance sheet via the sale of newly issued equity. In this example, the new investors will own approximately 22% of the company (their $7 million investment is about 22% of the company’s $32 million post-money equity value).
Unfortunately, when it comes to funding amount and valuation, we see too many founders put their energy in the wrong place. Because it is exciting to think about what their company is worth, founders fall into the trap of obsessing over valuation when they would get a much bigger benefit from considering the amount of money to raise.
This is not to say that valuation is unimportant — it is central to dilution and your percentage ownership of the business. Educating yourself on how investors value businesses like yours can foster a sense of confidence and help you craft a realistic vision of your company’s future. Beyond that, however, speculating about valuation is often fanciful and unproductive. On the other hand, doing the work to understand how much money you need to raise will create a new awareness that brings your unbounded vision into balance with your limited resources.
Looking through the finance lens can bring into focus the amount of money to raise. This is most productively done by creating a financial model that projects the company’s business performance a few years into the future. This approach has a few important advantages:
It is not enough for sales-oriented founders to think solely about where they want to spend marketing dollars to attract customers, nor is it sufficient for product-focused founders to think only about the engineering team they need to hire to fulfill their product vision. The model demands a thorough and even-handed approach.
that is, the revenue and profitability of a single quantifiable item, such as a software subscription or professional service. All companies, including early-stage, pre-revenue companies, should formulate and model their projected revenue using basic building blocks. Even the simplest of these formulations — quantity times price — forces the company to contemplate its product set, target market, ideal customers, and those customers’ willingness to pay. Founders can take this one step further by analyzing selling and delivery costs, which can help them understand customer acquisition costs, payback periods, gross margin, and so on. Getting these unit economics right is critical to building a scalable business.
Typically, investors want to see 18–24 months of runway before the company needs to raise capital again, so knowing this number is critical.
Building a thoughtful, comprehensive financial model is an iterative process that requires coordination across a range of stakeholders. Anyone who has developed a company-wide annual budget knows that coordination is the hard part. Working with marketing to calculate cost per lead feels straightforward until you realize that the number of leads you are generating is either too many or too few for the number of salespeople the sales team has budgeted for.
Adding to the complexity are numerous financial targets and constraints, which depend on your business model. For example, if you are building an enterprise sales model for SaaS, you probably want to make sure that the payback period on your sales and marketing spend doesn’t exceed 18 months. Simultaneously, you may be solving for the Rule of 40 (a combination of growth rate and profitability margin), a capital efficiency greater than one, or a burn rate less than a certain threshold.
It might sound like a lot of work to build a projection model that will never be 100% accurate. That’s true: It is a lot of work, and no business (especially a young one) ever operates exactly according to plan. However, if you take this approach and put your mental energy into thinking about the right amount to raise instead of daydreaming about a big valuation, you will:
When you focus on creating a comprehensive financial model for your business, potential investors will notice the difference, and you will be well on your way to realizing the valuation you were wasting your time dreaming about not so long ago.
Not a finance expert? You’re not alone — most founders aren’t. That’s why the most successful growth-stage startups seek out experienced partners with the expertise they need to scale. Fintelos helps growing software and services companies assess their readiness for raising capital, create projection models, and zero in on a finance strategy tailored to their goals. Learn more at fintelos.com or email us at info@fintelos.com.
