Understanding how much capital to raise goes far beyond calculating your business’s basic expenditures in technology, marketing, and administrative costs. Instead, good strategy is a must for understanding the amount of capital you should attempt to raise and whether you should be raising capital in the first place. The end goal should be to create a self-sustaining business. In some rare cases, you may need more capital, but even then, good strategy can help to guarantee that you reach the goals necessary to garner more investment. Regardless, deciding on your capital requirements comes down to two pathways: one primary and a second less frequent.
Ideally Self Sustain
Sometimes your business needs a bit of starting capital to kick off. The goal of initial fundraising is to give your business the boost it needs to clear the runway and become self-sustaining. Keep this in mind at every point in the planning process. Plan to run your business or startup so that you are not permanently dependent on outside investors (Link to capital dependency blog post here).
The goal is to pilot a successful business which, at the end of the day, means a business that grows based on its own revenue and profit. Constantly relying on outside capital injections can lead to the death of a business and frequently results in limited negotiation leverage. Investment is a two-way street, and investors will have certain conditions and requirements attached to their capital. More dependence on capital can lead to bad terms from investors, stress, and even losing equity. This doesn’t mean that a business that is more capital dependent is doomed to fail, it’s just to say that there are many advantages to running self-sustainably.
If you can’t Self-Sustain
If your business is designed to run in a way that will require additional capital injections keep in mind the extra time you will need to raise more capital. Not only will you have to consider your time to each milestone in this example, but you’ll also need to consider buffer time around the milestone, including the time it takes for you to put together documentation and get your pitch ready to go, rewarming and creating new investor relationships, and piecing together the right people.
Raising capital is a time-intensive proposition, but some businesses such as large tech-heavy firms or healthcare companies which require a multi-step R&D and approval process require expensive technology or capital expenditure that you as an entrepreneur may not be able to afford out of pocket. Relying on capital is certainly not a death warrant for your business when done correctly. Just be absolutely certain to take this factor into account when planning for the future.
Now that you know the two primary pathways (self-sufficiency or long-term ongoing capital requirements) you can begin to determine exactly how much capital you should set out to raise.
The first milestone is far simpler to calculate. Project your expenses over time to determine the point at which you achieve the milestone of self-sustenance. This is the timeframe you should plan on for determining the amount of capital you need.
The alternative milestone is the point at which you guarantee enough confidence from investors to procure more investment. Ideally, this milestone would be backed by an agreement between you and an investor that guarantees more investment if (and hopefully when) your business reaches a certain amount of revenue or sales or hits another agreed-upon milestone. However, more often than not this milestone will leave you making a best estimate as to what milestone will put you in an optimal, high-probability position to raise the capital that you need.
Once you know the timeline and goal milestone, you can calculate the amount of expenditure needed to reach that point and determine how much capital you should seek to raise.
There are three main expenses “buckets” to keep in mind: technology, marketing, and general and administrative (G&A).
- Technology costs include any sort of software or hardware that you need to run your business. These can be computers for your staff or licenses for software you purchased as well as the related development costs and servers and hosting.
- Marketing costs are expenses required for you to make sales and bring in new customers. This includes both labor (marketing manager), marketing asset development (photos, images, copywriting), and hard costs (Facebook ad cost, Google ad cost, etc). Look at how much you’re going to need to spend to continue to bring in enough customers to generate revenue.
- G&A costs are the day to day expenses required for your business to function. Think about expenses like rent, insurance, core-team salaries, utilities, benefits, etc.
Calculating your total expenditure before a milestone should take into account all of these costs.
The Bonus Step: An Even Wider Buffer
Calculating the amount of money needed to sustain your business is simple if you spend the time to create a solid business plan and pro forma which detail the path forward for the foreseeable future. There is, however, one area where first time CEOs (and even existing CEOs) make mistakes.
When starting this calculation keep in mind all of the expenses just mentioned. However, also keep in mind that you will want buffer room. Be sure to account for a ‘sh*t happens’ buffer. Things will go wrong, unexpected business and personal obstacles will arise, and you need to be prepared for this. It doesn’t even matter determining exactly what the issue will be — just simply knowing that something(s) will not go according to plan is enough.
The final step after determining a milestone, calculating expenses, and determining a buffer is to recalculate. However, this time do not include projected revenue. Plan to have more than enough initial capital to reach your milestone. Revenue is far more unpredictable than expenses. When using specific projections be sure to account for any errors in the projections themselves.
It’s important to understand how much you expect your business to need both with and without revenue. This accounts for error in both directions and allows you to approach investors as informed as possible.
In the case where a business overestimates they simply reach their milestone with cash left over. This can be used to further invest in the business if needed. Equally, while it’s important to protect your equity, it’s far more important to make sure your business is definitively alive. Creating a detailed and carefully thought through path forward is the best way to keep your business afloat in the long term. Preparation is one area where you can always outdo the competition.