Fundraising can supercharge your company’s growth, but it’s tricky to know when to start the process. That’s because raising money isn’t as simple as pitching your idea and receiving funds. It’s a choice you’ll want to think carefully about.
When you take money from investors, you’re giving them a piece of ownership in your company. You dilute your personal equity as a result, and you also open the door to outside feedback and opinions. Investors aren’t just sponsors—they’re decision makers with influence over things like which markets you enter, whom you hire, and how you handle product development.
That’s why it’s crucial to approach fundraising with clarity and strategy in mind. We’ll go over the various factors to consider, but first, let’s review how fundraising works.
The stages of fundraising
Fundraising doesn’t happen in one swift go. There are a few different stages (or “rounds”) of fundraising, each with different purposes and parameters.
To get a better idea of the process, let’s go over some key terms.
- Round: A particular fundraising event a company goes through.
- Priced round: An equity investment based on an assessment of your company’s worth, called a valuation.
- Bootstrapping: The process of funding your company’s growth with your own money and resources.
- Venture capital firm: A type of organization that makes private equity investments in startups.
- Institutional investor: An entity that pools funds from a variety of different investors to invest in startups. Institutional investors can be banks, VC firms, hedge funds, and family estate organizations.
- Angel investor: An individual who gives money to a startup in exchange for equity or convertible debt.
- Convertible instruments: A type of investment that has the potential to convert into equity at a later date. Common types are convertible notes and SAFEs.
Pre-seed round: During the pre-seed phase, your company is just beginning. You probably have a promising idea, but no product, customers, or employees yet. Institutional investors like venture capital funds are usually reluctant to get involved at this stage, so many founders use their own money to get operations off the ground and build a prototype. According to a 2019 report from DocSend, the average amount raised during a pre-seed round in the U.S. was just above $500,000.
Seed round: The seed round is one of the first funding rounds—if not the first—that a company typically goes through. By this point, you likely have something you can demo, but you might still need to create a minimum viable product (MVP) and conduct beta testing before you’re ready to push a version to market. Investors likely to be interested at the seed stage range from angel investors to venture capital firms specializing in seed funding. The median fundraising amount for seed rounds in 2020 was $2.2 million, according to Carta’s data.
Series A: During the Series A round, you’ll be focused on getting your product onto the market, demonstrating product-market fit, acquiring customers, and generating revenue. Institutional investors are more likely to come in during this round because they can see metrics related to revenue growth, customer acquisition cost, and lifetime value. Instead of lending your capital in exchange for convertible debt, though, most investors at the Series A round want immediate ownership equity. In order to determine how much equity they’ll get, you’ll have to negotiate a formal valuation of your company, which sets the fair market value of your company’s stock. You’ll also have to prepare term sheets with your attorney’s help; these contracts spell out the terms of your investment agreement with each investor.
As a founder, you can expect to raise anywhere between $1 million to upwards of $10 million with a Series A. According to our data, the median a Series A company raised in 2020 was $8.1 million—interestingly, that number rose by 80% over four years. (You can find some more data about fundraising trends in our quarterly private market report.)
Series B and beyond: Series B, C, and D rounds are for the purpose of expanding your market reach, growing your company internally, and becoming profitable. By the time you reach a Series B round, you should have a significant user or customer base, plenty of traction, and a proven record of revenue growth. Investors usually come in during these later rounds to help with business development and expansion.
When should you consider fundraising?
Each company’s trajectory is different, which means there’s no one time to start fundraising. The general rule is that you’re in a good position to consider raising funds when 1) you’ve validated that there’s a problem that needs to be solved and 2) you can demonstrate demand for the solution.
Getting that information usually involves heavy market research, thoughtful prototype production, and lots of experimentation.
Let’s say you want to create a service that bundles customers’ TV streaming platforms into one central hub, so they can see all their viewing options without having to toggle between apps. Before starting a priced round of fundraising, you decide to conduct market research about your potential customers, build a prototype and website, spread the word about your service, and encourage consumers to sign up for a free trial. If you get a lot of signups, you could use it to show investors there’s demand for your solution.
Bootstrapping your way through a successful experiment is a great signifier that you might be ready to raise funds, but it’s not an automatic indicator. Before you start raising a priced round, a few other factors will likely come into play.
Reasons to wait to fundraise
- You need to generate more interest from your end user or customer: The type of product you build—and the people you build it for—can dictate when funds are available to you. For example, some investors don’t want to invest in a consumer-focused product unless there’s already a long waiting list of interested customers, while that tends to be less important to investors funding companies focused on the enterprise or business-to-business audiences.
- You have enough resources to continue bootstrapping for a while: Think about the resources at your disposal, including the cash, talent, and tools you have access to. If you have enough capital from crowdfunding to continue bootstrapping your company, you may want to delay fundraising for a while. But if you don’t have enough money to hire the right talent or continue to build out your product, it may be time to consider an equity investment.
- You don’t have the time or bandwidth to invest in pitching: Pitching investors on your idea takes a lot of work. You have to create a pitch deck, contact the right investors, schedule meetings, and carve out space for conversations and follow-ups. If your focus is still on building out your prototype, you may want to hold off on pitching until you have more of a foundation.
Reasons to start fundraising
- You already have a lot of interest from your end users or customers: If you’re still working on your prototype but already have a lot of clear interest in your product or service, you may want to run with it and start reaching out to investors.
- You’re going to run out of cash and resources in six months: Fundraising doesn’t happen overnight. It can take three to six months of regular pitching and conversations with investors before you get any money. To avoid falling behind or missing opportunities to get in front of customers, you may need to start looking for funding before you’re 100% sure you need it.
- You need more support: Fundraising doesn’t just give you capital—it can also provide you with valuable investor support. If you’re at a point in your company’s growth where you need guidance from experienced investors in order to gain momentum, fundraising could be smart.
How much capital should you raise?
Here’s the simple answer: You should raise only as much money as you need to get to the next phase of your company’s growth. There’s no perfect formula, but there are a few areas of your business you can look at to arrive at a dollar amount you’re confident in.
Here are three factors to evaluate:
Your first milestone
A milestone is a particular benchmark you want to reach before entering the next round of funding. Milestones are usually tied to specific company metrics you hope to show, like acquiring 5,000 customers or launching your MVP within a certain timeframe. Milestones also have clearly defined timelines.
Depending on the stage your company is currently in, reaching your next milestone might take a small amount of cash—or it could require a significant capital injection.
Runway is the amount of time you can realistically fund company operations before you run out of money. If you have $500,000 in funds, for example, and it takes roughly $100,000 a month to run your company, you have five months of runway. In general, you want to raise enough money to give yourself 12 to 24 months of runway, since that’s typically the amount of time it takes to move from one round of funding to the next.
To figure out how much it costs to operate your company while working toward your next milestone, you have to consider:
- Your team: How many engineers, marketing experts, salespeople, and customer support reps do you need to reach the next milestone you’ve defined? How much will it cost to support your team working full-time?
- Your admin needs: How much will it cost to buy the right tech and equipment, rent an office space, and budget for potential travel?
- Your marketing and advertising budget: How much do you need to spend to build a website, create a social media strategy, run ads, and set up different distribution channels?
Once you figure out your company’s total monthly spend for people, admin, and marketing, multiply that figure by the number of months you think it will take to reach your next milestone. That will give you a clear idea of the minimum amount of money you need to work toward your next phase.
Keep in mind that this number is often just a starting point. It’s smart to cushion your budget to account for unexpected problems and delays. In general, it’s better to have more cash on hand and not end up needing the money than it is to have to account for every penny and still come up short.
Your ideal valuation
Your company’s valuation is a subjective assessment of your company’s worth, but it’s also a direct byproduct of two factors: the amount of money you raise and the amount of equity you’ve given up for the amount you raise. Most founders give up around 20% of their equity at the seed stage and another 20% during the Series A round.
After you define your company milestones and estimate your monthly operating costs, let’s say you determine you need to raise $1 million during your seed round. If you don’t want to give up more than 20% of your personal equity, you’ll need to shoot for a negotiated valuation of $5 million (since $1 million is 20% of $5 million). That figure gives you the capital you need to reach your next goal without diluting your equity too much.
Remember: valuations are fluid. When you negotiate your ideal valuation, your goal should be to raise enough money to reach your next phase of growth, satisfy investors, and maintain a reasonable ownership percentage.
What to do before you start fundraising
If you think you’re ready to start fundraising, take these steps to set yourself up for success:
- Chat with fellow founders: Consider reaching out to other founders who’ve had success reaching their milestones on time and securing capital. Ask them what they learned from their raise and what they would do differently if they could. Specifically, ask how they defined their milestones, how much cash they needed to reach their next round, and whether or not their fundraising target was on point.
- Ask your business attorney for advice: Your startup attorney may have guidance on what you need to do logistically to prepare for fundraising. You might need to firm up your idea from a legal standpoint, cross-reference your product or service with competitors, or apply for patents.
- Gather your data: It’s critical that you have the right metrics to back up your company’s growth and profit potential. You need to be able to show investors why it’s beneficial to bet on your company.
- Crunch the numbers: You should also be able to explain your spending costs, estimated runway, and funding needs.
- Prepare your pitch: Before you start fundraising, you need to build a compelling pitch deck—one that explains who you are, what problem your company is solving, and why investors should care.
- Target the right investors: Not all investors are created equal. To up your chances of securing funds, it’s important to target investors who have experience investing in your industry and who’ve demonstrated an interest in founders with similar backgrounds and missions as you.
Starting the fundraising process
When you choose to fundraise and how much you raise comes down to your unique needs and goals as a company—and a lot of it is personal to you. To ensure you’re prepared for the road ahead, take some time to reflect on your company’s trajectory and do some basic fundraising math.
At Carta, we help startups with fundraising, compensation, valuations, equity management and much more. Talk to us to find out how we can help you grow.