How Much Money Should You Raise?
Raising money is undoubtedly among the toughest aspects of running a business. Since money doesn’t grow on trees and you can’t live without it, a business owner has to learn how to find it and use it in an efficient manner.
There are often two schools of thoughts when it comes to answering the question, “how much money should you raise?” Some say there’s no limit, while others would prefer raising money at all. But neither of these answers seems realistic or useful when it comes to the real world.
This guide will look at 1) the problems of raising too much or too little and 2) help you define just the right amount of money needed to make your business succeed.
THE PROBLEMS OF RAISING TOO MUCH MONEY
Most business owners think the obvious answer to the question “How much money should I raise?” is “As much as you can”. When you are starting out, with a limited budget, taking whatever money comes your way might seem the right thing to do. But in reality, raising an unlimited amount of money can have some serious drawbacks for your business.
Too much money could harm your business, especially start-ups, in different ways. Before you start raising money without an upper limit, you should understand the below risks.
More money means more due diligence
If you are looking to finance your business with equity, you should understand the disadvantages. Adding a professional investor on board always comes with a loss in the ownership of your business. The more money you raise in terms of equity, the less ownership you have over your own business.
Not only can this end up costing your business a large amount of money in the long-term, it also adds much more administrative and operational burden for the business. Since your investors are shared-owners of the business, you can’t make major decisions without consulting them. The more investors you have on board, the more difficult and time-consuming this will be.
You also must ensure to use the money you’ve raised in an appropriate manner. Controlling a large sum of money, with a business that hasn’t been in operation for too long, can be a challenge.
Higher risk means funding isn’t cheap
As we mentioned above, your business might wound up paying more for the equity you raise in the long-term. This is due to the high risks associated with investing in start-ups. Investors often want a healthy return for their money, as they aren’t guaranteed to receive anything from a business that isn’t yet established.
Therefore, raising as much as you can is a negative attitude for high risks companies. It is much more advantageous to raise what the business needs to kick-start growing, rather than take all the money thrown at your business.
Overvaluation of the business comes with a risk
When a business raises money, it is essentially valuing its operations. If you are raising large sums of money, your business valuation will go up. While valuation of start-ups is always difficult, overvaluing has more potential risks to undervaluation.
Not only can it be difficult to find investors who are willing to invest in a company that is clearly overvaluing itself. But more importantly, raising a vast amount of money at the start can hinder your business’ opportunity to raise further funds.
Your second round of funding should typically be able to raise at least the same level as your first round did. But if the business received a large amount of capital, with a clear overvaluation of the business, a majority of investors won’t be interested in adding to this overvaluation at the second round. This would result in a so called down-round which is not well perceived by investors.
Check out the below video for tips on start-up valuation:
The problem of ‘easy money’
Interestingly, there’s also the issue of ‘easy money’. A start-up that raises unlimited amount of capital can easily mismanage the use of this money. From a psychological point of view, having an excess amount of money can leave you more careless, as you don’t need to focus on the key areas. Since you have money available for nearly anything, you can end up spending in areas that might not require the money at that point in time.
If you only have a limited amount of money, you are required to prioritize your spending. If you don’t prioritize, you could focus on the wrong areas or grow faster than your business is able to absorb the growth.
THE PROBLEMS OF RAISING TOO LITTLE MONEY
On the other hand, you also shouldn’t answer the question by stating, “I will never raise money”. There are still people who think raising money as a start-up is a mistake and you should only set up a business if you can afford it.
But just as raising too much money can have a negative impact on your business, so can raising too little. If you’ve considered skipping the fundraising bit altogether, consider the below drawbacks of raising below the bare minimum.
Executing your business plan can be difficult
Few businesses are in the position to execute their business plan without any extra funding. You shouldn’t set yourself in a position where a failing business will also mean you lose all of your personal assets as well.
The start-up environment is not easy, with nearly 90% of businesses failing in the first few months. You, therefore, don’t want to hinder your operational efficiency by having no extra funds available.
Having a strict amount of money will require much more operational oversight. While this focus can certainly have its benefits, it can also be harmful for your start-up. You might be forced to make difficult decisions, such as laying off staff or restructuring the way the business operates. These could mean your business can’t achieve certain milestones, which are essential for further growth.
Running a business is not easy, but you shouldn’t turn it into a living hell. As a business owner, you can’t be afraid of taking certain risks and raising outside capital is definitely not something you should actively avoid.
Not fundraising can hurt your competitive edge
Furthermore, while you might like the idea of operating without investment, your competitors are unlikely to share this view. You might be able to guarantee your business is operational by slowly building up the business and its revenue stream. But if your competitor can raise money, and therefore speed up its growth, your business can find making money even more difficult.
Not raising money in an environment where other businesses do so can hurt your competitiveness. In the long-term, this could mean your business doesn’t succeed simply because it refused to raise any money.
Hinder any potential future fundraising
You are unlikely to be able to ensure your business can operate without any additional fundraising. Even if you don’t raise money at the start, you might come across a need to raise funds later on. But if you wait until you are desperate for funding, you’ll cause fundraising to become harder. Investors can tell when businesses are desperate and this can cause alarm bells to ring in their head. You definitely don’t want to wait until fundraising is a must-do for business survival.
DEFINING THE RIGHT AMOUNT FOR YOUR BUSINESS
If raising “too much” and “too little” are problematic answers to the question, the answer must then be “You raise the right amount of money”. But how do you define the “right amount”?
There is unfortunately no official answer for the right amount of money, as it depends completely on your business’ situation. The good news is there’s a clear three-step procedure for defining the right amount of money.
Step one: define your milestones
Your business shouldn’t start raising money without a clear objective. You don’t want to raise money for the sake of fundraising, but rather in order to establish a specific goal.
Your business plan should have milestones it wants to achieve. With these milestones, you can ensure your business grows. Achieving certain milestones can be difficult without extra funding and therefore, you want to raise money in order to achieve the specific objective.
The milestone your set naturally depend on your business and the industry you operate in. But they could range from increasing your ability to ship 10k products to shops to opening up a new branch.
In essence, the milestones must add to the business value. In this sense, milestones reduce the risks involved with investing, which can be a great way to attract investors for your business. It will also help your future fundraising efforts to show investors how you’ve been able to hit your milestones in the past.
In fact, you could set milestones specifically aimed at helping you attract more money in the next fundraising round. As mentioned, you need to set milestones which add immediate value for your business By defining these, you also cause the actual process of raising money to appear easier. You’ll be meeting investors and you can clearly highlight what you need to boost your business, why and how it can help your business, and the route to achieving this. Being able to demonstrate this will help the investor understand your vision, as well as know the risks involved with fundraising.
Step two: calculate the needed money with milestones in mind
Once you’ve set the business milestones you want to achieve, you can start calculating the amount of money you need to achieve them. This will essentially give you the measure for the right amount of money to raise.
When you are calculating the sums, you need to keep the following points in mind:
- What are the resources needed to achieve the milestone? These could include anything from pure manpower to the equipment you need. Be meticulous and consider all the different aspects of reaching the milestone.
For example, you might need legal services in order to launch a new product line. Make sure you also calculate the cost of services such as this in your estimation.
- What is the timeline for achieving the milestone? You probably won’t be able to achieve the milestone in a single day. Therefore, your cost estimation must include the timeline as well.
Perhaps it’ll take you around three months to launch the new app. What are the business’ operational costs during this time? Again, it is a salutary idea to carefully think about this and draw a realistic timeline. You’d probably want to have the product on shelves in three months, but is it realistic?
- What funding do the resources needed require during this time? Once you are clear about the resources you need to achieve the milestone and the timeline for achieving it, you need to think the overall cost of funding all of it.
After these two steps, you have a very clear understanding of the amount of money you are looking to raise. But you also need to prepare something extra.
Step three: add a buffer
Knowing the exact amount you need for achieving a milestone can be near impossible. No matter how hard you try, there is always the unexpected element of circumstances. Perhaps the legal paperwork doesn’t file through in the first week or one of your project managers falls sick during the design process. Unexpected situations will occur in the business world and you need to prepare for them.
Therefore, having a buffer on the above estimation is crucial. How much the buffer should be can depend a bit on the nature of your milestone. It is beneficial to try to think how risky your milestone is – the more risky the project, the more buffer you might want to add.
But as we’ve discussed the dangers of raising too much and too little, you don’t want to go overboard with your buffer. Typically, around 3-10% of the total cost estimation can be advantageous.
The amount you conclude with, after calculating the above, can be close to the perfect fundraising target you should set.
WHAT IF YOU ARE OFFERED MORE THAN YOU ASKED FOR?
Although raising money is never an easy goal to achieve, investors can sometimes offer businesses more than what they asked for. Since you generally want to only raise the exact amount of money you need to achieve milestones, what do you do if investors are stuffing more cash into your pockets?
Since fundraising can be such a drain, it would be rather silly to deny money from interested investors. On the other hand, we’ve also explained the dangers of raising significantly more than you need, so you shouldn’t jump on the bandwagon without careful consideration.
If you are offered more than you asked for, ask yourself these three questions:
Will you maintain enough ownership of your company?
Investors are unlikely to just offer you free money. It generally comes with the cost of losing some of your ownership in the business. If you are offered more than you wanted, consider whether you’ll end up losing more of the business’ shares than you intended.
If the money comes at a devastating cost of ownership, you might be better off declining the offer. Although the loss of ownership, might not seem too devastating for you and accepting the offer can be beneficial for you.
Are you diluting your business in terms of valuation?
As discussed, more money tends to drive up the valuation of your business. But a higher valuation might not be beneficial for your business, especially if you are a start-up. You need to consider whether the extra money will manifest in diluting your business valuation and therefore, pose a risk for future fundraising.
What can you do with the extra money?
Likewise, you must have a specific reason for accepting the money, just as you have for raising funds in the first place. You shouldn’t accept money and then start thinking about what to do with it. Extra money will only benefit your business if you know how to use it.
This means that you should consider carefully whether you could use to money to add value to your business. Perhaps it could help you achieve your milestone. The extra funding might cut the timeline shorter since you can hire extra staff, for example.
If you have a valid route for using the money to either boost the way you achieve the milestone or to add value for your company, accepting the offer might be worthwhile.
When it comes to raising money, you can’t do it without a clear objective. You don’t want to raise money for the sake of it, but you also don’t want to starve your business from money just because you potentially could do without. Money can help boost your business chances and help you achieve the goals you want to achieve.
Plan your fundraising well and set objectives you wish to accomplish with the extra funding. Ensure you stay realistic and prepare for when events don’t occur according to plan. In the end, if you know the funds can help your business grow, avoiding a bit of investment is not justified. If it benefits your business and adds value to what you are doing, you’re on the right track.