Are You Raising The Right Amount of Startup Funding?

Updated on 29 September 2021

The money required to establish a new business is known as startup finance or startup capital. It can originate from a variety of places and be used for any reason that aids the startup's transition from concept to reality. The money raised by a new company to cover its first costs is referred to as startup capital. In order to market a concept to investors, entrepreneurs must first develop a viable business plan or build a prototype. Venture capitalists, angel investors, banks, and other financial organizations may give startup capital, which is typically a considerable quantity of money that covers any or all of the company's major initial costs.

Most early-stage startups in Malaysia not aware of funding amount needed

Around 90% of early-stage(!) startups I meet request more startup funding than they need. Sometimes, founders are looking to raise a multiple of what the startup requires at that point. This can lead to entrepreneurs giving away more equity than they would have to, or entrepreneurs having difficulties raising the large funds requested.

  1. Large amount raised @ a low valuation: Founders give away too much equity
    Some entrepreneurs give up a lot of equity early on to get their funding. By reducing the funding amount, founders can save their equity for later rounds when the traction is better and the valuation of the startup is higher. 
  2. Large amount raised @ a high valuation: Difficult to raise startup funding 
    Typically early-stage startups that plan to raise large amounts at high valuations find it very hard to raise funds and take too long to do so. If a startup is still testing the market and growth, or without good traction to back the high valuations, many investors won't consider funding such startups. (Exceptions could be founders with a one-in-a-thousand background or their personal investor network.) If a smaller amount at a lower valuation is raised first, fundraising would happen much faster and founders can quickly go back to building their business. 

What’s a good startup funding amount to raise during the early stage?

There’s no one-fits-all funding strategy, but a few things any entrepreneur should look into:

  1. Raise enough to achieve KPIs.
    Plan what (revenue) traction you want to get with the help of the raised funds. Either you have to hit a breakeven point, or you have to hit attractive KPIs for your next round of fundraising. Raise enough to achieve those KPIs - not more, not less.  
  2. Consider investments in tranches.
    For startups in idea-stage, I’ve seen it working well to raise funds in small tranches. Entrepreneurs in idea stage would raise just enough for a few months, to develop the MVP and validate the market. They plan to get some good initial traction and to raise more money at a better valuation after this short time. Often, initial investors are willing to do follow-on funding, if the validation could be done successfully. 
  3. Only plan to spend on what is really needed. 
    Mostly, it is best to focus on validating the business model by getting good traction in the market. The traction is more valuable than for example fully automating parts of the tech or moving into a bigger office (those expenses can come in at a later stage). Also, don't include high buffer funds in your planning. 
  4. Consider local context. 
    Funding amounts competitors overseas raise are not a good reference point for your own fundraising strategy. Malaysian startups enjoy a cost advantage if they operate in the local market, and are able to test and go to market at a lower cost. You will most likely need a lot less than for example US or European competitors.
  5. Plan right.
    Work out what (revenue) traction you want to achieve, and what expenses you have to incur for that. Put all of it into a simple monthly cash flow file, planned out until the next round of fundraising (Cash flow planning template). From there, you will be able to easily see how much additional money you need to fundraise, to achieve your projections. 
  6. Can you do it with less?
    Have a critical look at your required startup funding amount and your projections! Ask yourself: If you were to only get half of it, what will you spend it on? Could you still achieve your projections? If you are leaning towards a ‘yes’ or ‘maybe’, you are looking for too much money. If half the funding means lower projections, how much lower would they be? Most of the time, smaller amounts have a much higher ROI (comparing funding amount to revenues achieved).

The Danger Of Raising Too Little

Inaccurately estimating your capital requirements might have major consequences for your company. It will lead to insufficient validation of your concept or the implementation of growth efforts that do not make a significant difference. Whatever the case may be, the company is in uncertainty.

The overall result of raising insufficient capital is that the company runs out of cash and all expansion comes to a halt. There will be few options available, and you'll be in a terrible negotiating position in front of the few investors who might still be interested. Still if you are fortunate enough to be given another chance, you can bet that the investment terms will be so onerous that you will wonder why you are even fighting.

Raising funds takes time, is distracting, and is costly. If you get it wrong the first time, you might not get a second chance.

The Danger Of Raising Too Much

So, generating more money than is required is the best strategy, right? Certainly not. Raising too much money, like raising too little money, has its own set of risks.

The main problem is technology. Any investor will value your company based on a variety of factors, such as key business KPIs, patents, and assets. However, raising too much money will boost the valuation.

Higher expectations are associated with a higher firm valuation. Getting more finance usually necessitate doing more due diligence and accepting more control provisions from investors. Furthermore, an investor wants you to provide value to the company for every dollar they invest. This will increase the pressure on you to find new sources of value. From the company's current performance levels, a larger step shift is expected.

The Different Stages of Fundraising

The early days of a firm are almost utopian: a founder and a co-founder bouncing ideas off one other in a wonderful creative environment.

Even the name of this creative place, the incubator, conjures up images of the warmth, coziness, and safety of a womb. However, there comes a time when a firm must transition from ideas to actual products, and in order to do so, they must consider how to make money. But how do you raise funds before you have a product to sell? So, when a business raises funds, it does so in rounds termed the Seed Round, Series A-B-C, and so on, until it either incorporates or sells. The company receives money from venture investors that target specified growth points at specific sizes in each round. The Startup's Funding rounds can be categories into the following stages:

  • Seed Capital. This is usually the initial financial expenditure made in market research and product development. It could come from the founder's own funds or from friends and family (known as a "Friends & Family" or "F&F" Round). This is usually a small sum of money given to a business to help it get off the ground and produce its first product. In most cases, the company will have a concept and will know that it has commercial potential, but they will not yet have a functional prototype. Seed money provides just enough runway for the company to progress from its early idea stage to a product.
  • Angel Investor Funding. Due to the limited nature of seed funding, it is frequently necessary for an entrepreneur to seek out affluent individuals outside of their friends and family - this is known as a "Angel" investor. If the firm has developed a basic product that customers seem to appreciate, the next stage is usually to raise a "angel" round of funding.
  • Venture Capital Financing. Venture Capital Finance is often employed by businesses that have already begun to distribute or sell their product or service, even if they are not yet profitable. If a business is not profitable, venture capital financing is frequently employed to compensate for the negative cash flow. There may be several rounds of Venture Capital funding, each of which is assigned a letter of the alphabet (Series A, B and C) The various Venture Capital rounds reflect various valuations (e.g. if the company is prospering, the Series B round will value company stock higher than Series A, and then Series C will have a higher stock price than Series B).
    • Series A: The Series A round is the most difficult to obtain because it necessitates a venture capital firm investing at least a couple million dollars in the company. Series A funding is often used by startups to figure out the best business strategy for their company and to work out the details of getting their product into the market.
    • Series B: A startup has a product and a business plan by the time it reaches series B, and it needs enough funding to bring the product to a larger market. This is a considerable rise in the amount of money available.
    • Series C: It's all about rapid expansion. Companies may use series C capital to expand on their efforts in series B, such as expanding into overseas markets or broadening their offering across several platforms.
  • Mezzanine Financing & Bridge Loans. Companies may be considering the following types of chances that require additional capital at this time, an IPO (Initial Public Offering), a competitor's acquisition and a management buyout. They can do so by obtaining mezzanine or "bridge" finance. Mezzanine financing is frequently employed 6 to 12 months before an IPO, with the revenues of the IPO being used by the firm to repay the mezzanine financing investor.

Conclusion

When it comes to seeking funds for your firm, there are several lessons to be learned. If you are unrealistic and aggressive in your fundraising campaign early on, there are a number of risks. The causes are numerous and have already been discussed. Your success is contingent on being realistic and having well-defined goals. Don't set your expectations too high too soon. Wait for the perfect moment and the correct valuation for your business. The credo of your startup's success is to be pragmatic when it comes to funding.

If you are looking for advice for your startup fundraising strategy,
email your pitch deck & the questions you have, and we will get back with
some questions & feedback from an investor point of view.

[email protected] 

Reference

The Dangers of Raising Too Much / Too little

The Different Stages of Fundraising

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Written by Pinky

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