The Physics of Fundraising 2/3

Understanding the needs of the investor

In Part One of this series we got the “reality-check” on what start-up investors expect to see in terms of valuation, stage and amount to be raised.

It is absolutely critical for an entrepreneur to also understand what the investor actually needs….in terms of mechanics of the financing round.

Angel investors and individuals who participate in your SAFE or convertible note will generally expect to see:

• A valuation Cap (in the case of a SAFE) in-line with stage and traction
• A discount to the conversion in the subsequent financing round (converting event) usually 15%-20%
• A standard, typical 12-month term

Venture Capital funds (Seed-funds, Series-A funds, etc) have an established model for how much equity they need to get on a per-round/per-company basis.

For example, a typical pre-seed/seed venture fund that is taking your entire round will expect to get a minimum (10%-15%) up to a maximum of (30%-35%) of the total equity in the company for taking that risk.

So….if you need to raise $2MM in your Seed-Round:

• Pre-money of $18MM would translate to 10% equity =$2MM/($2MM+18MM)
• Pre-money of $3.7MM would translate to 35% equity =$2MM/($2MM+$3.7MM)

…..Why such a possible variation in valuation?

A. Macro (the times) — start-up valuations in 2008 Vs 2021

B. The investor/fund type — some investors employ the “spray & pray” methodology of investing (they will pay high valuations), some investors only do cash-efficient companies that can reach $1.5MM in ARR within 24-mos (low valuations)

C. Company Momentum: “we just signed an LOI with SpaceX , the round is already oversubscribed and Warren Buffet is joining the board.”

D. Company Traction: “We are at $2.5MM in ARR pre-funding and growing 300% per month”

Obviously, every company and every financing round is different….HOWEVER, it’s important to understand what the baseline investor expectations and typical/standard structure would be before you start talking to investors.

Generally, it is when these concepts are “out of whack” in some form that entrepreneurs get stuck in a never-ending fundraising process that can’t seem to reach a finish-line.