This post is an extension of an earlier Founder Coach discussion of when you are ready to raise money for your startup. On that post, I encouraged founders to focus first on revenue and traction, instead of immediately trying to get investors to fund your customer discovery process.
Today I want to elaborate by saying that a small amount of traction does not mean you will be able to raise an institutional Seed round of $1–2MM. I see this way too often from first time founders who have limited experience with venture capital investors. Going around asking for too much money too early is a waste of your time and detracts from your ability to get money from investors in the future.
In another prior post I spoke about valuation for early stage companies, but a good rule of thumb for a Series A is probably something like 10X your annual revenue for tech platforms and more like 3X your revenue for product companies. Maybe your specific industry is different, so do your homework and find a few comps. Don’t just look at the highest performer you can find, search for at least three deals to get a solid picture. Maybe you can get a higher revenue multiple on a Seed round if you are showing phenomenal monthly revenue growth but do the math here. If your company is only making $10K or $20K in monthly revenue, the valuation is going to be below $5MM, possibly a fair bit below.
Generally on a Seed raise, you want to sell about a 10–20% stake in your company. If your valuation is going to be say $4–5MM, then you should be looking to raise something like $500K to $1MM, not $2MM. If you set the valuation too high, you’ll just spin your wheels and not get any money raised. And don’t try to convince me that “it is only a valuation cap on a convertible note or SAFE”, investors will assume your next raise will be above the cap in most circumstances.
You are going to have to figure out how to use a smaller capital raise today to build traction. You need to focus in the early days on building revenue and customer traction so that you can justify a next raise at a higher valuation. Go out to investors with something reasonable, and you will have a better experience raising capital. An ineffective process that drags on for months is going to crush your startup.
Thanks for reading today’s post, I hope this helps you right size your capital raise and have a successful round.