Hooray! It’s closing day!
Today we closed with the last investor for a $750k seed round for First and I got to thinking about the costs associated with raising money. Sure, there are legal fees, the time devoted by one founder to focus on fundraising, and the infamous “top idea in your mind” cost. Everyone says it’s better to get fundraising over with as quickly as possible and now, through experience, I can say that I wholeheartedly agree.
I wonder if there’s not a simple way to quantify the costs that really drives that point home.
A few weeks ago I was talking with a friend who raised a $2.7M seed round in under a month, from start to finish. He has an incredible track record and a deep network to pull from, so it’s not terribly surprising. My first response was to take the number he raised and subtract the amount we raised and think “he raised almost $2 million more.”
But that’s not true. He raised even more because he raised it much faster.
Our raise took six grueling months, for several reasons. We started our raise at the worst time of year (November, and yes that was unavoidable) and we didn’t have a significant track record in our market. Fortunately, we were blessed with a great network and some early traction that helped us demonstrate that the concept works and that people will pay for it.
So my friend didn’t only score $2.7M of funding, he also only paid a month of his time for that funding, while we paid six months. That’s significant.
Let me suggest two “costs” to attempt to quantify the time difference between my friend’s round and ours: Focus Cost and Time To Traction Cost.
Let’s say that during the fundraising period a single founder is devoted 100% to the fundraising process. In practice, this isn’t accurate except in very short raises, like my friend’s for example. But in any case, it is that founder’s primary responsibility, and remember that you can only have one “top idea in your mind.”
The most difficult problem I’ve encountered so far in launching a startup is focus. The challenge is a mix of picking the right priorities, exerting the discipline to stick to them, and continually editing those priorities as you learn. When a founder is in fundraising mode, that’s where their focus is. So, during the fundraising period, the focus effectiveness of the startup is reduced. In our case, there are two founders, and we dedicated a single founder to the raise, so I’d say our effectiveness of focus was reduced to 50%.
Effectiveness of focus translates directly to how effectively money and time are being used. Whatever your monthly burn rate is during fundraising, you can take that amount and multiply it by your effectiveness percentage, and that gives you the amount of money fundraising costs you. Every month.
Our average burn rate during raise was about $20k, so we paid $10k a month during our six month raise period. Our Focus Cost ended up being $60k.
Time To Traction Cost
The second cost to consider is what I’ll call the Time To Traction Cost. It would be impossible to prove since no two startups are exactly the same, but I would bet that longer fundraising periods cost you in valuation in the next round. As they say, “it’s all about traction in the next round”. But traction is a function of progress over time. Each month that you’re spending fundraising in the previous time is slowing down progress and spending time.
Think about how people talk about startup traction: “They got to a million users in only 11 months!” Let’s say that startup raised a round in a month. If it had taken that same startup 6 months to raise a seed round, it may have taken them 5 more months to get to a million users. It’s a little less impressive to say “they got to a million users in 16 months.”
I don’t believe that investors are immune to this form of simplistic “curb appeal.” Imagine two identical companies raising a Series A, but one got to a million users in 11 months, while the other took 16 months. It’s hard to imagine that discrepancy in velocity making no difference whatsoever in the discussion of the startup’s valuation.
Let’s start to quantify Time To Traction Cost by assuming that, similarly to Focus Cost, each month of fundraising diminishes the effectiveness of getting to traction by a factor proportional to the number of founders committed to the raise.
In our case, we had one founder committed during a six month raise period. That’s six months where we were making progress to traction at only 50% effectiveness. Using this model, the raise period delayed us getting to significant traction by 3 months. Ouch.
How can we translate this time cost into monetary cost? The time until the next raise seems important here. For the sake of simplicity, let’s assume that valuation is tied directly to traction. In our case, if we raise again in 12 months, we had a total of 18 months between raises to build traction (from start to start), yet we spent 3 of those months to raise the first round. If our hoped-for valuation in the next round is $10M, we should expect that number to actually be $8.33M, taking a 16.7% hit (15 months/18 months = 83.3% as far along as we hoped).
As you probably know, a lower valuation isn’t the end of the world. It just means you have to sell more of your company in order to raise the capital you need to keep moving. Which means your equity gets crammed down. Which means you own a smaller percentage of a company that is also worth less, at least on paper. Ouch again.
Raising more slowly doesn’t only cost you money spent less effectively now, it costs you in equity later.
These numbers aren’t particularly fun to look at, but they help drive home a commonly-accepted point: fundraising is costly for a startup.
I’ve fundraised enough to know that it is painful at best, and deadly at worst. Demo Day is something special, and many companies going through it don’t even know how good they have it. Demo Day sets up the perfect environment to make a market with artificial deadlines with investors filtered in batch. If fundraising is a painful marathon, Demo Day is like steroids. It makes it easier to get to the finish line and is an unfair advantage over other startups.
Y combinator uses Demo Day to create artificial deadlines. It’s probably worth thinking about how to create those artificial deadlines in your own fundraising process.
I’m not suggesting these numbers are magical or even correct. As another friend likes to point out, all models are wrong, but some models are useful. I hope this is useful in that it gets us thinking quantitatively about the cost of long fundraising cycles. Sometimes numbers confront us in a way that mere verbal wisdom fails to.
Long raises cost you now in Focus. Long raises cost you later in Time To Traction. Raise as fast as you can.
To make this a little more fun, I built a little model in Google Sheets that you can plug in your startup’s fundraising numbers and find out what your Real Raise Amount is.