Chapter #1: Do I Need Venture Capital and How Much Should I Raise?
Raising your Seed Round — a Playbook for Israeli Entrepreneurs
You found your co-founder(s). You validated a market need. Maybe you have a PPT, MVP, PoC, Design Partner, Alpha, Beta, Pilot, or your first paying customers. Now what? In the following series of posts, I’ve summarized my learnings from three years of seed investing in Israel, with the hope that it will help bridge the information gap between Israeli entrepreneurs and their first institutional round of finance.
Before diving in, keep in mind that your company may not need venture capital to succeed.
In fact, bootstrapping, grant funding, angel investments, consulting projects, and holding companies can occasionally bring a start-up to profitability and in control of its own destiny. But in order to capture a significant portion of a fast-growing and/or large market, it often makes sense to delay profitability in exchange for growth. This is in fact why Venture Capital exists — VCs make most of their returns by funding non-profitable companies until they become category leaders and/or monopolies, at which point they (hopefully) become profitable — mathematically known as a J-curve, crudely illustrated below.
Image Credit: Wikipedia
Alas, this guide is for entrepreneurs who want to raise their seed round from a VC.
Seed rounds help you build assets which help you raise a successful A round. A rounds help you build assets which help you raise a successful B round, etc. Always look at the seed round as a means to an end. Implicitly, raising a seed round is a function of convincing an investor you can raise an A round. If your seed investor doesn’t think you can raise an A, why would they take the financial risk? Logically following, if you can describe and justify what you’ll need to achieve to secure your A round, raising your seed becomes measurably easier.
So what’s the right amount of capital to ask for?
Just a few years ago, the average seed round clocked in at roughly $1m, today the average has more than doubled to $2.5m. Why? First, demand for engineering talent outstripped supply, increasing wages and thus the capital required to recruit and retain qualified employees and executives. Second, Facebook, Netflix, Tesla, and a variety of other publicly traded VC-backed companies generated most of their returns before going public, increasing institutional investors appetite for venture / private equity, thus creating more funds and expanding the size of existing funds — see the Softbank Effect. Third, the number of start-ups founded in the past few years dropped. With more capital to deploy, higher wages, and fewer companies created, round size has naturally increased.
Given these macroeconomic developments, make sure to ask for enough money to execute your research, development, product, marketing, & sales goals 3–6 months (the range of a typical A round investment process) before you run out of cash. Estimate your revenues, subtract your projected expenses, and add a safety buffer, since humans suffer from the planning fallacy.
Keep in mind that depending on your level of maturity, you might need to raise pre-seed money to generate some proof points before VCs will fund your seed round. In next week’s post I’ll outline the various funding sources in Israel and the impact they can have on your business.
Max Marine is an Associate @ lool ventures, an early-stage VC based in Tel Aviv.
You can continue the series with Chapter #2 here.