A company’s runway is the amount of time it can survive based on the cash it has in the bank.
While the struggle is real for established cashflow businesses and investor-backed companies that are yet to prove their business model, entrepreneurs who decide to raise capital are left to answer a difficult question: How much capital should I raise from investors?
Two schools on how much to raise
The first is to raise only what you think you need.
You Google ‘budget template’. Download it. You enter your estimates for year one through to year five, add some contingency and decide that you need to raise $X to achieve specific milestones to demonstrate traction.
This is a frugal plan. It’s designed to keep the business lean and not give away too much equity in the company.
The second school of thought is to raise more than you need.
While the budget construction might be the same, I think about the final numbers as the minimum I need. And instead of raising that amount, see how much capital I can raise above it.
While investor demand will ultimately determine how much I can raise at a given point in time, I follow the second school for three reasons.
First, building a company is unpredictable. It almost always takes longer than expected. Raising more capital means you can weather storms for longer.
Second, and for a similar reason, it’s important to have the capital to pursue opportunities you can’t see coming.
Third, I focus more on value creation and less on dilution. The right investors will help a company grow into a huge business and I expect to depart with ~20% of the company at each round.
The bottom line is that businesses don’t usually grow without a capital injection at some point. I prefer to own a proportion of something huge instead of a 100% of nothing.
Why 18 months?
Investors usually expect to see traction within 18 months of capital being raised.
It’s a convention based on the experience of angel and early-stage venture capital investors.
And while 18 months may seem arbitrary, it is usually enough time to test and learn and arrive at the first base of your product/market fit.
I call it first base because contrary to popular opinion, product/market fit is not a fixed milestone that ‘gets achieved’.
It is a continual pursuit which changes each time a company attempts to scale.
This is usually because products behave differently in different markets and while technology tries to solve for it, one size rarely fits all.
When it comes to raising capital, traction rules. Companies that develop compelling traction or learning after the first 18 months will raise more capital with relative ease.
Those funds will scale product and marketing and if timing, team and luck align, the company will be on track to achieve the next stage of growth.
However if traction is lacking, the 18-month runway goes out the window. In this case, all manner of survival techniques gets deployed. And this can last for a very long time.
Always expect the latter scenario to play out, as it does in 90% of startups.
Seed is a phase, not a round
If there is one thing that entrepreneurs get worked up about it’s the ‘stage’ of their company.
The stage of a company is typically judged on how much capital has been raised and the amount of traction that capital has yielded over the companies lifetime.
And the reason this is such a touchy topic is that up until a few years ago technology investors expected entrepreneurs to follow a relatively linear path when it came to raising capital.
It would go something like raise a small amount of capital from friends and family.
Then you would raise a ‘seed’ round of capital (e.g. $250K) that was based on momentum and opportunity. After the seed round and more traction, you would then raise a ‘Series A’ investment ($2M — $10M) and then larger rounds after that.
The punchline is that investors (and entrepreneurs) are turning their attention to the fact that ’seed’ is a phase, not a round.
In other words, the last decade of startup growth has shown that traction can take longer than expected.
And as the early-stage venture investor, Hunter Walk recently wrote:
Asking founders to prematurely perfectly forecast the amount of capital they need to get to a Series A is an unnecessary constraint.
He goes on to say:
Startups are raising more total dollars, in various configurations, to get to the point where a strong Series A can occur.
This takeaway for entrepreneurs is simple.
- Your company can raise multiple seed rounds providing it continues to demonstrate traction and learning, and
- If you don’t know what to ‘call’ the round, just say your company is raising capital and let your traction tell the story.
Don’t let the 18-month runway mask the marathon
Building a company is a marathon, not a sprint. But here’s the problem. Most people have never run or trained for a marathon. All they know is how to sprint.
A marathon in company building terms is ~10 years. That’s why investors look beyond technical skill and pedigree and carefully examine the resilience and tenacity of founders.
A number of early-stage investors I know ask first-time founders point-blank where they see the company in 10 years.
Predicting where or what form a company will take in a decade’s time isn’t the point. Investors don’t know and neither do founders.
It’s about seeing if the founder flinches at the first sign of commitment because even if an exit appears within five years, it sure as hell will feel like 10 years (if not longer) by the time that deal is done.
One last thing…
The very important thing to remember when raising capital is that the current round is just the capital you need at the moment.
In the 10-year marathon to build a great company, 18-month runways are the short term chunks of time to demonstrate momentum.
Chances are it will take two or three of these chunks to begin realising the potential of your product.
The best entrepreneurs always find ways to accelerate momentum. But even the best, because they are building something new, fall prey to a shortage of capital to manage unexpected issues or capitalise on unforeseen opportunities.
Think about time. How it’s your most valuable asset.
When the company grows beyond your wildest dreams you will have learned a lot.
When the company fails you will have learned a lot.
Raise more money than you need.
Focus on creating value with extraordinary investors and worry less about dilution.