Short answer: enough to get your startup to an accretive milestone plus some fudge factor.
“Accretive milestone” is a fancy way of saying getting your company to a point at which you can raise money at a higher valuation. As a rule of thumb, I would say a successful Series A is one where good VCs invest at a pre-money that is at least twice the post-money of the seed round. So if for your seed round you raised $1M at $2M pre ($3M post-money valuation), for the Series A you should be shooting for a minimum of $6M pre (but hopefully you’ll get significantly higher).
The worst thing a seed-stage company can do is raise too little money and only reach part way to a milestone. Pitching new investors in that case is very hard; often the only way keep the company alive is to get the existing investors to reinvest at the last round valuation (“reopen the last round”). The second worst thing you can do is raise too much money in the seed round (most likely because big funds pressure you to do so), hence taking too much dilution too soon.
How do you determine what an accretive milestone is? The answer is partly determined by market conditions and partly by the nature of your startup. Knowing market conditions means knowing which VCs are currently aggressively investing, at what valuations, in what sectors, and how various milestones are being perceived. This is where having active and connected advisors and seed investors can be extremely helpful.
Aside from market conditions, you should try to answer the question: what is the biggest risk your startup is facing in the upcoming year and how can you eliminate that risk? You should come up with your own answer but you should also talk to lots of smart people to get their take (yet another reason not to keep your idea secret).
For consumer internet companies, eliminating the biggest risk almost always means getting “traction” – user growth, engagement, etc. Traction is also what you want if you are targeting SMBs (small/medium businesses). For online advertising companies you probably want revenues. If you are selling to enterprises you probably want to have a handful of credible beta customers.
The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone. Building a product is only accretive in cases where there is significant technical risk – e.g. you are building a new search engine or semiconductor.
Now to the “fudge factor.” Basically what I’d recommend here depends on what milestones you are going for and how experienced you are at developing and executing operating plans. If you are going for marketing traction, that almost always takes (a lot) longer than people expect. You should think about a fudge factor of 50% (increasing the round size by 50%). You should also have alternative operating plans where you can “cut the burn” to get more calendar time on your existing raise (“extend the runway”). If you are just going for product milestones and are super experienced at building products you might try a lower fudge factor.
The most perverse thing that I see is big VC funds pushing companies to raise far more money than they need to (even at higher valuations), simply so they can “put more money to work“. This is one of many reasons why angels or pure seed funds are preferable seed round investors (bias alert: I am one of them!).
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you said it all! i would just add that sometimes the milestones is dynamic and is not really clear at the moment you raise. You can fix it but market conditions can make change its order of magnitude (competitive pressure) or its nature (traction vs revenue)
yes, i agree you want to hit an accretive milestone with any funds raised. but the hard part is putting numbers on that milestone, particularly for a pre-revenue start-up.
For a consumer internet company, in the current environment, what type of traction (e.g., user growth, engagement, etc) would warrant a $3M pre money vs $6M pre money? Does it take proof of a business model to get the pre money beyond a $4M pre money valuation?
Great advice.
We're raising an early round ($500K), but recently got interest from a VC fund with $2.5B in assets and around $500M ready to deploy and they like our approach/market. Cool to have their interest, but if their minimum investment is around $8M, what is your recommendation for handling this situation?
I know we don't want that investment now, but we may in the future (Series B etc). So is it just a matter of keeping in touch in the meantime?
It's like your speaking Greek to me with some of these details, but am taking a wag at interpretation.
1) So get enough to to build user traction if you're a consumer internet biz, build revenues if you're building ads, etc.
2) Don't get too much because it dissuades follow on rounds because dilution was too great in the first round
What about build something users want, and then generate some revenues to help channel into organic growth? Seek external funded as needed to step on the gas to accelerate through portions of the growth/building curve. That's my position (it may be sub-optimal).
Great question Reece, and a good position to be in. What you suggest makes rational sense, you want your business to be able to execute with current investments and to grow reasonably to hire valuation.
I'm training myself to be aware of the possibility that any investment round could be the final round. From then on you could be “on your own” unless the investor forces a liquidation (5 or so years).
Very true. When the stock market crashed a lot of good entrepreneurs adapted. Also people were saying “flat is the new up” (meaning if you could raise a flat round that was as good as a 2x in the old days).
The different between 3 and 6 pre is probably just whether you have 1 or multiple investors after you.
If you have the option to raise $500K from smaller funds/angels, I'd do that and then just stay in touch with big fund.
Sorry, I was trying to put jargon in ().
If you can get revenues before initial funding, do it. Potentially puts you in a much stronger negotiating position.
No need to be sorry. Some of these details are likely obvious to folks who have been through it at least once before but are pretty darn important to get one's head around for first timers.
I'm fond of minimizing catastrophic mistakes.
Makes sense. Is it likely that 2 VC firms will club/ally and agree on a price, so it actually take having 3+ firms interested to get up to 6 pre?
on of many reasons you never tell one VC which other VCs are interested…
i always tell founders that they need to focus on the next round re dilution; so the 1st round is all about raising just enough and hanging on to as much as poss … exactly as you said
yep, i know it sounds self serving as a seed investor but the path to least dilution is investors aligned with you on seed round where you don't raise too much money, and then raise the bulk of your money later.
I was trying to figure out today what a reasonable first round of funding is. I've got some plans I've been working up for a startup, but these are highly dependent on how much money would be available. There's a big difference between having 50K between two co-founders for a year, eating ramen- and having $1M available, hiring an office and putting together a small team.
We don't have any funding yet- so presumably we'd be looking for some level of angel funding/seed funding. I know that many micro funding rounds like yCombinator or TechStars Boston are sub 30K rounds, but I'm unsure of the size of most angel/seed rounds for tech companies.
Clearly I have more research to do.
You make a great point regarding how milestones are viewed in different terms, depending on where you're standing.
Most startups have two key types of risk: technical (to varying degrees) and market (all of them) – and the founders have different levels of control over each. In a nutshell, technical risk should be entirely under the control of the founders, whereas market risk is much harder to overcome.
In consequence, overcoming technical risk may represent a major milestone for the engineers – but from an investment perspective it is basically meaningless. It follows that achieving a technical milestone (eg a public launch) will not trigger a valuation uptick.
So far, so obvious. But things get interesting for projects with a large tech component and a long development cycle prior to launch. On this basis, a standard 18 month runway is useless, because only technical milestones will be reached in this timespan, leaving no scope for valuation upside.
In these circumstances, a longer runway makes sense. The founders should be willing to exchange some degree of valuation risk (dilution) for funding visibility.
The subsequent round (and with it a new valuation) should always come when there is a decent level of market feedback.
Would you say a similar multiplier applies for all founding rounds? That is, should one shoot to have the pre-money for a Series B be at least 2x the Series A post-money and so on for all rounds? Or does this apply just for the seed stage?
Similarly, should the amount being raised in all rounds be determined by what it will take to reach certain milestones plus a fudge factor? Or, is there a stage at which raising money becomes about more than hitting milestones and increasing your valuation for a next round?
Good point about big technical projects. Probably a case where
starting out with a big VC makes sense.
Awesome. If I had to stuff my response in a tweet, I would say, “As much as possible while keeping your dilution under 20%, preferably under 15%, and, even better, under 10%.” I think this advice makes even more sense for founders who aren't experienced “developing and executing operating plans.” What do you think?
Hey Nivi
I prefer to think of dilution over the life of the company. Sometimes you give up more now to give up less later. That's one of the key points I'm trying to make actually. I gave up 50%+ of SiteAdvisor to investors in the first round but in the long run was happy for it. All that said, if you can fund you company with the dilution %'s you outline, I'd certainly recommend it.
Thanks for the great posting Chris.
I would be interested in seeing a post from you on what Angel and Seed funds were used for during the first Internet boom and what they are used for now.
I agree that “accretive milestones” differ for each company and what they need to achieve to create traction.
There are two main differences I see about startups today needing seed funding to achieve traction versus last decade:
1. Technology for startups used to cost money. Today it doesn't have to. The increased usage of free technology from both open source platforms and from Microsoft via their BizSpark Startup program (http://microsoft.com/bizspark) on top of cloud hosting make the technology pretty much free. We are launching Alpha to over 100 users on February 1st and our monthly operating costs are around $34 per month currently.
2. Creating brand awareness used to cost money. Today social media marketing is free. It was expensive to advertise in Red Herring, but everyone did it. Today startups can create brand awareness around their company and product through being talked about in well-followed blogs, their own blog, Twitter, webinars, SlideShare, YouTube, and taking advantage of PR opportunities through HARO, etc. Having Microsoft talk about you and blog about you if you are part of their BizSpark program also helps tremendously. During the Microsoft PDC 09, SocialGrow had a press release done on the Microsoft site by Waggener Edstrom Worldwide on Tuesday, was named Startup of the Day worldwide on Wednesday, and had the founders video interview published on Microsoft Online Channel 9 on Thursday.
With the cost to create and run a web-based startup nearly zero, the amount of seed funding required should also dramatically decrease as well…if not start approaching zero at some point in the future as well.
Your thoughts?
Marsh Sutherland
President | Co-Founder
SocialGrow™
http://socialgrow.com
@socialgrow | @marshsutherland
Social Media marketing isn't free. Give Chris Brogan a call and ask him how much it will cost him to come in, consult and setup a campaign. Then what will execution cost?
You can say, “Ford is doing a lot with social media”, but having Scott Monty onboard I'm sure costs a few dollars, and handing out 100 Ford Focuses and flying people around the world and sending them on 'missions' also cost a large amount of money. Definitely NOT something a company can pull off with a zero dollar budget.
I agree that you don't need to do big name advertising, but social media marketing doesn't sell everything for free.
Great post Chris! However, when one ask the question “What’s the right amount of seed money to raise?” – I might be missing the scenario where the response is (and probably should be) NONE. I know that I am overly fond of bootstrapping, to the extent of romanticizing it, but the path to least dilution is to cling on to your shares as if your life depended on it – and sometimes it does
I'd respond to that with a challenge- name some big successful exits that have completely bootstrapped themselves. There really aren't many. While running a 'lean startup' is in vogue due to the economy, it rarely shoots you through the moon either. This isn't to say that you won't have a successful business, and in fact it will likely be more stress free, but definitely something to consider.
Very good comments. Independently of how much $ you raise though, what remains crucial is what you can/will deliver with it. Understanding the milestones you need to meet to get to the next stage. Delivering no matter what is the best valuation booster. I LOVE entrepreneurs who over-deliver. Focusing on the elements that are somewhat under the entrepreneurs' control (because soo much is already not). Also, understanding that when taking someone else money (Angel or VC) there is a new level of responsibility in the mix, you start indirectly reporting to someone (something you don't have to do when your a stand alone self funded entrepreneurs) no matter what the valuation is or what it will become, this will be new level of responsibility/stress.
Keeping it within the context of the question, which confines this to – seed – I actually do think one would be able to provide a number of great examples. That almost first full year of Apple Computer might be considered one. Leaving that aside though, it probably comes down to the question on who you are trying to maximize the return for and how you would define Entrepreneur. IF your goal (*as an entrepreneur) is to make, say, $5M, I do think there are scenarios where NO SEED funding, is the better route towards that goal. So no seed funding, does not equal a life style business without stress – at least it didn’t fell like that for me
Do you think this is still true? “flat is the new up”?
-Cory Levy
I mean this stuff changes quick and depends who you ask, but basically with the Dow back up above 10K, Twitter valued at 1B, I'd say up is the new up again.
[...] This post was mentioned on Twitter by Venture Hacks, Chris McCann. Chris McCann said: "I gave up 50%+ of SiteAdvisor to investors in the 1st round but in the long run was happy for it" @cdixon @venturehacks http://j.mp/5bgeRq [...]
David, whether or not social media marketing is free or not depends on what you define as a cost. SocialGrow is approaching 10,000 Twitter followers and has created excellent brand awareness as an evangelist on the benefits of having a large roster of RELEVANT social networking connections for free. SocialGrow has been published and talked about, and we haven't even release our Alpha yet. Sure, our rockstar CMO Ken Herron is one of the best social media marketers in the world and I've given him a significant share of ownership in our startup, but out of pockets costs for what he has done is zero.
We don't need to pay consultants like Chris Brogan because we have Ken. We are hoping Chris, another local Bostonian, will evangelize our product as well (or at least mention it) on this blog for free. Given out Ford Focuses and sending people on missions is simply foolish and neither Ken nor I would never approve of such an expense. Reminds me of when my former employer Akibia gave away a Porsche Boxster and then spent $100K on a street party at a Siebel conference and then ended up laying off 30 billable consultants a couple of months later because their $150K showed literally zero ROI.
Social media marketing can either cost money if choose to…or you can do it for free with excellent results, as we have.
Chris Dixon's blog post is about Seed funding, not about Series A, B, or C rounds of funding. Trust me, when SocialGrow has a marketing budget for Ken AND a publicly released product, look out for what he will do then marketing-wise. But he's done an awfully good job marketing for us with zero budget and zero finished product.
This post couldn't have came at a better time. Very nice, thanks a million =)
-Gary D
[...] From cdixon.org [...]
>> “The biggest mistake founders make is thinking that building a product by itself will be perceived as an accretive milestone.”
Although it **seems** counter-intuitive — after all, if you can't build the product, then that is automatic and absolute FAIL — this is a hard pill to swallow, especially if your role in a startup makes you directly responsible for getting the product built.
When you think about 'Chandler' (Millions of dollars and many years spent without even coming close to building the product they set out to build) and 'Duke Nukem Forever' (12 years and many more $ Millions with no product ever materializing) it just seems strange that successfully getting the product built would not count for much, doesn't it?
TJL
Building a product doesn't count for nothing. The problem is it doesn't make your valuation go up, generally because if you've gotten seed funded you already got a valuation that assumed product building competency. So its already baked into the earlier valuation…
@thomaslukasik,
It took me quite a while to let go of the esteem I used to accord to product development.
The painful truth that engineers must realise is that without traction, your product is basically nothing.
On a +ve note, by developing your customer base in parallel with your product , you can kill two birds with one stone. In other words, startups need to “unstealth” themselves.
@thomaslukasik,
It took me quite a while to let go of the esteem I used to accord to product development.
The painful truth that engineers must realise is that without traction, your product is basically nothing.
On a +ve note, by developing your customer base in parallel with your product , you can kill two birds with one stone. In other words, startups need to “unstealth” themselves.
[...] Dixon: How much seed money should I raise? Chris Dixon, serial entrepreneur and seed-stage investor: “… You should try to answer the question: what is [...]
[...] 11, 2010 by Peter In general, I agree with cdixon that a startup should raise as much money as possible. However, due to the difference in mentality and capital available, we Europeans might have a [...]