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Sizing the Ask
One important tactical decision when fundraising is determining the size of “the ask”. Sizing the ask incorrectly is one of the things I see founders get wrong most often, and it ends up having a meaningful impact to the fundraising process overall. Telling an investor how much money you are looking to raise seems like a simple and benign question, but it’s actually pretty complicated. A couple thoughts.
First, fundraising is a means not an end. Every fundraise process should start internally with the financing needs and goals that the business is looking to hit. Don’t let the tail wag the dog here. You are better off raising the right amount of capital (and at the right time) and screwing up everything I write below than doing the reverse. That said…
Every ask implicitly suggests a valuation range. Most series A funds are looking to own 15-20% of a company after their investment. Your “ask” then will imply the check size you think the lead is going to write and some sort of pricing expectations. If you are asking for $10M, that typically suggests something like a $25-40M pre. The new investor invests something like $8M (with $2M available for existing investors) , the new investor gets 20%, so $7/20% = $40M post. Conversely, a series A with a $6M ask suggests a lower valuation.
Because every ask suggests a valuation, make sure it is market appropriate. This means not making an ask that is way too big relative to where you are as a business, or way too small relative to the stage of investor that you are approaching. VC’s are typically looking for easily ways to filter out their top of the funnel, and one of the quickest ways to get to “no” is to have an as that is way outside the range of what seems reasonable. That’s why I think it’s important for founders to have allies that will tell them the truth about the reasonableness of their ask based on actual market data. Don’t focus on the outlier examples, usually outliers happened not by starting out with an outlier ask (more on that later). By the way, I notice that founders systematically over-estimate how positively the market will receive their company.
The ask also needs to be investor appropriate. Every VC has a zone they are trying to hit in terms of fund size and ownership. And not every round will fit their zone. A large fund looking to write $10+ checks might not take a company seriously if they have a $4M ask. Conversely, a smaller fund that writes $5M checks will have a hard time figuring out how they are going to lead a $25M round. Most funds can stretch in both direction if they have conviction. But the key is to keep things as close as possible to their likely zone so that they have the opportunity to build conviction. Using a range can be helpful here. I also think that founders that are on the border between pitching really big series A funds and medium sized funds might want to have two scenarios in mind that they can pitch equally well. My rule of thumb is that if the last fund was $500M or more, you can make an “ask” of $15M. But if a fund is under $500M, then keep your ask below that, probably more like $8-10M. Again, there are lots of counter-examples, but that’s my general rule of thumb.
This is very hard to do and counter-intuitive, but my number one advice to most founders is to start out with a lower ask. If you think that you have a good chance of raising a $15M round, make your ask $12M. There are a few reasons for this. First, most founders are overly optimistic about how the markets will receive their startup. It’s a combination of the necessary optimism required to be an entrepreneur plus the way investors whisper sweet nothings in the ear of a founder to maximize their own optionality.
But the second reason is more important. A lower ask is a better approach to get investors interested. Once you have multiple investors that are interested, you can leverage that competitive dynamic to improve the terms and increase the round size. It is true that a lower ask suggests a lower valuation. But I’ve found time and time again that the benefit of creating investor demand more than makes up for this in the end. When investors are in a competitive situation, they can often use check size and valuation to make their offer more attractive. So an investor willing to invest $7M for 20% might improve their offer to $10 or $12M for only slightly higher ownership in order to win the deal. It’s a lot easier to walk the valuation and round size up during a competitive process than is to it walk the valuation down when investors aren’t biting.