Raising capital for your startup can be a daunting task. One of the critical questions founders often ask me is, "How much capital should I raise?" Calculating the right amount of capital is crucial for ensuring your startup has the runway it needs to achieve its goals without running out of funds prematurely.
The amount of capital that pre-seed startups raise can vary significantly depending on the sector or industry they operate. While there is no fixed range for pre-seed capital across sectors, on average, a pre-seed round ranges from $100k - $1M for a 5% – 15% equity stake. This should provide you with enough runway to develop your MVP.
In this guide, we'll walk you through the steps to determine the optimal amount of capital for your pre-seed round.
1. Calculate Monthly Operating Expenses:
The first step in determining your capital needs is to calculate your monthly operating expenses. This includes rent, salaries, marketing expenses, software subscriptions, and any other recurring costs. Be thorough in your calculations to ensure you don't underestimate your expenses.
Also, when figuring out your monthly expenses, remember to account for the cost of building your Minimum Viable Product (MVP) if it's part of your pre-seed plan. Developing an MVP can be a significant expense, including software development, design, testing, and potential iterations. Having a clear estimate of your MVP costs is crucial for accurate financial planning.
A useful rule of thumb is that an engineer (the most common early employee for Silicon Valley startups) costs all-in about $15,000 per month.
2. Define Your Runway and Key Fundable Milestones:
Determining the appropriate runway for your startup is a critical step in calculating the right amount of capital needed for your pre-seed round. The runway represents the number of months your startup can operate with the capital you raise.
Your goal should be to raise as much money as needed to get to their next “fundable” milestone, which will usually be 12 to 18 months later, but your specific needs may differ. For example, if your startup requires more time to develop a complex product, an extended runway may be necessary. Conversely, if you can generate revenue quickly, you might opt for a shorter runway.
Identifying key fundable milestones is crucial when defining your runway. These milestones serve as checkpoints that demonstrate progress and attract potential investors. While fundable milestones can vary depending on your business, here are some common examples:
Proof of Concept: Demonstrating that your product or service concept works and has the potential to solve a real problem in the market. This might involve building a functional prototype or conducting successful early tests.
Minimum Viable Product (MVP): Developing and launching an MVP that showcases your product's core features and functionality. An MVP allows you to gather user feedback, validate your assumptions, and iterate on your product based on real-world usage.
User Traction: Attracting a significant number of users or customers to your platform or product. This could be measured in terms of user sign-ups, active users, or early revenue generation, depending on your business model.
Market Validation: Conducting market research and gathering data that indicates a substantial market demand for your solution. This might involve customer surveys, interviews, or pilot programs with potential customers.
Partnerships or Alliances: Securing strategic partnerships, collaborations, or alliances with other businesses or organizations in your industry. These partnerships can validate your business model and open doors to new opportunities.
3. Calculate Capital Needed:
To determine the capital needed for your pre-seed round, multiply your monthly operating expenses by the number of months in your desired runway:
Capital Needed = Monthly Expenses x Number of Months Capital Needed = $20,000 x 18 = $360,000
In this scenario, you would need to raise $360,000 in your pre-seed funding round to secure an 18-month runway. This amount should cover all operational expenses, giving your startup a comfortable buffer.
Consider Contingencies: While your calculations provide a solid foundation, it's wise to factor in contingencies. Unforeseen expenses, market fluctuations, or the need for unexpected hires could impact your financial situation. Some founders add an extra 10-20% to their capital needs to account for contingencies.
Align with Your Business Plan: Your capital needs should align with your business plan and growth objectives. If your plan includes aggressive expansion and customer acquisition, you might need a longer runway or more capital upfront. Conversely, if your business model allows for rapid revenue generation, you may need less capital.
Determining the right amount of capital to raise for your pre-seed round is a critical step in your startup's journey. By calculating your monthly operating expenses, defining your runway, and considering contingencies, you can arrive at a well-informed capital target. Align your capital needs with your business plan and seek advice from experienced entrepreneurs to set your startup on the path to success. Remember that securing the appropriate amount of capital ensures you have the resources needed to achieve your business goals and overcome challenges along the way.
