Ideally, the entrepreneur should bring in the right amount of funds into the company at the right time. So while the first rule of thumb talks about when is the right time to bring in a certain type of fund, the second rule guides the entrepreneur as to how much should be raised at each of the different stages. Mr Inderjit Singh – The Art and Science of Entrepreneurship In order to get a good valuation for themselves and their investors, entrepreneurs need to raise funds based on the value created in the company already and how much money they will need to run, till the next round of fundraising. So it will look something like this:
|Valuation = Current Value of Company + Funds Needed to Run the Company (for X amount of time)|
The aspect we need to look into today is the amount of funds needed to run the company. We raise funds to help facilitate the start up and growth costs incurred by the company, before we are profitable to cover our costs. This could take a while, especially with new companies. To get the company going, there will be need to for funding to waylay the costs of setting up, producing the products and making sales. So the first thing to do is to calculate what you would need to run the company for a certain period of time. At this point looking at your timeline you may gauge that it will take you perhaps a year to get your product to market and to sell enough to break even. At the same time, you look at your costs to see how much you will need. Lets say hypothetically, to start and run a pen company, it may take a $100,000 of expenditure in a span of a year, before the company has sold enough to make a profit. Since there is no guarantee of success and there may be problems along the way, we may start by raising a bit more money. So for this case, there could be manufacturing or even logistics problems that could cause delays. Keeping these problems in mind and allowing for some flexibility for the company, we will put a buffer of $50,000 when we are raising money. This will help us to keep manufacturing for 6 months more, giving us time to stabilize the company with cash inflow from sales or to raise more funds for the growth of the company. We start raising early because firstly the process takes time and secondly if we raise it late, especially when we are in need of money urgently, we leave ourselves open to being taken advantage of. There is nothing easier than to take advantage to squeeze a desperate entrepreneur. When Investors see that they will suddenly start offering new terms and conditions, or they will give very low valuations, so that they can get a larger share of the company by paying less. The whole entrepreneurship game has to be played very calmly. You have to ensure that you never are cornered or are making decisions in a panic state. That is where you will stand to lose your control over the company. In order to gauge how much buffer you need, it may be good to follow this rule: It takes twice as long to execute the plan and raise twice as much money as shown in the business plan. By doing this, we give ourselves the time and space to raise the money needed to get the company running and profiting. It is always good to have some cash in hand, so that you can make some last minute decisions easily, or you can rectify any mistakes quickly. Having some cash also gives you the confidence to take bigger decisions, not having to worry about scrimping on cash. So the best thing to do is to raise double the amount of money you think you will need.