Understand the Fundraising Market
Do research to find out the typical traction and round size for your stage. That will help you put together a compelling pitch and raise an appropriate amount of capital at good valuation.
Early stage investing turns out to be a very dynamic market, which has undergone many big changes in the last decade - from the birth of super-angels to seed funds and micro VCs to incubators and so much more. Therefore, it is important for entrepreneurs to put some effort into understanding the current state of affairs.
You can do that by talking with people in the industry - founders, lawyers, executives. Or by consulting online resources such as Crunchbase, PitchBook, AngelList, and so forth. It’s not a lot of work, and it pays off to be informed, especially because the market moves quickly and knowledge from just a few months ago can suddenly become obsolete.
Here is what kind of information you should look for:
Traction
The first piece is understanding what investors expect to see in terms of traction at a given stage. That can be harder than it sounds. Startup investing is defined by outliers and accordingly there can be a very wide range of the traction that companies raise with. And yet, there is definitely a general “market” where most companies fall. Here is one example (backup) to illustrate this point and here is another (backup). The more you know, the better you will understand how to put together a compelling pitch.
Don’t forget: early-stage fundraising is a mix between hype and traction as explained in Is the Business at a Fundable Point?. I discuss that topic further in Phase II - Fundraising.
Funding Round Sizes
Another priority is to know current valuations and typical amounts raised for your stage. I have personally seen seed rounds go from $300K to 500K to $1M to $4M in the last 10 years with valuations increasing accordingly. These are large differences so even if you have raised in the past, it still makes sense to learn about the present.
Don't Raise Too Little
I see some entrepreneurs set to raise a very small amount, say a $500K seed round when the typical round is $2-4M. They operate with a faulty assumption: namely, that it is easier to raise less money. That’s certainly not the case. Raising capital is hard work regardless of how much you are raising (barring the exceptional cases where you can go to someone you know and they just write you a check and you are done - but then you don’t really need the Fundraising Lore).
Another common justification for going out to raise small rounds is that the company doesn’t need a lot of capital - so why raise more? That’s also an incorrect assumption. Fundraising takes a lot of effort and time, and the very act of raising capital creates need for more capital as explained in Why You Need a Strategy.
Don’t fall into these traps. Otherwise, you run the risk of entering a vicious cycle, where you don’t raise an adequate amount and/or discredit yourself as an inexperienced operator in front of investors.
How Much to Raise at What Valuation
My advice is to understand the typical funding round range for your stage. Then open your fundraise at the 50th percentile with the goal of closing at the 80th percentile. Here is an example: if the typical seed round is $2-4M, then say you are raising $3M and aim to close around $3.5M to be oversubscribed, which always has a nice ring to it. I talk more about the mechanics of this bidding up process in Phase II - Fundraising.
As explained in What Can the Market Bear, you will need to reconcile these numbers with what your company needs to succeed. As per The Purpose of Fundraising, typically, you should be setting out to raise 18 + 6 + a buffer. That is, 18 months to achieve the next milestone, 6 months to raise the next round, and a buffer because everything always takes longer.
Combined, these two factors also determine your valuation. That’s because how much you sell per round is largely fixed and determined by the ownership target of VCs as explained in Company / VC Fit. That is, typically, you will be selling 15-20-25% of the company in early-stage rounds. Your lead funder will take 10%, with the rest going to the rest of the investor syndicate. Working backwards and taking into account the amount you want to raise, based on the funding market research you did, you get your valuation.