When Should I Raise Money?: Key Milestones Ahead of Your Seed Round

At Samaipata we meet hundreds of inspiring entrepreneurs every month, and we thought it was time to share some tips on what to get under your belt before raising seed money.

Breaking the startup journey into stages delimited by fundraising events (pre-Seed, Seed, Series A, B, C…) has become a standard practice. The logic of ‘raising-delivering-raising’ has proven to be the most capital efficient way to finance and build a big business. Ideally you raise the exact amount needed for the next growth stage optimizing the valuation as much as possible and then your business valuation increases as a function of the milestones achieved which allows you to raise capital again at a higher valuation.

Among these key stages in the lifetime of an entrepreneur, raising the seed round it’s definitely a turning point. Although you may have raised some pre-seed funding earlier on, Seed is typically the first time an institutional investor (who presumably looks at hundreds of businesses every year) decides to back your business and gives some sort of preliminary validation to that crazy idea you came up with a few months ago. The magnitude of this feat cannot be underestimated, as less than 0.5% of startups worldwide raise venture capital funds. Furthermore, it also has the romantic angle of being the first time you raise!

By seed round we refer to either the first or the second round of financing of a startup typically ranging (in Europe) between €0.5m and €2m depending on the stage of the company. Here we share some of the milestones that we believe are key to have in place ahead of kicking-off your seed fundraising. For further information about our specific investment focus, in our Founders’ Q&A we answer all the questions about us and how we invest.

OK, but first, why should I raise money?

This is a fair question. Some founders might be able to self-fund their businesses or may decide to operate profitably from day 1. There are also public and private sources of non-dilutive funding like bank loans or grants that can really help founders at the very beginning.

After all, it has never been cheaper to set up a tech company and raising unnecessary capital at a very early stage (and typically at a low price given the stage of the business) can harm founders’ motivation in the mid-to-long term if their dilution has gone beyond market standards.

However, if you are embarking on the journey of building a fast-growing company you will very probably face the need to burn capital at a very fast-pace (and very likely beyond the pocket money you carefully saved to become an entrepreneur, if any). In fact, according to Forbes, 50% of all small businesses do not survive the first 5 years of operations, mainly due to lack of working capital (the overall mortality rate of startups is >90%). Equity funding can help you with this, and can also be a competitive advantage to build defensibility within the space you have decided to launch your venture in. If you’re not sure how much raise at Seed stage, we’ve got you covered in this article.

In the end, it all relates to what you give more importance to: either the size of the cake (your company valuation) or the size of the portion you own (your stake). Resources can help you grow the value of your business (and hence your stake value), but that comes with the cost of progressively selling parts of your stake at a market value somewhat proportional to the milestones achieved.

Clear, I know I want to raise money, so what should I do beforehand?

It’s funny to think that not long ago, the first steps of setting up a business included renting an office, purchasing equipment, investing in servers massively, etc. This will definitely change a lot in the post-pandemic era.

Seed investors take very risky bets. This said, they do like to see a few ingredients in place to minimally de-risk their investment. These ingredients typically are:

1. A Minimum Viable Team (AKA, the “MVT”).
2. A real and sufficiently large market opportunity that is untapped.
3. An idea or how we prefer to call it: a vision with a narrative.
4. A Minimum Viable Product (AKA, the “MVP”).
5. Early traction (this concept can take many shapes) & unit economics.
6. Bonus point: ideally a cap table structure where founders still hold at least 80% of the equity.

Let’s dig into each of these points briefly.

1. Build your MVT

The team (and more specifically the founders) is the cornerstone of a seed round. Given the early stage of the business, and the fact that investors usually can’t build sufficient conviction on the early product or traction, the biggest bet is on the potential of an individual (or a few of them) to build an amazing company. We need to believe the founders can execute the business vision.

The Minimum Valuable Team is typically made up of the founder/s and, although not a requirement, some early hirings. Among the different things investors like to validate in founding teams, we highlight the following:

• Ability to attract talent: this can be assessed based on co-founders and/or early employees recruitment. Having at least one technical co-founder / first hire is a clear nice-to-have for a tech company.
• Short-term hiring plan (draft): basically having a minimum structure of the hirings to be done after closing the round.
• Role split: the sooner you define who wears each of the hats in the founding team the better for company governance (it also shows maturity).
• Ideally, early signs of founder-market fit: this can stem from previous experience in the industry and/or as an operator, or by meeting some of the necessary soft/hard skills (theoretically required) for a given vertical. Another early indicator of this, especially in B2C businesses, could be that as a founder you personally represent your target customer, giving you relevant information to build the product.

2. Validate there’s a Real and Big market opportunity that is untapped Now

VC portfolios follow a power law. This means that typically 80% of the returns of the fund are made by 10–20% of the portfolio companies. Given the high mortality rate of startup investing, VCs typically invest assuming that every single investment could at least be a fund returner (this means that the value they will obtain at exit based on the stake they hold at that point equals at least the size of the fund). Thus, VCs aim at investing in companies that can generate massive returns and this is directly related to the total addressable market the business is pursuing. Make sure the market you are running after is either large enough today or has the potential to become a huge market in the short-to-mid term (and you have several proof points to validate this hypothesis by the time you raise). For this purpose, we encourage you to do some research on the market need, size and dynamics (e.g. YoY growth, competition, concentration, etc.) as it is key to assess the long term viability and defensibility of your business. We highly suggest speaking to target customers very often, as best practice.

Make sure you differentiate between your go-to-market service addressable market (AKA, the GTM SAM) and your vision total addressable market (AKA, the Vision TAM). The first comprises the market size of your initial target market, while the second accounts for the entire market covered by your vision product.

In addition to the latter, investors are also highly driven by the time-to-market. One of the first questions you will probably get will be “why do you think now is the right moment to launch a business like yours”. We like to see tailwinds and market incentives that give a ‘raison d’être’ to your idea now vs. 5 years ago or in 5 years time.

3. Be ready to inspire with your vision!

We can all agree that investors like to be compelled. This is definitely very connected with the founders’ profile and their ability to pitch their business. Having an idea of what you want to build (your vision) and being able to convey a clear narrative about it is key. Disclaimer: do not confuse having a clear narrative with a ‘B.S’ story leveraging unnecessary buzz words (it will probably have the opposite result on investors). Some quick tips for this:

• Think BIG: remember that you plan to change the world!
• Show strong conviction (but be open to listen and learn): investors back autonomous founders that are able to take inputs into consideration.
• Be careful about confusing vision (long-term) with go-to-market strategy (your short-term trojan horse): Uber is a good example of this. They started as a premium limousine-like service in San Francisco (GTM SAM) to then scaling and becoming the operating system for everyday life (Vision TAM) moving people, goods, cargo, etc. A clear go-to-market shows focus.

4. Build your MVP (or at least a draft of it!)

Raising seed funding being pre-product has become more and more common lately. However, it is still an exception to the rule if we look at the overall market. Having at least a version of your product ready for commercialization is a key milestone.

While you will often hear that seed funding requires early ‘product-market fit’ (AKA “PMF”, meaning you’ve managed to nail a series of features that match the needs of a niche audience and already generates purchases), we see PMF as a continuum happening throughout the first years of the startup lifetime and not as a milestone reached at a given point (e.g. you wake up one day, or you finish x product development sprint and you have magically reached PMF!). Here are some of the ingredients that you should have in place:

• A first version of your product: desktop/app software interface ready-to-use. Quick tip: mockups or Figma demos don’t apply!
• An easy and structured product demo: with a detailed description of the solution as it is today.
• Keeping your product simple and targeted: be careful with over-engineering/building features prior to selling and gathering customer feedback.
• A short-to-mid term product roadmap: features you plan to develop based on early adopters feedback.
• A product/data-driven mindset: you are obsessed with each and every piece of user feedback and you make decisions based on data (regardless of how rudimentary your initial data infrastructure is).

5. Show some early traction and unit economics to ROCK!

Similar to having an MVP, initial traction is becoming less of a key milestone to raise seed funding. However it can definitely maximize your chances of raising and helps a lot to build conviction about your potential defensibility at scale.

Traction can be represented by different indicators of customer adoption and not only by monetisation (which is not necessarily a requirement). For instance usage metrics are key in B2C products (e.g. active usage) and so are Proof of Concepts (PoCs) closed with prospective clients for B2B platforms. Here are our articles on key metrics to track for marketplaces and for consumer apps and networks. It’s important to note that different businesses have different North Stars, and that these North Stars vary throughout the startup’s lifetime. Here are some quick tips for this:

• Have initial visibility on the business unit economics.
• Have at least a draft of your user/customer acquisition machine (either B2B or B2C): investors want to see if you are minimally able to digest seed funding and acquire users/customers with some degree of efficiency.
• We are big fans of using cohort analysis to identify strong stickiness of your product earlier on. We’d rather see a small but highly engaged user base than a bigger pool with negative MoM retention/engagement.
• Try to keep a linear and positive MoM growth of your North Stars (if your business has strong seasonality, try to dilute the effect to show a real picture of MoM growth).
• There’s a lot of information available online around traction thresholds. We aren’t big fans of these types of bars to reach but they do give an idea of the market standard.

That’s all folks! Here are some closing bonus points

If you have raised your seed funding without these things, congrats! For the rest, keep calm and carry on working on your product and listening to your user base ;) The road is harsh and bumpy but it does pay back at the end of the journey! Let me share with you some additional bonus points:

• BONUS 1 — Investors care about speed and efficiency of execution: they will balance the milestones achieved with the time and cash you have spent until that given point. While there isn’t a fixed rule, we can say the best case scenario is one that maximizes milestones achieved and minimizes time and resources spent and the worst case scenario is one that minimizes milestones achieved and maximizes time and resources spent.
• BONUS 2 — Investors invest in long-term defensibility: at Samaipata, we care mostly about your ability to build defensibility at scale. While defensibility at Seed is inexistent, it’s key to have conviction on why your business will be defensible in the long-term.
• BONUS 3— Plan your fundraising with enough time: fundraising takes time. We suggest you kick-off the process with at least 6 months of runway to ensure your business has enough oxygen until closing the round.
• BONUS 4— Be careful with early dilution: seed investors expect cap tables to be clean with founders holding the vast majority of the equity and fully incentivized for the journey ahead.
• BONUS 5— Learn the basics of fundraising: there are great books, courses and posts available online to learn about VC dynamics. The more you learn in advance the better. Here’s a post with some tips for VC calls.

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‍At Samaipata, we are always looking for ways to improve. Do not hesitate to send us your thoughts. We strive to partner with early-stage founders and to support them in taking their business to the next level. Check out more ways in which we can help here or for all our other content here‍

‍And as always, if you’re a European digital business founder looking for Seed funding, please send us your deck here or subscribe to our Quarterly updates here.