Defining the optimum amount of capital to raise

Just how much is the right level of investment cash to raise, and what determines it?

I have talked before about the challenges of deciding when to move from friends and family finance to more ‘professional’ sources, and some of the pluses and minuses of that.

Clearly, one determining factor that leads to pursuit of professional sources, and I hope to the many benefits of having the ‘right’ investor on board, is the quantum being sought given the typically finite resources of friends and family. But exactly what that quantum should be is an important and non-straightforward conundrum.

Forecasting the profit and loss of any business is difficult. But, for an earlier stage or rapidly growing one, it is particularly challenging. If not enough cash is raised the opportunity costs may be high, but if too much is raised too early the dilution will be unpalatable.

We spend a considerable amount of time with companies ahead of investing in trying to work with the team to accurately assess the best number to target.

Of the many factors driving that decision, there are two countervailing principles that are worthy of comment. The first is contrary to the old adage of ‘a stitch in time saves nine’, and the other potentially supports it.

One key factor in driving the quantum is how far ahead to look, and how much growth to assume to make certain of capital commitments.

Ideas above your own station

Frequently this is further complicated by ‘savings’ that can be achieved by investing early for growth. Take a retail business requiring warehousing space as a simple example. Often price per square foot gets significantly cheaper as the scale increases if committed to up front, and additionally extra space may simply not be available x years down the path necessitating the inconvenience and disruption of a move if available capacity is exceeded.

The obvious temptation is to overcommit on space to capture the saving once growth comes through, and for the convenience of not moving if performance is stronger than expected.

However, we have witnessed many businesses that have ruined prospects by overcommitting for the future and instead only achieving an unsustainable overhead cost before ‘the future’ is reached.

Clearly there are many situations where such future-proofing is essential, but we often find that accepting that it will cost more if you wait until you get there can be more appealing than it first seems.

If you do indeed get ‘there’ (i.e. the targeted growth has been achieved or exceeded) you can likely afford the premium overcommitting early. Conversely, if you look too far ahead, the overheads may sink the business before you reach the point to enjoy the ‘saving’.

In such situations, the optimal capital raise can often be less than was originally conceived if the level of capital being sought initially risks such overcommitment.

Time over money

The countervailing point is the time and management distraction of raising capital. Whilst all capital providers seek to minimize this, a fundraising round will inevitably mean a period of time when some portion of the senior team’s time has to be spent on non-core activities.

Whilst this should bear considerable fruit when completed, it is an exercise that should be undertaken as infrequently as reasonably possible. Accordingly, establishing a quantum that allows for ideally at least 24 months of growth initiatives without returning to the fundraising process should be sought; not in order to overcommit as above, but to correctly support growth as it arrives.

Whilst this may mean raising slightly more than initially considered, if balanced correctly, lack of management distraction on further fundraising will more than compensate a little extra dilution.

See also: Warning signs when raising capital from external investors

Related Topics

Raising Funds