The Entrepreneur Insiders network is an online community where the most thoughtful and influential people in America’s startup scene contribute answers to timely questions about entrepreneurship and careers. Today’s answer to the question “When is the best time to look for investors?” is written by Jason Cohen, founder and CTO of WP Engine.
Venture funding has completely changed in the past 20 years. If you understand the root cause of the shift, you can create a fundraising strategy that fits the new model.
In the ‘90s, it went like this: Series A funding rounds gave you $5 million just for an idea to see if it would fly. Series B was $10 million to take what worked and build the kernel of a business. Series C was $30 million to start scaling the business.
Today, it goes like this: A seed round nets you $1 million to $2 million if you have an idea, a working product, $50,000-plus per month in revenue, and strong growth numbers. That’s all before Series A.
Why the shift? First, the out-of-pocket cost of starting up a tech company is cheaper than ever. Cloud computing is free at small scale. Social media allows great content to reach millions without fees, so the potential customer base is global on day one. Business processes, like bookkeeping and credit card transactions, are easy and low-cost. In short, starting a business is now accessible to more people than it was before.
This doesn’t mean companies are any more likely to succeed. Fatality rates have not improved. But the number of startups has increased, and that means the absolute number of successes has increased. However, the number of investors has not increased. For the past five years, in fact, the number of deals done by VC firms has been generally flat (around 1,000 per quarter). So the demand of companies that could benefit from funding wildly out-strips the supply of money.
Taking these two facts together, investors can take their pick of the few, best startups. They don’t need to take risks on startups with an idea but no product, or a product but no customers, or customers but no growth.
So based on this type of a funding environment, you can create a strategy for raising money. Going out with a great idea—but without execution or business results—is folly. Entrepreneurs need to buckle down and get that “initial traction” (as the VCs call it) themselves.
But don’t wait until all of your ducks are in a row before you hit the road. As entrepreneur Mark Suster wrote in “Invest in Lines, not Dots,” an investment is a two-way relationship, and relationships aren’t formed with a single meeting, or rushing through a quick process of letters of intent and due diligence.
Investors want to get to know you and the business. They want to see you struggle and overcome. They understand there are always new challenges, so they’re interested in how you acknowledge and tackle those challenges.
Given that, the best time to talk to investors is before you need them. You should be upfront about where the business currently is, but genuinely interested in keeping in touch so you can update them quarterly on how things are going, and even how they might be able to help you along the way.
So, when is that sweet spot? A rule of thumb for a company to claim it has found early traction is revenue of $10,000 per month per founder. This is the point in a bootstrapped company where the founders have quit their day jobs and can devote all of their time and energy to the startup, which is the real fuel the company will need to thrive. It’s also just enough proof that customers exist and will pay the price asked for the product as it is today, and suggests this will continue into the near future.
Very early-stage seed investors will also be ready to invest at this point. Some modern “seed funds” are, too, but those who are really acting like the Series A of a decade ago will want to see revenue more like $40,000 per month to $100,000 per month. However, $10,000 per month per founder is still the right time to make “first contact,” to start the relationship that culminates in your reaching milestones and investors’ seeing that you can accomplish what you say you can accomplish.
Besides revenue, you should also have a specific short-term plan for the money. For example, you could say, “Our $1,000-per-month AdWords budget has been an extremely efficient channel for us. There’s enough inventory available to increase that to $6,000 per month. So we want to put $70,000 into that over the next 12 months. We also want to run experiments with other online services, and then double-down on whichever of those pans out, which amounts to another $70,000.” You can use the same pattern with product development, sales, customer service, finance, and so on. Although no one can see the future, especially with early-stage companies, having a specific plan of how the new investment will propel the company forward is key to piquing the interest of an investor, who needs to believe that “the only thing standing between this company and success is a cash injection.”
Finally, great investors want to help, even when they’re not investing. Great entrepreneurs interview their investors as much as the investors interview them. Forging an early relationship is a way to suss out both sides of that equation.
Then, when you have your traction, you already know who you want to invest, and they already know the feeling is mutual.
That’s how the best relationships are formed.