Fundraising & Valuations
14 mins listen

5th Nov, 2019

Fundraising & Valuations

Salonie: Hi and welcome to Matrix Moments. This is Salonie and I am here with Tarun Davda, Managing Director at Matrix Partners India. Today’s episode is about fundraising and valuations which is incidentally a topic that we have actually received and a lot of queries and comments about on social media specially since Avnish’s episode on "Making sense of valuations."

Tarun, how should founders - and this is something that I know a lot of founders kind of struggle with or have actually asked us specifically that when they are coming in at the early stages, how should they decide how much money to raise at that point.

Tarun: Thank you, Salonie. As you can imagine, this discussion comes up very often with our portfolio founders. And, I am going to share at least how I think about it and what advice we give them. I think at the outset like every business balances growth and profitability, fundraising also needs to be thought about as a balance between dilution and being well capitalized. And how much capital you need is a question that the founder first needs to spend time thinking about before they even start discussing with VCs.

Raising too little means that you are going to be in the market too often to fundraise. Or worse, you will run out of cash. Raising too much comes with all sorts of issues. There’s lack of discipline. There is too much dilution for the founding team. There is over valuations where one can’t justify the price to the next round investor. So, I think the rule of thumb is don’t raise too little, don’t raise too much.

And I know that’s too broad, but I think the rule of thumb that I ask founders to follow is how much capital do you need to execute your plan for a clean 24 months assuming that it takes you anywhere between three to six months to fundraise that’s basically giving the team enough runway for 18 to 24 months to ensure that they are able to show meaningful progress before hitting the market for the next round of fundraise. At the same time, it ensures that the team isn’t constantly distracted by the activity of fundraising which does tend to happen a lot.

When you look at competitive sort of market, there are companies which operate in highly competitive dynamics where there is a huge premium for who ends up becoming category leader. And in such cases obviously the competitive dynamics will inform how much you raise and when you raise. And it’s harder to predict and say that say listen, I am going to be on this 18 to 24 month cycle of raising capital. And at that time very often the advice is raise as much you can when you can, essentially see money, take money.

But, I think also understanding what kind of market you are operating in makes a big difference. So for example if you are operating in a market where capital can help you scale disproportionately, I think it makes sense to raise as much capital as you are able to access because to the point I made earlier if you are able to use that to get category leadership, more capital will get concentrated in that company, which will most likely help the company scale even faster and more capital then sort of chases you.

It’s not always the case. Obviously, it needs to be followed up by execution, but capital being one of the sort of fuel does become important. On the other hand if you are in a market that isn’t necessarily growing fast, doesn’t have the network effects which basically means that the business model is more linear, raising too much capital can actually cause more harm than good because your company is over capitalized, investors are looking for generating a IRR on the investment, start pushing you for growth, you start doing things that aren’t scalable, potentially start destroying economics of the business. So raising too much in those situations can actually result in your company being significantly worse off. So I think understanding what is the right number for your business is very important.

Lastly - and again I say this to all the founders that I meet, control what you can. The market determines the valuation, but founders should focus on dilution which is how much money is available at that price. And what matters at the end is how large of a company you are building which is the size of the pie. But also, what percentage of that pie you own.

And so I tell this to all the founders which is valuation is vanity. That number is going to keep changing with every round, but what will not change is the percentage of ownership. And once you dilute it, it’s unlikely you are going to get back that ownership. And so diluting too much too early can result in various issues down the line. And so, control what you can which is the dilution and how much money can you raise at that dilution.

Salonie: So what are the typical dilutions that you have seen at seed, series A and then of course B? And does this differ across sectors? And truly if you were a founder sitting across the table and if  you had to decide how much you would take in terms of dilution at these stages, what would be acceptable to you, not as a VC but as an entrepreneur?

Tarun: So I think at the outset all of us know and we have covered this in other podcasts, is early stage valuations are as much art as they are science. There is no one size fits all. A lot of it is a negotiation between the investor and the founder. Typical seed checks in India today are anywhere between maybe 0.5 million to a 1.5 million or so. Somewhere in that range.

Typical series A checks continues to be in the 4 – 7 million kind of range. Typical series B checks are anywhere from 8 million to 20 million or 25 million even depending on how much progress the company has been able to make. And obviously there are always sort of outliers. So, if you are a repeat founder, if you are a successful founder, if you are senior executive that’s worked at one of the successful startups, you will end up raising much more capital and the check sizes will go up. But, the numbers I have given you are more sort of the 80 percentile sort of median.

Dilutions I think have also stabilized. So dilution at seed rounds maybe of a million dollars or so tend to be in the 15 to 20 – 25% kind of range. Dilution for series A round is in the 20 to 30% range. And dilution for series B rounds is again 15 to 25%. Now I know the obvious question is well, this is a fairly wide range, so who determines what’s fair. Like I said earlier, it’s a negotiation. The best companies end up raising at the lower end of dilution in the range that I provided.

If there is a competitive dynamic to the round that’s almost always the case where you end up raising more money for lower dilution. If, however, the fund raise has been hard and there isn’t enough interest, investors tend to have more of a say in the valuation and the investor that is investing in your round tends to have a bigger say and likely will want to put in slightly lower amounts of capital for getting ownership at the higher end of that range.

And so that’s basically what decides valuations at the early stages. I guess the question that founders like I said earlier should ask themselves is how much capital available at that dilution.

So if I were to – you ask me what would I do if I was on the other side, I would start with saying A) I need so much money to execute on my business plan for 24 months. Is that much capital available at a dilution that I am comfortable with? Let’s assume I have decided that I want to dilute no more than 15% or no more than 20%. I will first figure out that, listen, I need x million dollars to execute on my business plans to get me to the next milestone whatever that milestone may be. It could be a revenue milestone. It could be some other PMF milestone. It could be whatever. So I will start with saying, hey, I need this much capital. Is that available a dilution that I am comfortable with? If the answer is yes, great. If the answer is no, in my mind what I would do is actually say how much dilution am I willing to take today and what capital is available at that dilution. And maybe that number is slightly lower than what I had in mind and that’s fine, I would most likely revise my business plan to then execute with that amount of capital that’s available because like I said you can reverse multiple things. You just can’t reverse dilution. Once it’s done, it’s done. And that’s what we guide our founders saying that, listen, you have to draw a line in the sand somewhere and understanding what you are optimizing for is what one should be – understanding what you want is important before start the fundraise process.

Salonie: And as a founder how do I know that I am raising money at the right price? Is there like a formula or is there like some sort of - I don’t want to call it a formula, but is there like a method to know if this is how much capital I am raising, it should be exactly at this price and nothing less or more?

Tarun: So that’s the mystery of early stage fundraising. Look, here’s the way I look at it. One should aim to create at least 10x value relative to the capital that you have raised. And I will tell you where I come up with this number. But if you see the best and the most capital efficient companies the world over, if you take Facebook, you take Uber, you take Slack, you take Appdynamics – you take a bunch of companies, all of these companies at various points in their journey of fundraising were valued at 10x of the total capital raised prior to that round.

So if the company had cumulatively raised 100 million, the next round of financing after that would be at a billion dollar pre or more. Now that’s a great benchmark and great aspiration to have. Not all companies are able to hit that. So if you see a bunch of ecommerce companies where the market is highly competitive, some of them have ended up raising at 2.5 even 3 times of total capital raised.

Now that’s not to say that those aren’t good companies. It just means that the capital efficiency of those business models is significantly lower than what would be required to create a lot of value for early shareholders in the company. And founders will likely need to dilute a lot more to take the company towards a large outcome.

The 10x obviously isn’t science. It’s more of a rule of thumb that I use to understand capital efficiency of companies. Enterprise companies by the way tend to be even more capital efficient. And these are valued sometimes at 10 to 20 – 25 times of total capital raised. So Zoom, which is a company that recently went IPO, raised all of 160 million before going IPO. And their IPO was priced at $9 billion valuation which is 55 odd times total capital raised. Guess what? They are trading today at almost 20 billion valuation.

And so with very minimal dilution for shareholders, the company has actually managed to create excellent value. Like I said, these are benchmarks. Not all companies will be able to hit these benchmarks. But it kind of gives you a framework of how to think about it because otherwise you are just shooting in the dark as you need to know how far you are from what the best companies are able to do.

The other rule of thumb that I have seen companies use and we have advised our companies is that between rounds you should try and aim for at a 3x markup. So let’s assume you raised your last round at 10 million pre, you should aim to make enough progress in the company with the capital that you raised that you can at least justify a 30 million pre-evaluation for the next round.

All these are again just broad benchmarks. And it kind of ensures that there is now value creation for founders and early shareholders in the process. Obviously, the flipside is that the company needs to have made enough progress. You can’t just say, listen, I want these multiples without having enough metrics to back it up. But again the founder then needs to start thinking saying that, listen, I have raised money at a 100 million valuation, let’s say for example. If I need to now match the three times value creation doing rounds and if my valuation the next round that I am targeting is 300 million pre, I need to ask myself with the capital that I have today, am I going to be able to take the company to a point where an investor will be willing to pay me a 300 million. And so, it could be a revenue multiple, it could be GMV multiple, it could be whatever metric is used to value your company at that stage.

You need to then also work backwards. The bottoms up math has to make sense for that investor because otherwise you are not going to be able to fundraise. And so it’s important that when you are thinking about raising capital at that stage when you raised whatever dollars you did at the 100 million price, you have to ask yourself that listen how do I architect my business today such that 18 months out or 24 months out when I go back to the market to raise capital and I want to raise money at a 300 million target valuation, have I built enough in terms of the numbers, in terms of revenue, in terms of GMV, in terms of whatever the metrics that you are focused on, are those at a value that somebody will be able to pay me 300 million valuation. And I think this is often lost in how people think. Everyone wants to raise capital and say, hey, there needs to be markup for my last round. But, understanding motivations for what makes sense for an investor, what makes sense for early shareholders, what makes sense for the founders, I think putting all those things together and sort of constructively thinking about valuations is what – or fundraising what we have seen works best.

Last is, I think whether your startup is leading industry growth is a big determinant of what multiple you can raise money at. High growth companies and category leaders almost always get valued way higher than the number two or number three player. And we have seen that across companies where if you are the market leader, you will end up raising capital at a much higher multiple compared to anyone else or any other company in your space.

Salonie: Thank you for listening. And you can find the transcribed version of this podcast on You can also follow us on Twitter and LinkedIn for more updates.