Many founders fail to thoroughly assess how much money they’ll ultimately need to raise from VCs to reach the company’s next inflection point. This is a critical consideration for founders, as it’s closely linked to how much of their ownership stake they’ll have to relinquish to raise sufficient capital. Understanding two concepts will help founders better determine their future financing needs.
Burn Rate. A company’s “burn rate” refers to how much cash the company spends over a certain period (typically monthly), including needs arising from hiring, market shifts, and seasonality. As a high-growth company begins to expand and penetrate new markets, founders and other decision-makers need to make allowances for significant increases in burn rate (e.g., due to greater marketing and business development requirements) to avoid depleting reserves prior to the next round of financing.
Runway. A company’s “runway” refers to how long it can expect its cash on hand to last at a certain burn rate. A short-hand method to determine this figure is to divide the company’s capital reserves by the monthly burn rate. For example, founders of a company with a monthly burn rate of approximately $80,000 USD and cash reserves of $600,000 USD might conclude that they have roughly seven months to close a financing round. In many cases, this may not be enough time to get introductions and build sufficient investor interest, resulting in a less favorable deal or even failure.
It is crucial to consider the company’s projected burn rate and runway until the next major inflection point in order to contextualize company needs. For many early-stage companies, when the burn rate is low and a small fundraise can provide sufficient runway, foregoing a large round with substantial dilution may be a wise decision.
Each member of the management team should be aligned with respect to financing terms that will be acceptable. In a financing led by US VCs, management not only will be relinquishing part of its ownership stake, but often will be expected to provide the lead VC with board representation, managerial control, and authority to dictate the company’s ultimate fate in the event of a change of control. While these requests are standard and subject to negotiation in many US VC deals, a non-US team should be prepared to address and respond to these requests.
If you have secured a meeting with a US VC firm and convinced them to fund your idea, the next step will be to negotiate the actual terms of the financing.
The key aspects of the deal initially will be set out in a term sheet, e.g. the value of the company, the aggregate amount of money being raised, and the board seats the VC will receive. By this point, your financial and/or legal advisors typically will be helping to navigate this process, but non-US founders should still be somewhat knowledgeable about key concepts, including valuation, liquidation preferences, and voting rights. These terms impact management’s influence over the company and understanding them will significantly help non-US founders in their negotiations with US VCs.
For more on this topic see our recent article on negotiating term sheets with US investors.
While the company’s lawyers and other advisors are preparing the paperwork for the transaction based on the signed term sheet, the investors usually will conduct their due diligence on the company. This involves the investors requesting and reviewing key legal, business and operational documents to confirm their assumptions about the business and that no material information has been withheld.
Non-US founders should plan ahead and work with their advisors prior to raising capital to resolve any outstanding issues, particularly in areas that often present challenges for multi-jurisdictional businesses, such as local market employment and intellectual property matters.
Make sure to look after yourself and your team throughout the process of raising money from US VCs. The US landscape is competitive, and for many companies raising funds can be a stressful distraction from running a business. In extreme cases, the stress can cause acrimony among team members and derail progress. Remember to keep the larger picture in mind, and always remember your ultimate goal should not just be to raise money, but to run a successful, dynamic business.
This blog was originally published here.