http://www.altgate.com/photos/uncategorized/2008/08/17/oie_money_tree.jpg A good rule of thumb is to have a financial plan with 18+ months of runway after you raise a round.  That is long enough that you can avoid worrying about raising money for a year while you just focus on running the business.  Any shorter and you’ll find you are back in the market looking for more money after 6 months and are facing a "flat round" in terms of valuation because you really haven’t had time to achieve much.  Note, in some industries (mobile is a good example) you want to have 24+ months of runway (because carrier deals take so long).  However if you raise more then 24 months of money in an industry where things move fast and don’t cost much, then you’re likely just going to watch interest accrue at the stunning rate of 2% in your bank account while kicking yourself in the butt for "giving away" equity at such a low valuation.  That said, raising too little money is a bigger risk for founders because those bridge loans extended by VCs make payday loans and pawn shops look cheap.

Another issue on deciding how much money to raise is related to investor capacity.  Typically angels work for amounts up to about $2MM and then beyond that you need to look for other sources.  Recently I’ve been seeing a lot of financial plans that call for a total investment of $4-6MM which is an odd-ball number for many VCs. 

Why?

Well, if there are two investors splitting the deal (all VCs like to have at least one other professional investor at the table) then you’re talking about $2-3MM each that they’ll be able to invest.  If a VC partner can sit on (tops) 8 boards and all the deals were like this, we’re talking about less than $20MM invested per partner.  If the fund has 4 partners and is investing out of a $250MM fund (pretty typical), then you can see the issue (either the partner has to sit on 24 boards or doesn’t get all the fund invested in the requisite 3-4 years).  Basically they need (on average) to put $8MM in each company.  So if you’re pitching a VC a deal that only allows $2MM, it’s…well….odd and has a much higher threshold to get done (because you’d be "using" up one of their precious board slots).  Why is a board slot "precious?"  Well, it’s really the *only* asset a VC has (and to avoid a rash of comments saying "money" is also an asset, remember, the money in a VC fund is from someone else…the VCs only asset is time).

Now before you head off to change the plan to need $16MM over the life of the company, you have to first make sure that the market opportunity really justifies it.  The conundrum outlined above is one that frustrates a lot of entrepreneurs.  VCs keep rejecting them saying something like, "your business is too small (for me)."  It doesn’t mean it’s a bad business.  [Note: some VCs are smart about how they respond to this.]  So what’s an entrepreneur to do?  Well, one thing to do is to focus on "small" VCs, i.e. firms that are investing out of a $100MM or less fund.  Another is to go for strategic investors or "super angels" or even go the consulting route. 

It is interesting to see how investors are dealing with this "donut hole" between angels and traditional VCs.  It’s becoming a more frequent dilemma (as the cost of building things decreases).  A new crop of funds along the lines of Y Combinator, Kleiner’s iFund and Bay Partner’s AppFactory has cropped up to address this need.  I haven’t worked directly with any of these guys, so I don’t know if they walk the walk, but they certainly talk the talk.  I think more funds are going to forced to do something similar if they want to stay relevant (or go find some other industry to invest in that is capital intensive).