Founders seeking venture capital typically know their target round size, but they underestimate the sales process involved with successfully closing. To make an otherwise distracting and stressful fundraising process more efficient, it’s important to have a target check size.
I’ve seen founders arbitrarily target checks of $100–200k in seed rounds, and $500k in Series A rounds. In this article, I want to explore how to rationally choose a target check size and why founders should probably aim higher.
Understand constraints heading into a roadshow.
Choosing a target check size leads to a more productive process because founders can intentionally spend more time focused on funds that are most likely to be both interested and able to invest in deals like theirs. The target check size should be different for investors that prefer to lead versus those that follow.
In early-stage rounds (Seed, Series A, and Series B), a startup typically sells a 20–30% equity stake, and the lead investor, the one who will set the deal terms, will commonly seek to own 10–20% with their check. That amounts to about half the round — leaving the other half open for follow-on capital from existing investors or for new investors.
Factors to consider when picking a target check size
A target check size should be a function of three variables: the amount of equity available for purchase, the expected hit rate (the appetite of investors interested in the opportunity), and the amount of time the CEO is willing to spend on completing the capital raise (which may itself be further constrained by a pre-existing deadline — such as a closing date).
Founders should be conservative when choosing a hit rate to ensure they have enough conversations to result in the desired target round. Based on our experience, we recommend founders assume a general 5% hit rate.
Lastly, because pitching investors requires so much effort, some founders prefer to give themselves a budget of time to meet a certain number of new investors rather than continue for an indefinite period of time. Usually, this process takes about 50 conversations.
From these three variables, and with consideration for common round structures, we can recommend a simple equation to determine a target check size for a follower investor:
For example, the target check sizes for a typical $2M seed raise with a willingness to pitch 50 investors would then be $400k ($2,000,000 / 2 / 50 conversations / 5% = $400,000).
With the typical Series A being ~$10M and a Series B being ~$25M, for those rounds, the target follower check size would be $2M and $5M respectively.
Minimum Check Sizes
Another consideration should be the smallest acceptable check (i.e., a minimum check size). Setting and accepting a small check requires closing larger checks in the remaining conversations to reach the target raise amount. So, founders should be wary of allowing themselves to chase checks that are too small.
What does the market expect?
Of course, what the market wants matters most when making a sale, so we wanted to check our generalized equation against actual venture capital activity.
Gathering data on startup funding is a challenge, but Crunchbase is pretty helpful for understanding what’s going on in the larger market given it’s a widely used crowdsourced dataset. Nevertheless, when we compared the number of investors that have backed startups we’ve worked with to what’s listed on their Crunchbase profiles, it’s clear that the reporting is inconsistent. To account for this common reporting discrepancy, we analyzed the data from the middle quintile (by the number of investors) of over 3600 early-stage rounds (which we found to be about 3.25 investors per round across Seed, Series A, and Series B financings). Then we assumed the lead investor financed half the round.
This analysis confirms that the typical check for a following investor generally matches what we see working with founders, and is inline with the methodology we recommended above.
For transparency, here’s how I calculated the average check sizes:
Avg Lead Check = RoundSize / 2
Avg Follower Check = RoundSize / 2 / (Avg Investors in Middle Quintile – 1)
What’s going on with that Seed stage data!?
While the simple formula we proposed is a relatively tight fit at the A and B stage, the market is coming in at ~16% higher than expected for Seed rounds. I believe that’s a result of two factors:
- Seed-stage investors are the most often underreported in Crunchbase
- Many Seed rounds are syndicated without a “lead investor” and in such rounds, there is more equity available for purchase to each investor.
So what does all this mean?
The complete a successful venture capital raise, the objective of a founder should be to target conversations with investors who can participate at a high enough level to be worth their investment in time.
Dylan Penn is a Research Analyst at Foundational where he evaluates the strengths, weaknesses, and opportunities of startups seeking to raise venture capital. Previously, he was a co-founder of C4Coin, an environmental blockchain startup, and has experience consulting with parties interested in distributed ledger technology.
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