Calibrating the Capital Raise
by Liam Pisano
“How much money are you looking to raise?” A question heard at the end of nearly every early-stage entrepreneur-investor conversation. More often than not, the response separates the wheat from the chaff in terms of those ready to raise institutional capital.
While there’s no right answer, the need to be directionally correct can be tantamount to success. A figure that outweighs the need for the Company is looked upon as out of touch and needlessly dilutive, and a figure too small can be seen as lacking ambition and dispels dreams of venture-like returns. A well thought out answer that is aligned with market conditions is a sign of startup financial maturity. Of course, there’s nothing that automatically triggers a wire on funding, but there is a way to navigate this question.
Here at EduLab Capital Partners, we are focused on investing in early-stage companies focused on learning and training technologies. Traditionally, EdTech was a sector painted as “slow” due to long sales cycles and a delayed digital transition that stifled innovation in and around the classroom. However, over the past five years as the digital conversion accelerated, an influx of invested capital and entrepreneurial success stories have chipped away at this perception.
Recently, the COVID-19 crisis has further thrust the spotlight on a once-sleepy industry. The pandemic has turned many EdTech products from “nice to have” into “need to have” in schools and living rooms around the world. For the entrepreneur building a business in the sector, this has created a new sort of dilemma. Recent success, whether it’s sustainable or an anomaly, has generated significant investor interest. Sales trends that can be amplified with an unplanned bridge round have become the relative norm.
For once, the EdTech entrepreneur can realistically ask themselves: how much “should” I raise, instead of, how much “can” I raise? A positive development, but a problem nevertheless, especially if this environment is not here to stay.
Our Fund’s initial investment entry point is at the seed stage. It is often the first institutional capital after friends, family, and accelerator money has worn thin. A typical capital raise where we invest ranges from $1M — $5M. We look for an innovative product in the marketplace with traction, a sizable TAM (Total Addressable Market), and a solid and likable team to work with, among other metrics. We also look for a responsible and well thought out plan for use of proceeds. This can take a little bit of gravitas when it comes to leadership.
As an entrepreneur, a raise of $10 million when you only really need $3 million might sound like a headline in the making. After all, cash is king, right? However, at times it’s often the first signal of an overreach that can be internally systemic.
In some cases, it’s a sign of bad judgment to come, which is a constant concern for an early-stage investor. A fat bank account does not make for a profitable business. And a sudden influx of investors and opinions can be confusing and disruptive, and not the good disruptive that is often referenced in tech parlance. With that said, we are very aware that cash ensures security, and that’s important. If the market will bear this overreach, shouldn’t security that allows for experimentation be a good thing?
In many cases, in the eyes of an investor, the answer is no. If disciplined cash conservation and planning seeps into the DNA of a Company in the early days, it’s tough to eliminate. That’s a good thing. Minimizing dilution, spending what you need and not what you want, and carefully plotting out when it’s time to step on the gas in terms of sales and marketing. Again, these are all good things. An entrepreneur who can clearly and concisely communicate why they are raising capital and what it will be used for quickly checks the high-level box of fiscal responsibility. This isn’t to say big ideas don’t need big money, they often do. But they need it at the right time. Finding a CEO who has a sense of that timing is part of the fun of early-stage investing, where you often invest in people as well as ideas.
In a time of relative irrational exuberance within our industry, many might say raise while you can and worry about it later because investor sentiment can sour quickly. As a long-term investor in the sector, I’d argue that much of this change is here to stay. That’s not to say we’ll be watching our children complete their education at the dining room table in five years, but we will be looking at a changed classroom experience.
While remote learning is in no way perfect, it does have merit and there will be a digital transition for a percentage of the day because of this crisis. But none of this changes the need to carefully plot growth and plan accordingly. My counsel is to choose wisely and over-explain every need for capital.
And good luck. As a father of two boys aged 8 and 4 who sit at our dining room table in a virtual classroom, we’re counting on you.