HQQA002 What will be your use of capital? How will you spend it?

What they mean

Literally, how are you going to spend my money and why?

If an investor is going to give you money they very much care about how you’re going to spend it. Yes, you’re going to complain that investors think you have a crystal ball and can see into the future and become preoccupied with the exact number. Your numbers will be wrong, they will never be right. The key thing is that they can look stupid, and this is what you want to avoid.

You very much need to know what you are going to do with every Dollar (broadly!). VC cash is super expensive, so you better need it for a reason. Otherwise don’t raise!

Your financial model exists to show that there is logic as to how much you’re going to spend and where specifically and when. You add commentary as to why? Your financial model can be very important. Read this for more.

Since you will never be sure how much exactly you should raise and how much you can raise, it is best to think of the upside and downside case for the amounts you can raise. Pick a baseline number you are pitching and discuss around that. Don’t make it sound like you picked a number out of the hat. Your number came from a financial analysis and what you need to achieve defined milestones.

Understand that raising is a game of pass the parcel. Your angel may not fund your seed, and your seed may do pro-rata, but they may not be able to lead your A round. Your seed investor almost certainly won’t lead your B-round, unless they are huge like Sequoia. You need to think critically about milestones and positioning yourself to raise. Say, in SaaS. the magic ARR (Read: ARR Monthly Recurring Revenue explained for SaaS startups) number is $1.5m to get an A-round. You have to do that. So when you are communication how much you are raising you can be an insider and say ‘we know we need to get to $1.5m ARR at our A. You agree? Therefore our execution plan will ensure we get there or exceed that. Anything lower will jeopardise that.’

I typically recommend that you go to investors asking for less than you actually want (the min you need) to make sure that you can actually raise the amount you asked for. You can often raise more than you asked once investors like what you’re doing and see the compelling logic of you growing faster by raising a larger amount. You, therefore, need be prepared for how you will spend that $500,000 you need and that million dollars you want.

I was raising money for a startup in Asia. The founder wanted around a million. We asked for $500k. Once investors got interested they actually said ‘you know what, you could achieve a lot more if you raised more money!’ We agreed. She ended up raising around $1.7m.

In the 50Folds financial model templates, there is some fantastic source and use charts to help you answer just this question. There is also a free source and use runway calculator.

There are always only three buckets to communicate: staff, marketing and other (typically your G&A). If you are tech heavy, then you might have a fourth box for developers. If you need to get into more details about how you are spending cash, I wouldn’t answer directly, I would talk about the drivers such as you need more marketing spend with a CAC of x$ and this will get you y customers, therefore you need to hire more customer success staff and care to support the users, as well as maybe the server costs etc. Make it seem like you are doing a model in your head and you know how everything is connected! You do not need to talk about your SaaS spend and the number of pencils you are going to purchase. Don’t bother with that level of detail when modeling your financial model.

What you need to say

“Let me tell what the key drivers are of our business. We deliver a fantastic product by hiring exceptional developers who are typically not the cheapest of people these days. The more features that we are able to integrate into our product, the larger the addressable market size.

Our primary go to market strategy is via paid marketing, specifically SEM. We, of course, build in referrals to get earned customers, but we are going to scale through that channel. Our customer and revenue growth is therefore proportional to the amount that we allocate to marketing spend.

As for any startup, there are always trade-offs; should we be spending more on the product, or should be spending more on marketing. There is no point in spending a lot on marketing if we don’t have a great product and there’s no point in having a great product if no one finds it!

If you look at our sources and use chart you can see that we spend approximately 30% of funds on developers, 40% of funds on marketing and 30% on G&A. Our G&A base is relatively stable so we flex additional funds raised to marketing and product depending on the raise.

Our base plan will get us to $1.5m ARR with a churn rate of 2.5% monthly. We think that our raise will get us over the mark, but we would like to have more than our minimum to make sure we are attractive so the raise happens.

Our current plan requires a $500k raise, but we clearly have plans for what can be achieved with a larger raise. We’re chatting with investors to see what vision they are aligned to. What are your thoughts?”