Planning for a Financing

RE: The Context of Raising Start Up Financing

Money begets money.

Almost every venture capital (VC) backed startup is in some stage of fundraising. Unless you have a business model that sells itself and provides a ridiculous margin of profitability to fuel not only your company’s ongoing operations but also its growth, then you’re probably somewhere in the process of thinking about, smack-dab in the middle of, or (hopefully) closing your next raise. And this makes sense.

Most VC-backed companies are trying to create a brand-new market, or gain market share in an established industry that likely has powerful players or solutions. In order to do this on a time scale that is acceptable for VC/private investors (~10 years from founding), capital is needed to unlock the value of a disruptive opportunity.

Sifting for Gold: find a lot of pebbles, occasionally a nugget

On the other side of an investment, all VCs, whether technically or financially oriented, are ultimately portfolio managers. This means that they manage a basket of investments and determine what to add to a fund’s portfolio. Acting as a General Partner (GP), VCs raise funds to deploy into startups in order to achieve returns (Target: >25% Internal Rate of Return) acceptable to their own Limited Partners, which are usually institutional investors and high net worth families.

VCs understand fully that startups are inherently very risky (90% failure rate), and will spread their capital across multiple companies in the hope of making a Home Run Investment. When VCs finds a company with the right product-market fit (prospective or realized), they naturally ask themselves if it has the value potential to cover the rest of the investments in the same fund portfolio. Additionally, from the outset of a fund launch, VCs will reserve a percentage of capital in order to make follow on investments into their strongest portfolio companies’ further financing rounds.

To better understand some basics on VC portfolio management, the generic economic profile of a successful Seed/Series A VC fund are outlined below:

*IRR assumes 3-Year upfront investment period, and subsequent 7-year straight line harvest period

A lot of numbers and acronyms, I know, but bear with me. The important thing to note above is the distribution across PortCos profiles. Assuming that this hypothetical fund invests in 20 early-stage companies, the vast majority of its returns are dependent on a small number of its PortCos progressing to a successful exit. But this is very hard to do, as you have to pick companies that have scant track records.

Even in the aggressive example above, I’m assuming that a PortCo’s failure rate is 75% (vs. 90%). This scenario helps us operators understand what investor incentives are and what types of companies they want to invest in. More specifically, when they invest, VCs are whale hunting for a Home Run investment that has the potential to pay back the entire fund and more. The one Home Run investment above creates the portfolio’s profit opportunity.

This portfolio-based rationale helps to decode a lot of VC jargon on what they’re looking for in investments, like “thematic moonshots” and “hockey stick growth”. Although few PortCos will be turn out to be ridiculously successful, most VCs will rationalize (at least at the time of investing) that every one of their investments has the opportunity to be a home run. Thus, in order to invest in you, VCs need to believe that the addressable market opportunity you’re pursuing is worth billions in the future, and that your company has the talent and a viable route to unlock value.

At Relativity, we are trying to launch a 3D printed rocket in order to decrease the lead times and launch price of orbital launch services. As you can imagine, this is a highly capital-intensive mission due to a lengthy initial development cycle, and capital expenditures on hardware, equipment, and facilities. And we need all of these things up front before we have a final product (a rocket) that allows us to provide launch services to customers.

Over the past 5 years, we raised $685M across four equity financing rounds with our most recent Series D financing amassing $500M in 2020. This may seem like a lot of funding for a start up, and granted it is. But recall that NASA’s Saturn V rocket that took astronauts to the moon had an inflation adjusted development cost of roughly $60 billion prior to its first launch.

Regardless, our investors ultimately need to believe that the market we’re going after can support our valuation, and that we have the secret sauce to unlock it. Now, having left the company, I can honestly say that I believe in the billion-dollar market opportunities Relativity is pursuing and that the talent is there ;)

Now, back to your financing. Given that you are pursuing VC funding, you have to think long term and strategically about how you tackle value creation. Of course, the why and how much to raise is contingent on your business model and what it will take you to go from zero to one. But with financings, typically there are some questions that every venture backed company at any stage needs to answer and gain internal consensus on prior to a raise:

  1. Signaling: What can we accomplish before our next, next fundraise?
  2. Use of Proceeds: Why are we fundraising?
  3. Size of Round: How much do we want or need, and how much are we willing to give away?

Fundraising is a time intensive and distracting exercise. Finding the winning combo of answers to these questions will help smoothen out the rest of your fundraising in the future months and years. I outline my perspectives on the questions above in the following posts:

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