The Art of Startup Fundraising

By

Alejandro Cremades

Read in
December, 2020
My rating:
6
/10

Summary

For a layman like me, this was a helpful ready reckoner covering the ins and outs of how startups work from a financial point of view. I don't have a startup but I do work with them, so an understanding of some of their tensions was covered quite helpfully. Straightforward to a fault and more of an instruction manual, but useful all the same and a very quick read.

Notes

Fundamentals

Before trying to get too much money in the door, have a working product that people are paying for. Being able to show you already have revenue is a powerful thing.

Eventually, look to merge your business plan with your fundraising plan and tie this to key milestones that you hope to achieve:

  • Idea conceptualization
  • Market research
  • Business plan creation
  • Testing the waters
  • Finding your cofounders
  • Making key hires
  • Building a board
  • Prototypes and beta testing
  • Launch of a minimum viable product
  • Expanding early adopters and users
  • Gaining revenues
  • Proof of demand and potential for scale
  • Breakeven point

Be sure to know what your potential investors do and don't want. It's important to remember that they are not buying your product or service—they are buying a part of your business.

Make sure there is some way in which you are able to beat the competition, otherwise why would they give their investment to you and not them?

  • Sales
  • Profit
  • Social media
  • Growth

'Note that investors will be more interested in organic growth. This means building channels that give you traffic without having to invest capital in order to acquire users.'

Storytelling is incredibly important and helps evoke the human side of what you are doing. More importantly, it's something you can sell. Stories:

  • The story of the company
  • The story of the product
  • The story of the customer
  • The story of the brand
  • The story of the founder(s)

'Many entrepreneurs unfortunately overlook the value and importance of storytelling, and focus on technical info, which investors and consumers simply can't relate to. It doesn't matter how great your invention or innovation is if people can't relate, and if of you can't speak their language.'

It's better to have 2-3 founders than be a lone wolf or a cast of thousands. If you're on your own it suggests that you weren't able to find a co-founder to come along for the ride and, if you have too many, it becomes complex, dilute and opens the door to potential disagreement.

It's important to always be connecting the dots. That is, conversations with investors (or even simply the people that may yet connect you to investors) is about building human capital. If all you want from others is 'just cash' then you won't get very far and people will see your single dimension a mile off. Instead, build connections by following up, nurturing and connecting others together where there is no obvious direct benefit to you. You never know what may follow later.

'Ask for money, get advice. Ask for advice, get money twice.'

Setting Up For Success

Most of the time, investors don't want to invest. They're looking for very particular things and most startups are passed over.

It's not enough to have a great idea, you must combine this with great execution.

You must have a good management team from as early as possible, and this will ideally include legal counsel so that you don't make any serious errors.

Investors will be looking for domain expertise, momentum, press, hype and feel like there is a train leaving the station that they need to board as soon as they can.

Similarly, you should have all your homework ticking away in the background so that, when an investor does show interest, you have the means to back up what you're saying. This should most importantly include a knowledge of what your company is worth, the % you want to sell for what and why.

'There is nothing that turns off investors more than entrepreneurs who say they do not have any competitors. To paraphrase Mark Cuban, at least 100 other people have thought about your idea. The difference is in the execution.'

The Pitch

Your business plan is not your pitch. These are two separate things.

Every pitch will have 1-3 key messages in it. Decide what these are and make sure that everyone in the business is behind this message.

There are three levels of 'pitch':

  1. The elevator pitch - 30 seconds long, clear, authoritative, concise, sparks an interest, about them not us, shows both value and the problem being solved
  2. The one-pager - a boiled down and concentrated version of the deck: clear messaging, key data, the mission, the pitch. Should be powerful and bring a lot of visual impact if possible.
  3. The deck - the long form of the above in two versions: one you send over email, one you present with. Should have some call to action/'ask'.

The pitch deck should include these pages at a minimum:

  • Company purpose
  • Problem
  • Solution
  • Why now
  • Market size
  • Product
  • Team
  • Business model
  • Competition
  • Financials

Absolutely worth investing in good copy and strong design.

Due Diligence

The due diligence stage of investment is chiefly about making sure there is clarity in these four areas:

  • People
  • Product
  • Market
  • The Deal itself

To get to this, a huge number of documentation and evidence is needed and it can take a long time to compile. I won't include the full list here but Cremades recommends you keep on top of collecting these as you go in a clear google drive folder structure.

Sources of Capital

There are a bunch of different places where you can get money from at every different stage, all with their own pros and cons.

Bootstrapping

Making do with what you have and scraping by. You need to get good at the following things if you want to make it work:

  • Guerrilla marketing
  • Budgeting
  • Time management
  • Hiring
  • Growth hacking

Credit cards

Easy to access, but can screw you long term if you aren't careful to make sure you make repayments or if a recession hits and your capital is cut off. Make sure you do the following:

  • Set limits on spending
  • Preset timeline to pay things off
  • Protect your credit score
  • Repay balances

Business loans

Hard to access but can be useful if they're at all available. Most banks don't lend unless you really don't need the money, ironically.

Friends and family

Can be an easier source than most for getting funds, but comes with very unique risks you won't see elsewhere. Faster and often on better terms, but if things go wrong it will make family functions incredibly awkward.

Crowdfunding

Two types of crowdfunding:

  1. Donation based: swap products for cash, keep all your equity. Kickstarter and Indiegogo.
  2. Equity based: more risk, more complicated, less equity. But more money and no need to deliver products afterwards.

Angel Investment

High net worth individuals looking to make a profit and/or some kind of impact

Can bring a kind of 'personal touch' along with advice, particularly useful if they've been in your shoes before.

Oftentimes club together to form 'angel groups'; reduces the risk for each individual in the group and gives a greater capacity to invest.

Family Offices

$100MM+ high net worth families. Often overlooked as a source of funding, but have a lot of money to splash if they're interested.

Venture Capital

Commonly sought but hard to land. Pooled funds with investment from many sources. Most often looking to make early stage, higher risk but high growth potential investments with an exit in the 8yr+ range.

Venture Debt

Like venture capital, but it's...debt. Often linked against accounts receivable.

Venture Capital in Detail

People who work in VC firms tend to be one of four grades:

  • Analysts - most junior. Tend to scout for opportunities and do the heavy lifting analytical work.
  • Associates - Analyst+, has financial background, good at building relationships.
  • Principals - senior, often on cusp of making partner, make some investment decisions but don't set strategy.
  • Partners - build the fund, set strategy, make big investment decisions, manage the firm.

Attracting VC investment:

  1. Identify the right VC
  2. Make a connection (usually with a junior)
  3. Send presentation (to junior, who may kick up the food chain)
  4. Face to face meeting with principal/partner
  5. Wider presentation/pitch to other principals/partners
  6. Decision/terms/due diligence

Investment Rounds

Preliminary Round

Usually this will be sourcing capital from friends, family, your own capital. There are four key goals at this stage in the life of a startup:

  1. Develop and test the concept
  2. Market research
  3. Test viability
  4. Pitch development

Pre/Micro Seed Round

An alternative to the preliminary round if you are unable to source capital from friends and family (precious few can do that anyway). Capital here will tend to come from angels, incubators or micro venture. Limited time to explore viability in this time, often limited to a handful of months. Key objectives:

  1. Product identification
  2. Market orientation
  3. Demographic targeting
  4. Team creation

Seed Round

Similar role to prelim or micro rounds but for higher sums, at higher risk with greater returns expected later.

This type of round existed before micro did—micro filled a gap.

Can take a startup very close to market but not necessarily all the way. You would expect the core team to be in place, though, and the product near as damn it close to being ready.

Series A

This is the first 'major' round of funding - the big cash. Series A should catapult you to market if you are not already there. Main goals:

  1. Increase distribution
  2. Enter new markets
  3. Take business to next level
  4. Fill shortfall to embed self-sufficiency

Funding here will come more or less entirely from Angel/VC.

Series B, C, D and beyond

Like series A, just more of it.

B tends to be for expanding profits and/or market share.

C tends to be for expansion prior to acquisition or IPO.

D and beyond tends to be rare.

IPO - Initial Public Offering

For late stage, well established startups normally around 6yrs+.

Opens the company up to public investment and is a straight capital for equity swap. Can go well, can go terribly.

PR

Good for generating interest for relatively little cost. Brings in customers and investors if done correctly.

Can also be used to vault through a plateau to reach new levels of growth. Can also enhance major events, key milestones and any other major announcements.

Press releases are a good start. Worth building relationships with journalists, bloggers, influencers if that's helpful.

What to Look for in an Investor

Key points:

  1. Know who you do (and don't) want as an investor
  2. Know how to screen an investor
  3. Know how to converse with investors effectively and efficiently

Things you'll want your investor(s) to have:

  • Domain expertise
  • Connections
  • Solid finances

Things you won't want your investor(s) to have:

  • Greed
  • Lack of scruples
  • Intersted in a takeover

Ultimately, they also need to be a human being you can get along with on a personal level. Can you go for a run with them? Get a beer together? If you can't, worry.

Term Sheets

These are basically just contracts that you will have with your investors. Simpler sheets are preferred over complex ones, typically 10 pages in length.

'The term sheet is the document that lays out the terms of the investment and collateral. It details what you as the startup are giving, and what you are getting in return. Then it lays out the guidelines of how both parties will act to protect the investment.'

Commonly included in term sheets:

  • Who is issuing the note or stock
  • Type of collateral being offered
  • The valuation
  • Amount being offered
  • Shares and price
  • What happens on liquidation or IPO
  • Voting rights
  • Board seats
  • Conversion options
  • Anti-dilution provisions
  • Investors rights to information
  • Founders obligations
  • Who will pay legal expenses
  • Nondisclosure requirements
  • Rights to future investment
  • Signatures

Closing the Deal

To close the deal you need three main things

  1. Urgency - lowers the chances of cold feet, means investor(s) are able to study fewer alternative options, keeps legal fees and expenses down.
  2. Completion schedule - working to both a signature closing date and financial closing date helps your investors understand your timetable and means they can't drag their feet for too long.
  3. Managed expectations - keep people updated and make sure they are expecting what you want them to expect.

Common Fundraising Mistakes

Cremades identifies four major mistakes that founders make when raising:

  1. Not building connections or a network.
  2. Not being clear about what you will do.
  3. Not doing what you say.
  4. Self-sabotaging during the deal-making process by changing the terms, setting higher terms than usual, not reading all the fine print.

Red Flags for Investors

Investors will be looking out for red flags when looking to invest. These are some of them:

  • Too many founders - dilute, diverging
  • High overhead - fragile
  • Buzzwords - substance > jargon
  • Other jobs - is this a hobby?!
  • No other income - rash decisions
  • Bad credit - poor track record in the past
  • Blind optimism - unrealistic, foolish
  • 'We have no competitors' - yes you do
  • No technical founders - do you know the nitty gritty?
  • No skin in the game - why don't you have something to lose?

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