It’s that time of the year…
At one point or another in your journey as a startup founder you’ll start thinking about raising funding for your venture, which can be one of the most daunting tasks ever to accomplish. Raising funding, if anything, takes a considerable amount of time both for preparing the funding round as well as actively prospecting potential investors and taking pitch meetings. For the first-time founders out there, raising funding may bring about a series of questions which you may not be too sure of. That’s the reason why we’ve decided to write this quick guide tailored for raising seed-stage funding!
We’ll start by looking at the timing for raising capital, how much you should raise and then discuss the fundraising process in more detail. At the end we’ll also cover the funding options you have as a founder along with some concluding remarks on seed fundraising.
When to Raise Capital?
Raising funding generally depends on the stage of your startup as well as your own needs as a business. It’s typical to raise funding once your startup has a solid proof of concept coupled with PMF (Product-Market Fit). An idea turned into an MVP backed by tangible results (be it # of active users, downloads, tests, pilot projects or even early sales) is a good sign to get new investors involved in your venture. The key point here is to build up traction and momentum for your startup. The dilemma for many founders of course is to build up traction without having raised lots of funding first to do this. This can be solved in some cases by bootstrapping and leveraging resources available to startups (e.g. discounts on server hosting etc.). At the seed stage, funding is typically used to develop the product/MVP further and achieve a working model of the business that’s ready to be scaled up. This scale-up or growth phase is what the Series A round is for.
However, all of this should not make you forget the other aspects that investors look for in a deal. Having a strong well-balanced team is the basis for any startup to be successful! Seed investors invest first in the team managing the investment and secondly into the business model and market potential itself. A large market is key and having a new innovative business model that is technology-driven (or enabled) is a must in order to be competitive. Remember, your startup faces competition not only from incumbents but also other startups. No one would be too excited to invest in a startup that’s simply a copy of an older business model as the landscape tends to be very competitive (e.g. mobility or food delivery). Standing out and differentiating your venture from others is important!
In addition, startup founders ought to raise funding when they know what they are missing in order to grow things further and achieve success. This means looking beyond capital alone and asking yourself “what do I need to make this work”? For some it may be expertise in a certain domain (e.g. clinical trials for a new medical treatment or deep knowledge of AI). For others it may be support with recruiting to put a strong C-level team together post-round or gaining access to large industry networks. Knowing what you need both in terms of capital and non-capital allows you to look for smart money and focus your search on investors that can provide what you really need. As any experienced founder will tell you, having a strategy is important but being able to actually execute the strategy successfully requires many things. Investors today are selected based on what they can bring to the table. Gone are the days that investors just invest their money, sit back and wait for the good news (a big exit!). Actively managing the investment and supporting you as the startup founder is a must in today’s landscape.
How Much to Raise?
Once you know when you should raise funding, the next question becomes how much to actually ask for. How much is enough and how much is overdoing it? “How do I find out what I need”? Startups at seed typically raise at least 12–18 months of runway, meaning sufficient cash in the bank to cover not only overhead but also a number of key milestones to be achieved in your roadmap. Achieving these should help you grow the business even further and get you ready for the next funding round potentially. It’s important to also factor in your next round of funding (if you intend to raise again) in order to start raising on time. Raising capital once you’ve run out of cash might mean taking the first term sheet any investor offers you due to the urgency of the situation instead of taking a better deal being offered by another investor that’s a bit slower in their due diligence for example.
Overall, determining how much funding you need is a financial exercise of budgeting your regular costs, overhead etc. as well as your chosen strategy to grow the startup and achieve your milestones (R&D, marketing etc.). Having sufficient financial skills in-house is key for completing this exercise properly as most investors will ask you about the funding amount, your logic behind it and your use of funds (i.e. a % breakdown of how you’ll spend the capital). Not being able to answer such questions properly won’t be a total deal-breaker but does show the need to do your homework better. Quick tip: if you are the founder & CEO of your startup but finance is not your strong suit, see if another member on your team is more skilled at crunching numbers in excel and putting together a financial model — this doesn’t make you any less of a founder. In fact, realizing that you have an area to improve in means you have room for growth!
What Should the Process Look Like?
The main idea when raising funding from investors is to pitch them and get them excited to invest in your startup. For VC’s in particular, as much as you’re pitching your startup it is also somewhat of a race for VC’s to get into the best deals in the market. Investors should also convince you and your team of why they are the best partner for you. Thus, getting a good match between what an investor can offer you and what your startup is looking for is essential for a strong partnership, especially at the seed-stage.
The fundraising process starts by preparing your pitch by putting some documentation together. As a result, any funding round will usually include (as a minimum) a series of fundraising documents, including a pitch deck and financial model. For good measure it is helpful to also prepare an investment teaser (i.e. a one-pager) and a Due Diligence Questionnaire (DDQ). Working on a traditional business plan or business case document can be appreciated by some investors but is certainly not a must-have in the process. There are many formats and templates available for putting these documents together. Getting help in this area is a good idea as it’s important to convey your message in the right way and tell a good story (more on this below). This is especially true for pitch decks as they are the first document investors typically look at in order to get a feel and better understanding of what your startup is about.
When putting the documents together it is also good to think about the terms of a potential deal you’d be willing to agree on. For example, the type of funding round (equity vs debt), % of shares to be sold, types of shares sold (A or B class), pre-money valuation, board seat rights etc. This not only helps in being more prepared to raise funding but also gives you a better position to negotiate from. Once you’ve prepared the details of the round and put some documentation together, it’s useful to set up a data room. This doesn’t have to be something very fancy and can be done by setting up a shareable folder on G-Drive or any other cloud storage platform. The idea is to provide quick and easy access to all your relevant fundraising documentation so that investors are able to review the information and conduct their due diligence. The term due diligence is something you will keep hearing about as you raise funding. In a nutshell it’s a process of fact-checking things and making sure everything presented by you is in fact as such. For instance, saying you have a partnership with a big brand out there should be backed by some kind of written agreement or email correspondence. Some investors are more thorough with their due diligence process while others do a lighter form of due diligence. This tends to be typical for smaller investors (e.g. micro vc’s and angels) but every investor is different so it’s best to be ready for a full due diligence process. Furthermore, it’s good to note that there are different types of due diligence processes, for instance due diligence on the team, technical aspects, financial aspects etc.
With a data room in place, it’s time for the fun part — investor prospecting! Finding investors should be very straight forward. There are tons of platforms and databases out there for discovering investors. As a rule of thumb, we recommend having a set of criteria, for example the stage of investment, verticals they invest in, amount they invest, geography. Quick tip: make sure the investor is actively investing. Most VC’s invest from a fund they raise from LP’s. It might be the case that their main fund is already fully allocated and they’re not investing at the moment, so being aware of this can help save you time and/or manage expectations better.
Furthermore, every investor will have a slightly different investment procedure, be it completing a standardized form or sending an intro email to them as a first step. We recommend following every investor’s procedure as outlined by them instead of trying to “outsmart the system”. If a VC asks you to go through an investment associate, then don’t try to get in touch with a partner instead. VC’s see a lot of deals throughout the year and put together their procedures in order to process every startup that knocks on the door. While a partner might have some decision-making authority, it might be best to convince an associate about your startup first and get them to pitch the opportunity to the decision-makers internally. Partners also tend to be very busy while associates are generally expected to be the first point of contact for startups.
Funding Options?
There is a myriad of options available in terms of the type of funding you can raise. Every option of course has its own pros and cons that need to be considered carefully. Some types of funding are more suited for certain startup stages (e.g. debt financing for a Series A, B, C etc.). In general, seed-stage funding occurs as an equity deal for the most part but depending on the vertical and whether we’re talking about a hardware startup or not, it might be an idea to look into grants, subsidies as well as startup competition prizes. In other cases, a crowdfunding campaign (be it equity or rewards-based) can also be a good alternative for raising seed funding and building the startup further whilst testing new features etc. The same applies for incubator and accelerator programmes that can provide seed-stage startups with lots of support. It’s important to realize that as the startup’s founder, you are responsible for the decisions you make. Therefore, you should be comfortable and convinced about any investor you partner with (be it a vc, an angel or a lending institution). Internal dynamics tend to change as a startup grows and adds a board of directors, a board of advisors or third parties such as accountants and external audit firms becoming part of your startup’s operations. This means managing various stakeholders and expectations as you move along. Having investors that believe in your vision and support you is essential.
Taking a bank loan or closing a credit deal, while unusual, are also options that you can consider. However, realize that a loan means there’s a lack of balance in terms of taking risk. Even if things don’t work out, you still need to pay back the loan plus interest, which is very different from an equity deal. If things don’t work out, then the investor simply loses their investment. While most seed deals today occur as a convertible loan (that converts into equity after a certain date or funding round), doing deals as a loan to be paid from the revenues or profits (Revenue Based Funding) is on the rise and certainly an alternative option to look into!
Concluding Remarks
Realize that not all startups go and raise funding from professional investors. Some founders make do with smaller rounds raised from friends and family and/or grants, startup competition prizes or their own savings. Others bootstrap their way to paying customers that end up funding the venture over time. The type of startup you have can make a big difference here. A hardware startup for example has a lot of R&D costs early-on while a SaaS startup can be built in a very lean way with much less investment. While this is a slower path to growth it is also the safest and most reliable one as a business with no sales will soon be out of business.
If you’re thinking of raising your very first seed round, then make sure you’ve done your homework first. Investors ask questions, not because they want to sound smart but because they want to know why they should invest in you and your startup. Investors see many startups and pitch decks — telling them a clear and compelling story during your pitch is essential for grabbing their attention. If you receive feedback and are asked to follow-up once you have more traction, accept the feedback and work on things further. Remember, one investor’s no might be another investor’s yes so improve what you can and try again. VC’s often invest in founders that remind them of other successful startups they’ve invested in (so that have similar qualities). Quick tip: if pitching is not your forte, then get better at presenting before taking on more meetings. If you’re not good at the financials, then get better as you’ll need to understand the numbers order to succeed.
You can always meet an investor at some event that decides to give it shot with you but realize that this is not the norm — don’t attend more startup events than you need to just to “luck your way” into funding. Raising funding is time-intensive and requires your utmost attention in order to be successful. Getting startup advisors to support you is a good idea as they can take on the fundraising activities while you focus your time on building the business. However, make sure your advisor(s) keep you in the loop of what is going on and that they put you in meetings with investors as soon as these show interest. Investors like to speak to founders directly so the sooner this happens the better. Incentivizing advisors is important — it depends on how much of the work you’re delegating to an advisor and how much fundraising you’re doing yourself. There are success-based models as well as fee-based models. Some advisors only do fundraising and provide intro’s while others do much more. Choosing a startup advisor to support you early-on can be a big asset but make sure you choose your advisors carefully.
N3F Ventures aims to support founders by partnering with them early-on to build sustainable ventures, especially in the financial sense. Our objective is to assist early-stage startups in every way we can — from prototyping and testing the MVP all the way to scaling up the business. While we support founders with fundraising we also like to play an active role in key areas such as recruitment, business development, strategy and marketing to name a few. Feel free to pitch us your startup or get in touch directly via email. Whether we work together or not you can always expect to receive valuable feedback on what you’re working on and improve!
All images in this article were sourced from Unsplash unless otherwise stated. This article has also been published on medium. To stay in touch and receive our blog updates, please follow us on twitter.