Raising Money: 7 Guidelines07.21.11
I recently met with a few startups who are either actively raising a round or about to raise a round a few issues came up that I wanted to explore. Even though this post has "Some Guidelines" in the title -- I posit them more as things to consider if you're raising a round.
In "Inside Steve's Brain" [link], Leander Kahney describes how Steve Jobs likes to have multiple options when reviewing something. While I don't always do this myself, I think this is broadly a good rule. Often, a startup will get strong inbound interest and -- especially if they've never raised a round before -- will feel compelled to go with the first suitor. I think there's also a strong psychological reason to do this -- people don't like awkward / uncomfortable situations and/or turning people down. If a series of conversations seem really positive, it's hard to say, "I'm still talking to other folks." You can have multiple investors in your round and you can have co-lead investors. My point here is to make sure that you have a reasonable assessment of the landscape of potential funders. Who is out there that's interested? What type of terms / valuation each funder offering? What type of value-add (if that's important to you) do each of the funders offer? Most importantly -- it's easiest to get a sense of fit via options -- when you've talked to 30+ potential sources of funding, you're in a much stronger position to understand who would be good to work with and who would not be.
2. Know Industry Norms
Deals vary, but they don't always vary that much. Know what's typical or at least what other companies have done. If you're raising a seed round -- get a sense for how much money folks typically raise in a seed round and at what valuation. Is it $100K, $250K, $500K, or more? How much of the company do they give up? Do they give up board seats? Do they do it as a convertible note or do they price the round? Are there investors that would make institutional investors later shy away because of their perceived quality? This is more art than science, but it's always helpful if you're able to say, "Twitter did this." or "Squarespace did that." or "This YC company did this." Treat other companies' history as potential pathways and guidelines for your own. You can deviate -- but it should be active deviation. It should be where you mentally say to yourself, "I know companies typically do this -- but I'm going to do something different because it's right for my company." The situation you want to avoid is, "I'm not sure what I'm doing but this seems right." or "This investor told me this is what the industry norms are." Do your own homework, figure out what those norms are, and then only deviate when you have a specific reason to. Don't start from scratch.
3. Raise More Money Than You Need
Too many startups I see are too precise with their funding rounds. Let's say they raise $500K when they can raise $1MM. In a round that's priced, this is obviously with the expectation that they can raise a larger round later at a higher valuation -- preserving more equity for the founders and early employees. This is really logical. The problem is that often -- the seed round is one of the best times to raise money. Why? With some exceptions (those startups with exceptional teams / strong brands associated with their teams) -- when you're raising a seed round and have prominent angels, seed funds, etc. interested in your startup, this stage is one of the best stages to raise money. The reason is because the company is all promise. It's a great idea with a talented team. People want to be associated with it. What happens even 6 months down the road is the product is launched and results are almost never as good as what people expect. Then those initial doubts in the investor's mind (Will people use this? Pay for it? How many customers will they need for this to go big? Is this a big enough market opportunity?) -- those all crop up. At that point, the fears become concretized and you're running out of time to build your startup. I like to think growth trajectory of startups like an exponential curve. For those that make it, startups are often on the bottom portion of the curve for a really long time. Customer adoption takes time (just think how long it takes for a new brand to get associated in your mind or how many times it takes for you to hear something for you to try it out). Companies often pivot from an initial idea (see: Groupon, Twitter, PayPal, etc.) It's a fine balance between giving up too much equity at a seed stage and raising plenty of money -- but I like to sleep well at night and not worry about running out of money. Do the math. Figure out what your projected burn rate will be (not current burn rate -- how much it will be after you add more employees following your raise) -- how many months that will give you, subtract 4-6 months to give yourself time to raise a new round -- and that's really how much time you're buying yourself to really work the product. I know most people take way less than this -- but I like 12 months. So that's 18 months of runway if I can do that. Again, that's super atypical, but I like safety and a higher margin for error. As one of my venture capital friends says, "Don't overestimate your ability to execute." I know lots of startups who have had to fire people for the first time because they were running out of money. Those are situations you'd like to avoid.
4. Get Advice
Advice can come from all sorts of places -- but the best place is often quality advice without a vested interest. Probably my favorite place would be other entrepreneurs who aren't active investors. They've been through it before, they're not looking to put money in themselves, and they can tell their own stories about what they did right and wrong. With almost anything, I think you're building a library. A library you can draw upon to figure out what you might want to do and where you might want to deviate. Maybe one entrepreneur you meet mainly did friends and family and for their seed stage, then went out to institutions. Maybe another entrepreneur had lots of inbound interest, took a lead investor, and then filled in the round with angels. There are tons of variants but the good thing about getting lots of advice is you can see what situation makes the most sense for your company.
5. Consider Incubators
There are lots of benefits to incubators (most of which I won't get into this posting) -- but a big value is that it's much easier to raise coming out of an incubator. It gives a defined moment within the investor's mind in terms of what's happening: graduation / demo day. It makes sense you're raising at that point. Raising at other points sort of leaves you like most startups -- seemingly desperate for money. But when you're coming out of an incubator? Of course it makes sense to raise then. It also creates a temporary market -- lots of potential investors know who you are and you can then really gauge market interest. Also, psychologically, there's nothing like demand from others to drive up demand.
6. Social Proof
Think a lot about the idea of social proof. I like to think of this as, "Get your startup to the stage so success seems inevitable." This is in everything. Customers. Partnerships. Investors. Here's an example. I know this sports startup and they've been talking to some major professional franchises. They need to close the first franchise because once they do -- it'll be so much easier to get, at the minimum, meetings with every other professional franchise. That's the value of social proof. Once they have a few professional sports franchises as customers, it'll be so much easier to get major investors. Once you get one major investor... you get the idea. I don't want to use the word "flipping" because that's not exactly what's happening -- but you're always looking for one to get to the next. Look at the really great startups. The ones that have the logos of the New York Times, TechCrunch, Mashable, etc. on their homepage + the logos of major venture capital firms there too. Doesn't it seem like their success is inevitable? Wouldn't you feel comfortable working with them if you're a potential customer? Wouldn't you be interested in exploring job opportunities if you're a great engineer?
7. It's Just Work
Raising a round involves a lot of rejection -- a lot. Some of the meetings are bad, awful, or just rude. No big deal. There are more funders and more people. It's a mental place but it's an important place to get to where you don't place too much value on any one individual meeting. Desperation doesn't sell well -- even if you are desperate. Just view it as work. Make a giant list of what you need to do to accomplish those goals -- and start ticking them off. Take where to find funders. The answer is everywhere. I know that sounds trite -- but whether it's referrals, AngelList, demo day, booths at conferences -- I've heard them all work as potential funding sources.
The last point I'll make on this posting is that raising an initial round is one of those key moments in a startup's life. It's also a very dangerous moment in its life. Making mistakes -- taking on the wrong investors, giving up too much equity, not raising enough money -- all of them can threaten the startup's survival. Be thoughtful about the process.