As with all business ventures, capital (money) is the most important factor.
Without sufficient funding, no matter how great your product may be, it will fail due to operating costs or lack of market interest.
It is important to understand that fundraising is one of the most difficult and most chaotic processes of building a business.
Most entrepreneurs will enter the market relying on general advice and thinking about fundraising as an easy transaction, rather than seeing fundraising as an organized plan to execute.
There are far too many poorly written online checklists and outdated directories for finding investors. These types of resources do not help entrepreneurs understand how to raise capital because they do not explain how to develop a strategy to raise capital.
Fundraising is about much more than just asking someone for money.
Fundraising requires careful consideration of how to align your growth stage with the right type of financing instrument and the correct type of investor objective.
You must analyze how to structure your fundraising strategy to be able to establish leverage in your funding negotiations.
If you attempt to raise capital without a compelling financial story, well-organized data room, and strategic investor selection, you will not succeed.
The capital markets will not reward enthusiasm; The capital markets reward traction, clarity, and de-risked potential.
This analysis will provide you with an in-depth look at how to structure your complete workflow from "the time you decide to raise capital" until "the time you manage the close".
The state of the market for entrepreneurs raising capital
The current fundraising climate is very difficult for entrepreneurs.
The old approach of just providing a long list of possible resources along with a theoretical approach will not close deals. Investors view opportunities through a risk/reward lens.
Companies that are able to successfully raise capital have developed a well-defined disciplined process.
Companies do not cold-call venture capitalists with a generic emailed pitch deck on their desk.
The success of fundraising within a start-up organization is directly related to how well the organisation treats its fundraising efforts as an essential component to its overall strategy and success, just like any other full-time role within the organization.
Thus, in order for Founders to achieve success, they must ensure that the amount of capital they are targeting at any stage of the company’s life cycle (Pre-Seed, Seed, Series A, Growth) is matched with the corresponding capital provider.
Each time that dollars are raised in connection with any stage of a company’s development, the expectation from capital providers is scaling.
In general, Founders will be successful in raising capital during their Pre-Seed stage based on a strong founder pedigree and an early vision of their product.
During the Series A stage, Founders will generally need to have achieved certain tangible metrics (e.g. Annual Recurring Revenue (ARR) growth, Customer Acquisition Cost (CAC), Churn Limits, Solid Unit Economics) prior to attracting Series A investment.
As a standard rule, Founders will need to have enough capital to fund their operation for 18-24 months before they will reach a positive cash-flow position.
Achieving this goal requires that Founders are prepared and have controlled their capital-raising due diligence process, and understand what investors want to see when they are presented with a deal.
Assessing your company’s readiness for venture capital
In order for Founders to determine whether their company is ready for fundraising, it is important for them to assess themselves and their company in a brutal manner.
Raising capital is not an automatic requirement for building a company.
Several Founders spend several months trying to raise institutional capital before they have reached their current stage of maturity to be ready for fundraising.
Therefore, it is imperative that Founders evaluate their current status regarding their financing options.
When determining whether and/or how to fundraise, Founders must necessarily contend with three major operational issues:
The business’s operating runway vs. ownership dilution
Every dollar raised from any source results in ownership dilution for the Founder.
Therefore, it is vital that Founders are cognizant of how much cash they require to achieve their next major operational milestone compared to how much of the company’s ownership will be required to raise that amount of capital.
Raising too little money means that the business is chronically undercapitalized and is therefore forced back into the capital market before realizing a higher valuation.
Alternatively, if the business raises too much capital too soon in its development, it is incurring too much ownership dilution.
Therefore, the objective of any fundraising effort is to determine how much capital will be required to sustain the business operations over the next 18-24 months while pursuing ambitious growth targets.
Ready vs. fast
One of the most common ways founders fail is by moving too quickly into the marketplace without having enough traction to support their desired valuation.
SaaS founders who want to raise pre-seed funding and have little traction will need to develop an incredibly compelling story with extreme operational clarity in order to compensate for their lack of metrics/data.
If you attempt to raise your first round before you’ve built sufficient momentum, you will irrevocably damage relationships with tier-one investors.
In some cases, the best decision is to pause, delay fundraising for a while, significantly decrease your burn rate and generate positive traction before attempting to enter the market for investment.
What investors are really investing in is momentum. Without that, speed means nothing.
Control vs. strategic value
While capital is a commodity; the source of capital is not.
Founders must determine whether they are seeking pure financial investment or strategic acceleration.
For example, if a consumer startup considers both Kickstarter and a traditional venture capital firm, they will need to balance the marketing exposure that comes with a crowdfunding campaign versus the distribution channels, hiring power and credibility that the institutional firm provides.
On the other hand, if you are looking for strategic investors, you will have access to networks of people who can open doors.
If you are seeking passive capital only, you will be limited to those funds that will simply pay the bills.
The type of capital you’re seeking ultimately dictates the entire strategy you adopt when reaching out to potential investors.
The startup funding ladder: Selecting your path
Founders need to find the right investor for their startup in order to match the stage of development and the sector (industry) they are in.
It’s imperative to avoid trying to fit a square peg into a round hole—such as attempting to pitch a growth-stage private-equity firm on a pre-seed consumer app—because this will guarantee rejection.
The funding ladder presents specific expectations at each level.
Bootstrapping is the lowest step
Bootstrapping is financing a venture using one’s own savings or income from customers for early operations.
This allows a founder to maintain maximum control of the business while not requiring dilution of his/her ownership as the owner will not be subject to any form of outside financing.
Yet, it dramatically limits their speed of growth. Bootstrapped startups are forced to prioritize short-term profits over long-term market share.
For example, this model fits nicely into niche service and SaaS tools, but it fails miserably with any hardware-intensive or capital-intensive play such as deep-tech that takes several years of R&D before it ever sees the light of day.
Funding sources - Family, friends, angel syndicates
When your own personal capital has been exhausted, the next logical place to turn for funding is your immediate network of family and friends.
Therefore, family and friends rounds are generally taken on the basis of a lot of trust and very little due diligence. Angel syndicates are the starting point for getting into the realm of professional capital.
Angel investors are typically wealthy individuals who invest their personal capital.
They take a significant amount of risk in early-stage companies; however, they require a sizeable equity stake in return.
The emergence of syndicate platforms has allowed numerous angel investors to pool their money and participate in a single signature on the cap table.
Financing pre-seed & seed round
The initial funds raised during the pre-seed and seed stages allow a startup to move from the idea to the actual business model.
As such, when an institutional pre-seed or seed venture capital firm evaluates a startup for funding, they look for more than just a pretty presentation.
They want proof of traction via an early product and some level of product market fit.
Founders need to portray their vision and at the same time, supply the early data points that demonstrate that vision has been validated to this point.
Typical pre-seed funding will utilize a SAFE agreement or convertible note as part of its funding tool, allowing the funding round to delay valuation pricing until a more priced round of financing occurs.
Growth capital and Series A
The gap between the Seed and Series A stage is commonly the largest barrier to entry in the start-up ecosystem.
Growth is what will drive the growth capital; therefore a Series A investor will typically not provide funding for experimental purposes—they will fund the growth of a company.
Any startup looking to raise a Series A Round needs to present solid evidence to back up their claim for the amount of funding they are requesting from potential investors.
Investors will analyze metrics such as ARR, gross margins, Customer Lifetime Value ("CLV"), Customer Acquisition Cost ("CAC") payback period, and Net Revenue Retention Metrics before they make a final decision on whether or not to invest.
If a startup’s unit economics are broken or incomplete, then it will not be a viable deal for an investor.
Funding that occurs after Series, (Funding Stage B, Series C, etc.) is based entirely on numbers or mathematics.
Funding that occurs in these stages is viewed as 'throwing gasoline' onto a fire that is already producing a good amount of heat and light.
Accelerators and incubators
Accelerator programs like YCombinator, Techstars etc. are Hybrid programs used for capital mentoring as well as aggressive networking.
The price paid for participation in these types of programs is typically a set percentage of equity. The accelerator is acting as a forced function to accelerate years of operational learning to a few months.
The end of each accelerator program culminates into a 'Demo Day' designed to produce FOMO (Fear Of Missing Out) among investors interested in funding early-stage startups.
For a First Time Founder, the connection to an elite accelerator can be worth the initial dilution of equity.
Crowdfunding and alternative financing
Crowdfunding via an equity crowdfunding platform can allow small businesses to raise smaller amounts of capital from an Indeterminate Number of retail investors.
This funding vehicle can be beneficial for DTC (Direct To Consumer) brands with a large fan base or cult-like following.
Another method of alternative financing is venture debt which offers a non-dilutive loan option.
Venture Debt typically can only be offered to business, after the business has attained support from an institution and is using revenue generated via the venture deed to assist their company in extending their runway prior to securing additional funding via the issuance of equity.
Foundational assets for investor interest
Clear expectations are critical. An investor's decision to invest is generally based on three foundational assets.
These assets are the items that will either increase investor interest or kill momentum immediately.
The architecture of the pitch deck
While a pitch deck is a highly targeted sales document to obtain a second meeting, it is not a business plan. Most templates are ineffective because they do not have narrative flow.
The best pitch decks follow a simple but strict logic.
First, establish the enormity of the problem. Next, present the solution as an essential step to take place, followed by clearly identifying the market size, and lastly, proving actual traction for the concept.
Introduce the team as not just employees, but as the only people qualified to execute the vision for the solution.
Clearly state the amount of money being requested, and define what the funding will accomplish in its entirety and at each stage.
If large amounts of text are displayed; slides cluttered with numerous graphs that are incomprehensible; or vague data is presented, this indicates the presenter is unsure of their idea.
Financial narrative mastery
Investors primarily look at the financial model to gain insight into the founder's vision for the future.
To predict how the capital investment provides a path to the next round of funding, it is necessary to utilize reasonable assumptions about customer acquisition and churn rates.
Failure to explain the basis for the predicted upward spikes in revenue (to reflect hockey stick growth) will lead the investors to disregard everything in the pitch deck.
The foundation for growth is actual traction.
How to build an unassailable data room
The data room is where deals are made and lost.
If the data room is poorly constructed, the due diligence process will take longer than necessary, which will reduce investor interest and create doubt.
If the data room is well constructed, the diligence team will have anticipated and organized all of the questions that the team has about the company's financial history and product offering and has thoroughly prepared it for the due diligence process.
Governance and corporate records
A well-organized data room provides good hygiene for basic corporate governance.
Basic Corporate Governance: Articles of incorporation, Bylaws, Board minutes, Shareholder agreements.
Historically, it's important for the investor to have absolute confidence that the registered entity is in good standing and has no hidden liabilities related to historical disputes.
Cap table and equity grants
Investors must have a "pristine" cap table.
The cap table must have details for every currently outstanding share, option, and convertible note. An investor must see exactly who owns what, the option strike prices, and the total shares fully diluted.
Any uncertainty here is an indication that the structure may not be stable.
Assignments of intellectual property
Ownership of every line of code, every design, and every core asset must be clear and belong to the company and not individual founders or contractors.
A missing PIIA is an immediate red flag.
A company cannot secure funding if the company's primary technology can be challenged by a disgruntled former developer.
Financials and operations metrics
In addition to the above, the diligence team will have access to the company's historical profit/loss statements, balance sheets, cash flow statements, and forecasts.
Diligence will compare the company's actual financial statements with the financial model included in the pitch deck.
Any discrepancies between the claims made in the pitch deck and the underlying financial statements will destroy the investor's trust.
Twelve-week operational fundraising workflow
The fund-raising process is time-consuming and ultimately detracts from a founder's time spent building the product.
As a result, fund-raising should be treated as a very rapid and aggressively managed pipeline. If the fundraiser drags on, it shows weakness to the marketplace.
Creating an urgency to execute within a 12 week timeframe is artificial.
Week 1 – 3: Preparing and constructing a pipeline
You are not allowed to be in contact with investors during this period.
This time frame is only for internal preparation of your company to prepare for the fundraising process. You will be completing your pitch deck, finalizing your financial model, and populating your data room.
You should also build a highly specific CRM database that targets investors that have invested in your particular stage and sector. Exclude any investors that have previously invested in direct competitors.
You will also identify the partners at each of the funds that you are targeting who make the investment decisions in your area of focus.
By participating in this phase, you will create a list of 50-100 qualified potential investment targets to pursue.
Week 4 – 7: Pitching and looking for patterns of interest
This is the phase that you perform the roadshow. You should plan to have many of the early pitch meetings occur back to back.
The earlier pitches will uncover the issues in your storyline. Think of the first pitch as a prototype; you will make adjustments to your pitch following each early meeting.
Observe where you are gaining the most interest from investors during each meeting, and where they are losing interest.
If you receive the same questions that demonstrate skepticism from multiple investors, you must modify the content of your pitch deck to address those points in the future.
Your goal is to generate multiple invitations to second and third meetings from your targeted funds to move toward a partner meeting with those funds.
Week 8 – 10: Term sheets and negotiating
Once you have gained interest from your targeted funds, the dynamics of the fundraising process change. At this point you should be focused on obtaining a lead investor.
A lead investor is responsible for establishing pricing, defining the terms, and providing the momentum for the completion of the remainder of the fundraising round.
The first term sheet from a lead investor completely changes the balance of power to the founder.
Obtain an offer sheet from all prospective investors, regardless of whether they are interested in investing in the company at this stage.
Use this offer sheet to apply pressure on other companies that are still evaluating a potential investment.
This is the perfect time to negotiate aspects such as value of the company, Board seat assignments, liquidation preference and pro-rata rights.
Week 11 – 12: Preparation of the legal and financial aspects and close of the transaction
While the offer sheet has been signed, it does not mean that the cash is in the bank.
The signing of the offer sheet will start the formal acceptance of all items in the financial due diligence process. The legal team from the Investor will visit the documentation room and, if everything is properly documented in week one, this will go smoothly.
It is extremely important that each founder has a legal advisory firm and manages the process effectively to ensure the documentation is drafted, reviewed and executed in a timely manner.
Any delay in this phase will result in the termination of the deal. Once the legal documents have been executed and wired into the account, the round is officially closed.
The reasons why a funding transaction is not completed
Founders often believe that due to a strong initial presentation, they will be able to secure a funding check; however, this is typically not the case.
An overwhelming majority of funding transactions fall apart late in the transaction process due to entirely avoidable structural failures.
Cap table disorder
Dead equity will kill all companies.
When there is too much dead equity owned by early advisors or founders of the company who are no longer with the company, or passive Angel Investors, Institutional VCs will not invest in the company.
The value of the company will be based on how much equity the current founder has retained after the founding stage, so for an institutional VC to invest, the current founder must keep enough equity to provide a motive to stay with the company for the next 10 years.
When the management holds too much dead equity on the capitalization table, or in other words, the table is broken, a recapitalization will have to be done to fix it, and this will delay the funding process for months.
Misalignment of expectations based on stage
Another common mistake committed by founders is presenting their opportunity to the wrong type of investor.
Some investors do not invest in specific stages of the organization's life cycle or at specific levels of growth for example, Series Seed, Series A or Series B.
When a founder presents a concept they developed at the pre-seed stage to a large private equity firm, it usually does not end well for them.
Likewise, if a founder tries to tap into a micro-fund to raise their Series B for 20 million dollars, then the founder has wasted a lot of valuable time.
Before creating an introduction, a founder should determine the normal check size and the level of company maturity required by the proposed funding firm.
Weak unit economics
A weak unit economics structure creates an insurmountable barrier for companies post-seed.
If the cost for a company to acquire a customer exceeds the lifetime value that customer generates, then that company is draining money with no route to gaining profitability.
Financing a severely flawed business model with venture funds simply increases the rate of system failure.
Investors will quickly identify negative unit economics during their financial diligence and withdraw their term sheet.
Founder arrogance leads to friction
While it takes a great deal of confidence to lead a fundraising campaign, investors have an extremely low tolerance for defensiveness, aggressiveness, or non-responsiveness from a founder when they question the founder about the founder's performance metrics.
Therefore, investors will assume that if a founder has been aggressive or evasive to questions about their metrics, the investor will most likely deal with that same type of behavior over the next 10 years of their relationship with the founder.
Once investors determine that the founder will be unteachable or a challenge to work with, the investor will quietly withdraw their investment from further consideration.
Post-fundraise funding management and investor relations
The end of the funding has only just started.
The "guns" have fired to indicate the start of the scramble to begin executing on the operational efforts of the company.
100-day execution plan
Immediately after securing the funding, the founders must begin deploying the funding toward achieving the milestones detailed in their pitch book.
The initial 100 days following funding should focus on rapid hiring, increased product development, and new market opportunity development.
Transitioning quickly from raising money to executing a business is necessary for startup founders after raising money to ensure continued trust with the newly formed board.
Delays in execution will cause a lack of trust with the newly formed board.
Setting up the reporting rhythm
Transparency is critical to maintaining strong relationships between the founder and the board members.
Therefore, it is essential that the founders create a regular schedule by which they will provide the board updates on the company's performance.
Monthly updates are normal practice and they should not be treated as marketing materials.
The monthly updates should include in-depth analysis that describes how much money has been spent (i.e., cash burn), how long the company will remain in operation (i.e., runway), what metrics are growing, and what current problems are preventing them from operating at their optimal capacity.
Keeping the board updated allows investors to support you by providing additional resources and connections from their own networks.
When the founder does not keep the board updated, they breed distrust.
Preparing for the next round of financing
As soon as a funding round has been completed, the count down to the next round of financing begins.
Company founders must continually monitor their cash runway and the current state of the economy.
Company founders who are aware of the required metrics to obtain additional capital at the next tier will not hit a wall 18 months after the previous round is completed.
Fundraising is a process that continues as long as the company continues to operate and provides evidence of success through continuous execution and validation of business processes.
The bottom line: Execution wins
Capital markets are constantly declining and rising based on global economic conditions that are beyond the control of the founder.
However, even if the global economy declines, the fundamental concepts of how to raise money for and build a startup will not change.
Success will not be based solely on the brilliance of the founder's concept, it will depend on the ability of the founder to effectively execute their operational plan.
A well-constructed capital raising plan that provides clarity on key performance indicators, and a comprehensive streamlined approach to building up your cash reserves, are part of what separates financially viable start-ups from unviable start-ups.
Start-ups that rely on a rigorous analytical approach to obtaining funding have higher rates of obtaining funding than those who utilize their charm, or provide vague metrics or do not maintain organized lines of communication when reaching out to investors.
Having a sound strategy is important but continued methodical and disciplined execution is what will ultimately bring the funding to completion.
Frequently Asked Questions (FAQs)
What should a seed round cover in the way of a runway?
A seed round's goal is to provide sufficient cash to keep your business operational for roughly 18-24 months.
Most of that period will consist of an aggressive 12-18 month timeline for achieving the various milestones associated with a series A, with roughly an additional 6 months of time available to execute a successful series A fundraising campaign.
Raising less than 18 months of operational cash will lead to having to turn around and start fundraising immediately after that 18-month period, negatively impacting your operational momentum.
Do I have to have a lead investor to raise a seed round?
If you are raising your money with a SAFE agreement or a convertible note, you can raise money on a rolling basis without having to secure a lead investor.
However, if you are raising your funding with a priced round, you must have a lead investor.
They will be responsible for determining the price per share and for conducting the majority of the Due Diligence, as well as developing the terms of the investment.
Consequently, it will be very difficult to fill your priced round without an established lead investor.
What's the difference between a priced round and a SAFE?
A priced round allows investors to buy actual ownership shares in your company at a negotiated or agreed upon price.
The process of conducting Due Diligence for a priced round is complex and time-consuming and requires legal formation of a Board of Directors and the calculation of potential dilution.
A SIMPLE Agreement for Future Equity (or SAFE) is a deferred equity instrument.
Investors contribute cash right away and convert that money into ownership equity in a later priced round at a discount or with a cap on their share price.
SAFEs are faster and cheaper to set up than a priced round; therefore, they have become the preferred method of funding for early-stage businesses.
