Last week Chris taught a Skillshare class at the Union Square Ventures office called “Planting the Seed: How to Raise Your First Round.” The room was full of energy, with lots of first-time entrepreneurs. It was a fun event, so I thought I’d post some of the key concepts for those who couldn’t make it to the class. Enjoy!
1. The process gets much easier after getting one “yes” - Having a lead investor is an important signal to the market that *someone* has conviction in you. A lot of investors will say, “I’ll invest if you can find a lead investor.” This is basically the investor asking for a free option on the investment, so don’t make the mistake of counting it as a firm commitment. However, finding that lead investor can turn a lot of those weak commitments into strong ones.
2. Being active in the tech community will help you raise money - Investing is a trust business. The investor has to trust that if they give you money you’ll use it wisely. Being active in the community and having people who can vouch for you is key. Go to meetups, blog, and engage with people on twitter. You should try to become a known entity in the community. Ideally an investor will recognize your name when they first see it.
Every investor has filters they use to source introductions. Entrepreneurs they’ve already funded are a nice place to start because they are generally sympathetic to the fundraising process. After receiving an introduction, probably the first thing an investor will do is Google you. So understand that Google results effectively are your reputation.
3. “Come back in a month” usually means “no” - Additional information that comes with the passage of time is beneficial to investors so they will often delay making a decision to “flip over another card.” Again, they are looking for a free option on the investment. Why give up the option to invest if they don’t have to? In contrast, entrepreneurs generally have constraints that make them want to raise money soon. Less experienced entrepreneurs may mistake “come back in a month” as a positive signal. In fact, it basically means, “I’m not interested.” Anything short of, “I’ll write you a check” is “not interested.”
4. There are four main types of investors- Friends and family, Strategic investors (Someone in the industry - for example if you are a payments startup getting American Express to invest), “Dabblers” (such as the person who just made 20 million on a startup and wants to invest on the side) and venture-style investors. Try to avoid the first type - being an entrepreneur is stressful enough without having to worry about losing grandma’s life savings.
5. Understand the type of investor you are pitching - Venture investors think a lot about whether a company will be able to continue to get funding at the next milestone, and eventually have the chance to be a billion dollar company. So pitch the upside of the business, not the mean. You’d prefer to leave the investor thinking that there’s a 1% chance you’re the next Google rather than a 25% chance you’ll be a $10 million dollar company. Remember that the difference between a good venture fund and a great one can be one big exit.
The number one kiss of death to a company is for an investor to say “it doesn’t seem big enough.” Technique and bravado are key here. Simply changing the pitch or creating an emotional narrative can go a long way. And if you don’t think you have a chance of being a billion dollar company, that’s fine, but perhaps you shouldn’t be raising money from this style of capital.
6. Pitch the story, not the numbers - On the first pitch focus on the narrative, and move the numbers to the appendix. Have numbers ready but if you start with them you may lose your audience fast. The best pitches talk about how the world is changing and why the product fits well into the macro trends. You also have to answer the question “why now?” Why didn’t this happen 10 years ago? For example, now everyone has a smartphone and therefore can check-in everywhere they go. That wasn’t possible 10 years ago.
A typical deck is about 6-8 slides - Here’s a great post on putting together an investor deck. And a product demo is necessary - venture investors will demand it. But again, before showing the demo you want to frame things as a narrative form. For example “here’s why what I’m about to show you matters.”
7. In an early-stage deal the team is usually most important - The product is really a window into the quality of the team, because quite often the product changes. Also key is that the team has demonstrated mastery of the industry they’re in. Over time other metrics emerge that signal the quality of the product, such as traction and revenue. The later-stage the investment, the more these other signals matter.
8. Option pool and acceleration on change of control are key terms - Employee option pools generally come into play at the Series A. Entrepreneurs often underestimate how much the option pool will cut into their ownership, tending to focus more on money raised as a percent of valuation.
Also, acceleration of vesting on change of control is relatively easy to get and can really make a difference. For example, you can negotiate to have vesting acceleration to 3 years if acquired within the first year after the financing. This can make a big difference if it actually comes into effect.
9. Don’t get creative with the legal documents. Use the standard stuff - Gunderson, Cooley, Fenwick & West, and Wilson Sonsini are a few “standard” startup lawyers. Using standard lawyers with standard documents saves you time and money later because most investors (and even acquirers) know these documents and trust them.
The one legal book you need to read is The Entrepreneurs Guide to Business Law. It goes through the most common ways entrepreneurs mess up. For example, it discusses the “forgotten founders problem” - describing the situation when someone who helped you out early in the life of the company and sues you when you show signs of success. Ideally, you would have gotten a release from them as soon as they stopped working. Good lawyers will make sure everything is clean when you raise money.
10. Be thoughtful about how much money you raise and at what valuation - If you can avoid raising money you should. You’ll retain ownership, and not every business is a venture-style business (i.e. shooting for a billion dollar business). But if you decide to raise money you should aim to raise enough to get to an accretive milestone - be it profitability, sale, or whatever makes the company worth notably more than it is today. Figure out that milestone and work backwards. Ask, what is the team I need to get there, what milestones do I have to hit? And then add 50% to that just to be safe. Finally, remember that the valuation of the last round sets the bar for your next round. This is important, because you don’t want a down round.
Additional tip (from me):
Be completely transparent about the market and competitors. Assume the investor will do their research. And when they realize you didn’t bring up any of the competitors, or identify the main issues with the market, they’ll either think: a) you were being deceptive (see point #2 about investing being a trust business) or b) that you don’t know what you’re doing. It may help to send over some industry research from Gartner or the equivalent. An investor isn’t going to invest in an industry he or she doesn’t understand, so it’s in your interest to get them understanding the market as fast as possible. A good rule of thumb is that when in doubt, always err on the side of being upfront and open.