Fund raising 101 for early-stage startups

Before you start!

It’s very important to ask yourself as a founder before you begin your fund raising journey, “Why am I trying to raise money and what ambitions am I fueling?”

Like it or not, a lot of the narrative on fund raising is driven by venture capital money. So, if you are competing for that, then you need to be prepared for the ride of building a VC style business. And also do a reality check. Does the company fit the profile of a typical VC style business?

VCs are typically driven by large markets and revenue pools which can lead them to oversized outcomes. Their potential exit should be meaningful to the overall fund economics. There could be outliers to this definition but the fact is that not every business fits the “VC model”.

Many lifestyle businesses would be examples that don’t.

A caveat. This article is written keeping in mind fund raising for early stage for-profit ventures. There are also businesses in the ‘impact for profit’ and ‘not-for-profit’ spaces which are the focus for specialised investors and grant givers. Their approach to investing would typically differ from traditional for-profit VCs in some aspects. Not everything that I cover can be generalised to those situations of fund raising.

Finally, I want to underscore one point upfront. While some businesses may not be the typical venture type, they could still be perfectly sound and profitable, giving great satisfaction to the founders and also creating decent long-term wealth along the way for stakeholders. Just because they aren’t VC funded doesn’t make the achievement any less.

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When to raise

John Doerr famously compared fund raising for founders like being at a cocktail party. When the waiter shows up with the snack, you take one as you really don’t know when the next one shows up! Well, I think that’s mostly true with one rider. You are not ready for fund raising until you know where you want to steer your company and what do you need to get there. So, don’t get down to raising till you have answered those questions for yourself.

Also, be doubly sure that you are raising for the right reasons. As an example, if your product market fit (PMF) is visible and sales are shooting up, then hiring for customer services is a good example of right fund usage. But if you are yet to hit the PMF, seeing poor retention and then you want to raise funds, hire more sales people to push revenue, that is bad usage and will probably not find investors.

How much should I be raising

Once you have decided that you want to raise funding to take your startup to the next level, my general advice to founders is to raise enough to support the next 18–24 months of their plans. Usually that’s the kind of time which a company needs to show significant change in business metrics.

Ideal is to try and not raise too much or too less as both the extremes are recipes for trouble. Raise too much and you dilute yourself unnecessarily early on. What’s worse, when there is excess liquidity in the company, the best of the founders can lean towards irrational spending leading to wrong decisions. A good example is going aggressive on paid customer acquisition which can be a big “false positive” on business growth.

On the contrary, if you raise too little or too late you can run out of runway or get cramped to execute your plans. And be aware, VCs can smell desperation from far severely compromising your position in the next raise.

Also remember to factor in the time taken to raise. It usually does take about six months to bring the money in if all goes well. So, effectively your fund-raising efforts should kick in at least nine months prior to running out of cash in bank to ensure you comfortably get home. If you do the math, you will realise that there is very small window in which you are not working on fund raising. Such is entrepreneurship.

Dilution dilemma

I see founders often times trying to over value their company in their fund-raising efforts.

High multiples to revenue, to EBITDA or to GMV are badge value, but honestly not much beyond that. Getting above normal outcomes doesn’t serve much purposes in the long run as this math almost always catches up with you. It gets harder in subsequent rounds to show progress and justify similar valuation multiples. So ephemeral euphoria at best.

So, keep your goal simple. Raise just enough and raise at fair valuations. The worst outcome – you raise less money at very aggressive valuations. In this situation, you don’t have too much to execute all your plans and justifying the next valuation becomes almost impossible. So definitely avoid this trap.

Your first cheque

If you are early stage and looking at a small raise to fund the early years of your company which is mostly MVP stage, then your own funds/friends and family is a popular place to start. Only caveat here is to not get into a valuation discussion at this stage. It’s too early in the life of the company to arrive at any valuation. Also, the other party is usually not equipped to negotiate due to lack of knowledge or vested interest in you as a family or friend. So be nice! Convertibles and SAFE instruments are best options.

Also, avoid getting too many people on your cap table early on. It can really complicate your life when you go for subsequent rounds. If your ask is a bit bigger at the seed/early stage than what you can fund or F&F can support, then angel networks, syndicates, crowd sourcing are good options to explore. Only thing to be mindful with these options is to not get dragged into lengthy conversations for tiny cheques; angels are notorious for that.

Also, never go for money from someone you haven’t been able to reference check properly and when in doubt, always choose quality of angel over cheque size. Smart angels can be great advisors and add a lot of value to an early stage company if engaged well.

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Finding the right institutional Investors

Okay, so you have hustled your way through the first year or so of your company. You used the seed/angel money and an MVP has fallen in place. Product validation is looking good. And early customers have started coming in. Congratulations! Now the business needs money to scale. It’s time to moves to the big game. Institutional VCs.

This is when it can be confusing and at times intimidating. For example, a funding market like India has over 200 funds which are active at any given point of time with most of them having a stated investment thesis on sector, stage, ticket size, geography, etc. Not done the right way you can end up wasting a lot of time and not getting anywhere in this maze. And this is where I urge founders to do two things – follow a process and seek help from advisors.

Start by being very disciplined in doing your homework well to shortlist funds where you tick the boxes and the match with your startup looks good. Definitely have your databasing skills handy for this one – Excel, Google Sheets, Notion, whatever works for you.

When you find a fit, go deeper. Read the fund’s website. Those normally are a great place to start. From there, you will mostly be able to know who are the fund’s General Partners dealing with your sector/stage/geography. Do your research on them and their investment approach from basic internet search. Follow them on LinkedIn to see what are they writing about, their views, etc.

Next, try and seek warm introductions to them through your network or best if you can go through one of their portfolio companies. Cold emailing is fine too but the golden rule there is to keep it crisp. Remember, the idea is to get a meeting and not tell them everything about your company and your whole back story in the first email. It’s also not very wise to not say enough in the email and just seek a meeting. Say enough to excite them to agree for a 15-minute first call.

The pitching

Okay, you have done all the hard work and landed up a meeting with the right Investor. Then comes the pitch. This one is both an art and science.

Pitching is a lot about story telling. This is one skill I always push founders to keep building. The art of communicating effectively. It always comes handy and is one of the top differentiators between the good and the great founders. And it’s one skill you use all the time – with early employees, with customers, with investors and with external stakeholders. So, invest time in it and keep getting better and better.

A golden rule for the pitch start is that you should be able to say in 30 seconds flat “what you do”. This is one part that I see the best founders struggle with. There is so much passion and emotion involved in what they have been building that they are either too detailed or just too vague.

Next, to the actual pitch/pitch-deck. There are many formats, but barring some outlier sectors involving advanced technology, most B2C/B2B businesses can be easily explained in an 8–10 slider over a 15–20 minute conversation covering the following headers. And remember to always keep the jargon out.

1 What problem are you solving, who experiences it?

2 Your unique insight/your solution/your differentiation from competition.

3 The market size.

4 Your team.

5 Your product-MVPs, prototypes, slides – anything to bring this to life.

6 Your go-to-market strategy, i.e. how will customers know about and buy you.

7 How will you make money/the unit economics/the financials?

8 What’s the investment needed for?

9 Lastly, a vision 3–5 years down the road of what success could look like.

If you are a technology company, your product demo is an element which can make or break a pitch. They are worth gold. They show earnestness and focus on building something out, an action bias. And honestly, it doesn’t matter if it is clunky or bad. Take any world-class product today and you will realise most MVPs for those were not even remotely close to the final products.

If you are an impact venture (could be either for profit or not-for-profit), then there are some nuances to your pitch would look a bit different. It is important to clearly establish your purpose. And how you will protect that as an organisation and the metrics that would show progress on that purpose.

Above all else, in early stage investing, it’s the founding team that really matters. People are mostly investing behind the grit, vision, execution capability of the founders. The solution comes next. Most other things can be made up for along the way by good founders.

The logistics of fund raising

Try and run your various VC discussions swiftly and in parallel and not be an investment opportunity which is around and available all the time. This is easier said than done as you are mostly dependent on the fund for meetings, but do your bit by hustling enough. Pitching can be physically and emotionally draining and it’s best to go through it in a burst.

Scarcity and fomo around your deal do help, but with some caveats. It’s a small ecosystem, so don’t trying to bluffing. Be honest if you have some funds chasing you and that is always good leverage in a discussion.

Lastly, do not get swayed by “number of meetings” metric. I often hear founders update by saying they are in so many active discussions. Well that’s good, but are those all relevant and moving in some direction? VCs are famously poor at saying no. So as a founder, you need to be able to spot a no, they hide in the maybes.

Once you find an Investor

The terms established early on in your first funding cheques are hard to let go off. So, it’s important to build simple vanilla structures initially. To underscore a point I made earlier, stick to convertibles with F&F/angels as those contracts are much simpler and don’t complicate future equity rounds.

With your institutional investor deal structure, be very careful of the fine print. There are potential mine field clauses such as liquidity preferences, voting rights, etc. which founders can overlook and really regret later. Liquidity preferences can easily spoil a good exit for the founder and the early team. Voting rights is another tricky one. Badly negotiated, it can easily lead to key decisions moved from the management and board to shareholders and that is very inefficient for any company. What’s worse is subsequent investors always demand these and it keeps getting knotted more and more.

The board construct and how to make the most of it is another important decision for founders at this stage linked to the deal making. Great boards can be a huge asset and lousy one’s can sink a good startup. But that probably deserves a full write up by itself.

Also, a word about the negotiation. Remember, what you do is towards a goal – the fund raise. The negotiation is not the goal itself. In other words, know what terms to negotiate and what to let go. Idea is to do a good deal which both sides are happy about and bring in a partner who will truly bring in more into the equation than just capital.

There is an important milestone in the deal closing journey, an aha moment but not something that you can relax on – the term sheet sign off. From term sheet to closing are various hoops like diligences, SHA, SSA, etc. which need a lot of time, effort and discipline to close. There a many a slip between the cup and the lip in deal making and you want to avoid those. Be process-oriented in this phase and obsessive about the follow ups with various stakeholders like lawyers, accountant, company secretaries and investors to ensure closure.

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What if my funding doesn’t happen?

Less than 1% of the startups reach institutional funding. But remember, if you are unlucky to not be able to close, it’s not the end of the world. Never ever take the rejection personally as a lot of factors feed into the decision and not everything is in your control. There are many instances like a tough liquidity cycle when funding is not easy to come by. Like right now, we have entered one of those long winters. Smart founders will pivot in these instances and find a way to extend their current runway so that when the times improve, they are alive and kicking and prime prospects for investors.

I also urge founders to also make sure that they have explored outside of classical venture equity funding by way of government schemes, debt and banking and leasing channels where possible. It seems obvious but many miss this.

To wrap up, fund raising is a time consuming and emotionally draining process and it’s not done till it’s done. So be mentally prepared for the ride, enjoy it and you will excel in it. There are really no short cuts.

And in this fund raise journey, stay inspired by what Biz Stone, the co-founder of Twitter, once famously said, “Timing, perseverance and ten years of trying will eventually make you look like an overnight success”.

Good luck!