How to raise your first round of capital

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If you are looking for great information about startups in an easily digested format, e.g. slides, I highly recommend Slideshare.net.

One major change in VCs in the past decade or so, which I believe was spearheaded by Brad Feld of The Foundry Group and Fred Wilson of Union Square Ventures, has been a sincere attempt to educate entrepreneurs. While I’ve known both of them I never asked them about their motivation, but I can take a good guess. Top flight VC firms see literally hundreds of pitches a year, year in, year out. Yet a partner like Brad or Fred may make only one or two investments per year. So it is in their interest to teach entrepreneurs not only how what VCs want to see in a pitch, but how to conduct themselves in a VC meeting, as it is much more efficient to deal with educated founders rather than having to teach everyone, one at a time.

I’ve already written about and recommended Brad’s book, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist. Now I’m going to recommend a great slide presentation by Jeff Bussgang of Flybridge Ventures entitled Mastering the VC Game: How to Raise Your First Round of Capital. It’s a 19 slide primer that takes the founder from first pitch to due diligence. While its six years old I don’t think anything has really changed in the VC game regarding how to raise your first round of capital. Of course Jeff being a VC he doesn’t spend any time educating founders about the alternatives to VC funding, such as corporate VC, angel groups, angels, super angels or grants like SBIR. After you’ve gone through Jeff’s presentation check out my blog post VC funding and its alternatives to help decide what type of investor is the best fit for your venture.

I have to admit I have not yet read Jeff’s book, Mastering the VC Game, but based on his blue chip reputation and the quality of his slide presentations (you can search SlideShare for others), I’d venture to say it’s well worth reading.

If you still have questions and the time to search for answers there are a number of posts on this blog that fill in the many gaps in knowledge of raising capital that I’ve seen from mentoring dozens of founders in the past decade.

Lessons learned by a successful serial entrepreneur

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I’m going to excise the important lessons learned from the Forbes article 300 Investor Rejections And 1 Failed Startup Led This Entrepreneur To Build A $1 Billion Business by 

Here are his lessons learned along the way, which I heartedly endorse, both from my own personal experience as well as experience mentoring dozens of founders:

Three Essential to-do’s

  1. Surrounding himself with good product engineers
  2. Really getting a handle on product market fit
  3. Learning how to talk to investors

If he was to ever start again:

… he would spend a lot more time thinking about and vetting an idea before jumping into it. Spend a lot of time talking to customers or potential customers, and also talking to investors, and really starting to define and refine the business model, the customer acquisition strategy, the business model, the defensibility, the network effect.

Raising capital

  • He had to go from fundraising in California to New York where investors got it
  • He learned the secret isn’t convincing investors, it is finding the investors that love the idea
  • Learn to leverage a lead investor who will syndicate the deal to others
  • Learning some sales skills

Ward had about 300 turndowns from investors for his two startups! But his second point is perhaps the most important lesson learned about raising capital: it’s all about investor-venture fit. Founders tend to think that by getting more meetings, sending more emails, making more phone calls – whatever, more is better – they can convince an investor to fund them. No! If you don’t get resonance from the first two meetings move on! Take that energy and your precious time and dig for a well elsewhere, digging deeper and deeper won’t strike oil! Of course, this assumes you have heeded Ward’s start again tip to talk with investors before you jump into a venture. You have studied their portfolio and talked to some founders they have invested in – performed your due diligence on prospective investors.

 

 

VCs need to hit grand slams, not just home runs!

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The best single line I’ve heard about how venture capital works is from investor Marc Andreesen: “returns are a power-law distribution” with the majority of returns concentrated in a small percentage of companies. That’s true now more than ever, and one of the great promises of the venture capital industry that motivates and drives investors.

It’s vitally important that founders seeking investment understand the venture capital industry, what motivates VCs and how they make investment decisions. The article on Medium by Eric Feng A stats-based look behind the venture capital curtain is de riguer reading for founders planning to raise capital from VCs.  Eric Feng is now at Kleiner Perkins. Previously CTO of Flipboard, Founder of Erly, Founding CTO of Hulu, and Microsoft Research alum.

Mr. Feng’s article focus on how the VC industry has changed in the last fifteen years – which is substantially – more money, more investors, more deals, bigger exits!

In the past 15 years, the amount of money invested by US-based VC firms into startups grew more than 4x to almost $85 billion dollars last year. Before 2011, an average of $28 billion was deployed each year but in the past 7 years, that number has jumped to $62 billion invested annually. Not surprisingly the number of deals has seen a corresponding sharp increase. From 2003 to 2010, the industry averaged almost 3,800 investment deals per year. But since 2011, the average number of deals per year has shot up to more than 8,700.

What is the effect of many more funds deploying more capital into more companies? The industry is making over 5,000 more investments each year compared to 15 years ago (with most of those being seed investments). One would think that it must true that any given startup thus has a better chance of raising capital than 15 years ago. However, there’s an unintended consequence of the changes: On average, there are more than 7x the number of billion dollar exits now than a decade ago. 15 years ago venture capital was considered a hits business where the hit had to be a home run to make up for all the strikeouts in an investors portfolio. But now?

“Venture capital is not even a home-run business. It’s a grand-slam business.” Bill Gurley, Benchmark

As a result there is even more pressure on an investor from their fellow partners, their peers and their limited partners to swing for the fences. Now the rule of thumb is that you need to build a company with a minimum of $100 million in yearly revenues, so it would be valued at 10X sales, or a billion dollars, commonly called a unicorn. If you can’t meet this yard stick don’t waste your time chasing VC dollars or pivot to a multi-billion dollar market where you have a markedly better chance to qualify for the grand slam derby.

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If you search Eric Feng’s article for the term “profit” you will get zero hits! That’s right in an article about venture capital the word “profit” doesn’t appear even once. If you need more proof that profitability is not a key success factor for startups just look at all the companies now going public or that have gone public recently. They are all losing money with the exception of Zoom! Uber and Lyft are losing billions of dollars.

So founders, pay attention to what VCs pay attention to: top line revenue, revenue growth, growth of your customer base, and stickiness of your customers. You can start worrying about making money after your IPO, what you need to worry about now is growth and the ability to scale.

Questions to help you become investor ready

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I’m a strong proponent of the Socratic method and as such I’m always on the lookout for good questions to ask, especially for the founders I mentor. The Forbes article 15 Key Questions Venture Capitalists Will Ask Before Investing In Your Startup by

I’m going to simply refer you to that article along with a couple of posts of mine. If you can successfully run the gauntlet of all these questions you’ll be ready to sit down with an investor, with confidence!

Here’s another set of questions, Investors questions to address and the post Are you investor ready?

But rather than simply view answering these questions as a one-time exercise I recommend you convert them into a to do list, as it will be highly unusual for a zero-stage founder to have good answers for every question. For example, if you haven’t launched your product you should make sure to arrange for customer testimonials and if you haven’t built a set of KPIs (Key Performance Indicators) there’s a major milestone for your venture. For that one I’ll refer you to my post 12 KPIs you must know before pitching your startup.

 

 

How things look from the investor’s side of the table

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Eric Feng, now a VC at Kleiner Perkins, but previously a CTO of Flipboard, founder of Erley and founding CTO of Hulu knows what venture capital looks like from both the founder’s and investor’s sides of the table.

His article A stats-based look behind the venture capital curtain on Medium has an analysis of trends in VC funds in the US over the past 15 years that is highly recommended reading for any founder seeking capital.

From 2003 to 2011, an average of 157 new funds were raised each year. But from 2012 onward, that average rose to 223, or an impressive 42% increase. More funds equals more active investors working at those funds.’

Another insight from Mr. Feng is that all the recent growth in the number of funds raised has been from seed funds, not venture or growth funds.

There has been an even bigger increase in the number of seed investors active in this country because of the disproportionate growth in the number of seed funds raised each year. So if it feels like there are thousands of new investors in the industry, particularly seed investors, that’s because there are.

“A lot of capital does disrupt venture capital, which is the problem we’ve had as an industry.”

— Sarah Tavel, Benchmark

Founders heed well: So even with the sharp influx of seed funds, the vast majority of the dollars are still invested by traditional venture and growth funds. Since 2011 the average number of seed deals per years (4,300) is not about equal to then number of non seed deals *(4,500).

But as veteran VC Bill Gurley says: “Venture capital is not even a home-run business. It’s a grand-slam business.” Virtually every founder I have met with over the past couple of years just assumes they will raise venture capital. However,

As investor Marc Andreessen has said, “returns are a power-law distribution” with the majority of returns concentrated in a small percentage of companies. That’s true now more than ever, and one of the great promises of the venture capital industry that motivates and drives investors.

So while this article is written from the viewpoint of a venture capitalist, it is well worth studying for founders in search of capital. Basically if you can’t show a VC that you have the potential not to just hit a home run, which was good enough the previous decade, now you have to show that you have the potential to hit a grand slam. Otherwise you are unlikely to even get a meeting with a VC, let alone an investment. Yet at the same time there are significantly more investors today than 15 years ago. The size, growth rate, and dynamics of your target market are the gatekeeper metrics for a venture capitalist today. In other words, disrupting a very large market is table stakes. If you are going after anything smaller you need to either bootstrap (be self-funded) or find an angel that falls in love with your startup,

Getting a VC investment has now become much like getting an acceptance to an elite college or university. The strategy is the same, send out a lot of applications and pull every string you can find in your web of contacts to get warm introductions. The only exception to this rule is Demo Day, where you get to present to a mass of investors, alongside your fellow founders. Demo Days are highly efficient for both founders and investors as both sides can cut through the introductory dance to get directly to a presentation or demo of the venture’s product. In higher education the table is tilted in favorite of athletes and legacies – children of alumni. How does a founder tilt the table in the VC game? By being a serial founder! It’s a chicken and egg problem, if you can’t raise money because you never have raised money what can you do? For one thing, find a partner who is a serial entrepreneur. Beyond that close advisors, like your former professors, with deep startup experience can help you distinguish your startup from all the competition.  But keep in mind where you truly need to distinguish yourself is in the minds of customers. If you can do that the money may well beat a path to your door.

Things you should know about VCs

vcThere are lots of myths out there about VCs, about how they will take over your company and replace you as CEO or that getting a VC investment paves the way on your path to riches. But Jason Lemkin of SaaStr, the world’s largest community of SaaS executives, founders, and entrepreneurs, has an excellent article on some facts you should know about VCs – forget about those myths!

  1. Entrepreneurs tend to think about VC firms, but in reality VC firms don’t do investments, individual partners at VC firms are the ones making the investments. Just like medical device makers don’t sell to hospitals, they sell to the individual financial decision makers in departments in hospitals that need those devices. And the hard truth is that partners at VC firms do very few investments per year, typical just one or two. So as a collective firm they may do a significant number but the individual partner who’s a potential fit for your firm only one or two. So you need to have a really compelling fit for that VC and you better know from your research which partner in the firm might invest in your firm. That knowledge should be based on their track record, blog posts, social media presence, and G2 you can gather from their portfolio companies.
  2. As the Bob Dylan song goes, “Everybody gotta serve somebody” and in the VCs case it is their limited partners, those pension funds, college endowments, and wealthy individuals who invest in venture capital as part of their diversified investment portfolio. So check out the limited partners, for example, when we were talking to Greylock about funding Course Technology it turned out they had six or seven limited parters which were college and university endowments – so they were excited to invest in our educational software and publishing company.
  3. Partners are diversified, you aren’t. Unless you are Elon Musk or Jack Dorsey, chances are very high that the only company you are fully invested in is your own. Not so for partners in VC firms. In essence they are portfolio managers; your firm is just one amongst several in their portfolio. So they will tell you that their interests are fully aligned with your’s but in fact they are not. Resources – money, connections, and their attention – will go to only those firms in the portfolio that they perceive as the winners.
  4. VCs don’t just make money on exits, they make money on management fees. And to make a lot of money on management fees – typically 2% of funds invested per year – they need to raise multiple funds. And they raise those funds by getting step ups on the valuations of the companies in their portfolios. Yes these are paper gains but they can show their LPs strong IRR on their current investments. So VCs always have one eye on the next fund and how they will raise it.
  5. Small VCs Align With You, But Lowball You.  Big VCs Don’t Align As Well, But Can Pay More. Big VCs can write big checks and they also can hold funds in reserve, so they can participate in multiple rounds without getting diluted. But small funds will probably have to syndicate their rounds – share the investment and any returns – with other firms. Big VCs can write very big checks, but then they need to have a big return to impact the fund. And partners can only serve effectively on just so many boards – typically no more than seven to nine – so if you only need a small amount of funding they can’t afford the opportunity cost of taking the time and attention to invest in you, let alone serving on your Board.

Entrepreneurs have learned about product/market fit, but investor/venture fit is equally important. The amount you need to raise, the market you are targeting, how you play with the partner’s portfolio, and your need to raise multiple rounds to get to breakeven are all factors you need to take into account before you even start contacting VCs. As Sun TZu wrote in his work The Art of War, “Every battle is won before it’s ever fought.”

10 key steps in approaching your first VC

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If you are indeed investor-ready, then it’s time to take these key steps before you approach your first venture capitalist for an investment. And you do have a warm introduction to this VC, right? If not, go back a step and get one!

  1. Review the investor’s portfolio, which is virtually always on their web site. Are any of these companies competitors to you or potential competitors? If so, you should steer clear, as the only reason you will get the meeting is to have their partner gather information about you, for them.
  2. Are you at the right stage for this fund? Some funds primarily do follow-on rounds, they virtually never do seed stage. Make sure you are at the stage that is a fit with your target investor.
  3. Is the timing right? VCs, like founders need to raise capital. You don’t want to target a firm that’s closed out their first fund and is in the middle of raising capital for it’s next fund. Or a firm that has invested virtually all of its fund already. You may need to ask the partner the stage of their fund, this is not publicly available information.
  4. How much runway do you have? It can take 6 months to raise an institutional round. You might need to raise friends and family capital first, if you haven’t already. Or perhaps you start with an angel round. The cardinal sin in startups is to run out of cash! And you don’t want to be negotiating with a VC from a position of weakness because you cash is about to run out.
  5. Brief your team. They should know what firms you are approaching and which partner in those firms. You never know when a VC’s path will cross with one of your team’s.
  6. Create a killer two-sentence summary of your firm to go in the body of your email.
  7. Create an exciting one page summary of your business, including the team, your market opportunity, and secret sauce. Don’t forget your contact info!
  8. Come up with a good subject line for your intro email. Such as “Bill Jones recommended we talk with you” where Bill Jones is the person giving you a warm intro. Obviously, if he’s gone as far as sending you both an email, then the subject line would be “Following up on intro from Bill Jones.” VCs get a lot of email! Don’t let yours get lost due to a vague subject line.
  9. Do not send your pitch deck. Even if they ask for it. Politely explain the deck has been designed to support your presentation, not stand in for you. You want to use the one-pager to get the investor meeting, where you will be glad to present the deck. If you really want this meeting and the VC is adamant about wanting your deck first, you can one of two things: one, walk away. That may actually impress the VC; or two, craft a more detailed deck that can standalone as a document presenting a complete view of your business. But keep in mind, decks get passed around, do you want that? Better that your one-pager gets passed around.
  10. Do not specify how much money you are asking for! It may be too much for the fund you are targeting or even too little. Don’t give them the opportunity to use that excuse to ignore your email or follow up phone call. Once you get into the meeting your ask will be the last slide in your deck.
  11. Last and probably first: talk to some founders who have received funding from this VC. Do they think you are a fit with their fund? Do they recommend the VC? And most important, how does the VC act when times are rough? Read my post Founders need to perform due diligence on prospective investors.

So we’ve done it the Spinal Tap way, turning up to 11! There’s more to say, such as rehearsing for a phone call to or from a VC, but we’ll stop here so you can get going.