#10 | ?? How to raise money? [2 of 3]

March 4th, 2024 | by: Daniele Dellavalle?

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?THE INITIAL COMMITMENT IS CRUCIAL?

The perception of most investors towards your startup is heavily influenced by what other investors think. Once you secure commitments from some investors, attracting additional ones typically becomes easier. However, the challenge often lies in obtaining that first commitment.?

Achieving the first significant investment offer can represent half the battle in fundraising. The significance of an offer is determined by the investor's reputation and the amount offered. Investments from friends and family are generally not considered impactful, regardless of the amount. But securing $50,000 / $100,000 from a reputable venture capital firm or an established angel investor can be enough to kickstart the momentum.?

Since when fundraising, securing the first investment offer is often the hardest part, it's crucial to consider this in your strategy. You need to assess not just the likelihood of an investor saying yes, but also their likelihood of being the first to do so. Investors known for making quick decisions are particularly valuable early in the fundraising process.?

On the other hand, investors who wait for others to invest before they do are not helpful at the start. Many investors do follow the lead of others, but some explicitly state they will only invest after a "lead" investor commits. This term "lead" refers to investors who dictate the terms of a deal that others then follow. However, the concept has evolved, and now, especially before Series A rounds, startups often raise money from individual investors without a formal lead.?

The term "lead" is still used by some investors as a way to justify waiting for others to show interest before committing. This attitude reflects a dependency on the momentum generated by other investors' interest rather than an independent assessment of a startup's potential.?

Understanding this, when an investor says they don't "lead" or will only invest after you have a lead, it's essentially a non-committal stance, indicating they'll only invest if your deal becomes popular among other investors. Since an investor who won't "lead" doesn't add immediate value to your fundraising efforts, it's advisable to prioritize discussions with them later or not at all. Focus on investors willing to make independent decisions and commit early.?

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MONEY IN THE BANK?

Finalizing committed funds is crucial; a deal isn't finalized until the funds are securely deposited in the bank. We often hear founders boasting about raising substantial amounts, only to find none of that money has actually been received. The dual fears plaguing investors—fear of missing out, prompting premature commitments, and fear of investing in a failure—make this market particularly susceptible to buyer's remorse. Moreover, the volatile nature of public markets and potential surprises for startups, such as new competitors, legal challenges, or internal team issues, can quickly change an investor's willingness to proceed.?

?Even a slight delay can lead to new developments that make an investor reconsider their decision. Therefore, once an investor commits, it's vital to understand the timeline for transferring the funds and to closely monitor this process until completion. While institutional investors typically have dedicated staff for financial transactions, securing funds from angel investors might require more direct involvement, possibly necessitating in-person meetings to collect checks.?

?It's worth noting that inexperienced investors are more prone to second-guessing their decisions. In contrast, seasoned investors often view their commitment as irreversible, akin to jumping off a diving board, partly to maintain their reputation. However, there have been instances where even leading venture capital firms have backed out of agreements.?

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BE FLEXIBLE?

It's important to be flexible with your fundraising goals, as many investors will inquire about the amount you intend to raise. This question may lead founders to believe they need to aim for a specific figure, but in reality, having a unique set target in an uncertain endeavor like fundraising is not advisable.?

Investors ask this question not because they expect you to have a precise amount in mind, similar to how a salesperson might inquire about your budget for a gift without expecting a fixed answer. Instead, they're gauging whether you fit within their preferred investment range and assessing your ambition.?

For those who are not fundraising experts, it's best to adopt a straightforward approach: plan for multiple scenarios based on varying levels of funding. For instance, explain how you could achieve profitability with no additional funding, how a modest sum could allow you to expand your team slightly, and how a larger investment could significantly accelerate your growth.?

This strategy allows you to tailor your pitch to different types of investors, from angels interested in smaller contributions to VC firms looking for substantial series A investments.?

If you're considering the maximum amount to raise, a useful guideline is to calculate the funding needed to cover your intended team size for 18 months (an estimated timeframe to start generating revenue), factoring in a monthly cost of $15,000 per employee. This figure should include salaries, benefits, and even office space. Although $15,000 per month per person is a high estimate, especially for early-stage startups, it provides a safety margin for your budgeting. For any additional costs, such as manufacturing, add those separately to your total funding goal.?

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START WITH LOWER ASKING?

Feel free to underestimate your fundraising goals to a reasonable extent. While it's important to tailor your discussions based on the interests and expectations of different investors, a general strategy is to err on the side of underestimation regarding the amount you aim to raise.?

For instance, if your goal is to raise $300k, you might initially announce a target of $150k. Achieving $100k under this revised goal signifies that you are at 2/3 of your target, projecting a sense of progress and momentum to investors. This perception encourages a sense of urgency and FOMO among potential investors, as it appears there is limited space left for investment. Conversely, if you were upfront about a $300k goal, a $100k achievement might not reflect as positively, potentially stalling further investment due to perceived lack of progress.?

It's important to note that starting with a lower target doesn't restrict you to that amount; if investor interest continues after reaching your initial goal, you can always decide to raise more funds. Many startups find themselves in this position and successfully secure additional funding beyond their initial targets.?

The key is not to mislead but to manage expectations prudently. Beginning with a lower figure has little downside; it generally doesn't limit the total amount you can raise and often helps in increasing it by creating a more compelling investment narrative.?

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PROFITABILITY IS KING?

Having a plan that includes the possibility of not raising any funds — that is, reaching profitability on your own — places you in a far stronger negotiating position with investors. The ideal scenario is to be able to assure investors of your success with or without their money, though additional funding could accelerate your growth.?

The relationship between fundraising and dating offers a powerful analogy: desperation is unattractive. The most effective strategy to avoid appearing desperate is to genuinely not be in desperate need. This is why we advise startups to minimize expenses and aim for basic sustainability, or "ramen profitability," before presenting at Demo Day. Counterintuitively, the best way to attract funding is to evolve to a point where you don’t strictly need it.?

Fundraising can typically be categorized into two types: ?

• Type A, where fundraising is optional and pursued to expedite growth?
• Type B, where fundraising is essential for the company’s survival. ?

This distinction is crucial, as inexperienced founders often mistake the need for funds as a universal startup requirement, not realizing the challenges and drawbacks of fundraising without a solid plan for profitability.?

Not every startup can reach a state of minimal profitability quickly, and indeed, some manage to negotiate from a position of strength due to other factors like rapid growth or exceptional leadership. However, the challenge of attracting investment without profitability becomes increasingly difficult over time.?

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VALUATION IS NOT SO IMPORTANT?

Focusing on valuation during fundraising might not be as crucial as you think. Founders often pride themselves on securing high valuations, competing for the highest numbers as though it's a badge of honor. Yet, this misses the point. The true measure of a startup's success isn't its valuation during fundraising but its revenue and the growth it achieves. Fundraising should be viewed merely as a tool to reach those real goals, with the primary aim being to secure the necessary funding to advance your company and attract valuable investors, rather than maximizing valuation.?

Historically, successful companies like Dropbox and Airbnb raised money at what today might seem like modest valuations, demonstrating that a startup's worth isn't solely defined by these early numbers. When you begin fundraising, the initial valuation set by the first committed investor often sets the stage for subsequent investments. While it's tempting to push for the highest possible valuation, maintaining realistic expectations and focusing on the broader picture of your startup's growth and needs is more beneficial.?

If faced with eager early investors, consider using an uncapped convertible note with an MFN (Most Favored Nation) clause, which allows the valuation cap to be adjusted based on future investments, providing flexibility. Despite the intuitive belief that higher valuations are always better, a lower valuation can sometimes facilitate the fundraising process, emphasizing the importance of focusing on your startup's potential success over achieving the highest possible valuation at this stage.?

Prioritizing interest over valuation in early fundraising discussions can be a strategic move. If investors inquire about your valuation upfront and you haven't finalized an investment that sets it, it's crucial to steer the conversation away from pricing. This approach keeps the focus on the mutual fit and interest rather than prematurely locking into a valuation that might not reflect your startup's potential or the investor's value add.?

Informing investors that your main concern isn't the valuation, but rather finding the right partners to grow with, shifts the dialogue to a more meaningful evaluation of the investment's strategic benefits for both parties. If an investor is genuinely interested in your vision and potential, the conversation can then naturally progress to specifics, including valuation, once their commitment to invest is clear.?

For the initial investor commitment, offering a more flexible or lower valuation can catalyze the fundraising process, establishing a foundation for subsequent investments. This approach, when done thoughtfully, can set a positive precedent for future negotiations, emphasizing the value of strategic partnership over numerical valuation.?

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DEPRIORITIZE "VALUATION SENSITIVE" INVESTORS ?

Navigating investor interactions, particularly with those who are "valuation sensitive," requires strategic consideration. These investors are known for their focus on negotiating lower valuations, potentially consuming considerable time and effort in the process. Engaging with such investors too early can also lead to an unnecessarily low valuation for your startup. It's advisable to prioritize discussions with other investors and save those who are valuation sensitive for later stages of fundraising, where you can present a firm stance based on the commitments you've already secured.?

This strategy allows you to maintain control over the valuation conversation, ensuring that you're not pressured into accepting a lower valuation than necessary. If you encounter a valuation-sensitive investor earlier than anticipated, consider slowing down discussions with them, focusing instead on investors more aligned with your initial valuation expectations.?

Should you receive a lowball offer, it's prudent to view it as a secondary option rather than a primary path forward. Ethical negotiation practices dictate that genuine offers should be met with timely responses. However, significantly low offers, which deviate from previously discussed valuations, can be strategically delayed in response (what we call ‘VC style’). This approach ensures you maintain negotiation leverage while exploring better-suited investment opportunities.?

... to be continued?