This article is one of the 8-part series of evergreen topics that all startup founders face. It is based on what the mentors actually teach startups during the StepFWD pre-accelerator.
Our thanks go to Ciprian Borodescu, Head of Algolia (AI R&D) Romania, for helping founders efficiently raise their next investment round.
Before starting to think about getting an investment, you need to first decide why you want to do it. Is it because it’s an ego play? Or is it because you want to grow your business, your team, and your product? Do you have a plan of how you are going to do it? Or is it just a dream that you will somehow hope to just wing it?
Once you figure out that you are serious about it, then do not underestimate the process. Raising money is a full-time job! Seriously, throughout your fundraising round, you will hardly have any time and energy left during the week to be able to do anything else in your business. So prepare yourself to meet with 10s of investors and be rejected constantly before getting to that one “Yes”. If you are resilient enough to get to that first commitment then the game will change after that (in your favor).
Finally, make sure that you lawyer up and negotiate. This is a 2 in 1 kind of step. If you are going to lawyer up you are obviously going to negotiate. If you have a lawyer and you do not negotiate, why even bother to hire them? Oh yeah, if you don’t get a lawyer, for sure the investor will and they will not work to your benefit. You are the owner of your business and you have to negotiate. Albeit gracefully, but you still have to.
How VCs Make Money
Now that you are ready to enter the game of raising professional money, you should better understand how does venture capital work.
Venture firms raise capital from limited partners (LPs), who are often entities that manage sums in the billions, for a fund that has a lifespan of around 10 years. From the total fund size, the VC retains between 2 – 15% in the form of management fees to run the business. After 5-10 years, the profit obtained from startups existing or going public (IPO) is distributed 20% to the VC and 80% to the LPs.
What is expected is that from all the startups invested in:
- 1/3rd of investments would fail
- 1/3rd of investments would return the capital invested
- 1/3rd of investments would be successful
What actually happens in real life is that:
- One deal returns the fund
- Another 3 to 4 collectively return the fund
- The rest collectively return the fund (obviously quite a few not returning any)
Understand the investors’ business model in order to know how to play the game.
What are your options?
Depending on where you are on your startup journey, you can find below what is the fundraising stage you are at, what is the amount that is typically raised, and the respective valuation. These intervals can vary according to where you are located, and sometimes the numbers can overlap or you can skip some of the fundraising stages.
So, if you’re just starting up from an idea on a piece of paper and you have the right network, angel investment is a good route. If you do not want to give away equity, grants are another option.
After getting a little bit of traction, accelerators become a viable option for any respectful startup out there. Some will offer financing upfront as part of their standard deal, while all (good) accelerators give entrepreneurs exposure to angel investors, VCs, and other investment sources. Then while you’re going through the accelerator and growing your client / user base, you will most likely start conversations with VCs.
Once you have raised your pre-seed and seed rounds, you are entering the numbers game of the Series A, B, C, etc., where the play is a little bit different. To get to this point it’s safe to say that most of the time you either need to achieve (or be close to) product-market fit or to have a unique technology that compensates for this requirement.
Target investors that invest at the stage you are at.
Your first commitment
The best time to raise money is before you need it. And the reason for that is that depending on your stage, it will take you 3 to 6 months until you can close an investment round and see the money in the bank.
When talking to investors, you really have to as a founder to know your shit! Understand that for investors showing an interest and meeting you for a coffee or accepting the ZOOM call is not the same as signing the check. There’s a very, very big difference between them being nice and being interested and actually committing. If they say something like I’m interested, and they do not commit an amount of money, even verbally, they’re just being nice.
And what does a commitment mean? It means that they clearly articulate the amount of money they’re willing to put in and under what conditions. If you do not have that you do not have a commitment. Once you have that commitment, you can actually take that and convince other investors to join.
Specifically, getting to a commitment means that in 3-6 months you go through
- 50+ 1st meetings
- Around 10 2nd and 3rd meetings
- 3 soft commitment
- Signing 1 term sheet
Only then you will move to perform the due-diligence process and finally signing the shareholders’ agreement (which is one step away from getting the money in the bank).
To increase your chances of getting your first signed term sheet, do follow these practical tips:
# Mind the fund size – target investors that invest at the stage you are at
# Know the difference between soft vs. hard commitments
# Pick wisely your lead and follower investors
# Play the fear of missing (FOMO) game to your advantage
# Ask hard questions and challenge the investors
# Always feed the pipeline
# Continually build your Investor Data Room
# DON’T LIE – if you do, you will be found out and it’s game over
You only need one and the rest will follow. Not all of them, of course, but it’s going to be easier to get from 1 to 2+, than getting from 0 to 1.
How much and in what conditions?
You do not raise the amount of money that you’ve calculated in an Excel sheet. You’re raising as much as possible, or as little as possible, depending on your capability as a founder, as a CEO, because most of the time the CEO is at the forefront of raising the money.
Before talking about equity, really take into account using convertible notes or safes. Today there are so many companies and respectful VCs have published their term sheet with all of their terms (not just some). And those became industry best practices.
Giving anywhere between 5% – 10% (sometimes even 15%) equity is decent for a pre-seed or seed round, but it depends on the type of investor you are talking to. Is that person or group coming in with just the money? Or are they bringing in something else like an experienced network that is opening up other opportunities?
Be aware that everybody dilutes when raising money from investors. That’s the name of the game. To grow at speed, sooner or later, you will need to seek professional money, which comes with dilution. And this is not such a scary thing. What you should pay attention to are the rest of the provisions in the agreement.
As Ciprian puts it:
“the control terms are even more important than the economical terms”.Ciprian Borodescu
Be careful with these control terms as they are the most important ones. The best course of action here is to lawyer up because it’s absolutely impossible to know all of those terms in the agreement as a founder. And here’s another thing: investors invest every day, this is their job, so they know what these terms are and how to negotiate them. Your job is to grow the company, and of course, you do need to understand those terms, to have a good intuition, but you need to have help. And so a lawyer can tell you step by step, term by term, what are you risking, and what are the implications.
Finally, having an option pool for your future employees is a must for any serious founder to have for their startup. Although it’s debatable what you want that option pool to be, the typical amount is around 10 – 15%. Rest assured that you won’t find any professional investors that don’t agree with this.
At the end of the day, it’s a negotiation and you must have the maturity as an entrepreneur to know that you are worth more than what is being recognized by some investors.
This article is part of the StepFWD your startup series. Do you need resources for your startup? Check them out: