With as little as it costs to get a software startup off the ground these days, many entrepreneurs start off as what we call “bootstrappers” rather than fundraisers. There’s nothing wrong with that approach but staying in the bootstrapped mode for too long can carry some consequences. This article explores that further.
Not much different than the famous chasm described in Geoffrey Moore’s book “Crossing the Chasm”, funding your startup venture over time also has a chasm. This fundraising chasm doesn’t trip up all startups but that might just be due to luck. Explore this further with me to better navigate the chasm in such a way that it doesn’t suck you into the abyss.
When I ask entrepreneurs what their most valuable resource is, I ALWAYS get one of two responses: money (aka – funding, cash) or people. And it’s hard to argue about the relative importance of these two things. But those resources are replaceable. There’s another resource that isn’t, and it’s Time. Time is an entrepreneur’s most valuable resource and is the subject of this article. Given the various other tools and resources you have, how can you maximize time? Let’s explore further.
Almost no investor wants to be the “first check written” for your round of funding. This makes total sense if you think about it from their perspective. If you don’t secure any other investors, they are in big trouble because you needed a certain amount of money to remain viable and now their investment is already extremely risky. For this reason, until you actually have money in the bank from a few investors you will find most interested investors dragging their heels (artificially delaying things). This article describes how you can use verbal commitments as a crucial tool to shake things loose, get some money in the bank and trigger needed fundraising momentum.
Here’s a scenario I commonly see. A startup raises $1M in total seed funding to turn their MVP into a real product and figure out a profitable and scalable customer acquisition model. All goes well over the coming 12 months as they reach $80K in MRR while also growing the team to 10 employees. They find themselves setting plans for a Series A round of funding and predict the process will be similar to their seed round but just with venture funds as the primary target and larger check sizes. After eight weeks and zero success, they approach someone like me for advice and the reaction they get is some flavor of this: “a Series A is not just a larger version of a seed round”. This article dives deeper into what exactly that statement means.
I didn’t invent this quote (can’t remember where I heard it) but what a great one to help remember that with most business-related transactions, price is definitely not the only factor. Three such transaction types relate to the things I commonly write about on this site:
- Fundraising (valuation)
- Technology licensing (royalty or license fee)
- Acquisition (price tag)
In this article I provide insights into possible terms for each type of transaction that could dramatically change the value equation.
FINALLY!!! After years of waiting for equity-based crowdfunding rules (aka Reg CF) to be adopted and put into effect following legislative approval of the JOBS Act of 2012, it’s finally here (effective May 16, 2016). So should you stand on top of your roof and heed the battle cry to all of your fellow entrepreneurs? Well, not so fast.
I think you should “double click” on the final regulation to know what you would be advocating. I’m not sure it’s for everyone and certainly it is not for every situation. In this article I’ll attempt to demystify at least the basics.
I’m not talking about a stand-up presentation in front of an individual investor or VC firm but rather some form of on-stage pitching event. It might be called a “demo day” or “shark tank” and might also come with awards (including cash). Too often, I see entrepreneurs make basic mistakes that could have easily been avoided if they had prepared, even just a little. I actually think it’s a common personality trait of many entrepreneurs. They take pride in being able to “wing it”. But if the stakes are high, why impose the extra risk? In this article I cover a checklist of simple preparation tasks for pitching events.
While you are still in the idea phase, investors tend to focus on vision, promise, potential and personality traits of the founder(s) because that’s all you have for them to evaluate. Once you’ve got an established business model, starting management system and initial track record of paying customers, investors will naturally give those things focus when considering an investment. But when you’re in between these two phases with a yet-to-be-launched MVP (software) or ugly-but-working prototype (hardware), the conversations and debates are often more challenging. You have something tangible (MVP, prototype) but can’t yet connect any dots of real customer traction. This article describes a method for helping the investor understand where you are currently and how their money will effectively be used to continue your pursuit of building a great product and eventually a great company.
Most startups think of a convertible note as the most common fundraising vehicle used during the pre-seed and seed stages (see related article titled “Convertible Note Basics“). What they might not know is that convertible notes are also used for what’s called a “bridge round”. It is just like it sounds, bridging the gap between today and some point in the future. This article describes the use of convertible notes for such a scenario and, more specifically, the differences and nuances versus using them for seed rounds.
Every field of study has its basic vocabulary of words and phrases that come up over and over again. This vocabulary is so fundamental that it is used to explain other concepts that are more advanced. Well, fundraising is no different. This article is intended to serve as a primer of sorts with a description of ten basic terms that must be understood by any startup pursuing fundraising.
In a previous article, I described various ways to determine how much money to raise (you can read it here). If you’ve decided and communicated how much you are raising, you might be getting the obvious follow-up question: “Why is that the right amount?” It’s a very simple and justifiable question for the investor to ask but it is commonly met with a host of unacceptable responses, such as these:
It’s a necessary element of your business plan and pitch deck. It’s a question you’ll get asked all the time by investor prospects. And it’s something you’ll find yourself defending, even if much of the underlying data and assumptions didn’t come from you. As the title of this blog article suggests, I’m talking about your market size. But how do you go about estimating the size of your market and what should you do if the resulting estimate is way too big or way too small? Read further for a few hints and tricks for conducting this important exercise.
Let’s assume you have already determined $500K is the ideal amount of money to raise in your current fundraising round (see related blog article titled “How Much Should You Raise”) and you’ve also decided a convertible note is the right instrument to use (see related blog article titled “Convertible Note Basics”). Most convertible note templates have a statement/clause that mentions how much you are authorized to raise in that round (as a series of individual notes with multiple investors). $500K is the amount you should show as the maximum authorized amount, right? Not so quick. There are reasons you might want to set the amount lower or higher. Let’s explore the dynamics and trade-offs using $500K as the amount you truly think you need.
You didn’t plan for it to happen this way but you’re reaching the maturity date (end of term) on your convertible note and didn’t raise money in an equity round to cause a natural conversion (called a “qualifying transaction”). Your options are somewhat limited. You could try to complete the qualifying transaction, even if the terms are terrible. Yikes. You could talk to your attorney about offering to convert the note holders to equity using the Valuation Cap as the pre-money valuation. Not bad. Or you could request that your note holders give you more time by approving an extension to the maturity date. Yuck. It’s the last option that I want to explore further in this article so that you can see the investor’s point of view and decide how to best handle.
You’ve just completed a great investor pitch with heads nodding and good interaction. You’re about to ask “Does this opportunity interest you enough to explore an investment?” when instead you get a final question: “One final question. What is your exit strategy?”.
Oops, the last two times you got this question you were met with a sour look. The first time you wanted to show you aren’t looking for a quick-flip and so you answered something like, “We’re not even thinking about selling the company or doing anything crazy like an IPO”. The next time you decided to show the investor you want everyone to get a payday and so you answered something like, “We’ve already identified six companies that surely will want to acquire us as soon as we’ve reached $5M in revenue. They are A, B, C, D, E and F”. In this article I’ll explain why you got the sour looks and suggest a different response that aligns nicely with both company and investor interests.
Similar to the “So What” rule, every time you make a claim, prediction or forecast, imagine your audience is thinking to themselves “yeah, right!” in skeptical fashion immediately after seeing/hearing your claim. Make sure you aren’t asking them to make a huge leap of faith without supporting your claim. There are a variety of ways to do this. I’ll start with some examples and then dive a little deeper.
Made available by Y Combinator in 2013, the SAFE investment instrument was intended to improve on the highly popular convertible note used by startups during the seed stage or as a short-term bridge between equity funding rounds. SAFE stands for “simple agreement for future equity” and it is still most popular in California. However, over the years since it’s release it has started to show up in other parts of the country.
The purpose of this article is to review the elements that make up a SAFE investment, compare them to a convertible note and generally help both entrepreneurs and investors decide which is more appropriate for their situation.
Once you have a product in the market with an increasing number of paying customers, your valuation will increasingly be driven based on financial and operational metrics. Don’t get me wrong, establishing a financial valuation for any early stage company is part art and part science. So it is true that things like meaningful strategic partnerships, a robust product roadmap, and other non-financial items can help drive valuation. But the more you have an established track record of revenue/profit, the more your valuation is based on financial and operational results. What about establishing and defending your suggested valuation before you have revenue traction? Let’s explore.
There’s a reason it’s referred to as an “elevator pitch” – it must be expressed in a couple of sentences and no more than 10 seconds. And that might even be a little generous. Psychologist Michael Formica reported that the average non-task-oriented attention span of a human being is about 8 seconds. What you must realize is the only thing your elevator pitch needs to accomplish is to cause enough interest on the part of the recipient to ask you any question that lets you expand a little further. But also be careful about abusing the permission you’ve been given to continue. Now you have 2-5 minutes to generate enough interest for a full-blown conversation, either then or separately scheduled.
I mention this because I see a lot of startups way over thinking the elevator pitch. Start with two sentences that answer the following questions:
It stands to reason that each investor is different in the way they go about making their investment decisions, both in terms of time spent and the type of research conducted. One thing you want to figure out early in the courtship with an investor is how they go about making their investment decision. This best enables you to align your interactions with a broad group of investors to create proper momentum and a crescendo effect (see related article titled The Domino Effect of Fundraising). It sucks when you think you’ve got several investors lined up together only later to realize some of them were only half-way through their process.
As mentioned previously, the two key dimensions to understand are time and research. Let’s break them down:
In a previous blog article I explained what convertible notes are and when they are commonly used (see article titled Convertible Note Basics). Now I’d like to dive into one of the most controversial terms in many convertible notes – the valuation cap (aka – “the cap”). I say “controversial” in the context of leading to debate/negotiation between the startup and the investors. Rarely is the interest rate or term length debated. But a cap always seems to get attention. You’ll want to understand the basics about caps before reading the rest of this article (see article titled Convertible Note Basics).
Some convertible notes don’t have a cap at all, which means the sky is the limit on future valuation when the note converts. Startups that are super hot and have a lot of demand for their investment round might be able to get away with this. But that’s the exception, not the rule. So how should you set your cap amount? The answer involves much more art than science because the real answer is, whatever you are able to convince enough investors to agree to.
Similar to selling a house, you can fixate on what the appraisals and marketing reports suggest but the truth is that your house is worth whatever the highest bidder is willing to pay for it. So let’s look at the issue of a convertible note cap through the eyes of the two stakeholders:
Hopefully you are reading this before you decide how much to raise. I’m referring less to very early seed funding just to get your minimum viable product (MVP) built, which in many cases costs little or nothing, and more thinking about raising money after your product is built and/or your initial validation is completed. But the basic concepts outlined in this article apply to later stages as well. This article doesn’t describe the best fundraising vehicles and associated terms to use for seed-stage funding but two common ones are described in related articles: “Convertible Note Basics” and “Reviewing the New SAFE Investment Instrument“.
If you’ve already decided and communicated how much you are raising, you might be getting the obvious follow-up question: “Why is that the right amount?” It’s a very simple and justifiable question for the investor to ask but it is commonly met with either puzzled looks or unacceptable responses. Don’t worry, I have some suggestions that might help.
In a previous blog article I suggested the proper flow and order of topics for your pitch deck (see article here). Now I’d like to dive into the Problem section with a suggestion on how to describe the actual problem you solve. Many startups use industry statistics and other factoids to do this. For example, “65% of small businesses in the US report struggling with _____”. These factoids are commonly strung together in succession to support each other and help demonstrate a clearly recognized problem.
While it’s absolutely helpful to use statistics and factoids to justify your problem statement, it shouldn’t be the only way to describe it. Instead, start with a story that explains the problem. The subject of the story can be a real customer or a hypothetical one. Telling a story about a specific person/company that experienced a specific problem with specific attributes is much more effective than just statistics. Here are some examples of how to start the story:
Your pitch deck will become the single most valuable communications tool to use with external audiences of all types. You will use it for multiple purposes. If you ever decide to pitch at a pitching event, you’ll obviously need one (see related article titled “Why Participate in a Pitching Event” ). And instead of writing a 30-50 page business plan, let your pitch deck serve as the starting point for an expanded version that essentially becomes your business plan (see related article titled ‘Don’t Waste Your Time on a Business Plan’ Doesn’t Mean Don’t Plan).
There are a few different philosophies about this but the flow I prefer to use/see and what I encounter most often is outlined below. For each section I’ve provided a couple of tidbits or things to consider. But I could write a blog article on each section by itself, so don’t limit yourself to the things I’ve mentioned.
This article isn’t intended to get into every detail of convertible note mechanics. But I get enough questions about when to use them and what the basic components are that I thought a basic primer was in order. I’ve also included a FAQ at the very end to help you answer common questions from investors that aren’t familiar with convertible notes. And for those interested in the seed-stage SAFE investment instrument made available by Y Combinator in December 2013, ready my review and comparison to convertible notes here.
If you’re fundraising during the very early formation of your company, your ability to predict the future will be very difficult. Of course, you can imagine and dream what might happen. But many agree that it’s a waste of time to project your financials 3+ years into the future. I’ve already written that not spending the time to create a traditional business plan doesn’t mean you shouldn’t plan (see related article titled ‘Don’t Waste Time on a Business Plan’ Doesn’t Mean Don’t Plan). But what do you do when faced with an investor prospect that is specifically looking for predictability? You can either drop them from your list (at times the right thing to do) or you can share the following things with them in hopes they will serve as a substitute.
I recently heard Dr. Robert Wiltbank from Willamette University use this analogy and loved it so much I had to share it with others. Entrepreneurs are, by nature, very optimistic. It’s one of their core survival skills. But this often makes it hard for them to recognize signals of negative feedback. This applies to things like the success of their product and progress towards the business plan targets. But it also relates it to investor feedback while pursuing fundraising, customer feedback while pursuing a sale or vendor feedback while trying to secure a partnership. Experienced sales professionals are trained to listen for negative feedback and use various techniques to assess the real viability of the opportunity. But most co-founders aren’t experienced sales professionals and the techniques I’m referring to aren’t easily learned from a blog post or a book. I’ll explain further.
Some investors want to be the last one to commit and few want to be the first. It’s mostly a safety and survival technique. Think about it from their perspective. The first investors to write you a check run the risk that you only get half-way to your fundraising target, which means your business is suddenly an even riskier investment than what they originally predicted. Savvy investors that write checks early in the round will intuitively take this into account, which might explain why they are being extra cautious and demanding in their due diligence. These dynamics are behind my related analogy on fundraising (see article here titled “The Domino Effect of Fundraising“).
As it turns out, I’m a big proponent of letting the investors control the pace of the “dance”. But when you’ve got investors on the fence for excessive periods of time and need to close your round, you need to apply some genuine sales closing techniques. In fact, during your initial conversations with each prospective investor, ask what sort of things are important to them when making their investment decisions. Focus on those things during your conversation but also write this information down when you’re done so that later when you find yourself needing to nudge them to a decision you remember which aspects of your opportunity and business plan to accentuate and highlight recent progress or new information.
Fundraising is rarely easy and is usually a far underestimated undertaking by entrepreneurs that haven’t done it before. In the fundraising section of this blog, I describe ways of approaching the exercise (see related article titled “The Domino Effect of Fundraising“) and what to do if you don’t reach your goals (see related article titled “Stuck at 75% of your Fundraising Goal – Now What?”). But if you genuinely feel like your product idea and business model approach is sound, and have gotten validation of this via investor prospects and your Lean Startup validated learning approaches (order book here), you’ve got to turn your attention to other things that might be getting in your way of convincing investors to write a check. Below are a few on my short list to start with:
I know, I know – your idea is hot, your business plan is solid and you got an awesome reception from the recent demo day you participated in. You’ve got simultaneous dialog going with 10 different potential investors and have closed a couple of them in just the first three weeks of fundraising. But please don’t ratchet up your expenses to a level that assumes you’ll reach 100% of your fundraising goal. What happens if you don’t reach that goal?
Here’s the scenario. After finding your first investor and then having a flurry of activity over a month or two (see related blog article titled “The Domino Effect of Fundraising”) that gets you to something like 75% of your fundraising target, you hit a brick wall. You still have a handful of interested investors but none seem to be making a decision. Because the fundraising process is taking much longer than you thought, you dialed down the fundraising activities to about 20% of your workload so that you could spend 80% focused on the company. Now what?
Fundraising can seem like herding cats. You get some initial momentum, potentially from a pitching event, and have a bunch of conversations but can’t seem to get the funding commitments to roll in. I heard one person use the analogy that nobody likes to be the first one on the dance floor but as soon as one couple finally starts dancing, the floor fills with many others. Well, many investors don’t want to be the first one to write a check. Worse yet, most would prefer to be the last check written. Think about it from their perspective. If they write your first check and you don’t get anything else (or only get to 25% of your target), their investment is suddenly a lot more risky than the investor that writes the last check knowing exactly how much you’ve already raised and what you can do with it. Let’s explore further.
I use this rule all the time when advising startups and early stage companies. Actually, it has application in any sort of sales pitch, regardless of your company’s stage. I call it the “So What” rule because it’s an easy way to think about it during a conversation or presentation. It’s a fundamental element of all sorts of sales and presentation methodologies that are just called something different and with a longer explanation. Here’s the simple approach.
Remember that investors are skeptical to start with, and rightfully so. Most investments by angels and VC’s either fail completely or return less than what they invested. They count on something like 1 out of 5 investments to give some minor or decent form of return and 1 out of 25 to do really well. So many executive summaries and business plans come across their desk claiming to completely change the world that they basically get numb to superlative claims. Same for customer prospects you’re selling to.
I just came from a startup pitching event with about 100 angel investors and VC’s in the audience. The startups only had the typical 5 minutes to give their pitch, which meant they had to dramatically streamline their full story into something more akin to an elevator pitch in a really tall skyscraper.
I knew one of the startups because I have already verbally committed an investment to the founder. I talked to him at the mixer afterwards and asked about the feedback he got from the audience members. He responded that too many of the investors he talked to immediately afterwards said they didn’t quite get it. As I thought about it later, I realized that he might be suffering from the “and then magic happens” dilemma. Without knowingly doing so, his streamlined story caused his pitch to come across like this:
The immediate response is obvious: to facilitate the fundraising process. But what other benefits can you expect to gain from participating in a pitching event? How about these for starters:
Your 3-5 Minute Story
Before your first formal pitching event you probably had only two modes of responding to interested parties: the 30 sec elevator pitch (see related article titled “Your Elevator Pitch Only Needs to Accomplish One Thing“) and the 30-45 minute interrogation by an interested investor (mostly Q&A format). Preparing for a pitching event forces you to tell the most important elements of your story in 3-5 minutes. And you get to do it without interruption, which also means you are forced to connect your points in logical fashion.