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 commonly advise startups to think about toppling dominos that are setup like a triangle of bowling pins. The first domino is anyone that will invest, the next row of dominos are investors with at least some reputation and behind that are the investors you’d love to have on your side but are really hard to get.
Said a different way:
- Get anyone to invest
(of course, within reason)
- Get someone to invest
- Get someone specific to invest
- Get the rest to close out the round
Over-simplified, but you get the idea to keep in mind. Start by “getting someone on the dance floor” and use that to start the momentum. A related technique involves creating a perceived crescendo of activity. Go ahead and accomplish the first couple of steps described above but don’t advertise it. Keep the information to yourself and once you’ve got a few more investors seemingly interested, reveal that you’ve got multiple investors already committed (and hopefully with checks written). The perception that it all happened recently rather than the possible weeks/months that it really took creates the perception of momentum that you can leverage to close out the rest of the round. Just be careful not to play too many games with investors because trust is important.
If you can’t seem to get the first investor(s) to commit, your fundraising terms might not be attractive enough. If you find that you’re regularly having to justify a term like the discount or valuation cap in your convertible note (see related article titled “Justifying the Cap Amount in Your Convertible Note“), then it’s probably wrong. Especially for your pre-seed and seed rounds of funding, you don’t want good investors to have to think too hard about the terms. You just want them to focus on the upside opportunity when you have huge success.
If you feel like your terms are generally OK but instead need an incentive for your first few investors, consider the following:
- If the first 2 or 3 interested investors would be valuable advisors, offer them 0.25 – 1.0% equity in stock options for a 1-2 year period as an advisor. You’ll need to agree with them how active the advisory assignment should be and realize the more active, the less the equity is an added investment incentive and more just compensation for being an advisor. (see related article titled “Compensating an Advisor“)
- Offer investors for the first 25% of your target (ie – first $100K towards a $400K target) what is called “warrant coverage”. If you’re raising money on a convertible note, the investors get warrants that are exercisable at a price per share that is associated with the valuation cap on your note. How many warrants is up to you but start by thinking in the 0.25 – 0.5% equity. And make sure to work with your attorney on the mechanics of this.
- Offer investors for the first 25% of your target a lower valuation cap, a higher discount or both.
Once You’re “Over the Hump”
Once you’ve gotten above about 65% of your fundraising target you can use another technique to close out the round. Start using the words, “There’s only $____ left in the round, should I save a slot for you?” This communicates scarcity and might be what you need to get the investor thinking they might actually miss out if they don’t make a decision. And if you have some verbal commitments that haven’t yet written checks, you can include that in your calculation. Just make sure to only count verbal commitments that you genuinely feel are solid and be 100% honest if an investor asks how much is actually in the bank. Entrepreneur trust and honesty are critical personality traits for most investors.
On the topic of closing specific investors that seem interested but, for some reason, aren’t opening their check book, see my article titled “Getting to Closure with an Interested Investor“. Similarly, if you get close to your goal but then get stuck, check out my article titled “Stuck at 75% of Your Fundraising Goal – Now What?“. Finally, I’ve got a pretty comprehensive checklist of things you could attempt to achieve to convey lower risk to your investor prospects (see related article titled “Establishing Valuation Before Revenue Traction“).