Hacking the Startup Fundraising Matrix
“The Matrix is the world that has been pulled over your eyes to blind you from the truth.” — Morpheus
The Big Idea
Contrary to what you may believe, there is a proven formula for raising capital. It’s what the world’s best CEOs and expert fundraisers have been using for decades. And now with fundraising and investing moving online, this formula can be amplified, and exponentially more valuable to you.
As we’ve shared this formula with founders raising on Crowdfunder, the data shows that those who follow this formula raise ten times the amount of investment as those who don’t. Founders who follow the formula on Crowdfunder attract $240,000 (founders who don’t raise only $24K). Founders who follow the formula close money 50% of the time from interested investors, whereas founders who don’t close less than 10% of the time.
I will show you how to hack this matrix, but first you need to understand what the agents are doing…
The Quantification of Startup Finance
“Never send a human to do a machine’s job.” — Agent Smith
Last year in 2014, over 70,000 startups got $24 Billion in seed funding from 300,000 investors. The number of funded startups has doubled since 2002; and the data shows that even when total investment dollars drops — as it did during the 2008 financial meltdown — the number of startups getting funded (as well as the number of investors) has steadily increased each year.
But this is just the tip of the iceberg for what’s coming.
The Small Business Administration notes that 6.5 million new businesses are started each year in the U.S., and there are an estimated 6 million U.S. investors who are qualified to invest in startups today. Once the final piece of JOBS Act legislation gets implemented, the remaining 200 million adult citizens of the U.S. will be able to invest in startups for the first time in over 80 years. According to the research the angel investment market historically returns 27% annually.
By contrast, there is roughly $20 Trillion invested in fewer than 20,000 public companies. Quantitative modeling and flash trading has already taken over Wall Street, making it difficult to impossible for a professional investor to make more than the historical average of 9% in the public stock market. One successful hedge fund manager recently admitted to me that he was thinking about closing his fund because he can’t justify taking his normal fees given how efficient the market is these days.
Back in 2013 I gave a TEDx talk where I predicted a shift in quantitative investing from the public markets to early-stage VC:
Two years later, the quantification of venture capital has started, see here, here, here, here and here. At Crowdfunder, we have over 10,000 investors, 27,000 companies growing at 10% month-over-month. In a few short years we’ve seen the VC community go from ignoring us, to scoffing, to mildly interested, and now they are not only sharing their deals and sourcing new deals on our platform, but also finding investors for their funds on Crowdfunder.
As more data and transparency comes into the startup investing process, more angels and VCs are realizing the virtues of a mathematical approach. And the math says that the correct approach with startups is to massively diversify. Dave McClure of 500 Startups has gone as far as to suggest that VCs who ignore the math are “gambling with [their investors’] money”.
These trends are all great news for you as a founder raising capital — if you understand how to unlock it and not get lost in the noise….
Taking the Red Pill
“Every deal is unfundable… until it’s oversubscribed” — AngelList CEO
Everybody wants to invest in the Next Big Thing, but nobody wants to be the first to invest. Two reasons for this. First is that, if I lead and nobody follows, you will be undercapitalized; which means I’ve just made a bad investment. The second reason is that we investors are social creatures, and we need the validation of other investors in your deal before we will commit.
Thus, there is no such thing as an “objectively fundable” company. And because of this, the funding matrix is hackable. One of the main keys to hacking it is social currency.
The Matrix Runs on Social Currency
“Do you believe that’s air you are breathing now?” — Morpheus
Social currency is the trust, goodwill and credibility you have within your network, and more generally with your brand and reputation. Every person has it, and every company does too. While it may be invisible, social currency is what breathes life into startups, and transforms pure ideas into massive enterprises. Mastering social currency is what can take your deal from unfundable one day to oversubscribed the next.
Take for instance Neil Young. While he had a massive following as a musician, nobody would have believed he could launch one of the hottest technology startups of 2014. But he did, and he used his social currency to do so.
The first thing he did was get all of his influential musician friends to participate in a short video where he demonstrated his product concept: a high-definition audio player called Pono. The testimonials from these influencers was so powerful that it helped Pono raise $6 Million in pre-sales on Kickstarter. He then parlayed that success into a $4M equity investment round on Crowdfunder. The demand was so high for Pono’s equity that 8 out of 9 interested investors were turned away, leaving an estimated $6M in investment interest unsatisfied.
While you may be quick to dismiss Neil Young’s crowdfunding success because he was already famous, many founders just like you have already raised over a million dollars using equity crowdfunding.
The key to their success is always the same: leveraging their social currency and transforming it into investment capital.
Transform Your Currency
“I know Kung Fu!” — Neo
Your campaign will consist of five phases:
- Building Social Currency
- Closing Your Lead
- Closing Your Network
- Public Closing
- Victory Lap
While you don’t have to run the public portion, I personally believe this is like playing tennis with a wooden racket today. Here’s why. Until the recent JOBS Act, it was illegal to run a public investment campaign for a startup. And because of this, the entire industry became accustomed to working within the restrictions, and frankly, we became gunshy. Which means there’s a near-term opportunity for early adopters to take advantage of the advantage, before everyone else catches on. So I’m going to assume you will run a public portion, but if not, you can just skip Phase 4.
Also, I’m going to assume you will use the Crowdfunder platform (or another online platform). Sure you could run your campaign entirely offline like in the old days. But consider what that signals to your investors, especially if you are a tech company. Also, the power of the internet combined with the JOBS Act changes makes online fundraising the perfect complement your offline efforts.
With those caveats out of the way, here we go down the rabbit hole….
Phase 1: Building Social Currency
In order to close investors, you will first build your social currency using your company’s Crowdfunder profile.
Each of your stakeholders should have a full social profiles. This includes your team members, advisors, existing investors, key customers and partners, as well as your family, friends and fans. Anyone who would be willing to help you get the word out about your campaign, either because they have a financial stake in your company, or because you asked as a favor. They can populate their profile by simply logging in at Crowdfunder with their LinkedIn or Facebook accounts.
Next make sure everyone Follows your company. This is important because you will engage them later with the Crowdfunder messaging system to activate your campaign.
The final step once your stakeholders are onboard is to use your social currency to activate three key groups: potential lead investors, your broader social network and the general public. You will work on these tasks simultaneously and thoroughly before moving on to Phase 2.
Sourcing Your Lead Investor
You find a lead investor by targeting your hitlist of ideal leads, methodically going about meeting each of them, and forming good relationship with each. They might already be on Crowdfunder, but even if not, you can use the six degrees of separation principle with your friends and colleagues to get to each investor on your hitlist. If you’re not sure who would make a good lead investor, ask your stakeholders who they recommend. Then use LinkedIn to figure out who can make introductions.
Target ten potential lead investors and don’t stop until you meet all of them (or find suitable substitutes). Scott Sherman says that you can get to anyone in the world if you can get three of their first-degree contacts to mention your name to them within a relatively short period. Use Scott’s “Rule of Three” to engineer an introduction to the people you want to meet.
Ideally, you want ten conversations going about your company with potential lead investors. Your goal here is simply to form a good relationship without the pressure of pitching them to invest now. Tell them that you are not currently fundraising but want to be prepared. In return for their valuable time/advice, you will give them first look before you open your round.
Share your plans for the company, and specifically what you are doing between now and when you do open your round. Make sure whatever you tell them, you work hard to do it. Then report back to them on your progress, even if you fail to meet your goals. Investors look for founders who show this type of transparency and followthrough.
Even if none of your hitlist ends up becoming your lead investor, you will have ten powerful allies. They may end up investing in a later round, or introducing you to colleagues who are a better fit for you as an investor now.
Activating Your Network
This is where you max out your LinkedIn, Facebook and rolodex. Let your friends and colleagues know you will be opening an investment round soon with a professional lead investor. Let them know that if they want to get in before the rush, they should Follow you on Crowdfunder. Also ask them for introductions to their friends and colleagues who would appreciate the introduction to you.
Don’t forget about your best business relationships, especially your best customers and strategic partners.
Whenever possible, meet with prospective investors in person or video chat. Just as with the lead investor, build a relationship. Let them know you will come back to them once you have chosen a lead (who will set the investment terms).
Keep detailed notes on each meeting and each person, especially the reasons why they invest, what size investments they typically make, and what value they bring to the the companies they invest in (beyond just their capital). You are not only presenting yourself to them, but also assessing their fit as an investor for you.
Make sure everyone you speak to Follows your company. If you need to couch it as a favor, do so. This is proper use of your social currency, which will pay dividends later on as your campaign unfolds.
Preparing to Go Public
Back in 2012, Mike Del Ponte revealed to Tim Ferris how he hacked the Kickstarter matrix in gory, glorious detail. Then in early 2015 Peter Diamandis and Steven Kotler devoted a whole chapter to crowdfunding success in their bestseller, BOLD. While both of these pieces are about donation or pre-sales crowdfunding, at least 90% of the learnings and techniques can be applied verbatim to your public equity crowdfunding campaign.
The operative concept is that you are “engineering overnight success” at least a month ahead of your public launch. It’s a numbers game. For instance, lets say you are raising $500,000. If you can reach a collective audience of 100,000, then get 1% of them to click through, then get 10% of those to make to make investment reservations, and then close 10% of those people to invest $50K each, then you’ve reached your goal.
One advantage you have over most Kickstarter campaigns is that you likely already have a customer base, user base, or some sort of product/service offering that you can use to get the word out. That’s in addition to the buzz generation techniques that Mike outlines above. One of the biggest mistakes I see founders make is being reluctant to message their users/customers about their investment round. But what better candidate to invest in your company than someone who already knows and loves what you do?
The other advantage of equity crowdfunding is that you can incentivize interested investors with your product/service in the form of Investor Perks. Investor Perks work similarly to Kickstarter Rewards in that the more money someone invests, the more value you give them in the form of Perks. For example, Sierra Lifestyle gives its investors credit vouchers for the full amount of their investment. Thus, the more they invest, the more credit they get towards product purchase.
As a prospective investor, this is a fantastic value for me. In my mind, I know the investment is risky and I could lose everything. However, if I receive fair market value in product for my investment too, then I feel like a return on the equity is somewhat of a bonus. In my mind, the Perk has “de-risked” my investment.
While Investor Perks are not always appropriate, they can turn a difficult close into an easy one. If you do add Investor Perks make sure they are value-aligned with your company’s mission and products. And don’t be afraid to be creative. Sometimes the best Perks are unique experiences with little hard cost to you but huge perceived value to your investors.
Phase 2: Closing Your Lead
Part of what you have told your prospective lead investors in Phase 1 are the milestones you will achieve before you are ready to open your round. You will also have gotten feedback from them to make sure you are setting the right milestones. Once you achieve the milestones, go back to each of your prospects and close them.
If you have achieved your milestones and there are still objections, then those people are probably not going to invest. Let them know you are interviewing other lead investors and will come back to them if there is still room in the round.
The terms under which you close your lead investor is a matter of negotiation. There is no right answer, but both you and the investor will each have a range of acceptable terms, for example a range of acceptable valuations for the company. Assuming there is overlap in your respective ranges, then there is a zone of possible agreement. Where in that range you end up is what’s being negotiated.
The way you get the best deal possible for yourself (and existing shareholders) is by having the option to walk away from the deal. And you only have that option if you either don’t need investment, or you have multiple investors you are negotiating with simultaneously. This is where your work in the previous phase begins to pay off.
Phase 3: Closing Your Network
Once you have closed a lead investor, you can begin closing people from your network.
Your pitch is online at Crowdfunder, as are all Your supporting documents, such as financials and disclosures. And through your efforts in Phase 1, a good portion of your network is now Following your company. Send them a message announcing the lead investor. Then reach out to each person directly via email/text/phone to set up a closing call or meeting. Make sure to reach out to everyone you spoke to, even if they are not Following your company.
To close investors, set up group calls and meetings if possible. This creates the proper signaling to investors that your time is limited, and that there are many other investors looking at your deal. (It’s the same dynamic created by having an open house just once a week when you are selling your house). If grouping is not possible for certain investors, limit your call to 15 minutes.
Once they have agreed to speak, direct them to your online pitch and documents and urge them to review prior to your call/meeting. This does several important things: (1) gets them invested in your deal with their time/attention (2) sets the proper expectations that the call won’t be to pitch them, but rather to close them (3) filters out the tire-kickers from the buyers.
Before you speak to anyone, make sure that the major questions and objections (which will inevitably come up) are thoroughly and clearly addressed in your pitch and diligence documents. For less important questions, you should maintain an online FAQ and update it when new objections or question arise. Then, when you are speaking with investors, instead of answering questions that can be found in the FAQ, politely remind them that these details can be found on Crowdfunder. Tell them you want to be respectful of their time (and your own) by sticking to the most important, high level items that are make-or-break for their investment.
Reserve part of the time to interview the investor about what makes them a good investor for your company. Ask them what they plan to contribute besides capital — if y0u accept their investment. Give them your list of needs, for instance: introductions to strategic partners, advice in their area of expertise, feedback on new product features, etc. By having your investors qualify themselves, this will make it easier to close them as investors, and it will set your relationship up for success going forward.
Use Crowdfunder’s investor CRM system to efficiently track and reflect the momentum in your round.
The more interest and momentum you share with investors who are looking at your deal, the more excited and likely they will be into invest (remember, you’re “unfundable until oversubscribed….”)
Finally, you should end every closing conversation with investors by giving them a deadline for their decision and for getting their money wired. Let them know that the public campaign will begin after the deadline, and they will lose their spot if they miss the deadline.
Phase 4: Public Closing
The more of your online campaign goal you have already closed from your own network, the easier it will be to attract and close investors from the Crowdfunder network, and the public at large. Having lots of interest from the public is also good signaling for folks in your network who are on the fence.
There is no hard and fast rule, but I like to close 70% of my fundraising goal privately, before letting the public in. Note that you are always free to take in more than 100% of your stated goal, as long as your investment documents allow for that.
Once your deal is public you will have to take active steps to verify that investors coming in are accredited. Crowdfunder will help you with this if you ask, just email firstname.lastname@example.org.
Phase 5: Victory Lap
The final phase of your campaign is to let everyone know the good news of your success. Remember, your ultimate goal is to build a successful business and serve your customers; the investment capital you raised is simply a means to that end. With your successful raise, you have just built up new social currency, which you can utilize to grow sales and build your brand.
The first people to contact are those lucky folks who invested. Congratulate them and welcome them aboard. Most importantly let them know how they can help you build the business, and hence increase the value of their equity.
Next, you should contact everyone who you touched in the campaign process, even if they didn’t invest. This includes all the folks who expressed interest in your deal on Crowdfunder but didn’t invest for whatever reason.
Finally, you should let the world know through PR and social media. Here’s a press release that one of our companies issued, which got picked up by a number of sources. This extra publicity mostly likely helped them attract new customers too.
Matrix Training Program
“Everybody falls the first time.” — Cypher
I’ve just showed you how to hack the startup fundraising matrix by planning and executing a five phase campaign using your social currency. Now you have to jump in and start. You won’t be perfect, and that’s okay. Don’t let the perfect be the enemy of the good. Here are some tools and resources to help:
- Success Stories from Crowdfunder
- The Ultimate Pitch Deck to Raise Money for Startups
- The Guide to Equity Crowdfunding
- Term Sheet Resources
I also highly recommend listening to every episode of Gimlet Media’s Startup Podcast. Here are some episodes especially poignant for fundraising:
- How Not to Pitch a Billionaire
- Startups are a Risky Business
- Another Side of the Story
- How Listeners Become Owners
Finally, here are some matrix subroutines to reflect on…
The Eightfold Path to Investment
- Right Motivation — If you want investment because you value having new partners who can help you build the company bigger and faster than you could without them, then this is Right Motivation. Many entrepreneurs seek investment as a validation of their idea/company/self. If your motivation is to be validated, then you are on the wrong path.
- Right Plan — Have a plan (or at least a plan B) that doesn’t require investment capital to succeed. If you don’t need investors’ money, you will have a much easier time getting it. Let’s face it, what partner in a healthy relationship is attracted to neediness?
- Right Timing — There are times in your company’s lifecycle when investment will flow naturally. If the timing is not right, then your energies are better spent building the business. Building a business creates Right Timing for investment.
- Right Audience — Many founders make the mistake of pitching investors their product or their idea. Your Audience is a person who wants a return on their investment (as soon as possible).
- Right Message — The Message you deliver to that person is always the same: “Invest in me because I will return you significantly more money than you are investing.” Your entire investment pitch and diligence documents can be boiled down to that one Message.
- Right Story — The way you deliver the Message is through your story. But which one? There are many true stories to be told about you and your company. And it takes time and countless tellings for the right version to emerge, the one which resonates most with your investor audience. Tell your story to people you trust, people who will give you tough love feedback; then keep refining the story. You will know it’s Right when someone you asked for feedback actually writes you an investment check as their answer.
- Right Methodology — You are undoubtedly following Lean Startup methodology in building your Minimum Viable Product and achieving Product-Market Fit before scaling. The same principles apply to fundraising. What’s the Minimum Viable Investment that gets you to a significantly higher valuation once you’ve spent the investment? Failure to attract a lead investor is valuable market feedback: pivot and iterate before you proceed with your campaign.
- Right Closing — If you’ve done everything Right, you will be oversubscribed and have more investors/investment than you can (or want to) close. It is important that you choose investors who you want as business partners. And while this may seem counterintuitive… if you tell investors that you are vetting them, they will often times pitch themselves to you and close quicker as investors. But don’t forget: this is likely not your last round of funding; how you treat investors as they are closing — and how you turn away the unlucky folks who won’t get to invest now — all this matters as you look towards your next round.
The Five Hinderances to Getting Funded
- Ignoring the Heart— We are sold with our hearts and unsold with our brains. In fact if you don’t grab me emotionally in the first few seconds and completely enthrall me, then I won’t ever engage my brain to determine whether it makes financial sense to invest. Ultimately you need to convince me both rationally and emotionally. Help me fall in love with you, and help me have faith in you, and I might give you a pass on the numbers and projections that don’t make sense.
- Lack of Transparency & Authenticity — For founders like me who are Generation X or older, this may be the hardest part of your journey. Because we were ingrained with the notion that failure is bad and weaknesses are to be hidden. Even those of us who understand the need for transparency sometimes have a hard time executing on it. But here’s why you have no choice as an entrepreneur. Humans are hardwired to sense the inauthentic, and they instinctually know when you are hiding something. Sophisticated investors will ask endless questions until their instincts are satisfied. Unsophisticated investors will simply lose interest (or get spooked) and become unresponsive, and you won’t know why. Is any of this sounding familiar?
- Pitching The Wrong Thing — Even if investors don’t recognize or admit it, their actions reflect the following reality. Nobody knows whether you will be able to make the company successful. This is not predictable at the time of investment. We are placing a bet on you as the CEO that you will make it so, and we hope you won’t stop until you do (even if you run out of money). There will be numerous threats to your company’s existence, and many times when you will be tempted to quit. Don’t pitch me your idea, or your team, or even your massively scaling revenues or user growth. I’m investing in your ability and willingness to run through brick walls, dodge bullets, and at the end of the day make the company 1000 times more valuable than it is today, no matter who else is left standing with you. Pitch me that.
- Abdicating Responsibility for Results — It’s understandable that you would want someone to take over the responsibility of running your campaign. After all, being a CEO and running the company is more than a full-time job. In this context, fundraising can be seen as a distraction. But the buck stops (and starts) with you, so how can you possibly put that responsibility in anyone else’s hands? Consider for a moment that Kickstarter campaigns are 80% funded by people not on Kickstarter but who heard about the campaign from the founder’s efforts.
- Attachment to Results — While fundraising results are your responsibility entirely, the paradox is that if you are attached to results, you won’t get the money. Founders who “do the work” and limit the mental editorial, get the dough. Founders who obsess about results — or get defensive about what lack of results “means” — struggle greatly and turn off investors. Every investor is closable and every company is fundable… at some point in time. It’s your job as CEO to make sure the company is alive and thriving so that timing is not a factor. Don’t overthink it. Trust in the process. And when you fail, just get back up and do it again. And again. And again. Is it possible for you to actually enjoy the process, and the struggles and failures along the way? That is what non-attachment means.
The Way of the Velvet Rope
Imagine you are rolling out your first product to the world but nobody knows about it (or you) yet. So to build awareness and demand — and to bring in some capital to help you launch your product — you decide to create a unique, limited edition, exclusive offering that you will sell to tastemakers and wealthy buyers, who in turn will later help make your big product launch a success. How would you go about creating a campaign for your exclusive offering?
Since your offering is limited, and since you have the ability to say who gets in and who doesn’t, you might look to the world of night club promotion. The technique is simple: get a buzz going about it well in advance by having tastemakers spread the word; then leak to the press which celebrities will be in the VIP room; finally, set up a velvet rope at the door of the nightclub.
The velvet rope serves two purposes. The first is to make a giant spectacle of how much demand there is to get into the club (i.e. demonstrate your social currency). The second is to publicly pick and choose the lucky few who will get in, thereby making them feel very special and fortunate to know you. Simultaneously you are building up demand for your product launch with those who are locked outside the velvet rope. These things together create even more demand, and tell a story worthy of press coverage having nothing to do with what’s inside the club!
The exclusive offering, of course, is the equity in your company. The celebrities are your lead investors. The tastemakers are your private network, especially those who are investing. And the press is, well, the press… plus social media and whatever other channels you have to get the word out as far and wide as possible.
The Parable of the Crowd
The Accountant: “If you let The Crowd invest, you will have to update hundreds of people every month about your business.”
The Lawyer: “If you let The Crowd invest, there will be added scrutiny on your decisions, and potentially hundreds of litigious adversaries.”
The Consultant: “If you let The Crowd invest, you might not attract venture capital or private equity.”
The Crowd: “If you let us invest, we will buy your new products sight unseen; we will be an army to defend you from all threats external and internal; and we will provide all the capital we ever need to sustain and grow our company.”
Ready to Jump?
“Unfortunately, no one can be told what The Matrix is. You have to see it for yourself.” — Morpheus