How To Raise Money For a Billion Dollar Startup
If we’re starting a company that we hope will one day reach a billion dollar valuation or more, we’ll need a different kind of strategy from the beginning.
An app is not likely to ever get to billion dollar potential, not anymore. Even a standard software play is going to have to have some kind of first-mover edge or new science to transcend the glut of options that exist today.
No, in order to start a billion dollar company, we’re going to have to be playing with something that’s both crazy and dangerous. And by crazy and dangerous, I mean it has to have at least one element that scares the hell out of investors.
It’s a chicken-and-egg situation. A billion-dollar valuation is virtually impossible to achieve without a major cash infusion to prove out a crazy or dangerous concept. And since investors usually shy away from those kinds of concepts, how do we raise money for a billion-dollar kind of company?
Crazy and Dangerous? Hardware
So what do we mean by crazy and dangerous? It’s something that comes with major risk and doesn’t yet have any kind of track record for return. It’s also something that’s expensive, either the talent is rare or strategy shifts are inherently costly. Or both. Usually both.
Artificial intelligence, until recently, was considered crazy and dangerous. And even today, investors usually just stick to machine learning. Bitcoin and blockchain make a great recent example, which is why an entire fake digital market rose up around those things and fooled a lot of people with phony ICOs.
However, one of the oldest and easiest-to-understand examples of a crazy and dangerous element that drives investors away is hardware. Yes, plain old hardware. Any kind of product you can hold in your hands.
Hardware startups run the trifecta of crazy and dangerous. One: It usually takes a large upfront investment to bring a physical product to market. Two: A physical product requires an expensive physical distribution chain. And Three: Mistakes and changes are so expensive that concepts like feedback loops, continuous improvement, and continuous delivery are all but moot.
But hardware products are indeed investable, so how does that investment happen?
“Everyone is saying NO”
Last week, “Kelly” contacted me via my website as she was about to start raising a round for her bootstrapped hardware startup. Kelly, her product, and her company were all pretty impressive. A first time founder, she had scratched and clawed her way to a working prototype, a small team which featured a couple of experienced scientists, a patent pending, and about four-fifths of the way through filling out a small, but not insignificant, seed round.
We hopped on the phone. Turns out we knew a couple of the same investors, and those investors had, unsurprisingly, soured on the hardware aspect. They were nice, they were interested, they were even helpful, but they were all hung up on the hardware.
So let’s dive into Kelly’s approach, and let’s use hardware as our example. But keep in mind that all of this applies to any of the crazy and dangerous elements we discussed above. Or you can bring your own.
Don’t Get Thesis-Blocked
Because Kelly is already quite far along, her number one priority in fundraising is going to be to waste as little time as possible. Fundraising is a drag, both on our time and on our energy. It’s not just hearing “No” all the time, it’s hearing “Maybe.” It’s hearing “Let’s talk again in six weeks.” It’s hearing “These numbers are great, but can I see them broken out by region and maybe use some different colors in the chart?”
I’m paraphrasing that last one. A little.
Fundraising with a crazy and dangerous element in our startup can be a slow death. We’ll end up spending way too much time explaining and convincing, not just to land the investment, but also when it comes time to spend it. Kelly is talking to a lot of high-growth software investors, but as a first-timer, she needs investors who know hardware growth strategy.
Thus, she shouldn’t waste a lot of time pitching investors who don’t have hardware in their thesis. The good non-hardware investors will reject her outright. The better ones will introduce her to investors and firms who do indeed have hardware in their portfolio.
That’s not to say she should avoid investors with no hardware in their thesis. We never know where the money is going to come from, and if the investor is interested in her tech and open to her strategy and aggressive in getting a deal done, they deserve all her attention.
Ask For a Shit-Ton of Money
As I mentioned, Kelly will soon close a small seed round to bridge her company finances while she raises a more significant amount to market test her product. However, the number she was looking to raise for that second round, low seven-figures, immediately seemed too low to me.
Sure, we always need to be careful that valuations and dilution don’t creep up on us, even with billion-dollar thinking. But hardware is a different beast. With software, small changes are inexpensive and big pivots are survivable if we do them right. With hardware, small changes not only have to be designed, tested, and rolled into production, but then there’s distribution, packaging, and retro-fitting to consider, just for starters. And big pivots? In hardware, that’s called “starting over” or, more commonly, “shutting down.”
The biggest investor fear with hardware is the distribution mechanism. Hardware has to be manufactured and shipped, inventory has to be stored, defects need hands-on repair, shrinkage is a thing.
So when thinking about a go-to-market plan, we need to realize that, yes, we can take customer feedback from an MVP, but applying changes takes a ton of time, a ton of money, and potential obsolescence of existing units. These costs add up quickly.
Kelly also needs to be thinking about what’s next. She’s raising on her “A” story, the product she is building today for the purpose it’s intended for. But what happens when her product is a raging success? Does she need to spend another six to nine months raising another round to expand? Will she need another bridge over that time?
A while back, I wrote a post called Three Stories Every Entrepreneur Should Know that outlines Story A — as described above, Story B — which is when the company uses its initial success to catapult into new markets and new products, and Story C — the billion-dollar story.
At every story transition, Kelly needs runway for the runway. She needs to be raising this round not just for Story A, but also to be able to start the transition to Story B. This tells me she needs to be thinking about raising three times the number she has in mind.
A move that far too few entrepreneurs consider is a strategic investment from an incumbent corporation within or related to the industry the startup is trying to disrupt.
These incumbent players are disrupt-able because they’re huge, they’re not nimble, and that makes innovation difficult for them. One of the ways they offset their lumbering size is to invest and eventually acquire innovation rather than creating it.
Not every disruption needs to be confrontational and not every investment needs to become an acquisition. If we’re careful with the terms, this kind of investment can make a nice stepping stone to that billion-dollar valuation while also acting as a soft landing if we don’t make it.
When we include corporations linked to the industry, we open up a lot of options. For example, if we’re building a better lawn-mower, we should be talking to John Deere and Honda. But we should also be talking to Toyota and Ford, because they don’t make lawn mowers. We should be talking to Dyson, because lawn mowers move a lot like vacuum cleaners. We should be talking to Scott’s, because people who care for lots of large lawns likely need lots of lawn mowing.
Many large corporations have research and development departments and a good number of them even have investment arms. Getting to know the people involved in those programs can never hurt, and it may open some doors that wouldn’t be identified otherwise.
Raising money for a startup with billion-dollar potential will always be an uphill battle, even if we use the right strategy, have a good head start, and get some early traction. It’s a long, winding road, but if we don’t start with the right strategy, we’ll never get on that road in the first place.