Venture Capital Primer. How to raise money from VCs

Many entrepreneurs face the challenge of raising Round A from VCs. How to do it? Let me go through three points that, in my opinion, speed up the process a lot and increase the chances of success.

8 min readApr 28, 2015

Point 1 — what game do you play?

Let us start from the very beginning; that is, from the thesis:

Entrepreneurs should build a $1 billion company and grow sales to $100 million annually.

The topic of unicorns is so popular that this thesis is a cliché. But wait — is it really so? Is the dogma of building a $1 billion company really valid? Unicorns are a very special and uncommon breed, so why should I care? A $50 million exit would be perfectly fine for me.

The reason is simple, and it lies in the nature of the VC business model. (By VCs I mean venture capital firms investing in Round A or later that is firms investing above $3m in a single deal). To make the numbers work, the message from VCs to entrepreneurs is simple:

(1) Find a new product with $100 million sales potential and (2) grow sales faster than your competition.
If you do that, you will get money from us to grow. Therefore you will have money to hire the best people, to grow sales, to improve product. Eventually to generate returns for yourself and for us.

Obviously this path is not the only way to build companies but the argument of VCs is that other options are sub-optimal. Without investment there are limited resources to grow sales, limited potential to attract talent and, eventually, limited success. Growth is what matters; therefore, if you want to grow fast, you have to raise money. And here it is: the first piece of advice for entrepreneurs who want to raise Round A:

Start on the path towards $1 billion company and towards growing your sales to $100 million annually.

It is a prerequisite. Growth matters, and to grow you need money. There are very few examples of twenty-first-century $1 billion companies that haven’t worked with investors.

Let us move on.

Point 2 — financial roadmap

If you want to raise money, the second piece of advice is simple:

Plan a financial roadmap.

As we all know, there are three stages of company growth that are named after the financing rounds that starts each of these stages: Pre-seed, Seed and Round A. Though well known, let me stress the rationale of each of these stages.

Pre-Seed

The goal of the Pre-Seed Stage is to build a prototype and get positive feedback from customers. In other words, the prototype and feedback is what you need to build arguments to convince seed-stage investors that you are worth investing in.

Seed

This is the most interesting stage for us at Innovation Nest. The seed stage is instrumental for the Round A and it influences Round A in huge extend.

The seed stage is about a quest for scalable sales. Companies start with a prototype and go through intensive experiments with value proposed to customers, with several versions of the product, with experiments on customer acquisition channels. It is a zig-zag process with small and big pivots, despair and exhilaration.

The essential thing is to remember about the goal: the seed stage is a search for scalable sales. Good Round A investors are really demanding. No BS. If you want to raise Round A, you need to have a checklist:

a clear understanding of client — problem — solution
a product that customers love
scalable sales channels
a big market that allows for sales growth up to $100 million

It may sound very qualitative, and most entrepreneurs say, of course, that they have all of them. VCs say, “show us the numbers that prove that”:

revenues exceeding $1 million runrate (that is 12 times last month revenues)
a growth rate exceeding 10% per month (3 times a year is a minimum, 5 times is good, 10 times is amazing)
a clear financial model capturing product costs, CAC, churn, LTV, margins, etc.
a plan to increase revenues 10 times.

You get seed money when you have a prototype and feedback from your customers. You have to use this investment to be able to raise round A that is to show scalable sales. In seed stage the only thing that matters is the search for scalable sales. Focus is important.

Round A

The goal of Round A is to grow sales and build a company. Let me stop on this general statement and leave this topic for other occasion or wait for others to write more.

It is really important to know where you are in the above process and what your roadmap is. When and how will you achieve milestones related to financing? Hence the advice: “Plan your financial roadmap”. Plan the seed round and plan Round A. Set milestones.

Point 3 — your startup is a product

The third piece of advice is about how you run the process of fundraising. Fundraising is not hunting in the dark, shooting blindly. Be professional:

Treat fundraising as entering an investment market

Any market consists of three elements: demand, supply and matching one with the other.

On the demand side are investors. They want to purchase financial instruments — shares in your company — and enter a long-term relationship with you. You are selling to them, and you better look at them carefully. You have to research and understand what investors are offering you. You have to build a list of dozens of top investors that fit to your startup. To pick the best ones you have to think two steps ahead. Seed investors will not determine but they will influence the success of Round A and who the Round A investors will be. You will also have to think about geography. Is it better to relocate, or stay where you are? In the next post I will go into the details of this.

The second element is the supply side. Investors see a lot of companies, and they have many options. You and your startup is just one of them. You have to package your company as a product for investors. The way you pitch and the arguments you have matter. Your company is everything to you, but for the investors it is just one of a hundred options. Therefore, empathise with the investor, see yourself through the eyes of investors and pitch what is important.

The third element is matching supply and demand. The number and quality of interactions matter. Therefore, assume that the process will take months, and assume that you will go through several iterations of your pitch. Also the way how you get the attention of investors will be changing. Be sure that in each iteration there is a critical mass of feedback. All this will lead to the best fit for you and the investors.

To sum it up:

Investors for you: (1) understand investors and their offer, and (2) have a list of the top 20–40 investors that fit to your startup.
Product for investors: package what you have as a product for investors.
Matching: (1) iterate your deck and your pitch and also iterate the ways of getting meetings with investors, and (2) meet dozens of them.

European Seed Investment Market

The last part concerns Europe. In my opinion we are not far from having a European market for seed investments, but we are not quite there yet. Before I make the last point, I would like to digress into what is going on in seed financing in the US and in Europe.

US seed

In the US there is a boom market. In places such as Silicon Valley and NYC there are hundreds of financing options. Of course, this does not mean that getting financing is easy, as there are thousands of companies looking for investment. The easily spotted main changes over last two years are the following:

YC is getting bigger and building its own eco-system.
Accelerators are abundant and often very focused.
The Angel list is expanding.
Kickstarter and Indiegogo are growing rapidly, especially with consumer hardware companies.
VCs are going down the ladder and investing at seed stage.
Micro VCs are flourishing.
Angels are growing in numbers.

European seed

There is a boom, but the market is much smaller. The trends spotted are the following:

Hubs such as London, Berlin and Paris are growing, but there are at most only a hundred active seed investors in a given hub
Smaller centres such as Stockholm and Kraków are growing as well.
Pan-European investments are growing as well, but there are, at most, only dozens of active pan-European seed investors.

Seed investment market

In the US there is a ripe seed investment market with hundreds of investment options. In Europe, on the other hand, the market is at the beginning. In my opinion there is a way to improve this quickly.

On the one hand, as I wrote above, entrepreneurs have to treat fundraising as entering the financing market with an effort on all three levels: (1) demand — investors, (2) supply — startup, (3) matching — interactions with investors. On the other hand, investors should have an interface to interact with startups smoothly: a defined, wide open process with a short but meaningful interaction with a great number of startups that gives valuable feedback on pitching materials, financial roadmap and business in general.

The matching of investors and startups will never be frictionless, and the seed investment market will never be fully efficient. But it is not that difficult to improve it fast.

Conclusions

Entrepreneurs . Here are three pieces of advice for how to approach VCs:

Prerequisite — enter the path to build $1B company and grow your sales to $100 million annually
Have a financial roadmap
Treat fundraising as entering an investment market

And the last one for investors and entrepreneurs in Europe: