A Primer to Raising Venture Money

Almost every entrepreneur who dreams of building a high-growth technology startup will, at some point, think about raising funding. How much you raise, who you raise from, when you raise, why you raise are all questions that you’ll have to answer. You can raise money from angels (wealth individuals), micro-VC funds (funds that only control $x-$xx million), or VC funds ($xxxM funds).

For some, raising money is a fun process where you get to talk about the ideas you have and the progress that you and your trusted team have made in bringing them to reality. For others, raising money is a necessary evil where you must spend a few hours each day for a few months juggling meetings with investors as well as all the other work that continues to pile up.

Since angels and VCs are different (and look at investments through a different lens), I’ll be primarily describing raising capital from micro-VCs and VC’s (and bucket them all as VCs for simplification). This is also Part 1 of a three-part series on fundraising that I’ll be writing. Stay tuned for the next two pieces.

What is a Venture Capital (VC) fund?

A venture capital fund is a firm that has raised money from other companies, endowments, institutions and wealthy individuals (called Limited Partners or LPs) to invest in startups in exchange for equity.

Who are the key players in VC firms?

  • Partners/Managing Directors: These are the people with the money. They make the investment decision and ultimately will be the people taking a board seat.
  • Analysts/Associates: These are (stereotypically) recent college or MBA grads whose job is to meet with potential startup companies and do “due diligence” (i.e. do the homework to see if its a good investment).
  • Entrepreneur in Residence (EIRs): This is the “been-there-done-that” person who is trying to figure out what they want to do next with their life. They’ve probably been a successful entrepreneur in the past that has worked with the firm or one of the partners at the firm in some capacity. Their main role is to help support the portfolio entrepreneurs while they ideate around their next startup idea. Once they do have their next idea, the firm typically writes the first check.
  • Support Crew: Some of the larger VC firms employ a support crew that help their portfolio companies with anything from sales to marketing to customer support. These people are invaluable to you because they help you reduce your own operational costs by being paid for by your VC firm.

What do VCs look for in companies?

Every VC firm is a little bit different, but in my experience, most VC firms are looking for:

  • If your idea fits their thesis: Some VCs have a specific fund thesis that they invest around. For example, the thesis for Essential Capital is investing in companies that tackle economic inequality, security & privacy and climate change. Even if you’re Snapchat, Essential Capital likely wouldn’t invest because the idea doesn’t fit into their thesis.
  • If you’re a badass founder: Being a founder with a great idea isn’t enough. You have to be someone who can attract top talent, lead a team, build a product, validate that product in the market, iterate on the product, sell the product and then continue to sell, sell, sell. You have to be someone that can learn quickly, communicate swiftly and stop at nothing to see your dream become a reality.
  • If you have the best team: The “best” team is subjective, but in general your team must be hungry as hell for success, quick learners and/or have a ton of industry experience.
  • If you have a track record of success: As much as we like to think startups can be one-off wild successes, VCs are looking for pattern recognition. Have you sold a company before? Do you do something when you say you’re going to do it? Or are you flakey and all over the place? Given the opportunity to invest in two people, they’d likely chose the person who has a track record of success.
  • If they can get a xx% of your company: If a VC firm is a $10M fund, their investors want a $40M-$50M+ return within the next 5–10 years. The way this typically happens is that one or two investments that the fund made does really well and gets bought or IPOs for an enormous amount. The VC will hopefully own a significant enough chunk of the business to pay back their investors. So, most VC firms will look for a large % of your company.
  • If you’re targeting a big market: Semi-related to the point above, VCs want to return their fund. They can only do that if you have a big liquidity event. You can only have a big liquidity event if you’re tackling a big market opportunity. Hint: if the market is smaller than $100M, it’s way too small (even for small funds investing in technology).

When should you raise?

“I need $1.5M”

“Why the $1.5M?”

“Because everyone else at our stage is raising $1.5M right now?”

Wrong answer. Only raise when you absolutely have no other option and you need money, either to get an idea off the ground or to grow. Investors might be willing to give you money in the short-term, but you are going to pay for it down the line — big time (if you’re successful).

Scenario A: Let’s say you raise a priced-round of $1M today at a pre-money valuation of $3M and a post-money valuation of $4M. This means that you’ve given up 25% of your company to your investors. As is typical, you’ve also put aside a 20% employee option pool to offer to future employees that you’ll add to your team. You and your founders now retain 55% of the business.

Scenario B: You’ve bootstrapped your startup, growing by selling to your customers and by putting in your own cash. You set aside a 20% employee option pool but retained the other 80% of the company for yourself.

A year from now, you have an acquisition offer. Someone wants to offer you $6M for your business. If you took the deal in Scenario A, you walk away with $2.8M. Not too shabby. However, if you took the deal in Scenario B, you walk away with $4.8M. Way better.

So only raise money when you have a plan for the money (e.g. I need to add $10K more per month to our marketing because we’ve learned that for every 25% that we increase our MQLs we add $100K with a gross margin of 70%). Should you be this detailed? At seed stage, you probably don’t have this level of detail around metrics, but by Series A, yes, you should know everything about your business.

What should you have prepared before you raise?

A dropbox folder with (at a minimum):

  • Your Articles of Incorporation & Bylaws
  • A folder for each founder that includes
  • Founder biography & current role
  • RSA
  • Invention Assignment Agreement
  • Your most recent pitch deck
  • Your most recent metrics (if applicable)
  • Your balance sheet (if applicable)
  • Your income statement (if applicable)
  • Your Cap Table
  • Your Financial Projections
  • Relevant Sales/Business Development Documents (if applicable)
  • NDAs
  • Evaluation Agreements
  • MHSAs
  • Documents from other Financings
  • Convertible Notes
  • Stock Agreements
  • Competitive Matrix

A few quick things to remember:

  • VCs are giving you money in the short term, but in exchange they’re taking your hard-earned money in the long term. Raising venture money is glorified in places like Silicon Valley, but the reality is that when you raise money you’re giving someone a portion of what would be your future earnings. It means that your company is given an opportunity to start or grow, but it also means that you’re not successful enough to do it by yourself: you need help. Treat it as such and raise from investors who do help.
  • VCs are people just like you whose responsibility is to return money to their investors. The only difference is that they’ve diversified their risk by investing in multiple people, and you are the crazy one who has chosen to put all your eggs in one basket: your startup.
  • VCs invest in people they like. Imagine trying to work with someone that is pushy, constantly annoys you by hitting you on 100 different social media channels each week or that always has a negative attitude. You wouldn’t do it…and neither would they. So if you do these things today, my advice would be to think twice. :)