Understanding the StartUp Fundraising challenge and setting your target — 2/3
You probably shouldn’t be spending time on fundraising right now. However, if you are convinced that raising funds is the best use of your time right now, don’t overlook the obvious: fundraising is a combination of a sales and dating process. Treat it as such.
Why a sales process
At its core, raising funds means selling shares of your company in exchange for an investment at the best possible terms. You collect leads, prepare your pitch and find ways to turn a no into a yes. You try to make the sale in as short a time as possible. You seal the deal or die trying.
You meet a lot of possible candidates over a short period of time. You set up second and third dates. You look for someone it clicks with, because your faith becomes tied to that of your investor for a significant part of the future. Partnering-up with the wrong investor on the other hand can mean a slow and painful death for your company. It happens all the time. You are searching for your business life partner.
Thus, raising funds is about striking the right balance between running an effective sales process and finding a partner you want to spend a significant part of your life with. To strike that balance requires hard work and mental problem solving simultaneously.
The conscious fundraising approach for early stage founders is composed of four phases:
1. Understand challenge
2. Define target
3. Prepare initial materials
4. Close investors
In this post, we will work on phases 1 and 2. The next post in this series will cover phases 3 and 4.
1. Understand the challenge
Once you understand the challenge, the way to tackle it becomes quite obvious. Understanding the challenge in this case is about understanding how investors work and how to close a funding round in a way that enables you to continue making progress on your mission.
Two Driving principles of investors
Investors typically see you in two states of mind, 1. they are scared your startup dies, after investing lots of money 2. they are scared of missing out on you, because you are the next big thing and grow like crazy.
Until the investor definitely knows where to place you they will wait.
Your current challenge might for instance be to grow the customer lifetime value (LTV) to 30€, to make the business model viable.
As long as you are at 20€ and there is an upward trend — you still have the potential of following the trajectory of both investor perspectives.
You might fail, because you are losing money currently and run out, before you can get your LTV to 30€. However the positive trend could continue, even grow, and you could become the “next big thing”.
As long as there is no clear and consistent evidence for either outcome, investors will prefer to wait. Time is on the investor’s side. Every week that goes by, delivers more data points to analyze. More data points about your LTV and the comparative traction from many other startups they talk to or look at, to potentially find that “next big thing pattern”.
Investors wait…by leading you on
However you are their source of updates. Waiting investors do not want to give you a definitive answer yet. Therefore they are often by default in a mode of leading founders on as long as they have not made up their mind.
Wishful thinking founders will believe them and only realize later, that the money they thought they raised was just imaginary.
Your goal is for the investor to be in state of mind no. 2 for so long that they prefer to close a deal with you, rather than waiting for more data and confirmation from you and other startups.
Competition changes the game
Once the first investor commits to an investment in your startup, the situation changes. Now there is urgency, first terms are set. You are going to close the funding round and grow your startup with fresh capital. It’s decision time for all the other investors that were waiting. Are they in or out.
Find and convince an investor that will say yes first/independently.
Talk to multiple investors at the same time to create competition and momentum.
(In order to avoid the above waiting game in the early days of a startup, it is advisable to use convertible notes instead of raising a complete equity funding round.)
Why mission trumps Investment
The inevitable pivots and near death experiences of a startup require a larger reason to go through this hugely irrational endeavor. That is why at the core of every good startup stands a mission. A higher goal and ideal to strive for — a purpose.
Once you understand your mission, values and connected behaviours you have the best possible tool at hand to filter out and find the right investors to partner with (as well as team members).
Imagine your mission were to “find a home for every single dog in Germany”.
You start by creating this beautiful website full of pictures and colourful descriptions of the animals character and their life stories. Users can adopt them directly online or visit them at a shelter.
After some time you notice, Labradors and Shepards are more popular by far.
Some investors you talk to advocate to just focus on marketing for these breeds. Some design challenging short-term milestones you need to hit in order to get an investment in such a way, that you would have to focus on Labradors and Shepherds.
Under these circumstances you will have a hard time realizing your mission. Despite successfully raising money.
Very clearly the hypothetical investors do not care about your mission. With these investors your mission would turn into making sure that popular dog species find a home.
Your mission is more important than millions from any investor. To make compromises on your mission by working with investors that do not care about it, is to lose the very reason you raise money for.
The same holds for your values.
Zappos´ “Deliver WOW Through Service.” only becomes real through behaviour representing that value. A Zappos team member receiving a budget at their own disposal to “wow” customers or being allowed to spend unlimited time in phone calls with customers is behaviour that makes “deliver wow…” real. If your investors on the other hand push towards minimising customer service costs, you will have a hard time to get everyone behind this value in the long term. Hence the value will lack authenticity and the team will forget why they are putting all this hard work in.
The challenge of fundraising is not to raise money from anyone, but from investors that are aligned with your mission and values.
You designed a good funding process, if at the end stands an investor that believes in you and supports your mission and values through behaviours and trust. Even if those behaviours might cost more in the short term.
You now understand the challenge you are tackling. You learned how investors wait by default, unless there is competition. You also understand that you are looking for investors that are aligned with your vision and to observe if their behaviours suggest, that they believe in the same. You are ready to formulate your target.
2. Formulate your target to stay on track
Since investors will prefer to wait, raising a funding round can easily take a year and longer. Either way, be prepared for the process to take longer than you expect. Over such a long period of time it is easy to derail. Formulating a concrete goal will help you to stay focused.
At the same time it is also impossible trying to control and perfect every aspect of the funding round. Instead, accept the chaos fundraising is and focus your energy on the elements you can influence and prioritize.
Below we cover some questions, that will help you to define your target in such a way.
What makes a funding round successful?
The simplest way to determine the degree of success of a funding round is to look at the amount of money raised.
A better way to evaluate a funding round is to look at the amount of time spent. If you are able to close your funding round quickly, it means 1. a lot of investors are interested (therefore likely offering you good terms) and 2. That you can get back to creating faster.
The ultimate evaluation however would focus on the alignment in vision and values and the strength of the relationship developed as described above.
How do I find out if an investor is suitable?
Test-drive investors. When you buy a new car, you only really know if you made a good decision, after you have driven it for a while.
It is very much the same with people and investors. Just that the transaction becomes even more risky when you pay with equity and can not reverse the decision. You only get to know people, by spending time with them. Test-drive your potential investors.
Work with the investors you like, as if they had already invested. Sharing wireframes, prototypes and KPIs for example. Ask for introductions, recommendations on candidates you are thinking of hiring and see what input they have regarding your strategy.
Interested investors will happily talk to you about the business and support hands on. Naturally, situations will occur, that will test the investors believe in your mission, values and you.
On the other hand, beware of investors that promise to provide all kinds of support, once the investment went through. Maybe even ask you for a discount, because of the promise of value they will add in the future.
The amount and quality of support and guidance investors provide before the deal is generally a good indicator for how much you will receive after the deal.
What will you use the money for?
There are generally two reasons for early stage funding rounds. Rounds raised to build the product, to prove the business model or a combination of the two. Later stage companies with defined business models raise investment rounds to accelerate growth.
Understanding the core reason for you to undertake this fundraising endeavor helps you to formulate your pitch clearly and aids you in evaluating, if spending time on fundraising is the right trade-off.
How much money do you need?
In the best of all scenarios, you are able to develop your startup without outside capital. That means you see investments as added bonuses, accelerating your development. In such a scenario, you can have different plans for different hypothetical investment amounts.
Founders commonly underestimate how much money they will need to build their business. Since fundraising is such a tiring activity for founders as well as startups as a whole, you should make sure to raise enough money to survive for the next 12–18 months without the need to raise money again.
By when do you need/want the money on your account?
Scenario 1 there is a clear deadline, since you will run out of money at that point. Define that point clearly.
Scenario 2 determined by your opportunity cost. From what moment onwards do you rather spend time on developing your product and business model, than fundraising.
Write out your goal
With this initial overview you are able to define a goal for yourself.
You understand that you need to strike the right balance between finding a “life partner” and running an efficient process. You understand, that investors are scared of missing out on you, while at the same time they are scared of losing lots of money in failing startups.
So they prefer to wait if they can, since they will collect more data from you and other startups. Yet they have to wait in a way, that ensures you continue to update them. You know to talk to multiple investors at the same time and to focus on the first investor to commit, so there is urgency for all the other investors. You understand that a good funding round is not so much determined by the amount of money you raise, but much more by the amount of time it takes you and the alignment in mission and values between the investor(s) and you.
You learned, that the only way for you to find out if the investor is right for you, is by working with them.
Lastly you received some pointers to define what you will use the money for and how much you need.
You are now equipped to define a conscious fundraising goal for yourself. For further inspiration, this is how we would define the goal for GlassDollar.
Now that we have defined our goal we are ready to prepare our materials and start closing investors. That is what the third post in this series will cover.