How do I get funded?
A relatively innocuous question with grand consequences for early stage CEOs. It’s our firm belief that a startup CEO’s job is to “keep the lights on”. With a venture market this challenging and deeply rooted, sometimes the only option is through. Below, I’ve outlined a few common themes (with real world examples we’ve seen) that have led to successful fundraises at Seed/A. To be clear, some of this isn’t what you’ll see in the “how you should raise” textbook, but will instead feature “how money is being raised”.
Get back to boring -> boring business are often times great businesses because they focus on fundamentals, cash flow, and selling to a specific customer segment. While inspiration and vision are central tenants of an early stage idea, investors want to see an operational track record that gives confidence in an executive team’s ability to execute.
Example -> to the extent possible, provide letters-of-intent (“LOIs”), memos of understanding (“MOUs”) or other agreements with potential customers that can give credibility to future revenue. While it’s important to show a strong pipeline and/or logos of potential large customers, expect a generic pipeline to be met with some skepticism. Internally, CEOs should prioritize meaningful conversation with Head of Strategy / Business Development (maybe that means speaking into a mirror…) to prioritize high return-on-invested-capital (“ROIC”) projects. Make this distinction clear to investors. If throwing money at every potential growth vector was the focus in 2021 and prior, that intent has changed.
Raise enough money -> CEOs should be aiming for the amount of money needed to reach their next company milestone. Keeping this fact in mind while also considering months of runway is paramount. 18 months of runway should give flexibility to both achieve milestones and (hopefully) bridge to a more favorable economic climate. Prepare for questions on why your current cost structure is appropriate if your fundraise doesn’t give you this runway.
Example -> In the dataroom, the CEO of Company A reduced burn significantly prior to raising funds and redid financial model to reflect this new cost structure. Making these changes prior to fundraising created faith in CEO’s ability to execute difficult, significant changes prioritize projects with high ROIC.
Clean the cap table -> Investors are looking for a clean ownership structure, free from complications, disputes, and large convertible overhang. If your cap table isn’t straightforward, build a narrative that describes each owner, why they’re important to a successful business outcome, and how you plan to manage their ownership moving forward.
Example -> an early (pre-seed) investor, we’ll call them Investor #1, continues to level-up early ownership in the Startup and owns ~17% — 20% at the time of Seed fundraise. Because (most) Seed lead investors want to be the majority outside holder (~11%–13%), new investors aren’t interested / won’t price the deal. Startup’s founder then has to raise on a convertible note (consciously excluding Investor #1) and generate appropriate dilution to reduce Investor #1’s ownership price upon Seed-2 conversion.
Incentivize investors -> VCs have been waiting to regain pricing power from founders for 5+ years. Your business is not a failure if your round is flat, it’s simply still alive. Founders should expect multiple compression even if their company has top tier metrics. To grab attention and get money in the door, deal preference may be needed. These incentives create a higher floor for VCs and help juice upside that pushes investors to a decision point. In this environment, time is your enemy and an investor’s friend.
Example -> Series A term sheet with an 6.5% compounding preferred share dividend. The Company can raise out of this dividend with a qualified financing that is 2.5x the prior post-money valuation. This sets a floor for the investor while also (theoretically) incentivizing the business to grow and remove compounding. Dilution from this construct won’t be as impactful in a large (5-10x) exit scenario but could be material in a smaller exit.
While this list is certainly not exhaustive, now more than ever it’s important for CEOs to understand how startup investment opportunities compare to other alternative uses of capital and position appropriately.
