Why it’s hard to raise money to fund growth experiments
I sent this to a founder during an exchange about fundraising. I tried to capture how an investor might view the pitch, based on my own experiences raising money for Cover and evaluating deals at AngelList and IA Ventures.
Here’s how I’m approximating the VC perspective:
VCs want to see your valuation 10x round to round. Doesn’t always happen but they want to believe it can/will. Eric Paley¹ put down a good rule of thumb: VCs want(/need) you to exit for at least twice their fund size². So, $50M fund needs to imagine a $100M exit.
This stuff has gotten harder as seed funds have become bigger. They need bigger exits so they look for more proof at the same stage — which is why preseed is a thing. But the gist of it is that to raise from any decently sized fund as a consumer mobile app, the bar for their imagination is either working unit economics or rapid growth. The other hack is for it to be something they or their kids/friends use and really like.
Pre-seed and angels will invest with less proof, but the calculations to estimate returns are pretty similar.
These economics are why some things that obviously need to exist also aren’t always venture fundable. If they work best at scale, there needs to be a clear sign of growth. It is particularly difficult to guess whether something will take off before it is actually taking off. (This is why AngelList was basically just a traction and social proof engine when I was there.³) Investors know just how difficult it is for an app to break through the noise now–which makes them even less likely to fund something without clear signs that it will.
The fact that you’ve been working on this for a while works for and against you. Survival is a pretty valuable quality; you also need to not appear stagnant. I.e. some metric should be improving steadily over time. It doesn’t have to be huge but it has to be significant enough to get someone excited. They have to see a non-random path to the moon.
(I just remembered — the YC startup school video on growth is great for showing what metrics to look at.⁴)
One possible (difficult) conclusion is that you need to spend less, not more, so that you can stretch it out long enough to get something growing steadily month over month. I’m sure you know this, but if the numbers are small enough you just need to compound small wins.
Now in case you’re reading this and the immediate reaction is that I’ve totally misunderstood what your momentum actually is, I believe that’s totally possible. The factual stuff about how investors make decisions holds. If I’m getting it wrong, then whatever story you’ve been telling me isn’t getting across how it’s going right, and that’ll probably apply to investors as well.
So that’s my thinking. If you can stretch it out any longer, I think you should. If you have to raise right now without an active momentum story, it will be difficult. I’ve been there.
1 Eric Paley is Managing Partner at Founder Collective
2 There’s no shame in a $100M startup
3 I worked for a AngelList for a period from 2011–2012. A lot has changed since then.
4 How to Start a Startup Lecture 6 — Growth (Alex Schultz)
