AN INTRODUCTORY GUIDE
How to successfully raise money as a startup
Eight lessons learned on financing rounds of young ventures
Raising money from startup investors is not the holy grail for every young venture. Still, some business models require external funding. A financing round is a reasonable means to obtain such funding from investors in exchange for your startup’s equity.
In various financing rounds — some successful, some unsuccessful, some as an entrepreneur, some as early investor or advisor — I have learned that financing rounds and entire equity stories need to be well prepared, thought through, and executed to ensure that they positively affect a startup’s likelihood of success. In the following, I will outline my eight lessons learned to keep in mind as a founder when raising money from investors.
1. Don’t raise too early
First, you should consider the moment to accept money from investors wisely. Raising external money too early can imply a too low valuation and hence a significant dilution of the founding team in the cap table (see point 7 on implications). In addition, even though many professional investors try to keep the investment process as lean as possible, preparing a financing round ties significant capacity of you as founders, which you cannot invest into product development or sales. Therefore, I highly recommend bootstrapping your company until you have received certain critical milestones or — if needed — accepting an initial investment from experienced business angels (for explanation see next point).
2. Choose the type of investor wisely
Typical startup investors are angel investors, venture capital funds, or strategic investors. Once you start fundraising, you should have a clear understanding of the type of investor that benefits your startup in its specific situation most. While all of them obviously provide you with funding, their value-add beyond money differs (sorry for generalizing):
- Angel investors are individuals, that invest their own money into startups. They are typically the first investors into a startup, do not require a lengthy investment process, and become close advisors to the founding team. Based on their experience, they offer “smart money”, thus contributing hands-on know-how and expertise that accelerates your business especially in its early phases. On top of that, angel investors can often introduce you to potential investors for later financing rounds.
- Venture capital funds are organizations that raise money from all kinds of investors, their so-called limited partners, in order to invest it into startups. They typically have a very strong network of other funds (for example based on their co-investments), which can be extremely helpful in later financing rounds. The degree of operational support that you can expect from a venture capital fund varies largely. While some funds do not actively support you, others can provide functional know-how and expertise based on their experience from other investments. Some venture capital funds even have dedicated teams to operationally support their portfolio companies.
- Strategic investors are companies that invest into startups in order to strategically advance their own businesses. In contrast to angel investors and venture capital funds, they therefore often do not only expect a financial return, but a strategic benefit to their business. Based on their market know-how and understanding, they can become your startup’s first customers and provide you with valuable product feedback. In addition, strategic investors with a similar client base can provide you with access to a market, thereby accelerating your growth. However, their strategic investment rationale can also lead to a desire to influence your key priorities, which you should manage closely.
I therefore highly recommend closely examining potential investors’ value-add beyond money depending on your startup’s specific stage and requirements.
3. Build a network of investors
Investors often like to observe the development of new companies. Hence, investing a certain amount of your time into investor relations early on typically pays off. In terms of approaching investors, introductions from your network (for example other founders) have the highest chances of landing an initial meeting. Furthermore, participating in startup / investor conferences can be an effective means to meet investors and build your own network of investors. In the run-up to your financing round, you can keep them up to date by distributing regular newsletters. Make sure to include interesting developments in your updates but keep the most promising news for the first meetings. Once you start fundraising, you can activate your network relatively easy and dive into the fundraising process right away.
4. Prepare the pitch
Needless to say that you should block a significant amount of time to prepare your pitch. This does not only imply creating a pitch deck with a compelling story, but also practicing the pitch. Leverage your network to gather feedback. Especially, early-stage investors primarily invest in the team. Whether they decide to fund your startup or not therefore often depends on their impression of you. In consequence, I highly recommend holding as many pitches as possible in person. Making an impression and demonstrating an extraordinary enthusiasm for your business is a lot harder via telephone or video conference than in a personal meeting. If you are not based in one of the startup / investor hotspots simply block time on the ground to meet investors personally.
5. Focus on critical KPIs
While you will certainly have a clear understanding of the critical KPIs for your business as a founder, you should refine this understanding in the run-up to a financing round. In order to do so, you can talk to other founders or simply ask your initial network of investors (see point 3). This allows you to focus on those KPIs that potential investors consider critical. These KPIs obviously vary depending on the type and stage of the company. Typically, they change from initial usage data of certain cohorts (e.g. in pilots) towards KPIs related to revenues and profitability over time.
6. Raise enough money
This one I had to learn the hard way at my last startup. While we had a clear understanding of the critical KPIs for the next financing round, we underestimated the time it would take us to reach the level that investors would want to see. In the end, we ran out of money and had to shut down the company. When raising money from investors, you should thus have a very precise understanding of the time and hence money you need to reach the next critical level. As you will most likely spend the money quicker than expected and as the next fundraising process will at the same time take longer than expected, it also makes sense to include a buffer in your financial plan.
7. Watch your cap table
One of the things potential investors examine critically when considering an investment into your startup is your cap table, i.e. the distribution of shares among all shareholders. I have generally found investors to pay attention to the following three factors:
- Ownership: Investors want to see that — considering the stage of the company — the founding team owns enough shares to remain fully committed on the journey ahead. This also implies that you should not take money from investors who try to maximize their share by pushing your valuation down too much. Don’t get me wrong: I am not advocating exorbitantly high valuations, especially as raising at a too high valuation can be harmful to your equity story in later rounds. But an investor, who is not aware that an unhealthy distribution of shares will lower the chances of success in later financing rounds, might not be the right partner for you.
- Fragmentation: On top of this, you should make sure that your cap table and especially the associated voting rights do not become too fragmented. If you consider taking relatively small amounts of money from various investors, I therefore recommend pooling their voting rights. This will protect you from lengthy decision-making and voting processes.
- Strategic investor: Lastly, you should pay attention to the share a strategic investor owns in your company. While strategic investors can accelerate your startup, a strategic investor with a too high share in your company might have the potential to block critical decisions, such as a potential exit. This might scare other investors in later financing rounds.
While there are various creative ways to fix a “broken” cap table, I highly recommend getting your cap table right from the beginning to avoid such a situation.
8. Bridge financing gaps
Finally, try to avoid closing a financing round prematurely, for example because you are running out of cash. This bears significant potential for disadvantageous conditions, which can harm the success of your startup in the medium-to-long term. Instead, consider a convertible loan from existing investors or potential new investors to bridge financing gaps. Convertible loans can be set up relatively fast and pragmatic. They typically convert into equity at a predefined discount in the next financing round, thus being an effective way to bridge a few months until closing of the official financing round.
Of course, there are many more things to keep in mind when preparing and closing a financing round. As usual, the devil is in the detail. But I have found these eight lessons learned particularly helpful to avoid bad surprises and set up a startup for success in the medium-to-long term.
As mentioned earlier, the article is based on my own experiences and therefore does not claim to be complete. I would love to hear your perspectives on aspects to keep in mind when raising money from investors as a startup. So, feel free to share any thoughts, additions, and critical remarks.