Our Startup Fundraising Guide
Our guide to help founders and startups raise venture capital.
Startups are in constant competition for two resources: capital and talent. Without capital, a business fails to exist. Without talent, a business fails to flourish.
This guide is intended to help you understand the the venture markets and improve your likelihood of raising venture capital. We will cover the history of venture capital, the investor thought process, finding and pitching investors, sharing data and documents, closing your new investors, and building strong relationships to help with future fundraises. Note: You can find the resources (blogs, podcasts, videos, books, etc.) used to fuel this guide in the resources tab located in the top right.
If you’ve raised venture capital before, you already have some combination of a great product, a highly functioning team, and a growing market. Before we jump into these aspects, we need to take a step back and study the history of venture capital.
As recent as the 1990s, the venture capital space was dominated by a few large firms that did incredibly well. Capital was enough of a scarcity that it was a differentiator for these large firms. As the internet skyrocketed in the 90s and early 2000s, in turn the cost of starting a company started to decline (and still is today). Fast forward to 2005, and Y Combinator is started. Y Combinator cracked the code on scaling entrepreneurship and used their founder and investor network to help more companies succeed.
Since the inception of Y Combinator, thousands of VC firms have started and have drastically changed the space. Capital alone is no longer a sufficient differentiator for a VC firm. Firms have started to specialize in specific verticals, offer extensive resources to their portfolio companies, and have created their own “secret sauce” for yielding the best returns.
That brings us to today, where it is easier to start a company, yet harder to build a company than ever before. Access to capital can be the difference maker between a startup thriving or joining the startup graveyard. Below we will share the tips and tricks to systemize your fundraising process to better increase your odds of raising venture capital.
Further reading and resources to help you learn more about venture capital:
Are you ready to raise capital?
First things first, you need to ask yourself, “are we ready to raise venture capital?” Or better yet, “what do I have to offer a potential investor?” As we previously mentioned, to raise venture capital you need some sort of combination of a compelling market, qualified team, or strong product.
Understanding How VCs Work
To understand if you’re ready to raise venture capital, you need to understand how VC firms function and how you can fit into their larger vision. In simplest terms, VCs go through a consistent life cycle that goes something like this: raise capital from LPs, generate returns through risky venture investments, generate returns in 10-12 years, and do it again.
Easy, right? Actually, quite the opposite. A median VC fund is generally not a great investment for limited partners. Just as companies are in competition for venture capital, venture capitalists are in competition for capital from limited partners. In short, LPs are institutional investors (University endowments, foundations, pension funds, insurance companies, family offices, sovereign wealth funds, etc.) looking to create excess returns by investing in VC firms (generally a small % of their overall investment strategy).
According to Scott Kupor, “If you invested in the median returning VC firm, you would have tied up your money for a long time and have generated worse results that the same investment in Nasdaq or S&P 500.” So why would an LP invest in a VC firm at all? Because VC returns follow a power law curve; a small % of firms capture a large % of industry returns. In simpler terms, LPs are in pursuit of VCs generating excess returns who are in pursuit of investing in companies that can offer huge returns. Which brings us to our next point…
A Compelling Market
VC fund returns are not the only place we see a power law curve throughout the fundraising process. The breakdown of a VC funds individual investment returns follows a power law curve as well. It might look something like this. Long story short, VCs are in search of home runs, not singles and doubles, to create the excess returns for their LPs.
The best chance of being one of these companies that creates the huge returns for a fund, have a compelling market. As Scott Kupor, Managing Director at a16z puts it, “Everything starts and ends with addressable market.” As a founder, it is your duty to model the total addressable market and paint a picture of how you will penetrate the market to become a “home run” investment. Without a compelling market, a VC fund will have a tough time justifying making an investment in your company. With that being said, if a market is not big enough right now, strong and innovative companies can find and create new ones (E.g. Uber’s TAM).
Markets fluctuate and you may have an investor that invests in specific products or teams to differentiate themselves.
On the flip side, there are investors who will base their investment decision of the product. No matter how big the market or strong the team, some investors will tout that a strong product is all that matters. The idea being that a strong and innovative product will sell itself and will have the ability to create new markets. As Peter Thiel states, “If your product requires advertising or salespeople to sell it, it’s not good enough.”
While the team may have no direct attribution to how large of returns your company can generate, it can display your ability to execute on the vision. Having a well experienced team is a great way to portray your credibility. Some very early stage investors, such as the Hustle Fund, may even place the most stress on the team when making an investment decision. As Elizabeth Yin of the Hustle Fund puts it, “of the two things I am most interested in for early stage investments is the assessment of the team… how well do they know the market? Are they executing?, etc.”
So the question is not, “are we ready to fundraise?” It should be, “do we have the market, product, or team to warrant an investment from an investor?” If so, it is time to get started on the fundraising process.
Further reading and resources to help you determine if you’re ready to raise venture capital:
Finding the Right Investors
When you’ve determined you are ready to raise capital, you’ll find that the fundraising process often mirrors a traditional sales process. Like any sales process, the fundraising process starts by finding qualified investors (leads) that you’ll build a relationship with the end goal of them writing a check.
Fundraising is often compared to a cocktail party, when the waiter comes around with a tray of snacks, you should always take one. You’ll never know when the waiter will make it back to you. The same with VC capital. However, it is important to remember that the average VC + Founder relationship is 8-10 years so you’ll want to make sure you’re starting with the right people to build a valuable and long-term relationship.
We suggest starting with your “Ideal Investor Persona.” This is a firm or person, that is highly targeted in all facets of your business. We suggest starting with qualities below:
- Location – Where are you located? Do you need local investors? Or maybe you are looking for connections and networks in strategic geographies.
- Industry Focus – What type of company are you? Where should your future investors/partners be focused? e.g. If you’re a B2B SaaS company don’t waste your time with marketplace focused investors. Mark Suster suggest that it is best to prioritize investors with companies in your space.
- Stage Focus – What size check/round are you raising? e.g. If you’re raising a $1M seed round avoid a firm with $2B AUM. If you’re raising a $30M round avoid a firm with $75M AUM.
- Current Portfolio – How is the rest of their portfolio constructed? If current companies are doing well, there may be less pressure to exit so they can return funds to their LPs. If current companies are performing poorly, there may be more pressure for you to exit so they can return as much as possible their LPs.
- Fund Age — How long ago did they raise their current fund? How many investments have they made? If the fund is young, there will be less pressure to exit and a higher likelihood of them having capital saved for a future round. If the fund is older, they may feel pressure from their LPs and may be looking for an exit as soon as possible.
- Deal Velocity – Are you in need of capital as soon as possible? Or are you taking your time and looking for strategic investors? Varying investor’s have different philosophies for the velocity they’re making deals. Point Nine Capital and Kima ventures are both regarded as top firms in Europe. However, Point Nine makes ~10 investments a year whereas Kima makes 1-2 investments a week.
- Motivators – Who are the firm’s limited partners? What do want to get out of your investors and what do they want to get out of you? Do they need to match your values and culture?
Once you’ve determined someone that meets your “ideal investor persona” you’ll need to do everything in your power to get a meeting with them. In fact, many VCs will use your ability to get their attention and set a meeting as a gage for your “hustler” prowess. Cold emails, your network, and events are all great ways to get a meeting.
Regardless of how you get a meeting, it is vital to do your research beforehand. Start with current connections and do what you can to get an introduction. Other founders and current investors are a great source for finding new investors. Go into the first meeting full of knowledge and ready to question investors.
Further reading and resources for finding the right investors:
Pitching Your Company Effectively
Just landed your first meeting? Great! But the pitching does not start yet. Many founders will walk into their first meeting and immediately start flipping through their deck and give the same presentation to each investor. However, you need to remember you are selling your company and want to make sure your pitch is as tailored as possible to each investor.
The first meeting should be most valuable for you as a founder. This is your opportunity to ask questions so you can figure out their pain points, figure out their motives, and other nuanced things you may not be able to find in internet research to tailor your pitch for future meetings.
As Elizabeth Yin, Founder of the Hustle Fund puts it, “Your job in the first meeting with a potential investor is to ask a lot of questions – ala customer development style – to understand how you might be able to tie your story to their problems and interests. And so your pitch should not be stagnant, and although you may have created a deck before the meeting, it’s important to tie your talking points together as a solution to the problems you learn about in that meeting.”
If you’ve done your research and asked the right questions, you’ll be armed with the information you need to effectively pitch your company. At the end of the day, pitching is storytelling and it is your job to figure out how each potential investor fits into the narrative. If done correctly, you’ll be able to control the conversation and better your chances of setting future meetings.
Further reading and resources for pitching your company to investors:
Data, Documents, and Due Diligence
Once you’ve determined an investor is the right fit for your company, you’ll need to share data and different documents with your investors.
Data & Metrics
At some point throughout the process, investors will need to see the metrics behind your business. You should have a deep understanding of your key metrics and have them ready to share at any time. Generally, we’ll see that metrics potential investors want to see fit into one of the following categories:
- Growth & Financials — This more often than not comes in the plan of a business/financial model and historical data. Show them a strong financial model that creates growth for the business and returns for them and their LPs.
- Margins — Margins on your product is a large part of the path to profit and returns for your investors. Investors generally have a % they are looking for in the back of their mind.
- Customers — Your customers are your business. Clearly showing potential investors that you can attract, convert, retain, and engage your customers is vital. This can come in the form of customer satisfaction surveys, net promoter score, and retention rates.
Documents & Due Diligence
Going from “I’d like to close” to actually closing is a big difference. When facing due diligence it is important to be prepared, understand the process, and do your part to speed up the process as much as possible.
There are a number of different corporate documents, protocols, references, etc. that you’ll need during the due diligence process. To learn more about the specific documents head over to our fundraising resources section.
Signaling most certainly matters throughout this process. You’re likely only meeting a few times before jumping into a 8-10 year relationship so everything will be magnified throughout the process. Be prepared and transparent throughout the due diligence to help avoid speed bumps and start your relationship off on the right foot.
Further reading and resources for sharing data, decks, and documents:
Nurturing for Later Rounds
Inevitably, you’ll hear a slew of “no’s” and maybe’s” throughout the fundraising process. An investor “no” can always be turned into a “yes” at a future date. As you would nurture a lost deal in a sales process, the same should be done with your potential investors.
If you’ve asked the right questions, you should have a good idea of what they’re excited about and be ready to pull the trigger to pick the conversation back up. How exactly do you keep potential investors engaged? We have found it best to send out a short update on the state of the business and industry. Share a promising metric or two showing strong growth in the business and any significant wins/improvements. If possible, address any concerns with the industry, team, product, etc. that you have discussed in the past with numbers. Hundreds of emails land in investor’s inboxes so be sure to include a quick snippet of what your company does and any personal notes.
By building a strong relationship with potential investors, it will make it that much easier when you set out to raise at a future date. Most importantly, make sure you are armed with the right information and data to stay top of mind.