About Fundraising

When people talk about startups, one term always appears – fundraising. It seems that fundraising is a must to startups, and indeed it is. In The Hacker’s Guide to Investors, Paul Graham mentioned that:

Practically every successful startup takes outside investment at some point.

Yes, Basecamp (fomally 37Signal) by Jason Fried and DHH is a bootstrap startup without outside funds, but this kind of company is among rare cases. The majority of startups needs fundraising.

There are many myths about fundraising, for example, raising funds indicates successes of a statup. Only after reading Startup School articles, have I gained some basic knowledge about fundraising.

What is fundraising?

Simply put, fundraising means that you use the splits of a comapny to exchange for outside funds. Fundrasing typipcally has a number of rounds: from early round (seed and angel rounds), to later round (round A, B, C, D, etc to pre IPO). Different round of fundrasing can come from different investors: personal (angel investor) or instititutional investors (VC or incubator). The former one may only invest in the early rounds, and the later one focus on the later rounds, but there is trend that more instituational investors participate in ealier rounds as well. The definition of different rounds of funds is complicated, and I will try to explain them in a seperate post.

The more funds you raise, the more splits you give to investors; the more rounds of funds you rais, the more splits you give to investors. This may dilute the value of the founder’s shares, or even take the control away from founders. Then, the question is, why would startups apply such a seemingly stupid strategy?

Why fundraising?

The answer is also obvious. Startups are all about growth, and only high growth can make startups successful. To achive this high speed of growth, startups need some catalysts to accelerate, and one of them is outside funds. With fundraising, startups can not only survive before being profitable, but also have more room to choose their own growth speed.

High growth companies almost always need to burn capital to sustain their growth prior to achieving profitability.

They could grow the company on its own revenues, but the extra money and help supplied by VCs will let them grow even faster.

Although, fundrasing means high price to be paid (not only the splits need be given, but also much time will be taken), but this is possibly the best solution for startups to survive and thrive.

Apart from enabling surviring and thriving, fundraising can also bring additional advantages, such as advices and connections from investors, especially when a single round of fundraising attracts multiple investors.

While a “good” market can also influence price, the quality of the investor is the most important target of leverage.

Such deals may be a net win for founders, because you get multiple VCs interested in your success, and you can ask each for advice about the other.

How to raise fund?

Obvisously, two questions need to be answered before fundrasing:

How much does this round to raise?
How much of the split is given out?

There is no clear answer to these two quesions, because the final answer depends on the negociations between founders and investors. However, some general guidences are given by Startup School:

I recommend companies think about selling 10-15% in a seed round and 15-25% in their A round (and about 7% if they go through an accelerator).

When these combine into one large initial round, I suggest trying to sell no more than 30% of the company in total.

Seed valuations tend to range from $2mm-$10mm.

Overall, the goal is to raise enough fund to survive to the next round. ‘Enough’ means not too much or too less fund. Too less fund may not support the survivial to the startup. Too much fund is more troublesome:

it may cost too much split;
it may lure founders to spend too much, which may kill the startup eventrally;
it may set a high bar for next round of fundraising: it makes not only difficult to raise the next round, but also elimiate the possibity to sell ealier.

but keep in mind that the goal (of fundraising) is not to achieve the best valuation, nor does a high valuation increase your likelihood of success.

The more you raise, the more you spend, and spending a lot of money can be disastrous for an early stage startup.

One rough rule to estimate the upper limit of a fundraising in Bay area is:

A good rule of thumb is to multiply the number of people you want to hire times $15k times 18 months.

Accoring to this, the cost per cost is $270k. If you aim to hire 20 people after finding product / market fit, then the fund to be raised is about 5.4mm. In different area, the upper limit is different, for example, in China, the upper limit could be set ¥50,000, roughly half of the one in Bay area, so, to high same 20 people, the fund to be raised can also be set as half as the above result.

Fundraising strategies

Some key strategies need to be remembered in fundraising.

Fundraising is never closed until the money is in the bank.

It’s not a deal till the money’s in the bank.

The key to closing deals is never to stop pursuing alternatives.

A termsheet is not legally binding, but it is a definite step.
Prioritize the best investors.

The disadvantage of taking money from less known firms is that people will assume, correctly or not, that you were turned down by the more exalted ones.

The better ones usually will not give a term sheet unless they really want to do a deal. The second or third tier firms have a much higher break rate—it could be as high as 50%.

Convincing the hot investors is the best way to convince the lukewarm ones.
Have multiple investors at the same round is better.

A deal that has multiple VCs interested in it is more likely to close, so of deals that close, more will have multiple investors.
Be at the strong position is more possibly to succedd in fundraising.

It may not be surprising, then, that the more money a founder has in the bank, the stronger their position when fundraising.

The only way a startup can have any leverage in a deal is genuinely not to need it.

No one wants you if you seem desperate.

In fact, most startups that are very successful at fundraising end up raising more than they originally intended.
Be proactive when raising fund.

The founders who have the most success in raising clearly and actively decide when to raise and then communicate that decision to investors, advisors, and other founders.

VCs don’t regard you as a bargain if you don’t need a lot of money. That may even make you less attractive, because it means their investment creates less of a barrier to entry for competitors.

Disadvatage of fundrasing

Nevertheless, raising fund may also bring problems to a startup:

the more fund a startup raises, the less control the founders have:

The board will have ultimate power, which means the founders now have to convince instead of commanding.
the more fund a startup raises, the less possibility it can be sold early:

If you take VC money, you have to mean it, because the structure of VC deals prevents early acquisitions. If you take VC money, they won’t let you sell early.
the more fund a startup raises, the more time it will consume:

Raising money always takes longer than you expect.

Conclution

To startups, fundraising could be a catalyst, but also could be a heroin. Raising fund should always be cautious, and I this summary may provide some basic ideas to you.