One of the big no-no’s we’ve learnt about early on in Silicon Valley is to publicly share the pitchdeck you’ve used to raise money. At least, not before you’ve been acquired or failed or in any other way been removed from stage. That’s a real shame, we thought. Sharing the actual slidedeck we used (and one, that’s not 10 years old) is by far one of the most useful things for others to learn from. In fact, both Joel and I have privately shared the deck with fledging founders to help them with their fundraising. On top of that, our case study is hopefully uniquely insightful for lots of people. Here is why:
- Half a million is not a crazy amount: It’s therefore hopefully an example that helps the widest range of founders trying to raise money.
- Both Joel and myself are first-timers: We couldn’t just throw big names onto a slideshow and ride with it. We had to test and change the flow and deck a lot.
One of the most important elements, that we had to learn during our fundraising process was the concept of “Ratio thinking”. Jim Rohn, the famous motivational speaker, probably explained it best:
“If you do something often enough, you’ll get a ratio of results. Anyone can create this ratio.”
It sounded simple enough as a concept to us, but man, this was one of the toughest things to learn. Here is how Joel described it in a recent article on ratio thinking
“The law of averages really comes into play with raising investment. Overall, we probably attempted to get in contact with somewhere around 200 investors. Of those, we perhaps had meetings with about 50. In the end, we closed a $450k seed round from 18 investors. Perhaps the most important part of our success in closing that round was that Leo and I would sit down in coffee shops together and encourage each other to keep pushing forward, to send that next email asking for an intro or a meeting. In many ways, the law of averages is the perfect argument that persistence is a crucial trait of a founder.”
I believe that this is in fact one of the most valuable things to know up front. It requires a huge volume of work and meetings.
How to read this deck: It builds up to one key slide – Traction
If you go through the deck, you will quickly realize that the one key slide was the traction slide. We quickly realized that as first time founders, this was probably our only way to raise any money: By focusing everything on the traction slide. Here is how Joel describes this in his article on raising money as a first-time founder
“So my advice for first time founders who want to raise funding is almost always to put that thought aside until you have good traction. Instead, focus completely on traction. Focus on product/market fit. When you have good traction, it becomes much easier to raise funding.”
Avoid confusion: Our second most important slide – competition
Another thing we quickly realized when raising money was this. Although investors were very interested in talking to us, especially because of our early traction, talks then stalled. Why? The social media space seems very crowded. From the outside, it looks like there are dozens and dozens of apps all doing the same thing. On the inside, you however quickly realize that there really aren’t that many options.
The question was almost always timed at the exact moment in each meeting: “So, aren’t there lots of other apps doing the same?” And we explained to them about the TweetDecks and Seesmics and that Buffer is different and so forth. That never worked. So after lots of meetings, we realized that the competition question (in our case) created the most friction and eventually left people too confused and not interested any more. We took some time aside and made this slide as easy to understand as possible and explain Buffers positioning without creating all the friction:
Without any further explanation, here it is:
A note on transparency
With Buffer, our goal is to take our ideas of transparency for our company to a whole new level. That’s why it was very important for us to make this slide deck public. This slide deck is far from perfect. As previously mentioned, it probably falls into the average category. But it was what at the end of the day helped us raise the funds to turn Buffer into the company it is today. So it’s hopefully a real-world case study that clearly shows what is important and what might not be so helpful for investors to know about. We want to continue publishing our ideas and thoughts about topics that get rarely talked about. Joel and I will be around to answer any further questions you might have on our fundraising process. Please post anything you have in mind in the comments below.
This is a guest post by Leo Widrich (@leowid), co-founder of Buffer. Note: I'm an angel investor in Buffer and my company HubSpot has a little bit of overlap in functionality in our Social Inbox product.
The following is a guest post by Alan Wells, co-founder & product designer at Glyder. [Disclosure: I'm an angel investor in the company. -Dharmesh]
It has been widely reported that at there will be least 1,000 orphan startups this year - companies that raised a seed round last year and will fail to raise follow on financing. The popular opinion in the tech press is that most of these 1,000 orphan companies will die due to lack of capital. As a founder, it's hard not to let this influence your thinking - with all the talk of failing fast, acqui-hires, and overnight success stories, it's easy to believe that your only options are to find a soft landing or shut down and try again with something else. And compared to sticking it out, walking away is most certainly the easier path (although it might make you a punk).
But I believe that in those 1,000 orphan startups, there are great companies - companies that can still put a dent in the universe, companies that can break through if the founders stick to it. Ben Horowitz says that all great CEOs have one thing in common: they don't quit, and at Startup School last year, this theme played out over and over again. Almost every founder that spoke went through a trough of sorrow that lasted 18-24 months before things really started to click for their companies.
Maybe it’s coincidental that the trough of sorrow is usually just a bit longer than the runway you have after an average-sized seed round, but I’m beginning to believe that great companies are often the product of these trying circumstances. Unfortunately people don’t like to talk about what’s not going right with their companies, and there’s not much discussion going on around what founders are doing to successfully navigate these waters.
I’m the founder of a startup that recently decided to double down and do our best to beat the series A crunch, and in the interest of focusing on the road instead of the wall, I wanted to share some of the things I’m learning as we find a way forward.
Acknowledging Your Reality
Founders are optimistic people, so it's easy for us to believe that if we just add this one thing to our product, hit that one key metric, or sign that one partnership deal, investors will come banging on our door begging to give us money. However, if you know things aren't going well or you are already having trouble raising your next round, what your startup needs more than anything is a lucid founder that can realistically assess the situation and identify a path forward.
Doing an honest appraisal of the things that were and weren’t working in our business was an important moment for our decision to press forward. Inside the head of a founder, things can seem great one minute and terrible the next, so getting outside perspective can be valuable as a check to your instincts and emotions. Meeting with advisors and existing investors also helped us get some third party perspective about trends in the market and issues we’re facing.
Understanding Why You're Not Fundable
As a startup founder, you're working in a four dimensional problem space: team, product, market, and timing. Hopes and dreams are often enough to raise money at the seed stage, but in my experience, you need more than that for your next round: you need to convince investors that you're the right team building the right product for the right market at the right time.
If you've been fundraising for three months and haven't gotten a check yet, something is probably wrong in one or more of these areas. Understanding what's wrong is critical to figuring out your path forward, and investors that pass can be the best source for understanding what the missing pieces are.
Until recently, I don’t think I quite appreciated the complexity of getting all this right at the same time, especially when you throw in the added complexity of trying to match up with the various investment theses and historical biases of top tier firms. As Ben Horowitz said, “this is not checkers; this is mutherfuckin’ chess.” Getting useful information isn't always easy - most investors seem to be worried about offending founders and prefer high level statements like "not enough traction" over candid feedback about the holes they see in your business.
I want to thank a few folks that were candid and helpful to us in this way - Ashu Garg (Foundation Capital), Thomas Korte (AngelPad) and James Currier were among the the people that gave us really insightful, critical feedback.
The Founding Team Gut Check
With some honest datapoints on the investor perspective of your business, you have the information you and your co-founders need to have a gut check conversation about the state of your business. You'll likely find your product, market, team or timing are in conflict with what investors see as likely to be a homerun, and you need to decide how to respond to that mismatch.
In our case the problem seems to be mainly around market - we're targeting very small businesses, a fragmented market where there is no historical precedent for big winners being built within the timeline that venture investors need for their 10x returns. We're well aware of the historical challenges in serving this market, but we believe that due to a number of new trends, big winners will emerge in this space in the next 3-5 years. Very few investors agree with us.
Our focus on very small business is one of the founding principles of our company, and we believe deeply in the potential that lies in serving this market. Our conviction in serving this market increased when we launched Glyder and started seeing the positive user response to the product. Because of this conviction, we decided that we would rather continue focusing on this market than switch to a different target market, even if that means we're not fundable in the short term.
Having an open and candid conversation with our team about the challenges to our company was a great chance to gauge everyone's commitment to the business. Building our business without more capital will be difficult, but when everyone voiced renewed desire to keep going forward, it helped me as the CEO get excited about figuring out how to do it.
Moving Forward & Changing Tactics
Paul Graham likes to tell founders that "the surest route to success is to be the cockroaches of the corporate world." The analogy works particularly well for orphan startups, because without additional capital, you must be resilient, resourceful and self-sufficient as quickly as possible. Here are some of the changes we’ve made as we continue building our business.
Incentivizing Existing Investors to Stay Involved and Excited
Before we started trying to raise a new round, we gave our existing investors the opportunity to put more money into the company on fairly favorable terms. The cap on this new note was lower than the cap that we had previously raised money on - although our business was much further along, the funding environment had changed as well, and we wanted to make the decision to put additional capital in easy for our existing investors.
We also went back and amended the documents for all investors who had put money in on the higher cap and gave them the lower cap instead. This is unusual, not legally required, and meant that we were giving up additional dilution.
Why would we voluntarily increase dilution? Our investor group includes friends & family, angels, and the great team at 500 Startups. Our relationships with most of them started long before this company, and we hope they will extend far into the future. These relationships motivate us to keep building the business - they trusted us with their hard earned dollars, and although they all know the risks of betting on our startup, we want to show them results. When it comes to a decision like the one we made with the cap change, the cost in dilution was well worth the goodwill it generated among our investors. It also demonstrated our commitment to acting with integrity even when things aren't going according to plan.
Re-evaluating the Product Roadmap
As we heard the skepticism from potential investors while trying to raise more capital, product priorities were the first thing to change for us. We no longer have the luxury to focus on user growth over monetization, so our entire product roadmap shifted to focus on revenue. Our app, once offered for free (to maximize signups) is now a paid download. We don't have the luxury of supporting users that aren't willing to pay for what we make.
Lowering Burn Rate
In addition to shifting product priorities to revenue, we also made dramatic reductions in burn rate so we could reach profitability faster. This meant letting several team members go - by far the hardest decision in this entire process - and asking remaining team members to take a pay cut (we softened the blow with this by giving additional equity). The changes in product and burn rate have put us on a path to reach cash flow positive before we run out of capital.
Preparing For Battle
In addition to the tactical changes in our business, the process we’ve gone through in the past three months has mentally and emotionally prepared our team for the road ahead. We know who we are and what we’re working toward, we’re aware of and very comfortable with the contrarian stance we’re taking, and we believe the long term opportunity is well worth the short term sacrifices we are making. As they say on Friday Night Lights, “clear eyes, full hearts, can't lose.”
I think Andrew Chen had it right when he said
, "there’s always another move." If you’re the founder of a startup staring headfirst at the Series A Crunch and you can find the will to keep going, your job is to find that next move and make it happen. I hope to see more discussion on how companies are sticking with it and navigating the trough of sorrow. If you're in the midst of this process and need someone to bounce ideas off, drop me a note at @alanwells
The following is a post from my friend and co-founder/CEO of HubSpot, Brian Halligan.
HubSpot just closed its mezzanine round, so I thought I’d share some surprising things I learned during the process. I’m by no means an expert in this field, so these are just the observations of one entrepreneur.
A Surprising Number Of Potential Investors With Widely Varying Value Propositions
My impression is that times have changed in the growth equity game. It used to be that early stage venture folks just did early stage investing, late stage venture folks just did late stage investing, and public equity investors only invested in publicly traded stocks. What surprised me is that now, it seems like everybody invests in late stage private companies.
This is certainly not the “official” way to look at it, but here’s the way I ended up bucketing types of investors in my own head.
- Typical Early Stage VC Firms with Growth Equity Funds – These are folks like Sequoia, Accel, General Catalyst, Redpoint, DFJ, etc., that have typically started new funds with new teams focused only on investing in late stage companies. They write checks from $15 million to $100 million as far as I can tell, and I think they’re pretty valuation sensitive as a group. They usually want to take a board seat and can add a lot of value in terms of knowledge, connections, and pedigree -- Sequoia led HubSpot’s last round and has been huge on those fronts.
- Late Stage VC Funds – Think Meritech, Adams Street, August, Norwest, Tenaya, Questmark, SAP, and DAG. These folks only do late stage equity and write checks from $10 million to $40 million as far as I can tell. I think they are less valuation sensitive than the traditionally early stage folks. They are typically a bit more arms length in their level of involvement which often translates into a board observer seat -- they seem to follow-on the top tier early stage folks and rely on them for their advice and connections.
- Big Check Late Stage Funds – GA, TCV, NEA, etc. seem to only do late stage equity and write checks north of $40 million. I think they are relatively valuation sensitive, but keep in mind I only have a small sample size here. It seems they’ll want a board seat and to be very involved – and they can add a lot of value.
- Private Equity Funds – TA, Summit, etc. are the types of firms I know the least about, but my sense is that these folks do late stage investing and write “biggish” checks. They seem to be wired to buy out existing investors, put in some working capital, and raise debt. This can be a great approach for a company, but it’s probably hard to work for a firm that already has a lot of venture money in it. My sense is that they want to be involved and are value-add.
- Public Funds – The last bucket is folks like Fidelity, T Rowe, Janus, Cross Creek/Wasatch, Altimeter, Tiger, and Morgan Stanley. They invest out of public equity funds, seem to write checks from $10 million on up, and tend to be slightly less valuation sensitive (we’ll talk about why below). They are financial investors and do not want to be overly involved, which means no board seats or observer seats for the most part.
That’s my sense of things based on insights from HubSpot’s mezzanine round of funding. If I’ve missed some funds, please do include them in the comments section so we can make this article as useful as possible.
The Surprising Value Of Public Investors Investing In Your Private Company
We went with public funds -- #5 above -- not private funds for three main reasons that made a lot of sense for us, though they might not make sense for your company:
- Public investors tend to buy more of your shares after you go public, while private investors will typically look to sell their shares after you go public. The venture funds incentive system is set up such that they are supposed to sell the shares and distribute the profits to their investors after a reasonable time elapses following the IPO. My sense is that the period of time between when you go public and when they sell varies widely, and the better the firm’s footing the more likely it is they will hold. Having said that, I think it’s pretty rare that the traditional venture folks actually buy more in the public markets. It’s important to note that this does not matter if your most likely outcome is a trade sale.
- Public investors can “recycle” their capital while most venture funds can’t really do that easily. Huh? If Fidelity gets a 70% return on their investment in your company in a year and a half, they are pretty happy -- they can turn around and reinvest that money into other stocks. If Accel gets a 70% return on their investment in a year and a half, they are actually pretty unhappy -- they need to return that 70% to their investors and can’t really reinvest it. In order for venture funds to make their math work, they need to get a 3X return on their investment. So what? Well, this means that the late stage venture folks will likely give you lower valuations and more “structure” (i.e. participation) in their deals to try to reach higher return levels, while the public folks will likely be more flexible.
- We are generally very happy with our board and were not looking for new members or even new observers.
Now, that’s HubSpot. Every company is different. Let’s just say, as an example, that you are a travel technology company that’s doing well, but you need some help on the board, some VC pedigree and connections to improve your team, domain expertise, and maybe some money to buy out existing investors and their board seats. In that case, you’d be nuts not to go with, for example, General Catalyst or Sequoia.
The Surprisingly Common Use of “Structure”
In our A through D rounds, the concept of “structure” did not come up. In fact, when one of the potential Series E investors asked me, “Are you open to ‘structure’?” it caught me off guard, because I didn’t know what it was and didn’t want to seem like a complete rookie. So I said, “Let me check with my board and get back with you.” That turned out to be a good answer, by the way.
Structure is a fancy word for preferential terms set up to increase the return of the new investor, or limit the downside of the new investor. As I mentioned earlier, private investors typically need to get a 3X return on a late stage deal, and they’re nervous that they will invest money into a company and six months later it will sell for 75% more than they invested. For someone who can reinvest that capital, that’s a great outcome; for a VC, it’s not. In order to protect themselves from that risk, they will ask for participating preferred stock that, for instance, will put a floor on their return of 2X. Given the VC’s incentives, it makes perfect sense, but that is a different type of equity that sits on top of everyone else’s equity that needs to be looked at extremely carefully. It comes in a lot of flavors and can work well to bridge a valuation gap, but can be confusing, so I recommend folks dig in and build the model on how it ripples through.
Another type of structure that VCs put in is a block on an IPO or trade sale of less than 2X (or something like that). This block makes perfect sense for the VC given their contract structures with their LPs, and it might make sense for you -- but you need to go into that with eyes wide open.
The Surprising Importance of Your Series A Terms on Your Mezzanine Round
It turns out that the terms from your Series A are most often cut and pasted into your later round deals. When you compromise on terms in the early stages, you will have to pay the price in the later stages. You generally don’t start from scratch and rehash the terms.
Surprisingly Rational Pricing
The initial pricing interest in our early stage rounds varied widely; but in our mezzanine round, the numbers came in much closer to each other. There are hard public numbers to look at with publicly traded companies and recent acquisitions by public companies. The pricing discussions just seemed much more “real” than the earlier stage deals.
My advice here would be to get your arms around the public companies for your industry, and where those companies were when they were your size. We built a chart that showed every public SaaS company and what their revenues and growth trajectories were from their early days to where they are today. It was a useful tool in our discussions, particularly when we were getting compared to public companies that were growing at 25% and we were growing at 85%.
Surprising Value of Currency Valuation in M&A
Private companies buying private companies with stock is a tricky business. After our Series D, we acquired another privately traded company called Performable with a combination of cash and stock. The trickiest part of deals like this is figuring out what their stock is worth, and what your stock is worth. The nice part about just having finished a relatively late stage, clean round is that at least our side had a real number to negotiate from. If neither side has a recent number, those negotiations are really tough to sort out.
Those are some of the surprising things we learned in our recent mezzanine round. Am I missing any insights that you have on this topic? Feel free to leave a comment and let me know.
The following is a guest post by Chris Sheehan. Chris is a seed stage VC and angel investor at CommonAngels. You can follow him on Twitter at @c_sheehan and his blog Early Stage Adventures.
Back in 2008, Peter Thiel did an interview at TechCrunch50 in which he said one of the most important things he looks at before investing is how much the CEO is getting paid.
The lower the CEO salary, the more likely it is to succeed.
The CEO's salary sets a cap for everyone else. If it is set at a high level, you end up burning a whole lot more money. It [a low salary] aligns interest with the equity holders. But [beyond that], it goes to whether the mission of the company is to build something new or just collect paychecks.
In practice we have found that if you only ask one question, ask that.
What's the average salary for CEOs from funded startups? Thiel was hesitant to answer, but eventually said $100-125k.
An interesting perspective. I'm not sure that it's a leading predictor of success, but it certainly is a very important aspect at the seed stage because cash is so precious. The more a CEO pays herself, the less runway available to hit milestones.
CEO founders sometimes ask me for guidance on what is “market” for salaries in a seed stage startup. Some observations:
- Stating the obvious, salary needs can vary widely. A founder with no mortgage, kids, etc will have different cash needs than a founder that has a minimum cash hurdle to clear (in the absence of being very wealthy)
- The amount raised in a seed round has an obvious impact. I know a couple of cases where if bigger seed rounds had been raised, the founders would probably have bumped up their salaries a little
- The percent equity owned by the CEO post the seed financing varies as a function of not just the size and terms of the seed round, but quite significantly, by the number of founders and how equity is divided up between them. While not a direct driver of cash salary, the amount of equity owned can have a psychological impact on salary expectations.
- Another influencing factor is how long the company has bootstrapped prior to the seed round and how much were the founders getting paid during this time. I know of a couple of companies I am invested in where the founders didn't pay themselves anything for quite a while as they were building the foundations of their product
- If the company raises a Series A round, its typically to see seed stage salaries adjusted upward.
- As companies mature, its typical that a compensation committee is formed by non-management board members. In fact, the VCs will insist on this. The role of the compensation committee can vary, from making recommendations to the board on executive salaries, bonuses (and option grants) to having authority to set executive salaries
So what is the range of CEO salaries in the seed stage?
Based on what I see in the market, I'd say the range for founder CEO salaries after a seed round is between $60k and $150k, with the average/median in the range of $90k - $110k. This is based on an average seed round of around $900k with the expectation that the round will provide runway for 12 to 18 months. Salaries at the upper end of the range ($150k) are correlated with larger seed rounds of around $1.5 million.
While there is no correct answer to the question, here is my main take-away: it's so critical to be capital-conscious at the seed stage. Within what will feel like an incredibly short, stressful period of time, the startup needs to build product, figure out the market, and get some initial traction. Every month of cash burn is valuable.
By the way, to see some survey data on what other people think the founder/CEO salary should be, check out the OnStartups poll on founder salary.
This is a guest post by Dave Balter. Dave is the CEO of BzzAgent, founder of Smarterer, an active angel investor and a holder of proms. You can follow Dave on twitter @davebalter
Everywhere you turn these days, you find an angel investor. Aside from those who have always invested small amounts of cash in startups, more and more venture capitalists are making personal side deals, active entrepreneurs are investing in other entrepreneurs, seed funds are cropping up everywhere, and Angel List has emerged for the everyman.
But most Angels will fail to get back the capital they've invested (let alone make money), and it's not because they don't pick good companies or back great entrepreneurs — it's because they're completely mistaken about an Angel's role in the investing cycle.
I know this because my in my early days as an Angel investor I fell prey to behaviors that would practically guarantee that I'd lose money. And now that I've gotten to know the Angel community, it turns out I wasn't alone. The problem: most Angels attempt to act like sophisticated venture capitalists:
a) They seek 10x (or more!) homerun acquisitions and;
b) do follow-on investments (pro-rata or more) often through multiple rounds and;
c) invest in game-changing ideas that are incredibly risky;
d) wait for companies to eventually get sold to see a return.
A more effective model for Angel investing is long overdue. If Angels want to win — they want to lower their risk, create better returns, and help entrepreneurs more they'll do the following: fly lower heights (avoid trying to fund the next 5 Facebooks) and take shorter flights (avoid riding each investment out all the way to the end).
An Angel investor should:
a) aim for a 2-4x return;
b) get out of deals in 1-3 years, selling their shares to VCs at the Series A or B Venture Rounds (and not feel bad about it);
c) Remember that they're playing with their own money versus risking someone else's via a fund they've raised. Angel investing isn't about charity work; if they want to spend money to help others, they should just donate to good causes instead.
Ultimately, it's about following the rules of the investing ecosystem: Angels get things started, venture capitalists create mature, sustainable businesses, and investment bankers sell them. And if we all play by our roles, we're all going to win.
Here's what playing by the rules will do:
- Reduce Risk. Losing money is rarely because the company goes out of business in the first few years. Rather, it's because the company matures and becomes more difficult to sustain through ups and downs. Getting out early will allow an Angel to get more out, more often.
- Allow More Companies to Get Funded. The majority of Angels have the ability to invest in just a handful of deals, let's say 10 maximum. Their money is limited, and they don't want to overextend. Assuming some follow-ons, most just can't do much more than that. If an Angel exits from one or two in the short term, that 2-4x return will allow them to help start more companies, more often.
- Avoid Dilution to Nothing. One of the major issues in Angel investing is that a successful company often goes through many rounds of funding at higher and higher valuations. Often at that stage, VCs don't provide early Angels the ability to invest, and even more often Angels can't invest due to the financial commitment. The result: an Angel is left diluted to a meaningless percentage.
- Keep In-The-Know. In the successful company scenario, the outcome is even bleaker. The major investors no longer provide early investors with Information Rights (the right to receive financial or strategic facts about the company). So that leaves most Angels with a variety of deals that they're entirely clueless about.
- Provide VCs with More Ownership. When a company begins to succeed, institutional investors want as much ownership as they can get. Without lowering valuation, this conflicts with founders who also wish to keep as much ownership as they can. One solution: Angels are expected to sell shares to the VCs as part of the round. The VCs get more ownership, an Angel makes money and the entrepreneur doesn't get diluted. Everyone wins.
- Reduces VCs and Acquirers from Having to Deal with — well, Angels. This is an important one. VCs want clean capitalization tables (less people involved = less headaches) and acquirers don't want to have to deal with shareholder lawsuits or other risks of having a whole bunch of (relatively) unsophisticated investors involved. The less Angels involved later, the better.
Again, this is really just about Angel investors agreeing to be what they really are: small-time investors who want to use their own money to help companies grow. It's a great thing, and it shouldn't be confused with investors who are seeking to deliver returns for the Limited Partners in the funds they've raised.
For this to work, the whole ecosystem needs to behave accordingly. Entrepreneurs need to be supportive of an Angel who sells their shares; venture capitalists need to be willing to purchase shares from Angels during the A or B rounds; and Angels need to know their role.
To the Angels: Aim shorter. Aim lower. And for that, you'll get better returns and support more companies.
Which is the point after all, isn't it?
The following is a guest post by Chris Sheehan. Chris is a seed stage VC and angel investor at CommonAngels. You can follow him on Twitter at @c_sheehan and his blog Early Stage Adventures.
I wear two hats one as a general partner of a couple of seed stage VC funds, the other as an occasional angel investor. Wearing my angel-investing hat, I wanted to highlight an issue that I encourage founders to be careful about when pitching. There are variations on the theme, but essentially it's a line that goes something like:
“…we've talked to some VCs who are really interested, but they tell us we are too early for them to finance our round. So we are raising a small seed round now to hit the milestones they want and then will raise our A round. Its often followed by, we just need $[insert here, but typically $100k - $500k] for  months to hit our milestones…”
So what's the problem with this pitch to an experienced angel investor? When I hear this, I'm thinking:
1. The way you have pitched it to me says you struck out with VCs so now are turning to angels as a backup strategy.
2. From your voice, tone, body language, it feels like you really want the VC money and angels are just a stepping-stone to get the VC round.
3. You are probably new to the process of raising money from VCs. You miss reading the buying signals, and are possibly confusing interest with a genuine desire to finance your startup. It's the job of a VC not to miss out on a potentially good deal, so the process can be full of we're interested signals rather than an outright no.
4. The likelihood of raising money from any of the VCs you are talking to is probably very low. Not impossible, just unlikely.
5. So not only is there high seed stage risk (product, market, team), there is very high financing risk on the deal. It's unlikely you will hit the milestones in the time frame you're thinking and the most likely outcome is that you need to approach your angel investors around the table for more money, which will set up a potentially challenging discussion and negotiation.
6. Even if the scenario plays out that short money leads to solid metrics, which then leads to a VC funding the next round, the way this has been pitched, it doesn't feel like there is the basis for a strong partnership.
Ok, so what can you do? Its perfectly fine to test your concept with VCs with large funds to get a range of feedback on various elements of the business like “is it fundable?”, “where are the key risks?” “what other analogs have they seen?” And if you're not getting them to bite on the seed round now, recalibrate your funding strategy for angel investors. But when you do that I'd suggest:
1. Pitch to angels as partners not just a means to get the VC round. This will comes across in your slides, voice, body language and how you frame your overall financing and de-risking strategy.
2. Consider if there a better financing approach. Is it possible to operate on a small amount of money for say 12 18 months, which will give you enough time to experiment, learn, adjust, and de-risk the opportunity? This seems like a more attractive proposition to an angel investor and if it works out, there is a good probability that a larger VC raise will be done at a decent up round valuation.
3. If angel financing is not available for 12–18 months, is it possible to work with the angel investors to do a small seed with agreed testing/learning/milestones that will lead to them funding another round?
Approaching experienced angel investors in this way will hopefully result in them leaning forward instead of backward, and being much more enthusiastic about finding a way to work together. What do you think? Any lessons learend from navigating the angel and VC funding?
The following is a guest post by Rene Reinsberg (@followrene). Rene is a recent MIT Sloan graduate and the CEO and co-founder of Locu, a company that helps close the gap between offline and online by building a real-time, structured repository for small business offerings data such as restaurant menus. Disclosure: I'm an angel investor in Locu. -Dharmesh
Raising Money Isn't About Raising Money
Our company has raised more than $600k in seed money over the summer. In a matter of a few months we transformed from a group of students working on what one notable Silicon Valley investor called a “class project” in early April 2011 to an eight-person company, with a unique technology, a clear value proposition and strong customer interest for our product. I'd like to share some highlights and lessons learned from our journey.
Back in April, we had been bootstrapping for about half a year, building our first prototype and some interesting back-end technology and learning a lot about our market. We also realized we had been working well together as a team and were all ready to commit full-time.
Testing the waters
One of our early inflection points was a team trip to the Bay area for a week in late May. We had been selected to present at a startup showcase and had also set up a few meetings with investors while out there. The four of us shared a double room at the cheapest hotel we could find, the Ramada Silicon Valley in Sunnyvale. It worked out perfectly: free WiFi, a good enough breakfast buffet and an In-N-Out down the street.
We went to almost all pitches that week as the whole team. While this is not sustainable for the whole fundraising process, I highly recommend it early on. It helped us grow stronger as a team and develop a common lens for feedback. Also, rather than insisting that our approach was the right one, we explored all possible directions to make sure we were not missing the bigger picture. After our daily debrief by the hotel pool, we would prepare for the next day. One night, Marek, one of my co-founders, built a prototype to test an idea that had come up during the day and that has now become an integral part of our product.
That brings me to learning. Looking back, these early meetings were invaluable. One thing that became clear really fast was that investors were much more interested in learning about the menu acquisition and data curation technologies we had been building than about our recommendation application. We had stumbled upon a potential solution to a big problem the local search industry had been battling with for years. Going forward, we built our pitch more around the technology and how it could enable a data platform for local business data and had much more success.
A lot of people have asked me how many investors I spoke to and met with in order to close the round. You might have seen the Anatomy of a Seed deck by Brendan Baker who analyzes AppMakrs $1m seed round, involving 173 people and taking 130 rejections to get to 14 commitments. Our round was a bit smaller and we were fortunate to hit a few super nodes early on, but I still ended up talking to around 100 people in the process.
While I prefer meetings that lead to investments, there is thing to be said about the ones that don't. Raising money is about building a network. A lot of people might be interested or intrigued by your idea but not end up investing for one reason or another. However, they might end up introducing you to potential business partners, clients or other investors. I talked to one potential investor and even though he did not end up investing, a month later, he emailed me and introduced me to a potential client.
At an early stage, it is important to surround your startup with people that can support you and extend you network in the areas you most need it. For us, we were targeting investors with backgrounds in data platforms, local, small business marketing, and the restaurant industry. AngelList turned out to be invaluable in the process of filtering. As Scott Kirsner from the Boston Globe recently put it, they are a true matchmaker between investors and startups.
A few words on due diligence: You probably expect your investors to do due diligence before investing. You should do the same. In a world of LinkedIn and AngelList, it is relatively easy to find people in your (extended) network that have worked with or can vouch for an investor. Even if it means delaying the closing of your round, don't take money from investors you don't think have the best interest of your business in mind or from whom you get a bad vibe.
Looking back, raising money was much more than just getting money in the bank. The process helped us to grow as a team, significantly refine our product and business model and most important of all, bring on investors on board that understand our technology, support our (ambitious) vision and will help us build a better company.
The following is the result of a collaboration between Ty Danco and Dharmesh Shah. Ty is an angel investor and startup mentor (you should be reading his blog). Dharmesh is founder and CTO of HubSpot, runs OnStartups.com and is an advisor to AngelList. [Note: All the smart useful stuff in the article is Ty, all the feeble attempts at humor are Dharmesh]
AngelList (AL) connects promising startups to a sterling network of early stage investors. AL has been getting a blizzard of well-deserved press of late after Venture Hacks released the networks 18 month statistics. But not a lot has been written for startups on how to best use the service. Here's our take in small, bite-sized pieces.
1. The Fundamentals Still Apply As Time Goes By
AngelList may be a game-changer, but most of the same rules are still in place. Angels still look for the same elements in a startup as always: a strong team; meaningful milestones; a differentiated product in a big potential market; capital efficiency and so on. Therefore, the excellent advice listed in OnStartups, Venture Hacks, AVC, Ask the VC, Both Sides of the Table, and the like still applies. What for now is unique to AngelList is the speed and efficiency with which they can harness an all-star network of active investors in front of a breathtakingly large, qualified stream of startups. Whereas B.A.L. (Before AngelList) you could mess up a presentation in front of an investor group and not worry too much (there's always another potential investor around the corner if you look,) putting in a half-baked effort on AngelList is a cardinal sin. First impressions count, so make sure you crush it!
2. There's a great primer already
"How to Hustle with AngelList", by Brendan Baker is the definitive how-to guide discussing how to make it onto AngelList, how to set up profiles, etc. It covers all the basic mechanics and throws in a few proven tactics. If you have time to read only one article on AngeList, that's the one.
3. Talk to People Who Have Had Success
With over 400 companies having raised money on AngelList in its first 18 months, this is easy. As Alex Cook of Rentabilities mentioned in this Boston Globe article, there's a learning curve involved, so make a point of talking to entrepreneurs who have previously used the site before you list. Who has been successful? Here are a few notable companies.
Quora has many dozens of questions on AngelList, as does OnStartups Answers and of course Venture Hacks, whose founders run AL. By the way, there is a high overlap between people who are active on Quora and the community of investors you want to attract.
4. Get a champion first
The first anchor investor is the hardest. Always has been, always will be. And for Angel List, it is important enough to be ranked #1 in Nathan Beckfords excellent post entitled Hacking Angel List. For instance, Rentabilities already was a winner of the 2010 MassChallenge, but they waited until they had won over Dharmesh as an investor/endorser before tackling Angel List. Nivi of AngelList will argue that it is not necessary to have a champion if one has a great team and traction, and he has several examples of this. But we respectfully disagree: just as your odds of success drop dramatically if you pitch to an angel group without already having a champion in the room, the same applies here. So don't launch prematurely. And, even if Nivi is right that you don't absolutely need a champion if you have enough traction and an awesome team, it can't hurt.
5. Don't wait too late in your rounds fund raise before you apply
Localmind is a company I invested in which had no trouble raising money, but they wanted to attract a few more angels with domain expertise and geographical diversity. Within days of listing on AngelList, they had identified 8 strong, deep-pocketed angels, all of whom could have strengthened the company. With only limited $dollars left in the round space left, they could only squeeze in 2. When I asked Lenny Rachitsky, the CEO about what he learned from the experience, he said he had wished he had started working with AngelList earlier.
Whens the best time? Others may disagree, but Id suggest getting your application in when your round is anywhere from 20% to 40% subscribed. With that head start, it should attract interest pretty quickly. If you get oversubscribed, thats a good problem to have.
6. Before launching on AL, mentally assemble your dream team of investors
If you cant dream it, you cant build it. Your ideal team may be 100% angels, you may wish to have some local micro-VC or it might be as simple as a pair of massive VCs and an industry insider. But rRegardless, the majority of investors should already have complementary holdings in your sector.
More importantly, assess what elements you need besides money, because the AL membership has their tentacles everywhere. Knowing what you need but dont yet have not only helps you get it, but it also sends a strong positive signal to angels that you understand your needs. Approaching investors who clearly dont invest in your sector is the telltale sign of a rookie.
7. Research the network, and target your angels
You can use filters to look for angels who have invested in your sector or in complementary companies. I invested in HealthRally because its CEO did just that and found me. While I don't always monitor the AngelList feed (just as you might not stay current with Facebook traffic or a Twitter stream), I got a very targeted letter from Zach Lynch, the CEO of HealthRally. He noted my investment in GreenGoose and other health tech firms, and then made the connection that one of the other GreenGoose co-investors, Esther Dyson, also had committed to HealthRally. Besides showing excellent progress to date on a shoestring budget, Zach demonstrated to me the type of targeted, "rifle not shotgun" marketing discipline that his company will need to land a few strategic partners and megaclients.
8. Get Personalized Intros
Ask all of the angels who are backing you to endorse you to their own followers. If they are not already on AngelList, ask them to sign on and do so. Helping syndicate a round is what angels do, and AL has found that personalized intros from an AL investor get opened far more than a generic profile. This is the original angel skill, (after all, Howard Lindzon calls his fund "Social Leverage" for a reason,) but now it's so simple it can be done to all of an investors AL followers with one mouse click. Using the Rentabilities example, Dharmesh has many people watching his recommendations, and when he gave the company a thumbs up, more than 100 people followed the company, and over 30 asked for introductions. Clout (and Klout) matters.
9. Spend a few calories (and maybe dollars) a good name.
For many of you, AngelList might be one of the biggest initial exposures your startup will have. And, theyre some very powerful people. Its worth spending a little bit of time and energy getting it right (it gets harder to change it later). This is particularly true if you have a consumer (B2C) startup. I guarantee you that folks like Jason Calacanis care a lot about your brand and domain name. I do too. Here are some quick tips on naming a startup. Dont obsess over the name, but its worth investing a little time on this.
10. A video is worth 1,000 slides
No one can tell your story better than you. Make a short killer, video and include it in your profile. I made my first AngelList investment in UpNext after I saw the link to the companys interview on Untethered.tv. If you can, include one. Especially if it can showcase a quick demo.
11. Get your website right first
This should be obvious. Even if you just have a well-done landing page with a good design and a good URL name, it's a plus. Every angel is going to click through, and most won't go further if your website sucks.
12. Remember Inbound Marketing, baby!
Yeah, I know that going through AngelList qualifies as traditional outbound marketing, but sophisticated angels will check on their own to assess your knowledge of the basics. Do you show up in Google search results at all? Do you have mentions in social media? Do you own the company name on twitter and have you tweeted recently? Do you have followers? Do you have an engaging blog that tells your story and has a point of view? Have you checked out your traffic graph on Compete.com and made sure its pointing in the right direction? Face it: AngelList exists because of the Net. You may be able to get away with a sloppy web presence and strategy at a traditional angel group presentation, but that won't fly with the AngelList crowd.
13. Advisors are huge.
Social proof is hugely important in Angel List. I invested through AngelList in Saygent. Why? Not only did I like the schtick, I really liked that they had sought out and won Sid Viswanathan (co-founder of CardMunch and a master at using Mechanical Turk) as an advisor. Currently Im doing due diligence on a company which landed Jason Calacanis as an advisor. Having an advisor like Jason, who is an indefatigable promoter of his portfolio companies (via his interests in the Launch Conference, Open Angel Forum, and This Week in Startups, he sees a TON of companies), shows instant credibility and is a harbinger of future success.
14. Clearly list your price
If you haven't figured out what you want to raise at what valuation, do so now. If you're going to raise convertible debt (although I'm personally not a fan,) say what your cap is going to be. There's no upside in wasting both your time and that of the investor if you're asking a price where the investor is unwilling to go. If you're unsure and you haven't already figured this out with the anchor investor, the AL team can help point to some comparables. Speaking of comparables, if this is your first startup and you're a rookie, try not to over-reach with respect to terms. Just because everyone you talked to so far thinks you are brilliant and your idea is spectacular, don't push for a really high cap on your convertible note. Going from a $4 million cap to a $8 million cap might seem like a 100% increase in valuation, but the math doesn't work that way. Such a move might decrease the number of investors interested in your deal.
15. Use a standard termsheet
Resist the temptation to introduce clever, non-standard terms into the termsheet — even if you think you can get away with them. Two reasons for this: 1) You'll come off as naive or greedy. 2) Even if you somehow manage to sneak these in now, you'll have issues when you need to do your next round. Save your creativity for your product and keep your termsheet clean. If you need an example, you could do worse than the standard financing docs that Y Combinator provides. But, there are others. Ask around.
16. Be ready to pitch on short notice via videoconferencing
This could be via Skype, Gmail video chat, Go2meeting, etc. But you should have perfected all of the logistics and have accounts and slide share materials ready on quick notice. With investors no longer being local, you need to find ways to let them see you and your pitch. Insider secret: Some investors have found a strong pattern that suggests entrepreneurs that respond to late night emails quickly have an edge over those that don't. Lets save the “but work-life balance is important” debate for another article. Meanwhile, you better be working your butt off.
16. Think one round ahead.
Listing on AL now will give you a giant head-start on your next round, as investors who aren't ready for this round may step up for next round. As Mark Suster says, VCs invest in lines, not in dots. Establish the connection for the next round now, and rethink if there are others you may wish to add to your initial target list.
17. Use the AngelList team
Who is more wired in than Nivi and Naval? Who's seen more pitches and knows what works? Once they accept you, get their advice and give it great weight.
18. Know how investors will use AngelList
Here's a similar list of techniques investors use that work especially well via AngelList.
19. Get your backers to register on AL
You want them to comment on you and endorse you. Any angel should volunteer to do this for the good of the company, and they get to build their brand too.
20. Don't game the system
You're smart and love to hustle. We get that. You should do all manner of hustling to make sure your startup gets the visibility it needs. But, don't abuse the community or take advantage of it. It's a shared resource. Just like you, there are many other entrepreneurs looking to connect with great investors on AngelList. Many of them are just as deserving. It's fine to stand-out, but make sure you are adding value to the group, not taking away from it.
21. The best thing you can do is get traction
You should invest time in your fundraising process — it's important. The basics don't take that long. But, don't get too obsessed. Your primary goal is to build a business not build this phenomenal profile and network on Angel List. The most helpful thing you can do to get the right angels on board is to make measurable, meaningful progress with your business.
I'm sure a few of you that are already in the Angel List process are likely reading this. What other tips would you like to share with the community? What questions do you have that haven't quite been answered yet?
The following is a guest post by Ty Danco. Ty is an angel investor and startup mentor. Read more of his thoughts at tydanco.com.
You’ve got a killer idea, a good prototype, a terrific market opportunity, and maybe even some funding already. But you still may lose potential investors that have nothing to do with your deal, and everything to do with you. Here are 5 of my non-negotiable hot buttons that will make me turn down an investment, no matter how good the financial prospects appear.
1. You knowingly mislead people. If you’re not trustworthy, it’s over. Full stop. It can be as simple as pretending to know answers when you don’t, implying that you have investors or contracts that aren’t real, or giving half answers to questions that conveniently leave out non-flattering but significant information. Note that I’m not going to dump you simply for painting the rosiest plausible picture and showing hockey stick revenue numbers that seem ridiculously ambitious. Investors expect some amount of hype, and we can put up with that. But you have to be honest.
Worst is a coverup: An entrepreneur presenting to an angel group was discussing his record as a "successful repeat entrepreneur", but didn’t give particulars other than "the last company he founded went IPO." When upon questioning he told us the name of that company, it only took a few minutes on Google to discover that 1) the company was now defunct, having been in the middle of a penny-stock trading scam, with multiple lawsuits still ongoing; and 2) that the founder/CEO had a different name than the man presenting. He responded to the first fact that he had been the victim of those scams, and to the second that he had decided to change his name. Needless to say, no checks were written to that company. His new company actually had acquired rights to some interesting technology, but the integrity question made it a total no-brainer pass.
2. You haven’t done your homework. Unfortunately it’s not the norm that an angel will have deep knowledge of the sector you are in, so we’re going to ask questions, and lots of them. But imagine what our reaction will be if you don’t know the answers to our basic questions about your own markets, your competitors, or worse, haven’t even considered an obvious question. At best you’re too green to invest in, shown by your chase of angel investments before you are ready. The good news is that this is easily correctible. Do your homework before you pitch angels; when you practice your pitch dozens of times before mentors and other entrepreneurs, chances are you will have had a chance to think about and respond to almost all of the obvious questions. But until you get to that point, don’t burn your bridges pitching to investors too early. Work on your business model and your pitch until they are shining jewels.
3. Your projected expenses are unreasonable. As mentioned above, I don’t really mind—and come to expect—entrepreneurs showing revenue projections that go straight to the moon. However, I will scrutinize projected expenses, hard. If they are unreasonably low—for instance, having a model that depends on external sales without any meaningful salaries or commissions, not budgeting in legal expenses, etc.--that marks you as a greenhorn that needs to go back to school. Worse than the greenhorn is the greedy entrepreneur who is looking to raise money to immediately go back into his or her pocket. This is especially true when the entrepreneur has been on the beach, or an "independent consultant" for a period of time. It’s no sin to need or get a paycheck, but if you are looking to angels to fund your six-figure package, that’s a telltale sign of greed. Down the road, a me-first priority will manifest itself in losing employees, creating lousy margins, and other bad scenarios. The CEO needs to take the lead in all aspects—including demonstrated hunger, commitment, and sacrifice. If you’re focused on the short-term rewards, there won’t be any long-term rewards around for us investors.
4. You don’t follow through. This is another "tell", as poker players say. This won’t be evident at a first meeting, but in the follow-up. Dharmesh and many other angels are correct in saying that diligence can be quick, given that startups will change directions. I too believe due diligence needn’t take more than a week or two, but I still think that in most cases there needs to be several interactions between entrepreneur and potential investors. Why? With the biggest risk for startups being execution risk, we need to assess whether you will do what you say you’ll do. If you call us when you say you will, if you follow-up on our questions quickly and efficiently, those are all positive indicators that you are accountable and will deliver on promises. There’s no shame in putting a reasonable but later date on some deliverable because you’re busy—I hope and want you to be busy, and maybe even you’ll earn bonus points if you turn something around earlier than promised.
5. You’re dogmatic. It’s easy to say no to someone who is a jerk. But assuming that you’re not arrogant, full of yourself, and "getting high on your own supply", you can still turn us off by not considering alternative viewpoints. When you answer questions before we finish asking them, when you don’t take the time to really listen to what people are talking about, when you assume you know every answer cold even before it’s clear where a comment is coming from, that’s another telltale sign of too much hubris and not enough coachability. There are plenty of people who are uncompromising—Steve Jobs is just one example—but Steve Jobs are few and far between, and I’m willing to bet that he listens before he rules.
This is not to say that the investor is going to be right or that you are wrong. I especially like it when an entrepreneur has considered an option I just proposed and educates me why they have decided not to go down that route…as long as they have taken the time to listen. But an absolute black and white dogmatic approach that leaves an impression of "my way or the highway" raises the likelihood of an inflexibility that will most likely doom your company. Pivots happen…and you have to be open-minded along the way as you build your company.
For a good entrepreneur, it shouldn’t be hard to avoid these potholes: you do your homework, you don’t lie, you follow through, you’re not short-sightedly greedy, and you’re open to hear what others think about your strategy and prospects. Miss any of those, and you become a bad bet—low odds that can’t be papered over by any amount of experience, social proof, traction or the other building blocks that attract an angel’s attention. When our due diligence shows that you’re not going to let us down in those five areas—now you’re a whole lot closer to being bankable.
What do you think? What else should entrepreneurs keep in mind to keep angels from walking from their deal?
I’ve been following Y Combinator for several years and have a (sometimes grudging) admiration for them. The “grudging” comes from the fact that they abandoned Boston and are now exclusively running their program in the Bay area.
Given YC’s success, several organizations in the past have tried to replicate or improve on Y Combinator’s revolutionary micro-funding model for startups. Most of these have not really accomplished the objective. The reasons for their failure have been varied, but the primary one was that unlike Y Combinator, they aren’t revolutionary. Nobody sat down and said “how do we really take what YC has done and turn it on it’s head.”
Until now. I just read about Y Permutator. There’s a lot I don’t like about YP — one of which is it seems to be backed by some old school venture capitalists. Not that there’s anything wrong with them, I just have a hard time believing that those that made all of their money in the 1990s and maybe even the 1980s (gasp!) are really going to understand what it takes to start a new kind of investment vehicle. But, I have to give credit where credit is due. It’s
It goes back to the basics and brings back some of the same things that made VCs so successful across the decades — but adds some new twists.
I'm going to be particularlly interested in seeing what folks like Brad Feld, Davic Cohen, Dave McClure, Eric Ries, Fred Wilson and Michael Arrington think of this. But, somehow, I don't think the top-tier VCs are going to be shaking in their boots.
If you’re in the market for some micro-funding, check out Y Permutator and let me know what you think. Is this the future of micro-investing? What do you think?