Startup Fundraising: What Investors Want to See
The path to startup fundraising can be a long and arduous one. Our well-attended “Inside Startup Fundraising” breakfast panel in New York was meant to help make the process less daunting and give you some valuable tips to help you get ready.. Whether or not you’re in fundraising mode now, reading through this recap for the panel’s takeaways on timing your raise, funding strategy and vehicles, pitching, and some of the big mistakes entrepreneurs make should help give you more confidence when you do gear up for a raise.
The panelists: Eliot Durban, General Partner at BOLDstart Ventures; Adam Rothenberg, Partner at BoxGroup; Brendan Dickinson, Principal at Canaan Partners; Devon Bostock, Venture Banker at Square 1 Bank; Cassandra Anderson, HR Consultant at TriNet; and EGFS Founder and CEO David Ehrenberg.
The moderator: Jim Fulton, Partner at Cooley LLP.
Panelists were divided on one of the earliest topics that came up:
Are we in a bubble?
Brendan: There’s a lot of money floating around, but no bubble.
Adam: We see a lot of capital in the market. Almost anyone can get funded. The question for us is who and at what valuation? We are not in a bubble, but I wouldn’t mind a slight pullback in the market. Valuations are high. I care about average valuations, but not necessarily about individual ones.
David: (Of course, if you read his Tech Bubble 3.0 piece, you already know his opinion!). There’s a glut of seed funded companies. On the other hand, there is also more and more focus on traction and quantifiable metrics. But yes, we are in a bubble.
Jim: it’s necessary to have these kinds of bubbles; so I hope we are in one. Failure is not something to be ashamed of. I’m more nervous about one company raising $1.2 billion, versus lots of startups raising smaller amounts.
VC fund expectations
Adam gave a quick overview by describing a hypothetical group of 10 portfolio companies:
For 4-6 of these, VCs will recoup their investment or less
3-4 will deliver returns of 1-4 times their investment
and 1-2 will produce returns of 10-100 times the investment
How do you decide who to fund?
Seed investments usually come down to being impressed with the team and investors having evidence in its ability to execute. Given that this is shifting terrain, Adam pegged funding amounts per stage as roughly equating to $200,000-600,000 at the pre-seed stage; $600,000 -1.5 million for seed, $1-2 million at the institutional seed/Series A, and $5-25 million for Series B.
When’s the right time to raise?
As you might expect, the answer really depends on the individual startup. But panelists did agree that while there is no set timeframe and key metrics will vary, entrepreneurs need to have a story to go along with their product.
Startup fundraising strategy
Eliot: You should be using funds to hire engineers and build your product’s back end, rather than hiring a salesperson too soon. Remember that there are alternatives to VC funding. You could finance your sales or try crowdfunding.
David: Practice milestone fundraising. This is an approach where you tie each raise to hitting discrete, measurable goals that set you up for step increases in valuation during later rounds. If you needed any more convincing, for Eliot whether or not they practice milestone funding is one thing that distinguishes first-timers from seasoned entrepreneurs.
There was a lively debate around the issue and mechanics of debt funding, with Adam stating that not everyone needs to raise funds from VCs and that venture debt is under-utilized for cash flow generating businesses. Debt can make sense in a variety of instances including, as Jim pointed out, when you are using it to fund working capital to build sales.
In terms of the mechanics, venture debt comes with warrants and an equity kicker, with interest rates currently around 3-4%. As Devon noted, it’s senior debt, meaning holders have priority in the capital structure.
Jim: Caps are an art rather than a science. But no matter what vehicle you choose, expect to experience 25-40% dilution in your first institutional funding round.
As an example of the artistic approach, Eliot’s rough guidance was to figure your cap at $1 million per engineer.
David gave a quick rundown of what EGFS typically sees in early-stage financings terms: caps ($3-6 million) discounts (15-25%), interest rates (Prime+2-3%), and maturity (24 months).
What are some big mistakes startup founders make?
Cassandra focused on a common and costly one: wrongly classifying employees as contractors. Not only do violations result in per instance fines, but this is an area of heightened regulatory focus in New York (and for the IRS). Her advice? Companies’ biggest expense is for payroll. Using Professional Employer Organizations (PEOs) to handle administrative functions like payroll compliance and workers’ compensation can save startups lots of money on benefits versus going to a broker. That said, don’t rush into a relationship because it can be hard to unwind the relationship.
Jim highlighted entrepreneurs who are only in it for the money, have unrealistic expectations, i.e., your exit strategy is to sell to Google; and bring in too many small investors.
(And definitely check out David’s previous post on the 9 biggest startup fundraising mistakes.)
Pitch deck help
Lastly, here are some of the panel’s favorite resources for putting together pitch decks:
The Art of The Start, by Guy Kawasaki
Inside Silicon Valley: How The Deals Get Done, by Marc Phillips
Entrepreneur Pitch Workbook, by Canaan Partners
Venture Hacks (also check them out for good posts on converts)
For a quick overview of how to craft your pitch deck, refer to David’s previous post: How to Create a Startup Pitch Deck.
And as always, work your network: including advisors, other founders, and contacts at incubators, accelerators, and coworking spaces for introductions to VCs.
Deborah Adeyanju is Content Strategist & Social Media Manager at Early Growth Financial Services, an outsourced financial services firm that provides small to mid-sized companies with day-to-day accounting, strategic finance, CFO, tax, and valuation services and support. Deborah is a Chartered Financial Analyst (CFA) charterholder with more than a decade of experience as an investment analyst and portfolio manager in New York, London, and Paris.
Liked this post on startup fundraising? Join our mailing list to get our posts on startups sent directly to your inbox.