20VC: Fundraising 101
Today we are going to walk through the process of raising a funding round for a hypothetical company. We will break it down by different stages in the fundraising process and at those stages I will talk about how each element differs according to the round being raised.
First, for 99% of fundraises it is a game of shots on goal. You need to have enough investors in the pipeline, it is a sheer numbers game. Miki Kuusi @ Wolt said on 20VC recently for his Series B he got 68 rejections before Laurel Bowden @83North said yes. Wolt sold in 2021 for $7BN to Doordash making a monster return for the company's investors. But 68 meetings before that yes, for the Series B. Also goes to show, you sometimes just need one true believer.
How to Create a Target List of Investors
Now we know we need enough shots on goal, we need to bring together a target list of investors, put these investors in three buckets:
- Priority (5 names of people you really want.)
- Tier 2 (15 names of people you would like)
- Tier 3 (15 names of people you would take money from but would not invite to your birthday!)
So how do we choose who goes in what bucket? First, founder references speak volumes and lead to warm intros, so speak to your friends who are founders, ask which of their VCs have been the best, place even more weight on their recommendation if the company has not been a success. It is easy to be a VC champion when the company is flying, you often see the true colours of the VC when a company is really struggling or fails. Get a couple of names there and then analyse the VC landscape, you can do this on Twitter or the VCs website or blog and find the VCs that resonate best with your company. Look at the types of deals they have done before, are they interested in pre-seed fintech in Europe, do they do enterprise SaaS Series A in the Silicon Valley. You can see their portfolio, make sure it is a fit for them. I get about 200 inbounds per day across channel, about 150 are clearly not a fit for me because of stage, sector or location and so making sure the obvious are aligned is crucial. Then double down on their Twitter or public profile to see as much as you can about their values and how they portray themselves. Rule No 1, never work with assholes. Value alignment is really important. Now we have the five priorities and then I would say do the same for the Tier 2 and Tier 3 bucket, make sure they invest both in your stage, sector and geography.
The Biggest Mistakes Founders Make Pitching:
So now we have our pipe of investors. A couple of big mistakes I see founders make in this next step.
- They go to their priority names first. Do not do this. Your pitch both in delivery, style and messaging will improve so much with each meeting. Start with a couple where you would not be sad if they said no. Analyse in real time in those meetings what messages are hitting and what are not, where are investors spending the majority of the time, are there common questions that keep coming up. If so, create an FAQ page that is in the deck and that will prevent you from having to answer the most obvious in other meetings. With each meeting, you will find ways to iterate the deck, the messaging and the way you present.
- Another massive mistake founding teams make, if you are doing a Zoom call and it is a first meeting, do not have more than 2 people on the call from your team. It makes it tough to get to the core of the discussion and removes a lot of the relationship building with too many people too soon. If the investor likes the opportunity, they will ask to meet more team members but do not put too much in front of them to the point it dilutes the message and pitch.
Now we have done the first investor meetings and we have iterated our deck and messaging in accordance with the feedback we got. We now progress to taking meetings with investors we want as our partners.
How to Master the Subtleties of a First VC Call:
- Every investor call usually starts with each side telling a little about themselves and how they came to be the founder or the VC. As the founder, practice your intro, make it succinct, concise, break it into three chapters, a minute per one is a good guidance. In these you want to show a couple of things, founder <> problem fit or in other words, why you specifically have the right experience or skills to attack this problem. I also like to understand “insight development” as taught to me by the famous OG of seed investing, Mike Maples @ Floodgate. Insight development is the notion that the best companies are founded on a unique insight that the founder has about a product or market that is different to the way the world currently sees it. Include these two in your intro. Keep the intro to no more than 3-4 mins.
- For the VCs intro, it is important to try and understand a little more about them. Many VCs give boring and bland intros; “we do Series A and B in Europe and like to lead rounds.” Very standard response and so you should ask them how they like to work with their founders, ask them about a company that struggled and how they worked with the founder to help. Ask them about their decision making process for reserves and pro rata. This creates more of a conversation which will instantly give you as a founder more gravitas in the eyes of the VC.
- Use the deck as a vitamin and not a painkiller. I hate pitches where it is read off slide by slide. I would not have the slides showing at all, I will have asked for a deck pre the meeting and I should have gone through it before. The call is for me to ask about questions I want to understand more or double click on. That said, the deck can often be useful as a crutch and so it can work well to have it ready and refer to certain slides as and when necessary.
The 7 Sins of Fundraising Decks:
So while we are on the deck, I want to go through a couple of elements that I so often see and they are killer mistakes:
- Length: Keep the deck less than 10 slides. If you need a couple more to show data or additional research, put it in the appendix at the end of the deck.
- Introduction: First slide, company name and then answer the question; if I had a billboard in Times Sq, what would it say on it? 10 words max. From your first slide alone, there should be no doubt about what your company does.
- The Team Slide: where do people go wrong here. They put 12 faces on it with their names. No information about the people, where they worked, why they are the best team to solve this problem. A totally useless slide if done like this. So do not do this. Instead, take 4 of those people, break the slide into quadrants and expand on those 4 people’s backgrounds to why they are perfectly suited to do what they are doing. Fewer people more context.
- The Useless Advisor Slide: Aligned to the terrible pictures of many team members with no context, the advisor slide, honestly, advisor slides just carry such little weight these days, they are not worth having. Take it out, it is not needed.
- Market Sizing Errors: This is a massive one. I see so many make the mistake on market size slide. Say we have a CRM for hairdressers, taking a very random example here, so often I will see a $100BN market, thats the TAM for the hairdressing market or the CRM market, but we are CRM for hairdressers so that is not the right representation and is entirely misleading. It is much better to start with that, then show the slither of wallet spend that hairdressers spend on software and then show the even smaller slither that they spend on CRMs. Use the market sizing slide as a way to show your insight and intellect both into how the market is carved up today but also how it is going to change in the future. There is always the debate of what matters more, large market or amazing founders, the truth is, a massively growing market can cover a lot of operational sins and so showing how the market is and will expand and what causes this, the why now, will always be important. But do not show the massive market for hairdressing or whatever it is, I have seen more $1TN TAM for pet grooming businesses that you can imagine. So do not do that.
- Exit Slides are Terrible: I do not see this so often now but do not have an exit slide in the deck for your early stage company, the wrong type of investors will be attracted to you if they like this slide, it encourages short term thinking and is not the right way to present for a company that will reshape an industry so no exit slide.
- Why You Should Not Invest: One thing I love in startups and always have when I present my funds is a slide, why you should not invest in me. I think the most important thing for all founders is to be aware of their biggest weaknesses and then have clear action plans on what they are doing to mitigate the chances of them impacting their success. So have a slide that says, hey, these are our 3 biggest weaknesses and then tied to each one, this is what we are doing to solve it. This inspires trust in the relationship with the investor and really shows your self-awareness and strategic thinking.
How To Structure The Size and Composition of Your Funding Round:
Now at some point in the discussion the size of the round and the price of the round will be asked. Use this as a chance to show your calibre as a founder.
- You Cannot Sit With Us (You Get The Joke!!!): Massive mistake founders make is they structure a round that does not allow for a VC to invest. What do I mean by this? VCs that lead rounds need to own at least 8% very minimum and if you come in raising $2M on a $25M cap, that is not enough allocation for the VC and pro-rata amount and then angels as well. Do not prohibit the VC from investing because of the structure of your round. For that example, $5M on $25M would allow for the VC to have 12.5% ownership, a smaller fund to have 3-4% and then a 3-4% allocation for angels.
- Is This Check Meaningful?: An important question to ask is: is the check size being invested by the lead a material check size for them and their fund? For example, if the check size they are investing is less than 1% of their fund, it is not that meaningful, if it is less than .5%, it really is not meaningful. Now this could be bad as it means they are unlikely to be able to provide you with the same time and attention they would larger checks. That said, Jason Lemkin has also commented before on the benefits of this as they will leave you alone to execute, they will not put much pressure on you as you are not a core position and it is really yours to execute from there.
- Do Not Do a Range: In terms of the actual size of check being raised, I do not like ranges. There is a massive difference between 3 and 5 million, and that impact on your runway is huge and so state a clear and direct number you are raising and what runway that will provide.
- Milestone Hitting and Showing Resource Allocation: Use the question of how much are you raising to show your insight into the milestones that you need to hit over the next 18-36 months. Never raise less than 18 months, you also do not need to raise more than 36 months. Plan for a 6 month fundraise and execution 99% of the time always takes longer than you anticipate. With that in mind, I always prefer 24 months as the right period to raise for, this will give you 18 months heads down execution and then 6 months to raise.
- Fundraising Rounds are To Prove Hypotheses: If we assume that fundraising rounds are science experiments and you have to prove or disprove a set of hypothesis with this time and money, make sure you can clearly articulate what you need to prove and by when. For the love of god do not say, this is the last round we will ever need to raise before we are immensely profitable, I could have a fund the size of Softbank if I had a dollar for everytime someone said that to me.
How to Answer the Question of Valuation:
When you say the size of the raise, say $2M, the basic assumption is that each round will dilute 15-20% and so the average VC will think of a $10M post money valuation straight away when you say a $2M raise. That said, you do not want to anchor yourself to a price, you are running a process as transactional as it sounds and I am not saying you want to optimise for price by any means but the majority of the time, it is best to say, “hey we are raising $2M and we will let the market decide on the price”. This is a great way to answer the question as this will not put anyone off, it will not anchor you to a price and it will also show you are savvy as to the raise process which any incoming investor should want to see as your ability to raise the next round is fundamental for them. Again, use this question to show your sophistication and knowledge as to the finer details of how to navigate a fundraise successfully.
How to Choose Your Lead Investor?
The biggest problem of the last 2 years was people chose their lead having met them once. They will be a partner to you for 10 years and you will not be able to get rid of them, it is literally harder to remove an investor than it is to get divorced. Brian Singerman @ Founders Fund said on the show recently about how he was unable to do his job in COVID as he could not meet founders in person. It is so important to meet your lead investor in person before signing the deal, so much can be gained and learned from those meetings in person. Then there is the question of how do I really get to know someone, especially if it is in a compressed timeline, there are ways that you can accelerate a relationship and getting to know someone, make sure to ask:
- What would success look like to them with this investment? What are the 1-2 core ways they believe that you will not achieve your outcome? What worries them?
- Can they give you a reference for founders they have worked with where it has not gone to plan? Also do off sheet references and try to find others where it did not go to plan. You can find their email with the Google Plugin by Clearbit and that is super easy. That should reveal alot.
- I also find really being vulnerable, talking about ambitions, inspirations, fears, childhood, my mother has MS and it is a tough and horrible thing to see your mother suffer with, I will discuss that and how it has changed me and my mindset in many ways.
How to Set a Timeline in a Fundraise?
In this deliberation phase where you are waiting for a term sheet, you do need to create some form of urgency. Investors often need a reason to move and so it is good to put a timeline on the raise. 14 days is perfect, this is enough time for any VC to do the work they need to do but also if they cannot do it in that time without a plausible excuse, it is unlikely that they would have done the deal and so it will force timewasters to a no sooner and save you time.
Your Term Sheet is Ticking:
One thing to be wary of is exploding term sheets. If any VC says you have to sign this here and now, that is BS. Do not do it and that is no way to start a 10 year relationship. That said, it is fair for them to set some form of timeline, otherwise, you can shop the term sheet; share it with everyone and use the first people to commit as leverage to create FOMO to get other people to commit. This can be a disadvantage of being a first mover as a VC but that is why they will often have some form of expiry date and that is not unreasonable.
When You Have Multiple Term Sheets: KISS (KEEP IT SIMPLE STUPID)
Then you have leverage and you can optimise the round on price, size of round, size of lead check to angel allocation etc etc. My advice here would always be do not over optimise. If the chosen partner is slightly lower, take it. Do not lose the right partner because of a small 5% difference in price or size of round. Another big mistake founders make when they have multiple term sheets is communication. It is fine if you need another couple of days to consider the decision but keep everyone updated. Let each investor who is waiting know, you are still thinking it through and will be back to them shortly. Name when you will have an answer, a communicated delay is fine, no communication is not. Then another massive mistake founders make is for the VCs they choose not to go with, they do not turn them down graciously. These investors could likely fund your next round, a bridge round and you never know when you might need them and so always turn them down super well and keep them on side, they could be helpful in the future.
If a VC Does These 3 Things: Forest Gump It:
Now the massive red flags with leads in this process that we need to call out:
- Pay to Pitch: If any VC ever makes you pay to pitch them. This is unacceptable and we have to remove this from the industry. Tweet me the details of these investors, it can be anonymous but these bad actors need to be called out.
- Investment Tranches Kill Companies: If it is an early round and they want to do the investment in tranches. No. This is such an inhibitor for the business it will not allow you to allocate resources effectively or with confidence. Do not allow for tranches. A bad deal can sometimes be worse than no deal. Tranches does not set you up to execute against a plan, build a world class team and achieve what you can. Say no.
- Early Signs of Excess Control and Ego: If they haggle immensely on salary over small amounts, if they suggest you should be on $60K not $62K and they make a big deal out of it. This is a sign of what they will be like to come. Do not accept it.
So now we have our lead VC locked in and we have to allocate the rest of the round. I would work hand in hand with my VC to construct the rest of the round. They will have angels they work closely with and think highly of. Use them to help map out those people and then make those intros for you.
How to Allocate Your Angel Allocation:
Assemble your angel cap table as you would a sports team. Each person has a specific position which they are specialised to and have a world class skill in. Someone for marketing, hiring, regulation, PR, partnerships etc. A massive mistake I see so often is founders try to cram down all their angels to their smallest allocation so they can fit as many as possible. Do not do this. Give fewer people more allocation. The only thing that matters is that the check size matters to them. For some it will be $10K for others it could be $50K but fewer with more skin in the game is important.
Next I see so many founders drag out the process meeting just one more investor and just one more, after a certain time, just get it done, get it closed and move on.
Just Closed: Time to Prep for the Next Round
So now we have closed the round, congrats. Now time to start prepping for the next round, one thing to remember, as a founder, you are always raising. So here is what we should do next:
- Sit down with our new lead investor and align on what we believe we need to hit to unlock the next round of funding. Will that next round come from them or external financing?
- If external financing, what 5 names should we focus on?
- Make sure to send those 5 names monthly updates with your progress. Investors invest in lines not dots.
- Make sure to meet them on a quarterly basis.
- By the time of your next fundraise, following 6 face to face meetings and 18 updates, the investor and you will know if this is a partnership you want to pursue.
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