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Fundraising for Startups

Where to start when you are looking for investments:

What type of investors?
How to approach them?

Ramen profitability concept!

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Fundraising for Startups

  1. 1. IMPRENDITORIALITA’ E STRATEGIE Laurea Magistrale in Sviluppo Economico e dell’Impresa ALESSANDRO BIGGI
  3. 3. 3 Raising money is the second hardest part of starting a startup.
  4. 4. 4 Investments are like gears, through different stages they serve different goals
  5. 5. 5 Competitors punch you in the jaw, but investors have you by the balls.
  7. 7. 7 5 FUNDING SOURCES 1. Bootstrapping 2. Friends & Family 3. Angel Investors 4. Seed Stage Firms 5. VC Funds
  8. 8. 8 If raising money is so painful, why do it? Whatever you make, you have to sell a certain amount to break even. It will take time to grow your sales to that point, and it's hard to predict, till you try, how long it will take.
  9. 9. 9 Bootstrapping FUNDING SOURCE Companies that were actually funded by their founders through savings or a day job. 1
  10. 10. 10 Bootstrapping can work 2 ways: BOOTSTRAPPING 1. You use the “bootstrapping period” to test your assumptions, collect metrics and then meet investors 2. You begin life as consulting company and gradually transform into a product company
  11. 11. 11 Bootstrapping through consulting: BOOTSTRAPPING But consulting is far from free money. It's not as painful as raising money from investors, perhaps, but the pain is spread over a longer period. Years, probably. And for many types of startup, that delay could be fatal. If you're working on something so unusual that no one else is likely to think of it, you can take your time.
  12. 12. 12 Friends & Family FUNDING SOURCE A lot of startups get their first funding from friends and family. If you’re able to play well your cards you can make a first little funding last very long. 2
  13. 13. 13 Friends & Family Advantages FRIENDS & FAMILY The advantage of raising money from friends and family is that they're easy to find. You already know them.
  14. 14. 14 Friends & Family Disadvantages FRIENDS & FAMILY There are 2 main disadvantages: 1. you mix together your business and personal life; 2. they will probably not be as well connected as angels or venture firms;
  15. 15. 15 Angel Investors FUNDING SOURCE Angels are individual rich people. Angels who've made money in technology are preferable, for two reasons: they understand your situation, and they're a source of contacts and advice. 3
  16. 16. 16 The contacts and advice can be more important than the money. ANGEL INVESTORS Leveraging on Angel’s network represents a huge opportunity and advantage for startups in their initial phase.
  17. 17. 17 Introduce the concept of valuation ANGEL INVESTORS When someone buys shares in a company, that implicitly establishes a value for it. If someone pays $20,000 for 10% of a company, the company is worth $200,000.
  18. 18. 18 Introduce the concept of exit strategy ANGEL INVESTORS The reason is that investors need to get their capital back. They'll only consider companies that have an exit strategy—meaning companies that could get bought or go public.
  19. 19. 19 Syndicates of Angels ANGEL INVESTORS Some angel investors join together in syndicates. Any city where people start startups will have one or more of them. i.e. in Italy there’s IAG (Italian Angels for Growth)
  20. 20. 20 Advantages ANGEL INVESTORS Beside the networking potential, they’re also not bound by all the rules that VC firms are. That means thy are more flexible and easy to deal with. Disadvantages One of the dangers of taking investment from individual angels is that they have less reputation to protect. In many startups' lives there comes a point when you're out of money and the only place to get more is your existing investors, and they can take advantage of that.
  21. 21. 21 Seed Funding Firms FUNDING SOURCE Seed firms are like angels in that they invest relatively small amounts at early stages, but like VCs in that they're companies that do it as a business, rather than individuals making occasional investments on the side. 4
  22. 22. 22 Incubators SEED FUNDING FIRMS Incubators can provide: working space, use of their office staff, lawyers, accountants… Also, the investment process is more standardized. Seed firms usually have set deal terms they use for every startup they fund.
  23. 23. 23 How to reach them? SEED FUNDING FIRMS Because seed firms are companies rather than individual people, reaching them is easier than reaching angels. Just go to their web site and send them an email. The importance of personal introductions varies, but is less than with angels or VCs.
  24. 24. 24 Seed Funding Firms Advantage SEED FUNDING FIRMS One of the advantages of seed firms is the advice they offer: for example, a seed firm should be able to give advice about how to approach VCs as the company grows and needs more financing
  25. 25. 25 Seed Funding Firms Disadvantage SEED FUNDING FIRMS The earlier an investors enters your company, usually the lower is your valuation. You have to be careful and understand when it is the right moment to ask for money not to get too diluted too early.
  26. 26. 26 Venture Capital Funds FUNDING SOURCE VC firms are like seed firms in that they're actual companies, but they invest other people's money, and much larger amounts of it. 5
  27. 27. 27 How VCs usually work? VENTURE CAPITAL FUNDS VC firms are organized as funds. The fund managers, who are called "general partners," get about 2% of the fund annually as a management fee, plus about 20% of the fund's gains.
  28. 28. 28 VCs: more money with more restrictions VENTURE CAPITAL FUNDS Because VCs invest large amounts, the money comes with more restrictions. For example, VCs generally write it into the deal that in any sale, they get their investment back first. So if the company gets sold at a low price, the founders could get nothing.
  29. 29. 29 Impact on Board of Directors VENTURE CAPITAL FUNDS In a typical VC funding deal, the board of directors might be composed of two VCs, two founders, and one outside person acceptable to both. The board will have ultimate power, which means the founders now have to convince instead of commanding.
  30. 30. 30 Timing is crucial VENTURE CAPITAL FUNDS One of the most difficult problems for startup founders is deciding when to approach VCs. You really only get one chance, because they rely heavily on first impressions. And you can't approach some and save others for later, because (a) they ask who else you've talked to and when and (b) they talk among themselves. So when do you approach VCs? When you can convince them.
  31. 31. 31 When can you convince them? VENTURE CAPITAL FUNDS If the founders have impressive resumes and the idea isn't hard to understand, you could approach VCs quite early. Whereas if the founders are unknown and the idea is very novel, you might have to launch the thing and show that users loved it before VCs would be convinced.
  32. 32. 32 FUNDING STAGES
  33. 33. 33 Stage 1: Seed Round FUNDING STAGES Let's start a company. You not only want to work full-time, but more than full-time. So some or all of the friends quit their jobs or leave school.
  34. 34. 34 PRE-LAUNCH PHASE Decide where to run the company: usually at the beginning it will be your apartment/garage The main expenses are setting up the company, which costs a couple thousand euros in legal work and registration fees, and the living expenses of the founders. We'll suppose you start with $15,000 from your friend's rich uncle, who you give 5% of the company in return. 1 2 3 By living really cheaply you might make the remaining money last five months. When you have five months' runway left, you need to start looking for your next round immediately. But of course the main job is to build version 1 of the software.
  35. 35. 35 Every startup's rule should be: spend little, and work fast.
  36. 36. 36 LAUNCH PHASE After ten weeks' work you have built a prototype that gives one a taste of what your product will do. It only does a fraction of what the finished product will do, but that fraction includes stuff that no one else has done before. You've also written at least a skeleton business plan, addressing the five fundamental questions: what you're going to do, why users need it, how large the market is, how you’ll make money, and who the competitors are and why this company is going to beat them. 4 5 If you have to choose between spending time on the demo or the business plan, spend most on the demo. Software is not only more convincing, but a better way to explore ideas.
  37. 37. 37 Stage 2: Angel Round FUNDING STAGES Now you want enough to last for a year, and maybe to hire a couple friends. So you’re going to raise €200,000
  38. 38. 38 €200k Investment: dilution ANGEL INVESTMENT The angel agrees to invest at a pre-money valuation of $1 million. The company issues $200,000 worth of new shares to the angel; if there were 1000 shares before the deal, this means 200 additional shares. The angel now owns 200/1200 shares, or a sixth of the company, and all the previous shareholders' percentage ownership is diluted by a sixth.
  39. 39. 39 Vesting ANGEL INVESTMENT Some investors might expect the founders to accept vesting for a sum this size. Vesting means that some shares are retained from the founders and successively give to them based on a defined time frame. Vesting is also a way for founders to protect themselves against one another. It solves the problem of what to do if one of the founders quits. So some founders impose it on themselves when they start the company.
  40. 40. 40 DEVELOPMENT PHASE You have no immediate financial worries, and few responsibilities. You get to work on juicy kinds of work, like designing software. You don't have to spend time on bureaucratic stuff, because you haven't hired any bureaucrats yet. You work to improve your prototype. You hire a new collaborator. If he’s good enough, you can pay him little and give him some shares with long vesting (3-5%) so you align interests. 4 5 The point after you get the first big chunk of angel money will usually be the happiest phase in a startup's life. At the end of month four, gradually through word of mouth you start to get users. Seeing the system in use by real users—people you don't know—gives you lots of new ideas. The system is starting to have a solid core of features, and a small but devoted following. People start to write about it, and you are starting to feel like experts in the field. 6
  41. 41. 41 Stage 3: Series A Round FUNDING STAGES Armed with your now somewhat fleshed-out business plan and able to demo a real, working system, you visit the VCs you had introductions to.
  42. 42. 42 Who else have you pitched to? SERIES A ROUND VCs all ask the same first question. Their interest in a company is a function of the interest other VCs show in it. But you can be smart and avoid answering this.
  43. 43. 43 SERIES A INVESTMENT PROCESS One of the VC firms says they want to invest and offers you a term sheet. A term sheet is a summary of what the deal terms will be when and if they do a deal; lawyers will fill in the details later. By accepting the term sheet, the startup agrees to turn away other VCs for some set amount of time while this firm does the "due diligence" required for the deal. Due diligence is the corporate equivalent of a background check: the purpose is to uncover any hidden bombs that might sink the company later, like serious design flaws in the product, pending lawsuits against the company, intellectual property issues, and so on. 7 8
  44. 44. 44 €2 million Investment SERIES A ROUND Here are the terms: a €2 million investment at a pre-money valuation of €4 million, meaning that after the deal closes the VCs will own a third of the company (2 / (4 + 2)). Post-money valuation is now €6 million. The money might come in several tranches, the later ones subject to various conditions.
  45. 45. 45 Now you can keep growing, investing the money you received to scale quickly you company. SERIES A ROUND Then, you’ll decide whether you would need additional funding (Series B, C, D, E) or if you’d keep the company self-funded and sustainable.
  47. 47. 47 Have low expectations. FUNDRAISING SURVIVAL GUIDE Startup founders tend to be optimistic. Better to assume investors will always let you down. 1 What kills you is the disappointment. And the lower your expectations, the harder it is to be disappointed.
  48. 48. 48 Keep working on your startup. FUNDRAISING SURVIVAL GUIDE Raising money has a mysterious capacity to suck up all your attention. 2 The best way to survive the distraction of meeting with investors is probably to partition the company: to pick one founder to deal with investors while the others keep the company going. Raising money always takes longer than you expect. What seems like it's going to be a 2 week interruption turns into a 4 month interruption
  49. 49. 49 Be conservative. FUNDRAISING SURVIVAL GUIDE If someone reputable offers you funding on reasonable terms, take it. 3 As conditions get worse, the optimal strategy becomes more conservative. When things go well you can take risks; when things are bad you want to play it safe.
  50. 50. 50 Be flexible. FUNDRAISING SURVIVAL GUIDE "How much are you trying to raise?" 4 You shouldn’t just tell them a number, because you shouldn't have a fixed amount you need to raise. As little as €50k could pay for food and rent for the founders for a year. €200k would let them get office space and hire some smart people they know from school. A couple million would let them really blow this thing out. The message (and not just the message, but the fact) should be: we're going to succeed no matter what. Raising more money just lets us do it faster.
  51. 51. 51 Be independent. Or better, be”ramen profitable" FUNDRAISING SURVIVAL GUIDE 5 It is the situation where you're making just enough to pay your living expenses. Once you cross into ramen profitable, everything changes. You may still need investment to make it big, but you don't need it this month. Investors like it when you're ramen profitable. It shows you've thought about making money, it shows you have the discipline to keep your expenses low; but above all, it means you don't need them.
  52. 52. 52 There is nothing investors like more than a startup that seems like it's going to succeed even without them.
  53. 53. 53 Don't take rejection personally. FUNDRAISING SURVIVAL GUIDE 6 1. Odds are against: thousands look for money, only few end up getting it. 2. A good startup idea has to be not just good but novel. And to be both good and novel, an idea probably has to seem bad to most people, or someone would already be doing it and it wouldn't be novel. So when you get a rejection, use the data that's in it, and not what's not. If an investor gives you specific reasons for not investing, look at your startup and ask if they're right. If they're real problems, fix them.
  54. 54. 54 Be able to downshift into consulting (if appropriate). FUNDRAISING SURVIVAL GUIDE 7 Consulting is a dangerous way to finance a startup. But it's better than dying. Use it as a bridge phase only if you are waiting for a big response from the market/clients/investors. Don’t make it last just for the sake of it but only if there’s a strong reason behind.
  55. 55. 55 Avoid inexperienced investors. FUNDRAISING SURVIVAL GUIDE 8 Though novice investors seem unthreatening they can be the most dangerous sort, because they're so nervous. And their lawyers are generally inexperienced too. Big funds are used to write offs, it’s part of the game. Inexperienced investors are not able to absorb that easily. If you go for a first-time investor, guide the process yourself.
  56. 56. 56 Know where you stand. FUNDRAISING SURVIVAL GUIDE 9 The most dangerous thing about investors is their indecisiveness. The worst case scenario is the long no, the no that comes after months of meetings. So while you're talking to investors, constantly look for signs of where you stand. The best way to force them to act is, of course, competing investors. But you can also apply some force by focusing the discussion: by asking what specific questions they need answered to make up their minds, and then answering them.
  58. 58. 58 Make something worth investing in. Understand why it's worth investing in. Explain that clearly to investors.
  59. 59. 59
  60. 60. 60 SOME NOTES
  61. 61. 61 QUICK NOTES ON INVESTORS 1. Angel investors are the most critical because they risk their own money 2. Most investors, especially VCs, are not like founders: they're dealmakers. 3. Most investors are momentum investors. 4. Most investors are looking for big hits and they want to invest large amounts. 5. Valuations are fiction: VCs decide how much money you need and how much of the company they want 6. The contribution of investors tends to be underestimated: they do more than give just money. 7. Investors are emotional 8. The negotiation never stops till the closing 9. Investors like to co-invest because it spreads the risk 10. Investors don't realize how much it costs to raise money from them 11. Investors don't like to say no 12. You need investors but investors like it when you don't need them