One of the phrases I generally dread from a solicitious email or conference attendee is “Can I meet with you to pick your brain on X?”. It is such a broad topic, and generally it means the asker is so far from being ready to do X that my help may well be a waste of time for both of us… if they don’t know enough to be able to articulate what specifically they don’t yet know, there is probably too much they don’t yet know for any discussion at this stage to be really fruitful. I am much more fond of askers who ask very specific questions that I can easily answer: it feels like that answer is going to make an immediate and significant difference to what they are exploring.
That being said… and gripe over… I was today asked that very question – “Can I pick your brain on how to X” – with X being “how to raise funding”. However, I willingly spent a good half hour with the asker because… they used to be a Skimlinks employee and I always have time for SkimAlumni.
But at the end of the quite delightful conversation (SkimAlumni are usually quite delightful… though I am clearly heavily biased!) I realised it might be useful to document what I shared, so I can point future askers to this post and help more people at scale. So here goes…
How to raise seed funding 101
#1. Ideas alone won’t cut it. You need a working prototype at least.
Unless you are a seasoned serial entrepreneur with a demonstrable track record of building a business (and preferably achieving some kind of shareholder return already), you are unlikely to raise VC or even Angel funding without at least a working prototype. A Powerpoint deck alone just isn’t enough. Ideas are easy. Making them happen is fucking hard. Anyone considering investing serious cash into you wants to see that a) you can do it, and b) that the idea can actually be materialised into something they can see and play with. It makes winning investors over so much easier if they can visualise and interact with something tangible. So find a way to build it before you start pitching. Even if you hire off-shore engineers to build a crappy prototype that you’ll replace as soon as you have proper funding, that is fine, just build something that proves to investors you can actually build something.
#2. Prove someone will use it (and preferably pay for it) before you get investors.
This is the one that scares people the most… demonstrating revenues *before* you raise money. It is possible to raise a seed round without revenues or usage, but it is SO much easier if you do, and you’ll get much better terms. Don’t fret though, you should welcome this step. If you can’t find someone willing to use or pay for what you are building, you probably shouldn’t be building it anyway. You should only be building something if your thorough market research has uncovered a real market need and you have spoken to a number of actual people who would be your target market. And if you have a working prototype (see #1 above) you *should* be able to get these prospects to actually use your product. Then all you need is a statement that once those customers are past their x month free period, they will start to pay. I’ve seen smart founders raise great seed rounds using this tactic… and I’ve seen less smart founders waste a lot of time trying to raise seed round too early and being told repeatedly to come back “once you’ve found traction”. Save yourself the time, and get traction first.
#3 – Build relationships with investors before you need to raise
The myth of the founder who pitched to a VC and had a cheque written to them on their first meeting is a pernicious one that does a lot of damage. Most VCs like to get to know potential investments ahead of committing funds, and if they sense urgency and desperation in the fund raise process, will back away. You need to start the fund raise process significantly ahead of actually needing the cash, but your first set of meetings should be about getting to know the VC, not asking them for money. A friend once told me “If you ask for money, you get advice; if you ask for advice, you get money” and it is very true. You should spend time ahead of the actual raise approaching potential investors with a view *not* to pitch for funds but to ask their input on what you are doing, ahead of a future fund raise. Investors will almost always take these meetings, especially if you are introduced via a trusted third-party, and this is an opportunity to start building a relationship with that investor. Investors also like to see founders repeatedly over time, so they can confirm that you actually do what you set out to do and how well you take input and feedback. Most of my seed investors I had known already for a year and met repeatedly throughout that year to give updates on my progress. Same for my B and C round investors. Build relationships, trust me.
#4 – Orchestrate the timing of the actual raise artfully
There is a part of the fund raise process that is more art than science, and that is the game playing that inevitably needs to occur to get the best deal with the best VCs. You need to time is well, so they are all proceeding at about the same pace: there is nothing more unhelpful than having first conversations several months apart. You need to get all your first meetings with VCs to do the proper fund raise pitch within around a month of each other, so they can then all be paced together. The goal is to get partner meetings at around the same time, so you can have a number of term sheets to consider at the same time. Alternatively, you want to get a single good term sheet from a lead investor, and then have other investors ready to fill the rest of the round on those terms within a month or so after that. Then diligence and legals can take a few more months. The whole process – from first pitch to money in the bank – takes around 6 months, so always start waaaay before you need it.
#5 – Using a convertible note to get you to this point
The truth is, unless you are a trust fund baby or have a huge inheritance, you probably need some cash to get you to this point. It takes cash to build a prototype, to get early customers/revenue, and to survive while you pitch investors. The way to survive is to raise a “Friends & Family” round using a Convertible Note mechanism. Find people that trust you willing to invest in a pre-seed round: ask college friends, parents, partners, etc. If you are trust-worthy and the idea is solid, you should be able to raise enough to keep you going for a few months if you live cheaply. And what you *don’t* want to do is set a valuation for your company at this stage, nor waste time and money on legals. The best thing is to structure it as a convertible note, which is effectively a loan that converts to equity with a discount upon the next liquidity event. Translate this (as I remember when I first started and I had no idea what any of those words meant): a loan that becomes shares in your company with a discount (usually 25%) on the price per share that your seed investors negotiate when you close your seed round. This discount is a reward to early investors who invested when the risk was at its peak. So let’s say you raise $100k via a convertible note from your friends & family, and then you eventually raise a seed round at a valuation of $1m, then your pre-seed investor’s convertible note will essentially give them $133k worth of shares for their $100k (let’s assume $1/share. A 25% discount means the cost-per-share is $0.75 for pre-seed investors, so their $100k investment gives them 133,333 shares).
Usually you give a time period by which this will convert (usually a year), otherwise the loan is repayable with interest or converts to equity at an agreed valuation (which is usually punitive). And finally, if these people trust you, can you get by doing this all with a carefully worded email/document that commits to do this, rather than hire a lawyer to do it.
#6 – Too high or too low a valuation is bad
So many founders think the goal is to get the highest valuation you can… this is incredibly damaging if you get it wrong, because if its too high, you end up in a tough place for your next round of funding, which now needs to be significantly higher than this valuation in order to not dilute existing shareholders. I’ve seen so many founders have to accept a down-round because they couldn’t get past their inflated earlier round, and it is demoralising for everyone.
Conversely, accepting too low a valuation or too dilutive a position because your desperate is also highly damaging, as again, it makes irt almost impossible to raise future rounds of funding, or to properly motivate existing and future employees with meaningful stock option grants. Most savvy VCs will avoid investing in a see or A round if they see that earlier investors own too much of the company already, because they know a) it means the founder was desperate or not smart, which isn’t comforting, and b) it is hard to build a successful and long term business if too much of the company is owned by non-founders/staff before the A round. As a rule of thumb, each round you should dilute by around 25% (less if you are a seasoned entrepreneur). If you have away 50% on your seed round… there just isn’t enough equity left to survive an A round and the hiring of proper executives and to retain the founder/s for another 3+ years.
The trick is to ask for the right amount. How much you are asking for is an indication to what you are worth. There is no other science to how to value a seed company, no revenue multiples or mathematical formula to come up with something irrefutable. At seed stage, it is purely what someone is willing to pay. However, because of the rule of thumb above, if you assume you will dilute by 25% no matter how much you ask for, what you ask for determines your valuation. If you are asking for $400k, you are worth $1.2m pre-money and $1.6m post-money. If you don’t like the valuation you are being offered and you can’t get better, then just change the amount you are raising: in the previous example, if you are being offered at best a $1m pre-money, then accept it but only raise $333k, as this equates to the same dilution of 25%. It can be a clever way to get a good valuation at an acceptable dilution if you are having trouble negotiating. However, there is a disadvantage to this approach, because…
#7 – Don’t raise too little!
One of the biggest mistakes I see start-ups make is raising insufficient funding to give them enough runway until they can legitimately raise another round. This is a mistake made a lot in the UK where the allure of SEIS funding drives founders to raise rounds of £150k, which is just not enough to do anything worthwhile, and has destroyed so many promising companies. Trust me on this: raise more than you need, because raising too little is much much worse than diluting more than you’d like in a round. Diluting more than you like can be rectified later with staff/founder top-ups… it means you are still around. Raising too little will mean you run out of cash before you’ve grown your metrics or developed enough new features to qualify for a further round of funding, and you will be desperate and therefore unattractive to investors. Raising too little means you are also constantly on the road pitching rather than focusing on building your company. None of these are good things.
How much is too little and how much is enough? You need enough to fund you for 18 months, and expect it will take twice as long to do what you set out to do in those 18 months and it will cost you twice as much to get there. If it takes 6 months to raise, then you want to start raising after a year, with comfortably enough runway for another 6 months. That is more than £150k. It is likely to be around £500-£1m for a good seed round these days.
#8 – Valuation doesn’t matter. Only terms and investors matter.
My final point is one that surprises many early founders, but after running my company for over 10 years, I can say this with utter certitude. Valuations don’t matter really. If its a bit lower than you’d like, it’s not a huge problem. What is much much much more important is that the investors that are about to sign that dotted line are ones that you trust and can work with for 10 years, and that the terms are acceptable. It is easy to get share top-ups as founders… I had top-ups every round I raised funding, so dilution really doesn’t matter *too* much. But changing your investors and changing the terms of your Articles and Shareholder Agreements is MUCH harder. So focus your energies on getting the right people around the table, on terms that are fair and will last the distance. For example, do NOT give early stage angels with no start-up investing experience Board seats, do not give away control of your Board, etc. You want a governance and a Board that can hold you to account so you don’t make innocent (or not so innocent) mistakes; but you don’t want governance that is unnecessarily restrictive and cumbersome. Get one of your investors to join the Board and represent all Investors, and then ensure you add Independent Board members as you grow to ensure the Board is balanced. Getting good terms is the subject of another post, my main point here is don’t get hung up on valuation as getting good people on good terms is much more important for your long term sanity and happiness.
That is it! There is a ton more, but if your question is “can I pick your brain” consider my brain sufficiently picked with this post. The truth is, every round is always a bitch… I did 5 priced rounds (rounds with a negotiated valuation) in my 10 years, and it never gets easier. It is always a stressful, scary, frustrating process, and you will always make new mistakes. But that – my friend – is what you sign up for when you choose to become an entrepreneur.