Money Post #1 : A few Thoughts (and an idea) on How to Raise Seed Rounds
Raising Pre Seed Money: Part I The Network + The Pitch Deck
Time for a blog post on some fundamentals of financing. I’m going to focus this post on one scenario on how to raise money in pre seed and seed rounds. For Series A and beyond (B, C, D…), things change a bit and so I’ll save some of those thoughts for a future post…
So you have a vision, you’re amped, you’re ready to works towards bringing that vision to market? But, you have no money. That’s a problem and a big hurdle to get over. Especially if you are a first time Founder (translation: no track record). Typically, larger, more institutional investors want to see proof of concept and a few years of financials before you can get them to take your call. Welcome to bootstrapping…
First things first, put some (or a lot) of your own savings into it. Even if it’s just a bit to get things moving. It will wind up being necessary but it will also show others you are willing to put your money where your mouth is when you’re asking for theirs. You’re a risk taker if you’ve gotten this far… so put some of those pieces of plastic in your pocket to work (but try not to max ‘em out, PSA : easier said than done). Keep costs and overhead as low as possible.
Once you’ve got the ball rolling (albeit probably slowly), you should be ready for a ‘Friends and Family’ round. I personally consider this the same as an Angel round (which may turn into roundS). I advise to try to keep close friends and family separate from business, especially when money is involved (unless of course you have a great aunt that has millions of dollars and what you are asking for is petty cash to her – it’s all relative – but I still advise against it). Usually, nothing good comes from involving people who don’t fully understand risk and are close personally. So who are ‘Angels’? They are accredited investors (must have a certain net worth and/or annual income) who invest in early stage companies when no one else will. Generally, they are aware of the risks of early stage investing and have some experience in doing so (they can afford to never see the money they put in, but obviously don’t want that to happen). They take on more risk and therefore need to be compensated with a better reward on the upside. You can find them through networking or though some organized groups in your local area (ie Golden Seeds, NY Angels, 37 Angels in NYC). But likely at this stage, the people who will entertain the opportunity will have to come from within your existing database or one iteration removed (current or old colleagues, former classmates, bosses, teachers, etc – people who know or can vouch for your capabilities)
So how do you get them to invest in your company versus the other deals they see? Create a compelling Pitch Deck (aka PowerPoint presentation). It’s great to write a business plan as an exercise for yourself to force you to delve into thinking about the details and to use as a guidebook to check yourself along the way (but realistically, the plan you write at first will be very different from what actually happens). Early stage investors know that and aren’t sitting around reading 50 page business plans. What they want to see is a concise, exciting, aesthetically pleasing bunch of slides (10-20 I’d say) that:
· Outline the market opportunity / Need for the Business / Problem it will solve
· Introduce the Founder and his or her team (bios, headshots, etc)
· Vision: showcase the product or service and how it will solve the original problem
· 5 years of financial projections (we all know those wont wind up being the actual numbers but still good for investors to see where you think the company is going, what the growth and potential value opportunity is)
· How much money you are seeking in total this round and what the money will be used for
· Terms of the deal (when and how will the investor get their money back and with what potential return on investment) + existing cap table (if applicable)
Now, get to knocking on every appropriate door you know with deck in hand (aka emails, LinkedIns, attach that deck everywhere). Also, ask for referrals as you go (consider it similar to a job hunt). After the leads have received and reviewed your deck, if they are still interested they will take your call. This next part of the process is likely what will make or break the money coming in – YOU. An early stage investor is ultimately investing in a Founder – they believe in the market opportunity, like the solution you present, and see potential to make money - but they are betting on you to execute, adapt and iterate. So you better bring the passion, preparation and energy to the presentation. Try to pitch friends and family or colleagues in advance for practice and to field questions that may come up in front of the actual leads.
It is also very important to note THIS PROCESS WILL TAKE MUCH LONGER THAN EXPECTED. You will send deck, have initial call (maybe a week or two later if you’re lucky), then follow up emails and calls, stay on top of warm leads for potentially many months before the money is in the bank. I would be conservative and allot for 6-9 months to complete the financing. This is due to a combination of things from getting the investor comfortable with the risk to the potential lead just having many other things on their desk to deal with – you are likely on their back burner. The process will also be DISTRACTING AND DRAINING. Ideally, when you go into it you have someone as a #2 running the operations of the business to keep things going as you put your energy towards getting capital in or else your business could suffer and likely become capital constrained during this period. (*This goes for every stage of financing – angel rounds through final exits – and lots of times the smallest deals take the most amount of time and energy to close*)
Raising Pre Seed Money: Part II How to Structure the Deal
Ok, you’ve got a business established with some savings and credit card debt, hopefully some meager revenues and now a perfect deck complete with a refined, powerful pitch. Aside from that – what are you actually offering on deal terms? Debt? Equity? What, when, how? Mainly how will your investors to get their money back and how much will they earn on it for taking a big risk? It must be compelling.
Although there are infinite ways to structure financings, my suggestion at this stage of the game is a Convertible Note. This is a debt instrument that converts into equity (or shares) at a date usually 18-24 months from when it is issued. Lots of times the notes will convert prior to the expiration date when a clause known as ‘Automatic Conversion’ is triggered – usually by a Series A funding or an acquisition of the company. Typically, the investors will earn interest on the note and have the opportunity to purchase shares of the company when it converts (either at expiration date or when the auto conversion clause is triggered) for a discount to what the company is being valued at, at that time. This is the angel’s compensation for taking on more risk that any other entity at the early stage in the company’s life cycle. Should there be no Series A funding or takeover before expiration, investors typically have the right to their initial investment plus interest or to convert to shares at a previously agreed upon price plus accumulated interest (typically also gets also rolled up and converted into equity).
Why do I suggest this instrument? I think it works best for both investors and entrepreneurs at this stage. Determining the value (or price) of a start up company is very challenging because all of the revenues and profits (translation: value :)) are really on the come. For the entrepreneur, issuing a convertible note gives them time to grow the company a bit, put up numbers and get to a higher valuation before they start selling shares. (selling shares of your company will dilute your interest, you will own less of the total pie, other people will own more, you will start to lose more control – the higher the valuation of the company (bigger the numbers), the less you dilution hit you will take, the more of the company you will retain, the less control you will have to give up (at least in the first round or two of equity financing)).
The convertible note also protects investors (in theory)… Investors also won’t feel comfortable setting a price for the company at such an early stage (*important note : valuation will be a struggle between entrepreneur and investor from initial financing to eventual exit so get used to it – the entrepreneur will always think their company is worth more and the investor will always want a better deal – the goal is to both walk away from the table ‘satisfied’, I don’t believe in win/win for most of these cases*). Debt also precedes equity in the capital structure (meaning that if the company needed to be liquidated the debt holders have priority to get paid back first, over equity or shareholders). At early rounds, convertibles give downside protection and upside opportunity when you don’t have the visibility to set a fair company valuation. On the downside, the note holders have rights to liquidation value in theory (in practice, if the start up is going bankrupt, in a lot of cases the note holders will just lose their investment rather than pay lawyers to fight for whatever morsels are left). On the upside, note holders get access to a discounted share price when a valuation is set by an acquirer or a VC firm with more institutional money.
Appendix:
Most common example of this structure I’ve encountered: $250,000-1,000,000 raise with a valuation cap and/or 20% discount; current interest rates on these notes are around 8%
One random tidbit : if you can’t get to the goal total raise by when you want to ‘close’ the financing, don’t freak. Keep the dates rolling and take the money in when you can get it. It’s easy to get stuck. Keep moving. (I’ve seen companies get to $150k, get stuck, get back to business and be fine for cash for 2 more years…)
**Obviously all of this is a bit more complicated than a 2 page blog post that’s written in layman’s terms (I’m not going to write these thoughts like a textbook) and no 2 situations are the same – you know how to get at me if you need more in depth help with refining decks, understanding/structuring early stage deals, and/or finding angels**
