This is an extended version of my recent talk at SXSW Vegas. Many first-time entrepreneurs obsess about fundraising, and worse, let it take priority over what actually matters–building product and talking to customers/users. Having raised >$30M of angel and venture capital across three of my own startups, I’ve made my share of fundraising mistakes and want to spare first time founders some pain with some hard-earned lessons.
This is a long post, but I wish someone had shared these with me when I was first starting out. Hopefully if you’re a first-time founder you’ll read this and find this useful.
1. Before fundraising, consider not fundraising
Excluding certain specialized industries (e.g. pharma, med devices, energy are some that come to mind) it’s generally pretty inexpensive to build a company these days. Hardware or software. I’ve done both. Even if you’ll eventually need to raise capital, it’s likely possible to prove out your initial assumptions and verify “product-market fit” (ie that people want what you’ve got) before raising. As a sign of just how much has changed, when I was starting my first company less than a decade ago, I had to buy RAM, CPUs, motherboards, and other components, build my own servers, and colocate them due to the amount of computation we were trying to perform that surpassed hosted server capabilities. These days nearly everything has been turned into SaaS (including server hosting), greatly lowering the amount of money required to verify that your business is real.
Avoiding raising money may make sense not only in the beginning of your startup’s rollout, but also for the rest of its history. The proposition of taking $1 from an investor and purporting to return $10+ to them creates a lot of pressure that may not make sense for your business or market when compared to bootstrapping.
VC money in particular carries the expectation that you’re going to build a $1B+ business, and relatively quickly. Somewhat ironically, as reported [pdf] on by the Kauffman Foundation, of the fastest-growing private companies in the United States over the 10 year period 1997-2007 identified by Inc magazine in their annual Inc 500 list, only 16% had taken VC money. Although correlation is not necessarily causation, by that data, one could speculate that you have a higher likelihood of building one of America’s fastest-growing companies if you avoid VCs than if you work with them. Of course, many of today’s most recognizable tech giants did partner with VCs, and I personally have involved VCs in all of my above-mentioned startups, so you’ll have to evaluate your specific circumstances. I’ve recently started to ask myself why this discrepancy exists. I have a working hypothesis that the very best VCs do positively contribute to building category-defining large businesses, especially technology-driven businesses. However, there are many business models that simply don’t need VC capital to grow quickly; I have not yet reviewed the data to understand if these types of businesses get very large or simply grow and flatline. Companies like Dell, ShutterStock, and Esri all purportedly never raised VC capital.
The take-away from all this is don’t take it as a given that you must raise capital to start a successful company.
2. If you must fundraise to prove initial assumptions, raise as little as possible at first
As mentioned above, it’s possible these days to start a software or hardware startup with no or very little capital. I estimate $5-50k is enough to prove out initial assumptions and demonstrate that real demand exists or does not exist for most products or services. That’s a sufficiently small amount that you can conceivably scrape the sum together from family, friends, and friends of friends. These individuals will be more willing to invest on the merit of you and your character as a person rather than your non-existent business. Other relatively low-hassle sources at this stage include university entrepreneurial grant programs and business plan competitions which are becoming increasingly more prevalent. Even Airbnb income (if you have a spare room to rent) has been used by founders to finance their early operations. If none of the above is at your fingertips, you can still figure out how to hustle to put some money in the bank, ideally by doing something at least tangentially related to what you’re trying to build so you can gain helpful market insights, experience, and connections at the same time. It’s probably a waste of your time to speak with people who call themselves angel investors or VCs at this point, although you could get lucky if someone happens to like you. Some people advise that you speak with investors early and often to help develop relationships for down the road. That may hold true for later in your trajectory, but right now, it’s a waste of your time. Besides, they’ll probably try to give you advice about what to do. That’s the worst thing ever at your nascent stage–customer demand and data should be your guide, not investors’ advice (unless they truly know their stuff, but assuming you’re exploring some novel insight into a market, it’s unlikely most investors will be able to offer good advice that trumps simply getting your hands dirty and getting close to the customer/user and giving them what they want).
3. Do as little (and spend as little) as possible to test your initial assumptions
Effort and exertion do not equal results and output. It’s not cool to be pulling multiple all nighters working on your startup. Execute smartly. Determine what the minimum amount of work is that you need to do to test your initial assumptions, prove or disprove them, rinse, and repeat. Get over the desire to put something out there that’s perfect–instead, focus on the absolute minimum thing that is useful to people, get out there with people and talk it through with them, see what they say, and revise. The wonderful thing about this approach is it’s actually easier to execute on than to try to build the perfect robust solution that you think the market wants.
4. Beg, borrow, and steal. Don’t pay for space or people.
There’s something special about being scrappy. I think it puts you in the right mindset to focus on what really matters. You simply have no ability to get bogged down in nice-to-haves or distractions, because if you do, you will die. In order to stay scrappy, you definitely should be begging, borrowing, and stealing your way to resources you need to prove your initial assumptions. Try to stay scrappy as long as you can.
Assuming you’re building a software company, all you probably need that normally costs money is space and people.
When first starting out, the ideal setup is living and working in the same spot, which ought to eliminate work space overhead since your office is simply your bedroom or living room. Even if for some reason that does not work (maybe you have loud roommates, maybe you’re married, maybe you live in a car–yes I know founders who spent part of their early days homeless)–you have plenty of options. I discovered my first office for my very first startup one summer by discovering that a particular door at one of Stanford’s libraries could be opened without a key or key card. A quick ping to some of my Stanford friends for WiFi access info later and my team was online and working. Even years later, when starting FundersClub, rather than paying for our first office (which we could afford to do), we asked for and received free office space. We had heard rumors that Eric Schmidt had a beautiful office in downtown Palo Alto with floor-to-ceiling glass windows and 360-degree views of the Valley that was relatively unused. We figured out who he knew that we knew, got a warm intro to his people, and got what we asked for. You’d be surprised by what you can get simply by asking for it.
As for people, there are plenty of folks willing to work for free. Younger people tend to be willing to do this because they have a lot to prove and learn. The most ambitious and hungry young people especially tend to be willing to work for the chance to prove their muster and get hands-on, and those are exactly the type of people you want on your team early on. Many older, more experienced people are also willing to work for free, though for different reasons–their day jobs are boring whereas your startup is exciting. I haven’t proven this personally but I suspect stay-at-home moms and dads are also another great source of free, professionally bored, highly experienced labor.
5. Before deciding to raise a more substantial seed round, ask yourself “Why now?”
“Why now?” is a great question to ask yourself about your startup in general as a reality check on why now is the right time to be starting your business. However, it’s also applicable in the context of deciding when to fundraise.
To run an optimized fundraising process, you need to be situationally aware of where your business stands and where investors’ expectations lie. If you raise when these misalign, you will waste a lot of time raising money.
Quick story. Jeff Lawson, founder at Twilio (the telecom-as-an-API company), was fundraising in 2008 during uncertain times. The first 10 investors he met with said no. So did the 11th, 12th, 13th….and 20th. Finally he met a partner at a VC firm that thought what Twilio was up to was interesting and next-stepped Lawson to a full partner meeting with the intent of making the go decision following the meeting. Lo and behold the VC firm also decided to pass. Lawson and his team said “Screw it!” and figured out how to launch without funding. They began to see traction including paying customers, and within 2 months of launch, had closed their first seed round. Today, they’ve raised >$100M and have built one of the most promising tech startups out of Silicon Valley.
The point of that story is to demonstrate that for Twilio, for 2008, what the market needed to see was traction in order to “get” Twilio. One could get frustrated with myopic startup investors who lack the same vision and insights of founders, but it’s more productive to accept that having a keen understanding of investor demand will save you a lot of time and frustration and help you fundraise effectively.
Know what the early inflection point is for your startup. 1 hour spent fundraising after this point could be equal to 1,000 hours spent fundraising before this point in terms of results. Remember, executing a startup well is not about sweat, it’s about smarts. Speaking in generalities, for most consumer/web/mobile startups, this point is at a minimum demonstrating growth on the metrics of adoption and engagement, and in many cases also showing growing revenue. For most enterprise startups, some sort of prototype and early serious interest from meaningful customers in the form of letters of intent, trials, or actual revenue is good (and obviously growth is even better). For consumer-facing hardware companies, strong pre-sales are almost expected by investors these days. Its harder to define this point in general terms for other types of companies. I’m not saying you can’t try to fundraise before you reach these points–for some business models, you might be forced into this. However, you should know it will take exponentially less time to do so after, and your time is golden.
6. Don’t die prematurely
If you’ve validated your core assumptions and reached an early inflection point, raise enough to not die prematurely. From a fundraising point of view, the worst thing ever would be to ramp up with early funding, and then run out of powder midway through reaching your next inflection point. The likelihood of this happening is pretty high when you consider that the average successful startup pivots 3 times.
Imagine your dialogue with investors at that point: “Hey guys! Remember me? I said I was going to do this thing. Well it didn’t work. But we learned some stuff. We’ve had to go back to the drawing board and pivot. Now we’re doing this new thing. Can you back us again?” They might, but you’re not speaking from a position of strength at that time unless you’ve found traction with the new direction.
Part of startup success is about taking a lot of shots and not dying. The longer you have, the more shots you can take, and the more likely you are to live rather than die. Therefore I typically recommend that startups with early traction raise 18+ months of runway vs. the conventional 12 months (or vs. the advice of those who say to raise as little as you need to reach your next milestone…I only agree with that if your next milestone is demonstrating initial market demand as noted in #2 above).
7. Be authentically passionate, confident, and formidable when speaking with investors.
Credit to Paul Graham for citing “formidable” as a characteristic to exude when speaking with investors. When advising founders I had previously been citing being “authentically passionate” and “confident” as important characteristics, and I’ve since realized they are are subcomponents of being formidable. These character traits can’t really be faked. How you say what you say–your body language, tone, expression–are as important as what you’re saying. You really need to be convinced (or deluded) that your version of the future is the correct one and that you’re the right person to drive the change. Starting a company is really hard. Investors will want assurance that you will aggressively execute and stick by it when the going gets tough, because the going will get tough. Other investors have told me time and again when evaluating entrepreneurs that they like to pattern match for personality type.
One way to be especially formidable is to be upfront about challenges that stand between you and success. It’s a little counterintuitive, but by walking through the ugly underbelly of your endeavor to investors, you’re actually building trust and demonstrating your sophistication and knowledge of your pursuit. Too many founders only speak to the upside potential without addressing very real issues that lie in the way. It’s one thing to say electric cars are the future. It’s another to explain that existing battery tech has never been used to power vehicles with the mileage range demanded by consumers, that there hasn’t been a single new successful US car company started in the past few decades, and that key infrastructure is missing to make consumers comfortable with the vehicles. What you’re really doing by showing your ugly side is laying out a blueprint of key challenges to overcome in order to succeed–and that makes you seem calculatingly fearless and strong.
8. Choose investors wisely. Money is a commodity for the best founders, but not all money is equal.
Sometimes you’re not going to be in a position to pick your investors. If that’s the case, see #5 to be sure you’re not prematurely ramping up fundraising. Most high potential startups have their share of investors trying to get a piece of the round though, so hopefully you do have a choice.
If it’s not just about money, what matters? There are a lot of parameters to consider when selecting investors. I think the ones that matter most are below, but beware as these need to be considered together; optimizing for any single one could get you in trouble.
You probably would not hesitate to conduct reference checks on new employees joining your team. Likewise, I strongly recommend conducting reference checks on investors you’re considering adding to your team to ensure there are no red flags raised by founders in their portfolios.
a) Ease of fundraising
Is this an investor who’s going to string you along only to not invest after the 5th meeting and weeks (or months!) of back-and-forth?
b) Post-fundraising investor overhead
Say an investor optimizes on a) and writes a big check after an hour-long coffee meeting or 30 minute phone call. If this same investor subsequently calls you twice a week every week demanding updates or other hand holding, you might not be so happy. I have heard horrible stories of founders who took money because it was easy to take only to later regret it due to the trouble that the investors brought with them.
Most investors think they bring value-add. Many do not.
FOMO, or the fear of missing out, is for better or worse, a strong motivating factor for many startup investors. Who wants to feel like they opted out of the next Facebook, Apple, or Google, after all? Certain investors have established a strong record over time which leads to their investment in a given startup signaling to the market that the startup is a high promise startup. Having such investors can help to more quickly close your round. Perversely however, it is exactly the type of investors who are especially vulnerable to FOMO who tend to fail at a)-c) and who in general may not have the organic strength you ideally want. Conversely, there are certain investors who act as negative signals and you will want to avoid these.
e) Mutual respect
This is a rather soft criteria, but you will want to surround yourself with investors who have your back and respect your leadership. Running a company is hard work, and it will only feel harder if you don’t enjoy mutual respect with your investors. I’ve met multiple first-time founders running successful, high-growth startups who’ve received term sheets from certain VCs conditional upon a leadership change or an onerous Board structure. Screw those VCs. While you must be open to the idea that you’re not the best person for the job if the data speaks to that, if the data says the opposite, don’t start off the relationship with people who are betting against your continued success.
BTW, from a founder point of view, we started FundersClub to try to optimize a) through e) for our portfolio founders.
9. Get it over with quickly
Fundraising is a distraction from building product and talking to users. One way to get it over with quickly is to set aside a discrete period of time (e.g. 2 months) during which you prioritize fundraising over everything else. Everything else will suffer, but at least the damage is time-limited. Furthermore, treat it like a sales process, use a spreadsheet or CRM to track leads and progress. Don’t let fundraising happen to you. Instead, control your round and be deliberate about it. What happens if you reach the end of the allotted time period and you haven’t closed your round yet? Most likely, the market is telling you something important about your pitch, or more likely about the facts on the ground. The right answer is probably not to continue to bang on a door that will not open, but to instead return to execution. That’s after all what building a business is about, not fundraising.