Getting cash for a startup is hard, don’t make it harder by not knowing who to approach or when. Don’t panic, here’s some good stuff below to get you started.
Traction is King, Long Live Traction
It’s not a revelation that for business to grow it needs to make money, and for investors, it’s the most important thing. For the uninitiated, the ability to generate revenue, and proving you can, is called traction. You don’t always need incredible amounts of it to get funding, but there are things investors look for that help them make this decision.
Start by figuring out the core metrics of your business that help demonstrate your ability to generate revenue, including any ratios that help demonstrate improving unit economics. If there’s not much to demonstrate, don’t panic, there’s a solution. You just need to show increasing defensibility, and promise revenue the right way.
Defensibility:
- Strong Intellectual Property (IP), including patents, regulatory approvals, special know-how, and proprietary data
- Strong team experience, domain expertise, diverse applicable skill sets, big rolodex
- Strong team pipeline, explaining how capital will supplement your team with expertise
- Strong board of advisors1, helps a lot if your team experience is lacking, and usually doesn’t cost as much
- Strong network, translates into warm introductions, good references, and demonstrates an ability to reach the right people to close deals
Promising Revenue:
- Strong pipeline, name-drop some big potential clients2
- Clear growth plan with reasonable assumptions, ultimately models don’t matter very much early stage, but they help investors understand what costs you assume the business will incur to scale, and roughly what sort of revenues you expect from the capital you invest, basically a sanity check
- Having a “sticky” product, something that keeps people using your product such as keeping all their data hostage, or providing some key value that would be difficult to replicate elsewhere
- Signed customers and pilots
- Good customer references
- Validation, anything that proves that customers find value in your product, and that your business model works
More Money, More Problems
If your car has no tires, it’s hard to get anywhere, but if also your wheels are down the road, then you’re stuck, that is to say, traction, valuation, and capital all come and go together. If your business has good traction, and can show good defensibility, you’re promising the capability to make lots of money, that’s a sound investment with a good valuation. A failure to deliver on much of that promise, and you’re proving that the valuation was unsubstantiated, and investors will make you feel their pain.
Valuations are a negotiation for a reason. If the valuation is too low, the investor gets a good deal but the entrepreneur isn’t motivated. If the valuation is too high, the entrepreneur gets a good deal, but the investor isn’t motivated to spend time opening up their network, and you’re promising exceptional future traction. If you don’t deliver on this traction, you’ll have trouble raising future rounds. Will the investor take a down-round? Not likely. Instead, you’ll see a flat round with punitive provisions, or you risk turning into a zombie company, one that shuffles around for a long time, but never goes anywhere, slowly eating away at its cash.
Pro tip: Don’t worry too much about valuation, it’s better to own 10% of something big that scales fast, than 100% of nothing.
The Only Stages that Really Matter
Most of the time you’ll hear investors talk about stages like Angel, Seed, Series A, B C with the rest of the alphabet, but ultimately, there’s a better way of thinking about the growth of your startup, here’s four stages to wrap your head around.
- Product Development (Goal is Minimum Viable Product (MVP)3)
- Do you have the bare minimum needed to start validating your product and idea?
- Do you have sufficient defensibility to buy you time to test your product? (see above)
- Do you understand the needs of your target group?
- Validation (Goal is to prove your business should exist, and prove Product-Market Fit)
- Product Validation (Is your product useful to your target groups? Do they like using it?)
- Business Model Validation (Do your target groups want to pay for your product? Enough to be viable and scalable? Do you have Product-Market Fit?4
Pro tip: Complete the feedback loop and you have a stronger case. If your product makes something easier, that’s o.k., if it reduces costs, that good, but if it helps drive revenue, completing the loop, it makes your product a must-have, instead of a nice-to-have
- Scaling (Goal is to expand successful efforts to grow your business)
- Change, or reorient team to focus on mass customer acquisition, and optimization of key metrics such as LTV, churn, and ultimately revenue
- Make small experiments that improve key success metrics, then scale those experiments if they work
- Demonstrate successful unit economics that will give the business profitability once growth slows down
- Evolution
- Start again at 1, and evolve, iterate, or rebuild your product to adapt to changing needs
Who to Talk to Now that You Know Everything
- Yourself [Stage 1]5
- You’re either an investor or an Entrepreneur, if you aren’t comfortable gambling your life savings, don’t do it, there is always money looking for a project, but generally it’s a good sign when an entrepreneur puts some of his own money into the project, just don’t go overboard
- Instead, your biggest investment here is your time, colloquially sweat equity, the more you sweat the more leverage you have when you do need to raise money, and as a result you get to keep more equity
- Friends and Family [Stage 1]
- These are the first few thousands in your business, and it isn’t being invested because people think your idea is the next Uber for Facebook, they invest because they trust you and little else
- Always remember, the technical value of “a well developed idea” is “nothing much”, traction is king, and the king has all the money
- Free Money6 [Stage 1, 2]
- Here in Canada-land we have things like IRAP, SRED, and employment grants just to name a few, government is almost half of all capital in startup investing here, and due to limited accessible early stage capital, it is an absolute necessity up North, but this doesn’t mean these should be overlooked elsewhere
- It’s an increasing trend to have a mostly full-time person just spending their time applying for grants for the company, it might just keep your startup alive long enough to make it to your first real institutional money
- Crowdfunding7 [Stage 1, 2, if consumer product]
- $10K – $100K
- Generally you’ll only see successful crowdfunding when there’s an attractive consumer product. If you’re smart, you’ll use the platform to sell your first batch of devices and earn media coverage. If you’re really smart, you’ll use the platform to fund your product dev, and use this as validation to convince an investor to give you more money earlier. It’s effectively an early type of product & market validation
- Service businesses have a hard time getting crowdfunding, and B2B solutions have no mass-appeal
- Stay away from equity-crowdfunding, one-day there may be value here, but today, the poorest performing startups go equity-crowdfunding because they aren’t able to raise money another way
- Accelerators & Incubators [Stage 1]
- $50K – $200K & space
- These are small, often university funded, spaces that provide a desk, some capital, and mentorship, most often in exchange for some equity
- Money, or space is great, both buy you time, mentorship is a nice bonus, but if it’s all they offer for your equity 95% of the time it’s not worth it
- Everybody, including the baker down the street, has an incubator, so it shouldn’t be too hard to find capital here
- Watch out for vague promises of introductions to VCs, as it usually comes in the form of a demo day or a mass email, though some do break the mold, talk to entrepreneurs that have graduated from an incubator to figure out what value they can offer
- Giving equity for fair value is fine, but don’t waste your time and be careful with some clauses that give away key rights as they may make it very difficult for you to raise follow-on rounds
- Angels [Stage 1, 2]
- $20K – $100K per Angel
- Angels are often successful former entrepreneurs or wealthy retired specialists, tap your network first to get introductions
- The rule of thumb is, the more organized, the higher the expectations
- Individual angels with domain expertise may come in very early while the product is being developed, and will help you understand customer needs
- Larger angel groups may wait till your product is validated, with the right groups opening doors to your first pilot customer
- This investor will likely be a key factor in helping you get to your first institutional round, so finding well connected investors who are willing to open up their network to you are key
- VCs [Stage 2, 3]
- $250K – $2M early stage, $3M+ later stage
- If you’re talking to VCs, you should know your story, that is, what your product is, who your customers are, how you are competitive, and have proof that people want to use your product, and that they are willing to pay for it
- VCs are varied, some like the firm I‘m part of, iGan Partners, are early stage investors, and early validation with some traction gets your foot in the door, conversely, later stage firms often only look for hard metrics, typically monthly revenue, growth rate, market size
- If you’re not ready, that’s okay, VCs like to keep in touch with promising entrepreneurs and their ideas, and are happy to give advice, so reach out early enough before you need their money, but not so early that you’re still fleshing out your idea, they’ll tell you how to get ready, and can point to one of a hundred ideas to improve your business simply from having met hundreds of startups themselves
So there you have it, at least enough to point you in the right direction. Stick around, more to come.
TL;DR
- Traction is king, but good defensibility and solid promises for growth are usually enough to get capital
- Valuation isn’t as important as you think
- To build your startup you need to develop a good product, prove that people need it, and that they are willing to pay for it, then demonstrate this and replicate the success to scale
- To raise money, start with friends, and work with as many sources of cheap funding as you can get your hands on, at least so you have enough time to prove that your product works, and that people want to pay for it, then go to the bigger players to get capital to scale
- Don’t panic
- If you don’t know, say you know someone who does
- …and any relevant people you’ve spoken to once in passing
- Read Eric Ries’ Lean Startup
- Nobody truly agrees on what this means, but in general from Andreessen to Graham, the idea is to have something that many people want and are willing to pay money for it
- Don’t actually talk to yourself, entrepreneurs are already seen as reclusive and anti-social, need to step it up
- But only if you don’t value your time
- Also see: selling promises
