Simple Guide to Getting Your Startup Funded
Seeking investment for a new startup is no easy feat – basically you would be asking people who don’t know you very well to entrust you with their hard-earned cash on a business that most likely doesn’t yet exist!
This is not impossible either, as you probably hear about people raising large amounts of funding all the time from the news and social media – so there must be an art to doing it. In this guide we aim to simplify this complex process into easy steps, and offer some additional resources to guide startups along the journey.
Here are some general nuggets of wisdom, to consider before started your fundraising process:
Don’t hide your idea! It’s not advisable to keep your startup idea a secret in fear of it being stolen – ideas are abound everywhere and only successful execution matters in the end. Most investors receive hundreds of pitches daily, have no time or willingness to copy or implement such ideas and no interest to sign an NDA with each founder who pitches to them. Talk to people regularly about your idea (perhaps without giving away the “secret sauce” parts) and get their feedback, as you never know who may be interested or can offer come useful, targeted connections based on what you described.
Understand investor types. Investors come in various shapes and sizes, each with a different scope and mandate. Typically in early stages of a startup, friends/family and individual “angel” investors may be involved with funding. In more advanced stages, institutional funds and VCs would have an appetite.
Understand funding rounds. Occasions of funding are given labels to indicate their sequence. A small “pre-seed” round can be raised in the initial stages of planning a startup to help it develop, and a Seed round usually happens once development is complete and the business is ready to launch in the market. After revenues come in, more investment rounds can be pursued in the sequence of Series A, B, C, D etc.
As a startup you’ll need to put together a detailed estimate model for income of expenses covering a 2-3 year period. This can be in the form of a spreadsheet laid out by months, showing itemized categories of forecasted revenues and costs, taking into account your gradual market-entry and growth plan. Ideally, your CFO could take care of this or otherwise you could engage a financial consultant for startups if there are no finance skills currently in-house.
This exercise can help potential investors see clearly how your startup will earn money and spend funds, and also where the breakeven point is (that would be when cumulative revenues become equal to cumulative expenses, and start to surpass them). Most importantly, it can help you determine exactly how much money you need to raise in the current funding round – usually this would be the total spending gap (between revenues and expenses) for a period of 1-2 years, depending on how much runway you need until your next funding round.
This exercise helps co-founders of a startup determine the optimal split of equity shares amongst them, based on objective contribution assessments that help ensure fairness and reduce the risk of future disagreements. Most people have a tendency to divide shares equally to avoid discussing these issues, but that is not ideal as conflicts may arise later due to perceived inequitable allocation of rewards.
Some standardized tools exist which use common best-practice weighting algorithms to assess the contribution of each co-founder and calculate the optimal equity split accordingly. Using such tools offers the comfort of fairness and objectivity as per defined and accepted standards. Here you can read more details about this process and suggested tools.
Accurate valuation is critical for the fundraising process as most investment negotiations fail due to disagreement on fair value. Startups should always seek to conduct independent third-party valuations and not attempt to assign their own value to the startup while having the strong emotional connection to it which is typical of any founder. Bear in mind the fair value is what the market would bear to pay currently for immediate purchase of the startup given what it has until now, and not what it plans for the future. Everything you have built/collected may have some market value including technologies, IP, user data, contracts, etc.
For pre-revenue startups, there is no exact science for calculation valuation though there are a number of common methods that provide good estimates such as Risk Summation, Scorecard, and Berkus methods. If your startup already has 1-2 years of “official” revenue data (e.g. audited financial statements), you can use simpler methods such as discounted cash flow and VC (“multiples”) method. Here you can read more details about this process and suggested tools.
There is no valid pitch to investors without a proper “pitchbook” or slide deck containing all the brief data and arguments necessary to make your strong case for funding. The pitch deck should not be too long, yet should contain all the pertinent details which investor may ask for, most of which are described in this guide. Other items to include would a short description of the market problem and solution that your startup is offering, some background on the founding teams, product info, and growth plans.
Equally important to the pitchbook is your actual ability to pitch it! Your team should know the pitch by heart in various forms (a short elevator version and other lengths depending on the situation), and be able to convey it convincingly with solid delivery and confidence. Here you can read more about pitchbook skills, view best-practice samples and seek delivery coaching.
Cap Table Prep
Investors typically ask for an updated capitalization table to clearly understand the current structure of share ownership in the startup. This table shows how stock is distributed among founders, investors, employees, advisors, incubators or any other entities holding shares in the company, and how these holding have changed or become diluted over time. Here you can read more details about this process and suggested tools.
Term Sheet Negotiation
The term sheet is the main document which lists all negotiated terms between the startup and investor, to cover the agreed funding and holding of shares, outlining the rights and stipulations for each. While this document is usually provided by the investors, startups can also draft or edit it and must be savvy in understanding all the terms and clauses, ensuring a fair balance of benefits and powers between the two sides. It’s best to have a legal adviser review this document or use pre-vetted content – here you can read more about this document and some negotiation tips.
Most savvy investors will not take pitch statements at face vale and will opt do some form of DD in order to reconfirm startup traction and mitigate some risks. A good entrepreneur would be prepared in advance by having all the commonly-requested documents ready at hand such as Articles of Association, board resolutions, patents, rent and employment contracts, technical code specs, sales or marketing agreements and the like. Here you can read more details about this process and suggested tools.
Approach & Close
Once all the above materials are prepared, now is the time to start approaching investors and earn their support, convincing them to fund your startup. Be prepared to repeat your pitch with many investors, and accept a lot of rejection along the way until you strike the right fit. With of all the above documents in hand, you will be in a better place then most other entrepreneurs who come unprepared, and investors will notice and surely appreciate that – it will save them lots of tie and effort in evaluating the deal. Be flexible and keep in mind that everything in life is negotiable!