Fundraising is one of the fundamental aspects of a startup. But unfortunately, it’s also one of the most challenging areas. So we’ll try to make it simpler here. This blog series will cover the basics of raising your seed round - from getting ready for the round to meeting investors and eventually having money in the bank.
Why do even you need to bring outside money? The shortest answer is because almost everything costs money: developers for building your product, travel to present at conferences, office space, and so on. These alone will probably cost hundreds of thousands of dollars for the first year. So fundraising makes sense. But there is a way not to raise money, as long as you can generate revenue to cover your expenses - this is bootstrapping. If you can start generating revenue, you can use it to cover costs and grow your business. The advantage of bootstrapping is that you’re calling the shots. You and your co-founders are the board. What’s better than that? And there are some fantastic success stories for bootstrapped companies.
There are downsides to bootstrapping. The first and most important is speed. You’re operating in a fast-growing, highly competitive market. The first company to conquer the space will be the winner. The others will likely disappear. Raising capital means you can run 10x faster, which could be the difference between a winning and mediocre business. Fundraising allows you to accelerate using money. Bootstrapping also means you have more mental stress since you might need to live with zero or a minimal salary for a longer time.
For these reasons, most startups choose to fundraise versus going bootstrapped.
There are different types of investors:
- Angel investors are private people who usually invest anywhere from $10K to $100K, sometimes more. They often invest in groups, so the total amount is hundreds of thousands. Founders like angels because of their unique expertise and ability to help, sometimes more than their money.
- “Super angels” are angels that can invest anywhere from hundreds of thousands to $1M-$2M.
- A Venture Capital (VC) firm invests anywhere from $100K (a small or pre-seed VC) to a more prominent VC that can support anywhere from $1M up to billions in a single round.
- A corporate VC is an investment arm of a corporation. They aim to invest in startups for financial returns (like a regular VC) or strategic collaboration. Unfortunately, they are usually too early to bring in a seed round.
A software B2B company typically needs anywhere from $1M to $5M to get going. The heavier the tech and the sales cycle are, the more it needs. Another way to think about these amounts is by the stage or “round” the company is at:
- Pre-seed stage: the goal is to verify what the startup wants to build. For that, the company usually needs $500K or less. Then, a successful milestone will be to get the initial technology working or get initial users (usually in a B2C product).
- Seed stage: the goal is to show initial product-market fit (PMF). In B2B, an ARR (annual recurring revenue) of a few hundreds of thousands or several paying and referencable customers is a good sign of PMF. In B2C, this could mean thousands of users or more. Being ready for the next round means you can start hiring sales and marketing people to start building the commercial operation. The seed round is usually $1M-$5M but can be even $10M in infrastructure companies that are more capital intensive.
- Series A: building the commercial team and proving the Go-to-Market (GTM) fit, meaning raising an additional $10M-$30M, hiring your first executive team members (e.g., VP of Sales and VP of Marketing), and a small sales team. A successful milestone would be reaching $2M-$5M of ARR.
- Series B, C, D, and after: from here, it’s about scaling the business to $10M, $30M, and eventually over $100M ARR. A series B usually starts at $20M and can be much more. Also, the terminology usually fades at these stages, and you’ll see very different ranges of numbers.
If your startup’s valuation is $15M, what does it mean? It’s straightforward: the pre-money valuation is the valuation on the day of investment, and post-money is the valuation a moment after raising the round. So: post-money = pre-money + round size.
How does that work with dilution? The investor’s ownership is the round size divided by the post-money valuation. So if an investor invests $3M in a company with a pre-money valuation of $12M, they get 20% of the company because three divided by 15 (12+3) is 20%.
Most seed-stage VCs want significant ownership in the company, usually 10% or more, sometimes up to 30%-40%, because they know, they might not have another opportunity to invest in the company. However, more prominent VCs can invest in later stages and be more flexible.
Since valuation is arbitrary and not based on revenue multipliers, it is mainly a market function and how much you raise. For example, if you ask for $1M, you might be valued at $5M, whereas $5M can make an argument that you are worth $20M. So don’t think of raising less as a way to have less dilution.
There are several factors you should think about when fundraising, including:
- The round size
- The valuation
- The duration of the round
- The VC firm and the person joining your board
From our experience, the most critical factor when fundraising is the person you will be working with closely during the next 5-10 years. So when deciding between different options, never choose someone, a person, or a firm that is not a good fit for you. That is always a no-go. However, you might be able to increase the valuation offered by the investor you want by having competing offers, so that’s always a good thing.
In the next chapter, we will talk about how to reach out to investors, create a fundraising process, and meet investors to get the best result for your startup.
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