Fundraising 101

Fundraising is one of the most important steps that a young entrepreneur takes. It’s a step that you take only when you need it or when the opportunity presents itself. But it’s also a very discontinuous process. And even though it’s kind of hard to really become good at a discontinuous process, that’s exactly what you have to do.

Entrepreneurs who become very good at fundraising are usually one of two things: good salespeople (because fundraising is just a different kind of sales process) or running a business that needs a looooooot of money.

If you’re going to do the next Uber and need to raise billions, having any success at all will put you into a very natural, always-on fundraising mode that just becomes part of who you are.

Still, one thing we’ve noticed at The Family is that the best entrepreneurs aren’t usually the best fundraisers, and the best fundraisers usually don’t make the best companies. It’s actually kind of obvious — if you’re really bad at fundraising, your only chance is to make a product that’s so good it becomes obvious.

You’ll find all kinds of tips online about how to seduce an investor, how to say things in just the right way… don’t worry about all of that.

You want to create a healthy, long-term relationship with this person, so don’t start off trying to trick them. The fundraising moment itself is much less important than all the moments that come afterwards, when you have to live with that investor being part of your company. Put your energy into showing your true self and creating a real base for that long-term relationship.

That can be hard too, because a good investor will only need 2 or 3 meetings to make a decision (bad investors will want lots more). That’s not much time to create a relationship. The stakes are high and time is short, so the more honest you are, the more open you are about yourself, your business, what you like and don’t like, what relationship you want to have with them, the better off you’ll be.

Once you’ve got that in your head, you can understand a central point of fundraising: it’s highly irrational. Especially the first round. As your startup matures, and there are more and more metrics and history, then fundraising can become rational. But at the beginning, most deals are made for totally irrational reasons.

Early stage VCs aren’t finance experts (or, if they are, they probably aren’t very good VCs). They’re startup operators, they’re entrepreneurs themselves, they know business, and they’re deeply optimistic people.

When you walk into a meeting with them, early-stage investors aren’t looking for a reason to say yes, they’re looking for a reason to say no. Their natural urge is to say yes. But they know they can’t, and so they have to find reasons why they prefer saying yes to one company over another.

Entrepreneurs who don’t understand that will go into a meeting thinking their job is to convince the investor. It’s not. Your job is to make the investor feel like this is an obvious deal, that they’re right to say yes.

Most investors know whether or not they want to invest in the first 10 seconds of a meeting. The rest of the time is spent on whether or not the entrepreneur keeps them feeling like it’s a good idea, that they should invest in this company instead of in any other deal.

Entrepreneurs also need to understand that no VC has a vested interest in investing in their company. From the entrepreneur’s side, the company is obvious — after all, you’re dedicating your life to building it. From the VC’s side, everyone who they meet has an obvious company that they’re devoting their life to.

So they aren’t really worried about missing out at the beginning. They don’t need to invest in every winner to make money (even if they’d like to). Every investor wants to be the first into Uber, but if they aren’t, it’s not that big of a deal — it’s like losing the lottery. Nobody’s upset at the end of their life because they didn’t win the lottery.

Understand their job. Professional investors have a business model that pays them fees, whether or not they make money. Entrepreneurs think that a VC’s job is to take risks, but it’s not — their job is to look smart when they’re talking to their own investors.

If a VC goes to their own investors and says, “We invested in a cybersecurity firm, great market, the entrepreneur had built other successful companies, but in the end it didn’t work out,” nobody’s upset. Ok, it didn’t work. Next.

But if a VC goes to their investors and said, “We invested in a couple of guys trying to use synthetic DNA to grow dragons, and now all the money’s gone, they didn’t grow any dragons,” people are going to freak out. Rightly!

Never forget that institutional investors have a boss. That means they could say no to you for an invisible reason that you’ll never know.

Take an example where a VC raised a fund and said they’d have 30% consumer companies and 70% B2B. Today, they have a great consumer company in front of them, they talk about it internally, and their investors say they can’t do the deal because the portfolio is 50–50 right now between consumer and B2B, and that wasn’t the deal that they agreed on.

Do you think the VC is actually going to tell an entrepreneur that’s the reason they aren’t investing? Of course not. They’re going to say, “Oh, it’s too early for us,” or “Oh, I’m not sure about the market”, blah blah blah.

Every VC lies when they say no to a deal, because it’s all about managing expectations with the entrepreneur. If they say something that makes themselves look bad, then you’ll never go back to them again. If they say something that makes it look like you’re missing something (“Oh, your average basket is too low”), then maybe you’ll come back when you’ve doubled the average basket. And maybe, at that point, those hidden conditions will have changed too.

In that way, a VC’s position is much harder than an entrepreneur’s. As an entrepreneur, you can tell everyone else that their project is incredible. Someone comes and pitches you synthetic dragons, you can say (and you should say!), “Man, that is so cool.” As an entrepreneur, you have no interest in shooting down other entrepreneurs.

But a VC has to shoot people down all the time, even when they don’t believe want to. I’ll talk to VCs who aren’t sleeping at night, thinking about that entrepreneur they had to say no to, and for a stupid reason, an entrepreneur they’re convinced will make it.

The entrepreneur only thinks the VC is the one with all the power because that’s the image the VC wants to give off. The VC makes it all look rational, when it’s really just about human relationships, expectation management, and looking good. So manage your own interpretation of what’s going on accordingly.

Of course, at the beginning there aren’t only VCs. At the beginning, there are a lot of different sources of funding you can look at; as you grow, those sources become fewer and fewer.

There are millions of people in the world who can write a check for €100K. They’re all very different individuals looking for different things. But when you need to raise €1B, it’s a very limited group of people you can talk to about that.

Still, that means raising €500K can come with a high level of complexity, because there are so many different combinations available. Raising a billion is pretty easy: either you have the metrics to raise with the dozen people who can make that happen, or you don’t. It’s a very binary situation.

At the beginning, though, you can have love money, business angels, superangels, micro VCs, VCs, government subsidies, corporate funds, corporate accelerator programs… make sure you don’t get lost in the woods.

The best way to avoid that problem is to never feel obligated to raise funds. And even if you do need the money, maybe you don’t need as much as you think. A lot of times, we’ll have an entrepreneur who says, “I need €500K,” or “I need €1M,” and really, they only need €100K to keep going for another 3 months.

Obviously then the question is, “Well, what are you going to have done in 3 months?” But you need to believe that the odds are going to change, as you go from where you are now to where you’ll be then.

Next, remember that when you build a relationship with someone, they become more likely to say yes. If you keep updating an investor and showing them progress, their perception of your progress is going to be even higher than the achievement itself.

Basically, if you go to see an investor for the first time and pitch your company, that’s a transactional approach. I have X, you have Y. To make that work, you can’t just be in the top 20%, you need to be in the top 1% of companies that investor sees.

But if you’ve established a relationship, and for the past year you’ve been showing them monthly progress, how your company is growing, how you just got these two great salespeople on board, etc., you’re not in a transactional relationship anymore. You’ve let them inside, and so now they’re looking at your company in an entirely different way.

A “No” for an investor today can become a “Yes” in the future, if you take the time to build the relationship the right way. It’s all about getting yourself on the right side of favoritism. It’s about being loved as a person just as much as being loved as a business.

This is why fundraising is a matching problem, not a seduction problem. Matching with the right investors before money is involved will have a huge impact once the time is right for your fundraising.

Make sure you have Plan A, Plan B, Plan C, Plan D, and so on. Start with the best, even if you know there’s no way they’ll invest. If you go from bad people to good people, you’ll never learn and get better. If you start with the best, you’ll learn a ton and it’ll help you get the best investors possible on board.

Starting with the best also gives you the chance for a miracle. We’re in a business of miracles. They aren’t common, but they happen. Just because they probably won’t happen to you doesn’t mean you shouldn’t try.

But because you can’t count on a miracle, it becomes a question of pitching as many people as you can until someone says yes. The hard thing there is that you should never stop your business while you’re fundraising (another reason why the later you go into fundraising mode, the better it is).

How do you know the time is right for your first fundraising?

As dumb as it sounds, the right time is when you need it. That doesn’t mean when you need money to build a better business, it means when you as a person don’t have any other choice. It’s when you’re sleeping on your friend’s couch, when you’re moving back in with your parents, when you’re eating leftovers of leftovers…

If needing money just means accelerating, that’s not enough: keep building traction, become even more obvious. Every bit of traction you build with the company makes the decision easier for the investor.

As much as possible, avoid weird sources of money: strange business angels, family offices that you just don’t understand, strings-attached love money… (I usually tell our entrepreneurs to avoid love money as an investment, only take it if it’s really just love; if people around you want to help you out, take the money for yourself, not for your company. Because if you have a family member investing in your company, you should treat them like any other investor. Don’t make the mistake of seeing love money as somehow different from other money, treat it with total respect.)

Never take money from anyone who can’t afford to lose it. You need to be able to look every investor in the face and say, “This money is lost, are you sure you want to give it to me?”

If you can’t say that, if you can’t make them understand that there’s a very, very high chance the money will be gone, don’t take it.

I say all that because it’s super dangerous to have people on the outside freaking out. If your investors start freaking out, the situation inside the company will get even worse. You need stability from your investors.

There are only 5 reasons why stable, good investors who know what they’re doing will put money into a startup.

The first is social proof. Someone fancy is putting money in, and so other people want to do it too. And half of their decision is just because they hope to maybe one day meet that fancy person, even though that’s never going to happen. And the other half is because people sometimes think that person has investor superpowers. But don’t get sucked into this game, social proof is weird and you can’t really play it well, it can go wrong in too many ways.

The second reason people invest is for the team. Sometimes this is a good thing, sometimes it’s weird. For example, right now, if you were in the first 100 people at Uber, your ability to raise money is incredibly high. And it makes sense, if you were there and you didn’t get fired, you saw things that very few people have ever seen in terms of growing a company.

Or maybe you have a team where you’re a proven expert in a key area. If you’re an expert in banking infrastructure and security, you’ll have an easier time raising money for a new fintech.

Just remember that investors aren’t evaluating a “good team” based on your having gone to a good school, or being smart, or giving off the sense of knowing what you’re doing. An investor is looking for that one thing that is so special and rare that they can use it as a proxy for how good you are, as something that covers them with their bosses if things don’t work out.

The third reason to invest is the product. That’s finally something where an entrepreneur can do something concrete. If you can build an amazing product, you’ll excite investors. Remember that professional investors are optimistic and they know business; they know that if you can build a great product, chances are good that you’ll learn how to convince customers.

The fourth reason is because you’ve got a strategic partnership or leverage that will let you beat the market. If you’ve got some way to get your supplies at half price, or have access to something critical on your market, that can be a reason for an investor to get on board.

The last reason is traction. Young entrepreneurs think traction is something that you can easily demonstrate — “Look, I’ve grown this much over the past 3 months!” But the reality in startups is that metrics don’t really excite people unless they’re totally unheard of.

If your metrics are just ok, nobody cares. Investors are looking for something that’s completely beyond the reality they know, numbers that make them say, “I’ve seen a thousand companies, and I’ve never seen that.”

That might be your acquisition costs, client onboarding times, high initial price, whatever. It’s important because professional investors know that, over time, everything tends to revert to the mean. So if you start out super high on something, it’ll regress to “normal” more slowly, which means you might have the time to build something really cool.

Again, remember that a VC goes in front of their investment committee. If they can say, “I like the team, I like the market, the product’s pretty good, and — AND — they’ve got this one crazy metric,” then the decision becomes obvious. Because even if you’re just “average good” on everything else, that one metric lets them develop a solid conviction on the opportunity.

So let’s say you’ve got a VC interested. Your next question will be, “How much do I raise?”

The funny thing is that money and valuation are directly linked in the first round: whatever happens, you’re going to lose 20–25% of your company. So the question is whether you lose that 20–25% for 500K, 1M, 2M, 5M, etc. The total cash isn’t going to make a difference in terms of the equity you give up.

I know that may seem weird, but it’s just how it is at the beginning. You the entrepreneur think that valuation is tied to your company as it is today, but that’s just because you don’t really understand how long equity stories are. That’s why good VCs aren’t worried about optimizing valuations in an early round.

It makes sense if you put the numbers on it: Let’s say your company could eventually be worth $1B. Right now, a VC might put in $500K, or $1M, or $2M… but they’re still getting their 20–25%. If the company is eventually worth $1B, they’re looking at a potential return of $200M. So who cares if they put in $1M or $2M? The difference in the end is so small, it’s not even worth talking about.

That’s not to say that VCs don’t make mistakes. I’ve seen it happen, especially with junior associates. They have to learn that it’s not worth arguing over a $4M vs. $5M valuation, because on the day you’re signing the papers, it’s true that it can feel like a big difference. But over the whole history of a successful company, it just isn’t. That’s why only bad investors really keep caring about valuation in early-stage companies.

In general, those first rounds aren’t really priced according to the companies, they’re priced according to the market. When we first started The Family in 2013, the first round valuation was usually 1.5M. Today, the average first round is around 2.7M. Do you think that companies today are almost twice as good as companies in 2013? No. It’s just that the market has shifted.

VC timelines are long — 7, 8, 10 years. Their early-stage investments are based on potential, not the state of the company today. So don’t fall into the trap of thinking you’re somehow objectively better than another company that raised $X at Y valuation. The potential for both of your companies is the same, so you’re pretty much going to get the same deal.

Once you’re in Series C or Series D, if you’re doing 3x better than some other company, sure, you’ll be able to raise more at a better valuation. At that level, the company is much closer to its final valuation, the risk has decreased, the potential has become more concrete. That’s when metrics matter for your deal; before then, metrics only matter because they help determine the “On/Off” quality of the deal.

This also explains one of the big mistakes I see. When entrepreneurs get to a level where they can go raise 1M at a 5M valuation, they keep pushing, thinking they’ll be able to boost that and get to 2M at 10M. But then 12 months later, people are still looking at them and saying, “Yeah, we want to do the deal, we’ll put in 1 at 5.”

If the valuation is driven by the market, a better idea is to optimize for your investor. How do you know who’s a good investor and who isn’t? How do you know who’s the right investor for you?

At the beginning, you’ve basically got two choices: institutional VCs and individual angels.

With angels, I really believe you have to trust your instincts. You have to develop that in your own way. With individuals, small bits of behavior tell so, so much about who they are. Some examples…

- When we were raising our first money for The Family, I had a simple rule: If we went out to eat with an investor and they didn’t pick up the bill at the restaurant, I didn’t let them invest. And with the benefit of hindsight, having seen a lot of those investors put money in other companies, I don’t regret a single one.

- If someone comes to the meeting and they’re dressed like an accountant, don’t take the money. Accountants aren’t meant to invest in startups, they don’t understand the level of risk that is needed. (And that’s fine! They’re not bad people, they should just stay away from startups.)

- Entrepreneurs are good targets, because you share something important with them. But be careful, because they’re still entrepreneurs, which means some of them want to run your company. So test them, ask, “Do you want to come to the office one day a week to work with us?” If they say yes, stay away from them. If they think that’s ridiculous, that it’s your company, they just want to give you money and let you build, that’s cool. Investors should be able to give you leverage, make good introductions, be available when you need them; stay away from hands-on investors.

When it comes to institutional VCs, don’t let them invest without doing proper due diligence on them. It’s super important to do that for the people who are investing in you. Go ahead and tell them, “We’re really excited about the possibility of you investing, can you please put me in touch with three entrepreneurs from your portfolio?”

And CALL. THEM. If you don’t do that, and you have a bad experience, well… whose fault is that?

And if someone calls you to ask about your experience with an investor, don’t lie. If you let someone bad invest, don’t let someone else get hurt just because you’re embarrassed. If you get stuck with a bad investor, help others to avoid falling into that trap, that’s how you can help to elevate an entire ecosystem.

As part of that due diligence, think about the three things where a VC can really make a difference and where some are better than others: brand, network, and crisis.

Brand is so obvious, and yet so many entrepreneurs don’t understand it. Don’t underestimate the value of a big, well-known VC coming on board. Because when you need to send an email to someone important, being able to say, “We’re BlahBlah.com and we raised $5M with [famous VC],” it’s so much more convincing than, “We’re Blahblah.com and we raised $5M with [someone you’ve never heard of].” In a world where storytelling is everything, don’t underestimate the importance of marketing and branding, both for your startup and for your investors.

Network comes in local, regional, and global forms. If you want to build a global company, you need your investors to have a global network.

Finally, a crisis will arise. How is your investor going to react in a crisis? Are they going to be supportive and helpful, or frantic and crazy? If it’s the latter, they’re going to be a huge liability. You need strong, courageous investors who don’t freak out.

Let’s close on the fact that fundraising’s hard. What do you do if you can’t raise with VCs? Should you get a fundraiser to help you? Should you go after more exotic investors?

Basically, only use a fundraiser after you’ve already tried and failed to do it yourself. If you try to use a fundraiser immediately, you’ll never know if it’s worth it. But if you’ve already failed, the fact that they’ll take 5 or 10% of your raise, well, you know it’s worth it because on your own you’ve got nothing.

If you’re not VC-compatible (there are great companies that aren’t VC-compatible), you might need someone to help you get more exotic investors like family offices. Not everyone can raise with Marc Andreessen, so if you need to go exotic, remember that generating a return on that money will increase your chances of being able to raise with Marc Andreessen later.

Entrepreneurship is a career, it can go down, up, sideways. Just make sure you’re getting as much out of it as you can at each point.