Money. Power. Respect.
Anyone asking you to work on a business plan while you’re still searching for a virtuous business model isn’t an investor you want. Who you raise money from is a key question - not every dollar is the same. Good money comes when you can reverse the balance of power. Raising funds is like a mix between playing poker and buying a house. You need to go all in with your own cards. But you can’t keep a poker face in front of the landlord, because it could be a long-term relationship and it should be based on honesty. Learn how to do this, player!
Money. Power. Respect.
The question that we have to knock down all the time at The Family is “Can you help me with fundraising?” The answer is “No.” And that’s not for the reasons that you might think. Essentially, it’s the wrong question and it comes out of a misunderstanding of how startups and investments work.
Instead, what you should be asking about investors is exactly why you, as an entrepreneur, need them. To answer that, you need to know who investors are, and why they would give you money. If you don’t understand both sides of the table, then you’ve got much less power than you could have.
When does a startup need money? Usually, it’s not at the beginning. Startups need money when they need to grow. At a certain point in the life of your company, if you limit yourself to only the revenues that you have coming in, your growth rate is also going to be limited. Accelerating that growth rate comes down to asking for money from investors.
Investing boils down to a relationship based on power.
Raise money when you don’t need it to survive. A business struggling to survive is risky; and even though they live in a world built on risk, investors don’t like to put money in risky businesses. Some might do it more than others, but given the number of opportunities that they have, they are going to put their money into companies that are demonstrating real returns and real growth that can accelerate thanks to their cash.
You’re not the only one talking to investors. You must realize that you aren’t the only person pitching any one investor. Good entrepreneurs live their company 24/7. And so many forget that theirs is just one of many. You’re in an invisible competition, with a lot of good projects. So the pitch can’t be, “I have a good project, please invest.” It has to be, “This is why my project is better than all of those other ones you could invest in.”
Investors aren’t omnipotent either. There are all kinds of reasons why an investor will pass on a project. Maybe they’ve already put a lot of money into different projects lately, and they need to restrict their new investments until they raise a new fund. Maybe they’re looking for a certain type of project, or a certain type of founder. There’s a game being played, and having as much information as possible on each player will help put you in a better position.
Investors pay what it costs.
One of the stories that you’ll hear a lot in Europe is that there’s less money, and so there’s less opportunity. But that’s not really true. As an absolute value, sure, there is less money being invested in Europe than in the US. However, there are also fewer projects in Europe, and in general less pressure at those early stages. In the very early stages, most investments in Europe are still local. As you get bigger, though, you’ll have access to a global capital market. Remember that whenever you hear about a European startup raising money globally, in the US, Asia, wherever, it’s not just luck. It happened either because someone knew someone who could put a deal together, or — more likely — it’s because the company has grown to a point where its importance is undeniable.
In Europe when it comes to money invested, $1 ≠ €1. This isn’t a question of exchange rates. It’s the fact that everything in the US, and particularly in Silicon Valley, is going to cost you three times the amount it costs in Europe. Starting a company and getting it into a growth stage in Europe is cheaper than it is in the US (and that’s even with the fact that starting a company has gotten cheaper for everyone over the last 10 years). So if you hear that someone raised $1 million in the US, you can figure that’s roughly the same as a European company raising €300K. A European company with €3 million in the bank is going to have about the same means as a US company that raised $10 million.
And don’t think that Silicon Valley is expensive because it’s inefficient — it’s actually the most efficient place in the world. But it’s like living in the center of a major city: because everything is concentrated there, it’s more expensive than living in the suburbs. Of course, that doesn’t mean that you can’t build a really nice house in the suburbs ;)
Because of the changing importance of money, in today’s overall investment world there’s a race to bet early. Investors are seeing more efficient returns going to those who invested early, so they’re trying to get upstream faster and get the best possible value for their money.
Winner-takes-all! Maximizing that value is important because we’re in an investment world where winner-takes-all. Good deals are very competitive, and it makes the negotiating process fluid. Don’t see fundraising as a static thing — if you have traction, and you have interested investors, your valuation and the money available can change.
That’s because that pressure to get in early and the relatively restricted environment create a butterfly effect with a good fundraising. Entrepreneurs will always start out wanting to control everything: who sees the pitch, who they talk to, etc. But optimizing your fundraising means that you can’t control everything: there will be small moments, brief meetings and unexpected details that have outsized effects on the final deal.
They’re not omnipotent: investors ultimately just have a feeling if something is a good deal or a bad deal. A final judgement is possible only with time. But the feeling is there from the beginning. And creating that feeling is an art, which is why seemingly small things can have huge repercussions. All of the numbers, all of the due diligence, it’s simply there to uphold that feeling: good deal or bad deal?
The truth always comes out.
For the entrepreneur, “good deal/bad deal” rotates around four questions: what, who, how and why. What money are you taking in, how much? What’s on the check? This is the easy part. Next, who is giving it to you? That’s harder, because again, not every dollar is the same. There’s a difference between a good dollar (from a smart investor that will lead you towards more dollars, etc.) and a bad dollar (from toxic investors that will end up killing your company). Then, how are you getting it? In startups, it’s strange but conditions are always negotiated after the “what,” which can lead to situations with horrible legal conditions. Some of them are so horrible that it’s better to not take the money. Bad investors make things complicated in terms of conditions. Good investors make things simple.
And finally, why? “Why” is the biggest source of misalignment between entrepreneurs and investors, because investors aren’t always upfront about their intentions, and entrepreneurs lie to themselves, largely because they’re afraid of losing the deal.
But those lies have a real cost. It’s like when someone lies to someone else just to get them into bed. That might work on a short-term basis, but over the long term it’s impossible to maintain. As an entrepreneur, you need to be honest with yourself and any potential investors, because it’s better to lose a deal than to make a deal where no one is honest about their ambitions for the company. The truth always comes out.
In most deals entrepreneurs only optimize the “what.” And really you should be trying to optimize the “who” and the “why.” As a young entrepreneur, those two factors can make such a difference, because at the very least you’ll be trying to grow your company with people who are fundamentally good and interested in helping you. They can generate a great relationship with your investor that’s beneficial for both sides over the (hopefully long) life of your company.
You raise money when you can.
“How do I know when to raise it?” It might seem a bit paradoxical, but the answer is simple: you raise money when you can. This is why it’s so important to do everything you can to have organic growth and traction, because it opens up the possibilities. Whenever you have more money in the bank, that means there’s less risk to your company. Of course, that also means that it doesn’t just depend on you.
So you raise to go faster, you raise when you can…what should your valuation be? It’s the most popular topic in the startup world, so how do you figure it out? Well, actually, you have two valuations: the fake valuation and the real valuation.
A real valuation is based on only one thing: predictable revenue. Over an infinite amount of time, your valuation is always going to be a multiple of your revenue. There’s nothing else that goes into it, because someone who tries to invest in you today is paying a certain premium in order to guarantee themselves the company’s cash flow in the future.
But until you can provide that kind of realistic projection into the future, you’re dealing with a fake valuation. And that’s where the problem is, since you as an entrepreneur will be optimistic, your potential investors are more pessimistic, and the goal is to find the equilibrium between your two positions. In Europe, the biggest problem is that early rounds are so tilted toward the pessimistic side that there’s no real benefit to them. You can see European deals where someone is putting in $150K for 30% of the company. Let me be clear, that kind of deal needs to be unacceptable for any entrepreneur.
The first valuation for fundraising should be somewhere in the $1.5–2M range. If we were in Silicon Valley, that could be upwards of $5M. But in Europe, you should be aiming for at least $1.5M, and never less. People will then ask, “Well, but how can we fundraise at that valuation?” You need to reverse the question — why are you fundraising if you can’t do it at that valuation? Keep building your company’s numbers until you get to the point where investors are happy to do a deal at that valuation. You can do that because cash flow in a startup is, by its nature, unpredictable. Push as hard as you can to make your sales and cash flow increase. That’s how you get the strength to negotiate for that higher valuation.
Forget your business plan.
Don’t bother with putting together a business plan and a projection model. A business plan doesn’t mean anything in an early-stage startup. And by the way, any investor who says that they only invest with companies who have a business plan is lying. If you say to an investor, “This is my budget and this is what I want to do with the money. I’m not putting together a business plan because I have no idea what my revenues will be, but the goal of this round is to establish a model that I can believe in,” they’ll either invest or they won’t. But if they don’t, it’s not because you didn’t give them a business plan — it’s just because they didn’t want to invest. Period.
Entrepreneurs see fundraising as a necessary early step in the life of their company. That’s a problem. That puts them in a position where they cannot say, “No”, to anyone. Anything that anyone asks them, they do it, because they don’t have the right outlook on what they’re doing. I promise that you’ll get more from spending two weeks building revenue than two weeks putting together a business plan.
When you have a real company, and you’re looking at a Series B fundraising round, that’s when a business plan is important. And it’s important because you have data. But before that, when you’re looking at an early round and you’re testing your hypothesis and you’re trying to see if anyone will pay you for your solution, none of that exists.
Your goal as an entrepreneur should be giving yourself the power to practice one key point: no money is better than bad money, and no company is better than a bad company.
Within the investment world, VCs are a particular breed.
One reason for that is because VCs are getting paid anyway. Investing is their job, and it’s a well-paid job, which means that their concerns aren’t the same as yours as an entrepreneur. Don’t feel bad about taking their money, because their entire purpose is to put capital at risk. If it works, it works out big time. If it doesn’t work, it’s ok, they move on and you’re the one who has to figure out what to do next.
They have their own rules. Because of how their job works, VCs are entrepreneurs as well. Their market has certain rules. That’s what leads to questions about exits. Any VC that gives you a check expects to get a bigger check back one day.
There are a lot of politics that go into targeting VC money. There are complicated economics within a fund, and not every moment is the right moment for a VC to invest in any company, let alone your company.
VCs are not the only way. The vast majority of companies never take VC money. At the same time, in the startup world VCs do have an outsized impact. So while they’re not the only way forward, they’re an important way that many leading companies take advantage of at some point.
There is no middle ground with VC money. Taking advantage of it does means that your outcome will be either 1 or 0. You have to perform, you have to report to your new bosses, and you have to justify what’s going on within your company. And at the end of the day, going down the VC path means that either you become huge, or you die.
Let them find you.
Ultimately, the best entrepreneurs know that building their company is the best way to find investors. If you build something real, something that people want, the investors will come to you. And having that negotiating power is the best way to push your company towards the holy grail of exponential growth.
The power is in the investors’ hands: if you want to reverse it, the first thing is to know them and to think like them by putting yourself in their shoes.
Begin local We are used to hearing that it is more difficult to raise money in Europe. The truth is that there is less money available for startups in Europe but there is also less competition and less pressure. Moreover, everything in the Silicon Valley costs 3 times what it costs in Europe: raising $1M there equals €250k in France in terms of means. Salaries, rents, everything is cheaper. Don’t take it wrong: Silicon Valley is expensive because it is the most efficient place on earth. It is like living in the center of Paris vs the suburbs. But the more early-stage, the more local your investors. The more successful, the more international.
Do not hesitate to take love moneyLove money is money that comes from people who do not care about what happens next and above all it is money that comes without any constraint. If your family and friends can give you money, take it - don’t feel ashamed or guilty.
Focus on the Who For your first fundraising, “Who” gives you the money is as important as how much they give you: 1€ does not equal another, depending on who it comes from. Every investor has an impact, especially in Europe where everybody needs to sign everything before proceeding. No money is better than bad money. Beware of big names. An easy due diligence is to call someone from their portfolio, to talk with people who actually work with the investor. If it is your first company, play it simple: avoid non-traditional investors such as hedge funds, business people, industrial figures...
Be clear on the What “What” is how much and which kind of money (capital, loan,...) you want to get. First round valuations are very low in Europe, or even unacceptable, such as 150k€ for 30% shares. First round valuation should be between 1.5 and €2M, never less. The first valuation is totally artificial so you have to put a high level. Do not wonder how to reach that valuation: reverse the problem. You should fundraise only if you reach that valuation. Try again and again until investors are ready to pay that valuation. Fundraising is an auction. A good strategy is called the “double divide”: divide by 2 the amount you want to raise and divide by 50% the valuation you are looking for. This way investors have the feeling it is cheap, you end up having more term sheets, you then double it all and you finally raise at a higher valuation than you expected, and for more money.
Do not do a business plan Playing with numbers is useless. Cash flows are unpredictable, especially for startups. A BP consists in building forecasts based on the past: as an early-stage startup, you don’t have a past, so making a BP makes no sense. Plus, it is your job to be optimistic, so of course you’ll come up with exponential forecasts, but it is really rare to reach them. So give your budget, show how you plan to spend the money and explain that the goal of this 1st fundraising is to establish a model you can believe in. If an investor in the first round puts a BP as a condition, they are not the right Who.
Beware of the How “How” is about the legal terms. What’s dangerous is that the conditions negotiation always comes after the money negotiation. The simpler the conditions offered, the better the investor. Do not search for equality with your investors, search for risk alignment.
Be true about the Why Investors are not sincere about the “Why” and entrepreneurs lie to themselves: it cannot work on the long run. If you are ready to sell at some point, say it, if not, say it. No one cares about the “Why,” but this is the true parameter that will make your relationship with your investors work.
Celebrate A successful fundraising is a nice milestone. Of course it doesn’t mean anything about your future, of course it is just a beginning and not an achievement, but still it is social proof, it boosts morale - enjoy it.
Use the money smartly Every investor knows that when they invest in a company, the following month is always the worst month ever in terms of performance. The pressure goes down and the entrepreneurs need a few weeks to get back on track (and some of them never do). A successful fundraising is a hard test for founders: the only way to know if they are capital-efficient is to give them capital. Remember that raised money makes you go faster only if it is well spent.
Become a star at reporting Reporting is not just about tracking data: you have to make that data understandable for people who have one hour to dedicate to you per month. Data reporting is key to your investor relationships and the future of your business. Your goal is to instill confidence with your performance.
Protect yourself by building your own insurance Whatever happens to you, your VCs get paid. So do not feel too uncomfortable losing their money: put it to work, if it pays off it will pay big for you and for them. Also, realize that anyone can be fired, including founders, so be comfortable with that. Our opinion at The Family is that you should build personal wealth from serie-A to secure yourself and your family. A basic way to do it is through secondary: secondary money is money that goes in the pocket of the one who sells its shares, vs primary money which goes into your company through new issued shares bought by external people. To do secondary, when you fundraise, you sell shares that you own with a 20 to 30% discount (never more). The discount comes from the fact that the money going in your company generates value, not the money going in your pocket.
Articles to go deeper
Nicolas Colin, “Better Get Used to Those Bubbles”
The Family Papers, March 2016
Ben Thompson, “Venture Capital and the Internet’s Impact”
Stratechery, November 2015
Matthew Yglesias, "At last, a convincing theory about why the tech boom\'s days are numbered”
Vox, July 2015
Dominic Rossi, “The Global Savings Glut”
Fidelity, May 2015
Barry Kramer, Michael Patrick and Nicole Harper, “The Terms Behind the Unicorn Valuations”
Fenwick & West LLP, March 2015
Dan Primack, "Stewart Butterfield explains why Slack is now worth more than $1 billion”
Fortune, October 2014
Scott Kupor, "Why the Structural Changes to the VC Industry Matter”
Andreessen-Horowitz, July 2014
Andy Rachleff, “Demystifying Venture Capital Economics Part 1”
Wealthfront Knowledge Center, June 2014
Andy Rachleff, “Demystifying Venture Capital Economics Part 2”
Wealthfront Knowledge Center, June 2014
Sam Altman, “The Separation of Advice and Money”
Ben Horowitz, "Angels vs. Venture Capitalists”
Ben’s Blog, March 2010
Paul Graham, “How To Be an Angel Investor”
Essays, March 2009
Paul Graham, “The Venture Capital Squeeze”
Essays, November 2005
We told you, they lived it!
Ross Bailey, CEO @ Appear Here
Ross dropped out of school when he was 19. He always hustled his way forward, from organizing parties to selling tee-shirts. When he was 22, he started Appear Here as a solo founder, with the goal of making booking a shop as easy as booking a hotel room. He managed to open hundred of spaces across the UK and signed up thousands of brands. He has raised $9m from investors such as Balderton and is now planning on expanding internationally.