This article is part 1 of a four-part Startups Playbook Series. Navigating the Startup ecosystem to build a business is a daunting, stressful, costly, and often lonely journey. But the reward for when you make it - priceless. Having the right tools, direction, and support is often the lifeline between success and failure. This series will guide you through 4 business-critical areas you’ll want to nail in order to keep you on the road to success.
Visit us March 16th for the release of part 2 of the Startups Playbook Series - Product Development–Rethinking the MVP.
The last 20 years of my career investing in and supporting high growth companies at all stages has taught me a lot about the key areas that can make or break a startup. Among the most important is fundraising strategy, an area that has been at the center of my venture capital, public company investing and strategic finance consulting experience. Fundraising is perhaps the most critical step for almost every startup at every stage, until it reaches a comfortable cash flow positive position wherein external financing is no longer required to fund growth.
While raising capital is vital for most startups to sustain themselves, the amount, purpose, timing, method, runway length, and sources of fundraising differ widely depending on the stage. Let’s see how by breaking up the early-stage fundraising lifecycle broadly into the Pre-seed, Seed, and Series A and beyond stages.
Timeline: Runway, or the time you have until your startup runs out of capital, is the primary metric you need to have in mind for determining the timing and amount of fundraising. While the runway is relevant for every stage until you are sustainably breaking even on cash flows, it is most relevant at the pre-seed and seed stages when startups are not only cash flow negative, but (in many cases) are probably not seeing ANY cash inflows.
Amount: At this stage, the target fundraise should be the capital required to get you to the launch of your MVP and gain the initial traction with your first set of targeted customers (beta users, initial customer pilots, paid users, etc.) Ideally, you would need to look at 6-12 months of runway, though this really depends on the lead time for product development, nature of your industry, level of competition, and extent of cash burn in the near term.
Sources: The pre-seed stage is a delicate one. The number and variety of investors with the risk appetite to back you at your early stage is small. Focus your fundraising efforts on institutional pre-seed investors, active angel investors/syndicates (specifically those with expertise or interest in your space), high net worth individuals, and accelerators with expertise in your sector that provide capital and meaningful startup accelerator programs. Use your network to connect to potential investors whenever possible. A warm intro is not always required, but it never hurts. Don’t overlook friends and family, which can be a reliable source of risk capital when you are at such an early stage that independent investors may not have the conviction to cut a check, but people who know you more intimately may. Proceed with some caution though since the probability of failure is high and if this does happen, it has the potential to jeopardize relationships. Also, don’t overlook thorough documentation (e.g. - term sheets, convertible notes, and SAFEs) just because your source is family and friends.
Target amount and timeline: Things get more serious here as you start adding more fixed costs as you build the team (engineering/product development, customer success, and perhaps even early sales and marketing hires) to support product development and early customer engagement. The target fundraising amount should be the capital required to continue product development beyond the prototype, MVP, or beta versions, and to increase customer traction to show the product-market fit needed for investors in later fundraising rounds. Ideally aim for a longer runway of 18-24 months since your milestones will be larger, further apart, and most of all, dependent on more external factors than the pre-seed stage.
Sources: Existing pre-seed investors could be some of your first calls, particularly the institutional firms and well-connected angel investors. They can be great assets when planning your seed financing, connecting you to a wider network of seed investors and providing you with early commitments for the seed round, which is a great signal for new investors. The next outreach should be to a targeted list of institutional seed funds that could lead/co-lead the financing. These funds could be quite helpful in guiding you through the seed stage and may provide strong signaling value in subsequent rounds. Similar to the pre-seed round, use your network (and your existing investors) to connect to potential investors. Some seed funds do a great job of managing cold outreach from startups, for others, a warm intro goes a long way. Institutional seed funds will typically expect to obtain 5-10% ownership for their investment at this stage. Spend a fair degree of effort in researching appropriate seed funds before you start the process. Startups usually waste a considerable amount of time and effort pitching to funds that are not good fits for their stage or sector (yes, fit works both ways). Sources for your research could be incubators and accelerators, your existing investors, other startup founders, and venture news and research platforms (e.g. - Crunchbase, Pitchbook). Budget at least 2-3 months for completing your fundraising.
Series A and beyond
Target amount and timeline: The target fundraising amount at the Series A stage should be the capital required to continue product development, build new features based on user/customer feedback, broaden the platform, scale customer traction, fortify the leadership team in key areas like engineering/product development, sales and marketing, finance, and operations. Your runway for each round from here forward would be around 24 months, but this (as always) depends on your growth rate, cash burn, and expansion plans.
Sources: At this stage, your focus will need to expand to traditional Series A focused VC funds with expertise and interest in your space. For larger multi-sector and multi-stage funds, be sure to target the appropriate partner(s) for your outreach after you have done your research on possible targets. Cast your net wide especially if you are planning a sizable fundraise that is beyond the average ticket size of the funds you are targeting. Series A rounds usually involve more than one investor, and lead investors at this stage typically expect to obtain 15-20% ownership. Given the size, scale, breadth, and variety of target investors, plan to spend around six months completing your Series A round. Subsequent rounds will follow the same template to a large extent (assuming everything is going well) with the size of investment potentially increasing significantly with each round.
Alternative Capital Sources
There are other sources of financing available for startups besides equity capital, though eligibility is not wide and even if you are eligible, some of these sources may not be entirely appropriate for your startup:
Bootstrapping and SaaS Recurring Revenue: Many startups founders have had success bootstrapping (self-funding or funding from operations) their companies to early product-market fit and revenue scale. One way to accomplish this is through an efficient SaaS business model. Most SaaS contracts involve monthly recurring revenue and, in some cases, annual subscriptions with an upfront collection. Expenses, on the other hand, may be deferred or include generous payment terms from suppliers. Such SaaS startups can have positive working capital for some length of time, which can be a valuable source of financing. For companies with notable amounts of contracted recurring revenue that do not include upfront payments, they can still use those SaaS contracts to obtain financing from a variety of providers. Predictability of your revenue and restrictions on refundability are important considerations for this source. Of course this also presumes the company is generating revenue (a minimum of $1-2M ARR in many cases) and hence doesn’t work for pre-revenue companies and pre-product launch companies.
Ecommerce Financing: Sellers on e-commerce platforms such as eBay, Amazon, Alibaba, etc. can access reasonably priced financing negotiated through the platform or through third-party providers. The loans are periodically repaid out of the proceeds due from the platform for products and services that are sold. The arrangement involves credit limits set by the provider, high levels of automation, and API-based information sharing between the seller and financier.
Venture Debt: Venture debt funds extend financing for periods ranging from one to five years at interest rates that reflect the riskiness of the startup’s cash flows – interest rates are usually much higher than bank financing. There is usually no equity dilution and principal repayments could be ratable over the loan period or backend loaded (i.e. interest-only payments and a lump sum of principal owed at the end); this depends on the purpose of the debt. Venture debt is generally appropriate for expansion and growth stage revenue-generating startups with reasonable visibility into operating expenses and other obligations. Earlier stage startups can also access venture debt in smaller amounts to provide capital to near-term milestones and upcoming fundraising, but companies at this stage should carefully consider this alternative as it may not be a great fit.
Grant funding: Even for-profit startups working in areas within sustainability, environmental solutions, the social sector and others are sometimes eligible for grant funding from foundations, government departments, high net worth individuals, endowments, universities, NGOs, and private trusts. This funding, although cost-free, comes with strict conditions on end-use and in some cases may even involve a payback clause if the startup ends up making money in the future. Research your eligibility thoroughly before thinking about this route.
Crowdfunding: There are a number of crowdfunding platforms available to founders today. If you’re a start-up that offers a physical good, this could be a viable option without having to give up equity. Many bootstrapped and early stage start-ups are able to successfully raise enough from the community to develop a prototype and get them to the next stage of their business. Be sure to package what you’re offering your investors/customers in an engaging, fun and creative way. Non-traditional “investors” like the transparency of knowing they are supporting a greater cause, or simply a humorous, cool and innovative product.
Non-dilutive funding: Although not always top of mind, it should be considered as part of your overall financial strategy. Growing your company with minimal dilution offers many benefits that are achieved through things like government grants and R&D credits.
The fundraising process can be terribly frustrating and quite time-consuming for many startup founders. With a reasonable amount of research and preparation, founders can make the process more manageable and improve their probability of fundraising success. Also, don’t go at it alone. Make sure that throughout the process you are engaging your network and reaching out to your mentor resources.
Don’t know where to start? Please feel free to reach out to me and my team at OneValley Ventures to discuss your startup and its financing needs.
Juan Scarlett is the Co-Founder and Managing Director of OneValley Ventures, where he leads the OneValley Ventures team strategy and investing activity. Before joining OneValley, Juan was Managing Director of Nimble Ventures and led growth investments at Passport Capital. During his tenure at Nimble and Passport, Juan invested in and managed investments in numerous billion-dollar startups. Juan has been in the venture capital industry for 14+ years and has worked in technology investing and research for the past 20+ years.