I wrote this blog for ghost publication in Growth Business in March 2022. Teamwork is dream work.
It’s a great time to be a startup – or is it? Only a few months ago we were celebrating a golden age of venture capital with $621bn pouring into startups around the world. Some commentators predicted 2022 would be even bigger.
Things today are looking a bit different. Persistent inflation, interest-rate hikes and conflict in Europe have cooled public markets. And while the early stage investment market continues apace, the effects we’ve seen in the public markets have shown some sign of spilling into the VC ecosystem.
Against this backdrop, now’s a great time for new founders to pause and take stock. In situations of uncertainty, you can give yourself an unfair advantage by knowing when and how to look for funding, how much to look for, and what VCs will want when you do.
All hands on (the) deck
First things first – VC money isn’t for everyone. The process of raising VC can be time-consuming, as well as rewarding. Done right, you can learn about important holes in your business and receive support from experienced investors who’ve seen people in your shoes before. Done wrong, fundraising is an unwelcome, never-ending distraction from running a business.
If you decide VC is right for you, the first thing to do is make a great deck, and ensure you know your market inside-out.
When creating a deck, the priority above all else is to ensure you tell a compelling story. Assume your reader is coming to your market without prior knowledge – this forces you to explain complex ideas simply. Then, ensure your deck leaves a reader curious and intrigued.
Some people try to make decks like business plans – long and full of data and financials. Of course, this information is important, but in a fundraising deck it is more important than anything else to you leave the reader with intrigue. Get many friends to read your deck, to know whether you’ve hit the spot in this regard. Are they excited by the opportunity you’ve explained?
Pitch perfect
So you’ve nailed your deck. Now what? Well, in reality a VC fundraise deck is just a door opener. The best VCs don’t sit and listen to your pitch alongside your deck, Dragon’s Den style. Real VC meetings happen after a VC has read a deck. It’s a two-way chat, digging into you and the detail around your business. The deck is a barely used prop.
In your first pitch meeting, your job is convey domain expertise and energy, above all else. Some call this ‘vision’. What you need to do is show your understanding and excitement for the market, while demonstrating that you are a commercially-minded subject matter expert.
In a good pitch, a left-field question from a VC should be a rare thing. The best founders come into meetings with VCs and know their space much better than the VC in front of them. It’s probably a warning sign if a VC knows your space much better than you. To be successful, knowing your market, your customers’ key demands and your company metrics is vital. A VC is looking for your ability here.
Which VC?
When you’re an expert in your market and you’ve got your deck sorted, there are two things to consider before sending VC emails out: the stage of both your revenue and product.
While some VCs back businesses with a dribble of revenue – or even just a deck – many want to see more revenue to prove you’ve built something others actually want (42% of startups fail because of lack of market demand – it is rarely because of product development!).
When picking your target list of VCs, it’s best to research online which funds are right for the stage of your business. Crunchbase is probably the best free place to start.
As a general rule, if you are pre-revenue and pre-product, you are a ‘pre-seed’ business. If you are post-product and have a bit of revenue (~£10-20,000 per month), you are a ‘seed’ business. If you have £1m of annualised revenue, you are ‘series A’ ready. These definitions change constantly – but this broad outline is a good place to start.
Alongside researching relevant funds, if there’s a pro bit of advice here, it’s not to pursue series A/B funds if you want pre-seed or seed funding (unless you have a very warm intro). Most of the time, they will say no, wasting your time, and worst case it could even close the door on a later round. However even if they do invest in you, your investment is a rounding error for that fund. They’ll see you like a call option for a later round. If you hit a speed bump, the signalling risk of them not investing could be much worse than the benefit of having them on your cap table to begin. In short – it’s not worth it.
If you are a pre-seed or seed startup, funds dedicated to your stage will have seen the growing pains you are (or will!) experience, time and time again. You will be a meaningful part of their fund, so they will give you time. And they will probably give you personal as well as professional support – as they’ve seen founders going through some of the hardest (and earliest) parts of business like you.
If you are pre-series A, it’s also important not to discount friends, family and angels. Of course, not everyone has access to people willing to invest in their companies – but individuals can make quick, decisive decisions that can get the ball-rolling on your fund raise.
The VC connection
Once you start meeting VCs, if you have a strong pitch several funds may offer to back you. At that point, your choice of partner is key for your own sanity as much as it is for your company.
At the early stage, an investment is a relationship. Early stage VC is about more than transferring a pile of cash into a company’s bank account and collecting a return a few years later. It’s a process of constant communication and hard work.
Good VCs are on hand when you need them, and the right friendship can be the difference between success and failure. After you’ve established a relationship and the VC has expressed an interest in investing in you, ask how they hope your partnership will work.
Most VCs want to help you in any way they can – their fund’s performance depends on you as much as your performance depends on their cash. VCs are normally good at opening doors, whether that be with future funding rounds (by introducing investors), or sometimes by introducing connections that can help with product, CS, tech or hiring.
More important than a laundry list of ‘value add’ items though, are two simple things. First, do you like them? Second, do you respect their approach and thinking? This is key, because if you like them, others will too.
VC is a relationship world, and if you like a VC, there is a chance their peers will too. If their peers do, their black book will be strong, people will respect them professionally, and that will open doors for you. On a personal level, when things get tough, the last thing you want is a ball buster.
How much and at what price?
When you are putting your deck together, a top question is “how much do I want to raise?”. There’s a lot of capital available to startups today, and seed rounds in 2022 are closer to the Series A rounds of 2012.
So, how much is enough? This will depend on how cash hungry your business is and the stage it is at. As a very rough rule of thumb, raising up to £500k at pre-seed is middle of the road right now. Then you are looking at £1.5-3m at seed, and £3-5m+ at series A. These numbers are heuristics, and change rapidly (probably on a six month basis). The numbers here are about average in the UK in March 2022. You’ll see rounds that are bigger than this, but it’s likely they aren’t the ‘usual’.
Importantly, every business is different, and there may be good reasons to raise more or less along the way. You should though, regardless of anything, raise enough money to give you at least 18 months of flat (no growth) revenue runway. That way, you’ll have time to make mistakes and learn.
Alongside runway, it is key to raise an appropriate amount without unnecessarily diluting yourself. A general rule is to aim for round dilution of 25% or less. In the current market, 20% dilution is standard. Beware of any VC that tries to own 30% or more of your company in a single round.
Alongside raise amount and dilution is the all-important valuation. On valuation, there’s one golden piece of advice – never suggest one to a VC. At best, you’ll get what you want. But at worst, they could think your valuation is too high or low, and decide you are either unrealistic or don’t know your market.
Given how quickly the market changes, founders are not expected to suggest a valuation. Decent VCs know where the market is, and will suggest a valuation. Focus instead on dilution. You can then negotiate a valuation if you have competing term sheets from multiple VCs. Suggesting a valuation upfront only risks closing a door, and doesn’t open any door.
Finally, remember that your valuation is the benchmark for your next round and, eventually, your exit. If you plan conservatively, think that your exit will be at a valuation of 5-10x your annualised revenue (assuming you are software). For a future funding round, assume it will have a valuation ceiling of 10-20x your annualised revenue at that point.
What does this tell you? If you are at a £20m post-money valuation after a round, you are likely to need at least £1m of annualised revenue before you can raise another funding round at a higher valuation. And the more money you raise, at higher valuations, the more performance you need for VCs to remain supportive.
Of course you could get better multiples than 5x, 10x or 20x. But entrepreneurs are great risk mitigators as well as great risk takers, so plan for a more difficult market. Also note that, like with fund raise amounts, valuation multiples change regularly. The above pointers apply to where we are in March 2022.
A final financial thing is to look ahead in the fund raise. Post-series A, a founding team should together have at least 30% of the equity in a business, and ideally 35-40%+. If the founding team is getting close to this early on, you’ve raised too much money or raised at too low a valuation. You will need to be recapitalised. Investors dislike this and it can make your round hard to support. The solution? Just think ahead and raise the amount you need at a sustainable dilution.
Good housekeeping
After you’ve done you deck, structured your raise and got a VC interested, the final piece of the puzzle is to have a structured data room available for an interested VC to review (Notion is hot for this right now).
In the data room, you include all your key company information, separated into at least four sections covering Commercial, Financial, Legal and HR aspects of your business. Gold standard would be to have a mini investment memorandum written in the third person for a VC.
Having the data room ready when you meet a VC makes it easy for them to take you to IC, and quicker for you to get the all-important ‘yes’.
Picking your moment
Even in the uncertainty around us today, there has never been a better time to be a founder. Some jitters caused by current events is to be expected, but there are plenty of willing investors for great businesses, whatever the year.
Picking the right moment to go looking for investment – and ensuring you’re ready before you do – can be the difference between a bumper, oversubscribed investment round and going home empty-handed.
Have the pointers above in mind, and you’ll be starting with an advantage!
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