Determining the right time to fundraise a seed round is crucial
Fundraising is an essential part of the journey when building a startup. Raising capital can provide resources to scale the business faster, hire new talent, and expand the team. However, determining the right time to fundraise a seed round is crucial.
The companies I have co-founded or led as CEO have raised over 130 million; as an advisor, I have helped founders raise millions. And I realized that the first round, the seed round, was always the most difficult.
Seed funding is an early-stage investment in a startup that provides enough capital to get the company off the ground. It typically comes after the initial stage of bootstrapping and family-and-friends funding but before series A funding. Seed funding can range from a few hundred thousand to a few million, depending on the startup’s needs and potential.
In my case, seed funding was always very costly. Initially, we had little idea how to approach investors, what the story was, how to communicate it, or what was needed. I may remember embarrassing situations at pitches where I forgot my text because I was tremendously nervous. It’s like your product; you get better and better by iterating.
Still, you may find fundraising in the seed round difficult for several reasons:
- At this stage, startups typically need a proven track record or revenue to demonstrate their business model’s viability, making it harder for investors to assess the risk and potential return on investment.
- Startups seeking funding in the seed round face intense competition as many new companies compete for a limited pool of investors. As a result, it can be difficult for you to differentiate yourself and pique investor interest.
- Seed investors are often looking for unique and innovative ideas that have the potential to disrupt existing industries, and this means startups must have a compelling and differentiated value proposition to attract seed investment.
- Fundraising is a time-consuming process that requires significant effort and resources from the startup team. It can be challenging to balance the demands of fundraising with the day-to-day operations of running a startup, especially in the earliest stage when the founders practically need to do everything.
- Finally, investors are often reluctant to be the first to take the risk of an investment. You will often hear, we will go along if you find a lead investor.
“Raising money is hard. It’s a full-time job, and you have to be completely committed to it.” — Ben Silbermann, co-founder of Pinterest.
As a startup founder, raising capital is crucial for accelerating your growth. It can provide the necessary resources to hire your first employees, expand your product line, and enhance marketing efforts. Moreover, securing funding can help establish strategic partnerships, negotiate better contracts, and increase brand awareness. In some instances, raising capital is also necessary to prevent the startup from sinking into bankruptcy. With funding, a startup’s growth potential may be unlimited, making it essential to consider raising capital to ensure your business thrives.
However, the harsh reality is that your counterpart will always possess more knowledge than you. In particular, venture capitalists engage in the same activities as you do for your startup, but at a larger scale and as a profession. They are familiar with industry terminology and seek to obtain the largest possible share of your company to maximize their return on investment.
Finding the right seed round investor is crucial for the success of a startup. Different investors have different areas of expertise, investment preferences, and expectations. By identifying the appropriate seed round investor type that aligns with your startup’s goals and needs, you can increase your chances of securing the necessary funding and support to grow your business.
Initially, I placed a high value on securing “smart money” from investors who could offer additional benefits and increase the likelihood of success. However, I changed my mind. Instead, accepting funding at good terms from investors who genuinely believe in your goals and vision is more important. Most of the investors are well-connected anyway and help when you approach them. But expecting day-to-day support and miracles is just not realistic.
Several types of investors are available for a seed round, each with advantages and disadvantages. Here are some of the most popular options:
1. Angel Investors and Syndicates
Angel investors are high-net-worth individuals investing their money in startups. They typically invest in seed-stage startups and offer mentorship and guidance. Syndicates are groups of investors who pool their money to invest in startups collectively.
- Can provide mentorship and guidance for startups
- Will often invest at the seed stage when other investors may not be interested
- They may not have as much funding available as VC firms
- They may have less experience in the startup world than VCs
- Too many angel investors on the captable can cause problems in the next rounds
2. Early Stage VCs
Early-stage VCs usually invest in startups showing traction and invest more money than angel investors. Examples of early-stage VC firms include APX, Wingman Ventures, and Sequoia Arc (while Sequoia arc is somewhere between a VC, accelerator, and incubator).
- Can provide more significant amounts of funding than angel investors
- Often have experience in the startup world and can provide valuable guidance
- May have access to a network of other investors and resources
- They may be less likely to invest at the seed stage
- May require a higher level of traction than angel investors
Accelerators provide startups with resources and support to accelerate growth, typically in exchange for equity. Examples of such programs are Y Combinator, Techstars or Kickstart.
- Provide resources and support to accelerate startup growth
- Often have a network of mentors and other resources
- Can provide funding and resources to help startups succeed
- Typically require equity in exchange for resources and support
- May have a limited time frame for participation
- They are often not as valuable as they claim to be
4. Crowdfunding and Investing
Crowdfunding raises capital by asking many people to invest small amounts of money. Crowdfunding and investing can be done on platforms like Kickstarter, Indiegogo, and Seedrs. It’s a good way to effectively raise capital or get revenue from the start — especially for physical products — and build brand awareness.
- Can raise capital while also building brand awareness
- Allows for a broad base of investors
- It can be an effective way to validate the market for a product or service
- It may not provide enough funding to support a startup’s growth fully
- It can be time-consuming to run a crowdfunding campaign
- Does only make sense for consumer products
Most importantly, you must find the investors that fit you, your vision, and your sector. There needs to be good chemistry as you may work with these early investors for 8, 9, or more years. And most likely, you will have a mix of angels and VCs on your cap table.
Bootstrapping is when an entrepreneur starts a company from personal finances or the operating revenues of the new company. It can be beneficial compared to venture capital because, as an entrepreneur, you can maintain control over all decisions and not get diluted. However, bootstrapping may not provide enough funds for the company to become successful at a reasonable pace.
Raising venture capital can be challenging for startups, and many will fail to secure the funding they need. According to a study by the University of California, Berkeley, just 0.05% of startups will secure venture capital funding, most of which will be concentrated in the tech industry.
“When fundraising, you need to be relentless and never give up. You’ll face a lot of rejection, but you only need one investor to say yes.” — Chris Sacca, founder, and chairman of Lowercase Capital.
To secure funding for your seed round, there are several key elements that investors look for:
- A robust business model: Startups must demonstrate a clear and viable plan outlining how they will turn a profit, which involves a detailed understanding of their target market, value proposition, and potential revenue streams. Please keep it simple, but have evidence (e.g., by testing the demand)
- A solid core team: For investors, a startup team’s skills, experience, and passion for launching a product or service and driving growth are crucial. At Growth Unltd. we invest only in pre-seed startups and are aware that the product and market might change; thus, the only thing we can assess is the team, which makes it so important.
- An enormous market opportunity: Investors seek a product or service with the potential for scalable growth and a broad audience. This requires identifying a market need and showcasing how your product or service can uniquely satisfy it. So seek markets with a revenue potential of over 100m $ if you want to attract investors.
- Traction: Showing traction is essential for investors, which can be demonstrated at this stage with first users, customer satisfaction, or a funnel with companies interested in the product.
- Value proposition: A compelling value proposition is essential for attracting investors. They want to see that your solution offers significant value to potential customers, whether through being 10X better, faster, cheaper, or a combination of all three. A strong value proposition should clearly communicate how your product or service solves a problem or meets a need in a unique and superior way compared to the competition. Investors want to see that your solution offers clear and tangible benefits to customers and that you understand your target market and how to reach them effectively.
- A well-defined go-to-market strategy: Investors want to see a clear plan for how you will bring your product or service to market and drive growth. This should include details on your target market, marketing and sales channels, and competitive advantage.
- A balanced competition landscape: A deep understanding of the competition is necessary. Investors will not invest if there are already other companies that are more likely to be successful or if there is no competition. The worst thing that can happen is: You pitch to an investor, and they know a competitor you’re unfamiliar with.
There are some essential strategies for startups looking to raise capital from venture capitalists and angel investors. First, it’s critical to understand the investment focus and criteria of the specific VC firms or angel investors you are targeting to tailor your pitch and increase the chances of success.
“The key to successful fundraising is building relationships with investors before you actually need to raise money.” — Ben Silbermann, co-founder and CEO of Pinterest.
Building relationships with VCs takes time, so attending networking events, participating in startup accelerators or incubators, and reaching out to investors that have funded companies in similar areas to yours can be helpful. Harry Stebbins from 20VC suggests intros to VCs via search on Twitter: “They are all on Twitter; it is easy to find their emails. Cold outbound is a crucial skill of a great founder; use the fundraising process to show yours.”
As a startup founder/CEO, you should treat fundraising as one of your priorities. I would never outsource it: It can result in losing control over the fundraising process, increased costs, and a lack of relationship-building opportunities with potential investors. Eventually, you will learn how to sell your idea and build a better product.
The fundraising process can be time-consuming and tedious, and I sometimes had to pitch 30 to 40 investors from a list of 80 to 100. However, you must persevere until you find someone willing to commit and help you reach your goals.
Raising capital for a startup can be difficult, but it can be a rewarding experience with proper preparation. Startups should aim to raise enough money to achieve a significant milestone (e.g., enough ARR to be profitable or a certain amount of paying customers), avoid constantly raising funds, and survive in a tight funding environment.
When determining how much to raise, consider progress, credibility with investors, and dilution, and prepare multiple plans. A pitch deck is crucial for startups seeking funding and should highlight the team, competition, target market, milestones, plans, and funding requirements.
Investors invest in people and teams as much as they do in the product, so emphasizing unique team dynamics and human capital will strengthen the pitch.
The process involves identifying potential investors, shortlisting them based on suitability and interest, and setting priorities. Once you have a list of potential investors, start with the C-list investors to refine your pitch and gather feedback.
As you gain confidence and refine your strategy, you can move on to the A-list investors, who can provide significant funding and connections to help your startup grow. It’s important to remember that fundraising is an iterative process, and it may take time to secure the funding you need.
You made it this far, and you seem to be serious about it. But remember that venture capital investors are looking for high-growth potential companies and expect a clear path to a significant return on their investment. The company should be able to demonstrate its growth potential, scalability, and a clear exit strategy while having a solid team, or in the words of Paul Graham, co-founder of Y Combinator:
“The best way to raise money is to make something people want.”
Therefore, I recommend bootstrapping until reaching product-market fit. It allows you to validate your business idea and test the market without the pressure of outside investors. Once you have a product or service generating revenue or showing traction in another way, attracting investors or securing loans will be easier.
Raising funds before validating your product with customers can be futile and consume valuable time, resources, and attention. It’s advisable to prioritize achieving product-market fit before embarking on fundraising efforts. Doing so gives you stronger confidence and security for yourself and your investors when you eventually begin fundraising.