Raising Money: A Conversation

Introduction 

This is the second of two articles co written by John and Joe.

Joe is an Investor with the early-stage seed-fund Coast to Crest. He is a startup founder with two successful exits who turned his attention to community building, starting a biotech incubator and running a startup accelerator program for 5 years. He also is a consultant who works with  growth-stage companies transitioning from startup to scaleup.  He has worked with hundreds of early-stage founders. You can read more of Joe’s writings on Medium.

John is the CTO of a startup building blockchain games and a veteran engineering leader with over two decades of startup and games industry experience. He is blogging for educational and therapeutic reasons at https://www.mofactor.com and soon hopes to announce what he is working on full time.

Why did we write this article?

John: 

I recently met with a first-time entrepreneur about to go raise money for the first time. It sent me on a wild roller coaster ride reliving experiences from over a decade ago. There is so much I wanted to say and only had a half hour or so to spare. I made them some quick introductions, including to Joe, to offer some additional thoughts about what they should be doing. At that moment I realized that, for a lot of people, raising money for their business is something they see in the news and hear about, and they do not fully understand the process. Much like our mentorship article, Joe and I decided to work on another shared article to help illuminate the process a little.

Raising funds

John:

So I have been on the management teams of companies that have gone through tremendous sums of investment money to try to do many, many different things. I have also attempted to raise money as a business founder a few times with less success. Given the amount of PR by companies raising rounds, and the number of people who I was spending time with at various tradeshows and in professional settings, it seemed like it would be an easy thing to do.

I am going to talk about why I did not raise money as a first-time fundraising entrepreneur and hopefully provide some transparency that surrounds the process.

Joe:

I founded a company that did NOT raise money, but was on the ‘other side of the table’ for my game company; we invested in startup indie game studios as a publisher. I also raised money for my accelerator program and my seed fund. I can provide insight into what I was looking for to fund (or not fund) a potential company, as well as techniques I used to raise money. 

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Why should you raise money?

John:

Building amazing things takes audacity. Just about anyone can build anything. That does not make a successful business. Generally, building an amazing thing and a successful business takes audacity… and investment capital.

There are a lot of reasons to raise money, and I was trying to raise the wrong kind of money right out of the gate; I wanted the wrong amount, and I needed it to solve the wrong problems. Because I was surrounded by people in silicon valley trying to raise millions of dollars of venture capital to do crazy things, I figured I would just jump in alongside them and do the same. I re-read some of my old pitch decks with more than a little regret, because I was clearly making a lot of rookie mistakes along the way.

So why should you raise money?

You should raise money to reduce risk. The type of risk you are reducing and the capital available to help you should generally be aligned. I was asking a lot of investors for a small investment round to help me build out a product to prove an idea. The people I was asking were always gently encouraging but almost never told me that I was going about it backwards. I would have been better off finding a few angel investors, or continuing bootstrapping, rather than distracting myself to ask for the wrong kind of money to reduce the technology risk.

Venture capital generally comes in at a later stage in a company’s life cycle. It did not really matter that we had a decent revenue pipeline and were profitable as a game studio. We wanted to do a crazy and risky platform to go direct-to-consumer in the carrier-centric world of 2005. Regardless of how good the idea was, and how the plan would have worked, no one I was asking was going to write our team a check for the amount we were asking to solve the problem we had.

Joe:

I am going to first state the main reason I choose not to invest, and that is the ‘validation’ problem. Too many entrepreneurs are looking for an investor to validate their idea as ‘worthy’ by agreeing to invest. Startups founders are often on the hunt for traction—attempting to see if their idea has merit. Getting investment is a shortcut to the process of having the product validated by the market.

Why raise money? Big things take resources. If the idea and its execution are good, then it is all about time. You could bootstrap, but it might take years to get to a scale that makes a significant impact. By the time this happens, the opportunity may have passed or a competitor may have surpassed you. If the idea is solid and the execution against that idea is working, it is time to exchange future value for present resources in order to make it happen quickly.

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When should you raise money?

John: 

It might sound trite but the worst time to raise money is when you need it. The best time to raise money is when you are about to embark on a structural change in your business that will be a significant step-function increase in its value.

You can try to raise speculative money on how successful you will be before you get the product live, which is where the most aggressive investors will want to be, or you can prove out the business and completely de-risk it which makes it a more clearly definable bank transaction. I have seen both of these investment rounds. Generally the more mature your business, the more it looks like the latter.

The amount of money you want to raise is also significant. Raising modest angel money should be started earlier in the process, compared to raising large tranches of B and C rounds later in the process. Your current series A and B investors will also participate in the timing and raising of later rounds.

Joe:

When to raise money is an interesting question, as there is no right answer. It depends on the industry, location, and team. That being said, generally the best time to raise money is when you are convinced there is a real opportunity there. If you are casting about for a market and think there is an opportunity there, you will probably not have much luck. In order to convince others, you need to be really convinced yourself and be ‘all in’ on the opportunity.

The process of starting raising money should start early. Raising money takes time, and the relationship that leads to investment should start as early in the process of your startup journey as possible. If an investor invests, they know that it is going to be an 8-10 year relationship.  Entering into such a relationship usually does not happen at the first meeting/conversation. 

How much to raise is also important. You need to raise enough to get to the next meaningful milestone. I also tell founders that the best size of a round is one you can close. You have a plan, but there is a back-and-forth in the fundraising process where the plan needs to adjust to the amount of funding you can close. Appetite for investment needs to be measured. You do this by having conversations with investors.  

It is never too early to start, but from the start of a conversation to a closed round could be a long time. Stay lean during this process and make sure that you can keep your operations running for six months or more. 

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Why won’t people give me money?

John: 

If you have glaring holes in your plans, team, or leadership, no one will invest in your business. Quite often most of them might see nuggets of potential and they will not directly say no to your face. This drives me up the wall. Most “no thank you” replies will be phrased as “let’s see where you are in two months”. Another reason people won’t give you money is you are asking for the wrong amount, or asking the wrong people. Quite possibly you might also be asking at the wrong time. Maybe you are doing all three.

In 2005, asking for 3 million dollars as a series A investment for a 50% services-based profitable studio was a bad idea. We should have put together a 500k angel round with specific milestones to prove out our new business, or else figured out how to ask for 6 million dollars for marketing and growth after figuring out how to fund the product ourselves. We could have increased the amount of recurring revenue we were generating on non-service-based product sales, or else found a few juicier service contracts with better margins. We went out and asked the wrong people on top of asking for the wrong amount.

Joe:

The answer is in the question. Investors exist to invest money, not give it away. I would say that 50% of startups I meet with use the term ‘give’ and it is a big turnoff. They are looking to raise money because they need or want money. As a founder myself, I get it. As an investor, the founder needs to understand that my goal is to take money and turn it into more money. I am not there to ‘give’ people money. It is not a gift. When a founder asks for someone to give them money, it is like asking for someone to give them a cookie. One cookie leads to a second cookie and more cookies until there are no more cookies. 

There is ‘what you think you need’, and there is ‘the right amount’ that, if deployed, will turn that money into more money.  

Too much money too early can create problems. There is the old adage “work expands to fill all available time”. Money buys time. More money makes more time available, and the amount of work will expand to consume all of it. My job is to figure out not how much you want, but how much you actually need. If we can agree on that number, then it might be a good investment. 

You have an idea. You need a plan. The idea might be good, but a clear plan that executes on that idea is necessary. Yes, the plan is probably not 100% correct (it is probably completely wrong), but there needs to be at least an initial list of needed resources in order to execute on the idea. This is usually a list of people, some activities that need to be done, and some initial guesses at the scope of the work. If the guess does not seem wildly off the mark, you may have a good shot at getting investment.  

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Why will people give me money?

John:

There are a handful of reasons why people want to invest in you. Largely they see a potential for you to give them a desired rate of return for the dollars they invest.

The four or five other factors after this include:

Location – Some funds like to invest in specific geographies. I have heard that talking to specific Sand Hill Road investors would be a waste of my time even from the Davis California area because some investors want to have a short drive to their portfolio companies. Some funds are specialized around cities or states also as a part of economic growth programs.

Business Focus – Some funds also possess an investment thesis. They believe in a particular market segment and are focusing their investments into these areas to establish synergy and to leverage expertise amongst their partners and their portfolio of companies.

The “right stuff” – When you go and ask for money the three basic requirements most people look for are:

The right idea

The right team

The right strategy

If you are two out of three, that is not necessarily a complete show stopper but then it will boil down to the investor figuring out if they have the time, energy, resources, or network to help get you to three out of three. Unfortunately for me, in 2005, when I was first raising money I did not have the right strategy. I had a mostly solid team, and a reasonably good idea. That was not enough. We had a pretty solid commitment from a marketing leader to join us after fundraising to help close the team gap, but too much of what we wanted to raise would have been spent on product development. That translates as pure market risk. Unfortunately that is not a very popular thing for venture capital investors.

Joe:

An investor will invest in, 

A clearly articulated idea, 

That solves a customer problem

In a market that is large enough to matter 

And

In a market that the founder understands (and the investor understands)

And

Has created a team that has some of the skills to start (that the investor can determine based on their experience in that market)

And

A clear plan with a clear price tag to enact that plan on a timeline that seems reasonable (based on knowledge of others doing work in that sector)

For an amount that , if successful, will generate returns in excess of the next person to walk through the door. (based on similar investments in that area of focus).

The order of risk reduction from smallest to largest is:

Reduce management risk, reduce technical risk, and finally reduce capital risk.

For early stage companies, the first thing that gets looked at is the team.  Does this team make sense to solve this problem? Have they done a startup before?  Do they understand the work that is ahead of them?  When I am assessing a team, my #1 criteria is ‘are they coachable’.  If a founder is not coachable they will not get investment.   

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Final thoughts:

John:

While I was out smashing through walls as a bootstrapping entrepreneur and building tight-knit teams that could create amazing products, that was not enough for me to level-up the business alone. Even taking on a technical co-founder, we did not de-risk our business enough, nor did we come up with a compelling enough strategy to get an investor to come on board.

Our plan at the time was to spend a few million dollars in building a high-end action RPG game that we would launch on only the best of next generation mobile phones, since we predicted there would be a must-have smartphone arriving in 2007 to 2008. A few years later after failing to raise money for this, that phone did arrive in the form of the iPhone. There were a lot of things we could have done differently to be prepared to launch compelling platform-defining content at just the right time. There were probably a lot of things we could have done differently to get one or more investors on board to make that journey less risky along the way.

Joe:

It is tough to add final thoughts as I feel we have just scratched the surface. My best advice for those starting the process is to focus on the long term. Many founders are focused on what they need right now. The short term immediate focus can be dangerous as it can leave you in no man’s land. If you are doing a cross-country trip, it is not a great idea to travel from gas station to gas station putting $5 in the tank. You can’t fill up for the entire trip, but you are better served to assume, and plan for, the probability that you will need gas during the journey. You should choose a path where there are gas stations along the way and for certain sections of the trip, plan to have enough gas just to get to the next one. You don’t want to be in Death Valley and out of gas.  

Having been a founder, I know now how long and arduous the journey can be. Back then, I was living very much in the ‘now’. I focused on what I needed then. I was not thinking from the perspective of the investor, which is longer term and focused on turning their investment money into a larger pool of money. You need to get out of the founder bubble and think of the needs of your investor, which are aligned with your needs, but different. My final thought and best advice: If your goal is to make your investor successful, you will fare better when you go out to raise.