How to Raise Money for Your Startup

I wanted to follow up one of my previous posts about How to Get into Y Combinator — in which I talk about the four kinds of risks investors look at when deciding to invest in your company — with a much more practical post about how to raise money from investors.

I’ll caveat here that in my own experience with One Month, we were fairly fortunately to have been accepted into Y Combinator, and so the process of fundraising was significantly easier than it would have been otherwise. That being said, I truly believe that’s because the partners at Y Combinator, including Paul Graham, have distilled some important truths about fundraising that they were able to pass along.

The first lesson is that the first investment is the hardest.

When you start fundraising, if you’re lucky you’re going to get a lot of “soft” commitments. These sound something like, “I really like the company and I’d like to invest, let me know when the round’s about to close.” In some cases, they may even say that they’re in, but they’re just putting up a little resistance to actually giving you the money.

You need to recognize that it’s not an investment until you actually have their money.

And it’s also in their interests as investors to wait as long as possible to actually invest. If they believe they can commit now, and put the money in later, they will always do that. Why? Because sometimes more information will come up and investors will back out. It happens all the time.

As an entrepreneur you need to apply a strong pressure here.

One of the advantages to using a convertible note or Y Combinator’s SAFE financing document as your fundraising tool in the seed stage is that you can collect money immediately as it comes in instead of all at once at the end. This is called a “rolling close.” It alleviates some of the risk of having to get buy-in from a bunch of people simultaneously and then having one person or problem fuck it all up.

The strategy that I learned at Y Combinator was that as soon as I got a soft commit from an investor, I wrote up a convertible note (using Clerky) for the highest amount they mentioned they might invest and sent it to the investor with the following email:

Our round is getting pretty tight, be we should have room.

I’ve sent over the standard YC convertible note docs using Clerky for a $100k investment at a $6M cap. Take a look and let me know if you have any questions and either [lawyer’s name] (legal counsel) or I can get back to you. Otherwise, just sign and we can guarantee your spot in the round.

So you really have to do whatever you can to close the first investment in a round. The first $25k or $50k or $100k. In terms of focusing your energy, don’t spend a ton of time on small investments like $5k or $10k (we actually didn’t accept any investment under $20k in our first round).

The momentum builds after you get your first investor, because it’s likely that investor will introduce you to other investors, and so on. Like a chain reaction. Sometimes that doesn’t happen but in a large enough round it will.

The second lesson I learned was don’t create a pitch deck or a business plan.

You’ll hear, “do you have a deck?” from investors all the time. The stock response that the YC partners told us to give was (roughly):

We’ve been too busy running the company to prepare a pitch deck. I’m happy to meet in person to tell you more about the company.

In the early stages, if an investor asks for a pitch deck, he or she doesn’t know what she’s talking about. It just turns out it’s not really necessary. And it saves you a ton of time doing something that isn’t important.

Instead of a pitch deck, prepare whatever short document you think the investor will need to see in order to invest (a simple Google doc will do), but only send it to the investor after your first meeting.

The later in stages you get, the more documents you’ll need to prepare, but in the seed stages you may not need to do any.

The third lesson is that with a “rolling close” you can change the amount you say you’re raising.

This can be helpful for applying pressure to investors that are on the fence.

At first we told investors we were only looking to raise about $250,000, and we had already gotten $150,000, so if they wanted to guarantee a spot in our round they would have to do it immediately.

This helps counter that investor feeling of, “I can still wait it out and get into the round right before it closes. I have time.”

The major caveat here is that it’s important to know how much the person or fund you’re talking to needs to be able to invest. This is a major mistake we made. We said we were raising the same number ($250,000) for angel investors and funds initially, but that essentially ruled out the funds.

Many funds have to be able to invest large amounts of money (anywhere from $500–750k to $3–5 million) for it to even be worth considering you as an investment. If you say you’re only raising $500k and you already have $250k, that essentially rules you out as an investment.

Find out what terms the fund typically invests in, the size of the fund, and how far through the fund they are. Almost all VCs are willing to tell you that information almost immediately.

But you don’t really need a lead in a seed round. It can be helpful for filling up the round faster, convincing others to get on board, and later for strategic stuff like introductions and advice, but it’s not really necessary. You can raise the entire round in checks like $50k or $100k if you need to.

And as time goes on, you up the amount you’re raising. You can even theoretically up the valuation cap on the note as you get more interest.

Take easy money.

If someone wants to invest, and you like the terms, take it. But be discerning. Talk to some of the companies they’ve already invested in, especially the ones that didn’t succeed, to see how the investor relationship worked (you may have to reach out to these companies yourself).

The last thing you want is an investor that’s going to cause trouble or be difficult to work with. (For example, we had one investor who asked for his money back after three months and didn’t want to sign a standard convertible note extension even after all our other investors had.)

At the end of the day, investors often aren’t as helpful as you’d like them to be. Their helpfulness comes in waves. If you reach out, they may offer a hand, but most of the time the intros they’ll make come right after they invest, and trails off as the excitement wears off. That’s okay. Money is money. And you wouldn’t want them too involved anyway.

Finally, don’t talk to associates.

It’s a waste of time. Insist on communicating with partners and getting partners involved early on. If you’re talking to an associate at a fund you like, ask which partner would really be interested in a company like yours and then ask if they can put you in touch with that partner.

Because some firms know this, Associates often go by the name of “Investor,” or “Venture Partner” instead.

What Are The Different Stages of Startup Fundraising?

When you’re building a startup, how should you go about funding your company?

The early days of a company are virtually utopian: a founder and a co-founder batting ideas back and forth in an environment of perfect creative bliss.

Even the term we use for this creative space — the incubator — calls to mind the warmth and coziness and1 protection of a womb. There comes a point, though, when a company needs to move from ideas toward an actual product, and in order to do this, they need to think about generating money. But how to get money before there is a product to sell?

Well, when startups raise money, they do it with rounds of investments called the Seed Round, Series A-B-C, all the way until they either incorporate or sell. In each round, the company receives money from venture funds that focus on specific growth points at specific sizes.

Basically, you can break a startup’s funding rounds into the following stages:

  • Seed Round: This is usually a small amount of money given to a company to give it the momentum it needs to produce its initial product. Normally, the company will have a concept and will know that it has potential viability on the market, but they won’t have a working prototype yet. Seed money gives the company just enough runway to move from this early conceptual phase toward a product.
  • Series A: At the point when a company has a prototype, they can seek funding from a venture capital group to work toward bringing the product to market. The series A funding will be larger than the seed round (usually between three and seven million dollars), and will be offered in exchange for a portion of the company. Startups typically use series A funding to figure out the best business model for their company and to work out the nuts and bolts of moving your product into the actual marketplace.
  • Series B: By the time they’ve reached series B, a startup has a product and a business model and need enough capital to bring the product to a broader market. This represents a significant increase in the funding, from $7 million to upwards of $50 million.
  • Series C: This is all about fast growth. In series C funding, companies might move the work they’ve been doing in series B toward international markets or focus on diversifying their product for multiple different platforms.

How long do you spend on fundraising rounds?

Funding rounds can go on forever if the startup wants, but that’s not really practical. In each round of funding, you offer a piece of1 your company to your investors. That works great in the first few rounds, since the company’s valuation grows as people invest, but since you give up about 25% of your company each time someone invests, aft1er a couple of rounds of funding, you don’t have much left to offer an investor. At that point, it’s important for a company to either sell (like Instagram did) or to start trading publicly (like Facebook).

A good model for thinking about how this form of growth works is Instagram. They started with a $500,000 seed round, and then within two years of that raised a $7 million series A and a $50 million series B, before they were finally bought out by Facebook.

Generally, a startup can expect between a hundred thousand and a million dollars in their seed round. With each round of funding, the startup gives up a portion of the company (usually about 25%) to their funders. Occasionally startups skip the seed round and raise a few million dollars of series A funding right out of the gate, but the Instagram model above is much more typical.

Key Takeaways

  • Startups raise money in rounds of investments with venture funds that focus on specific growth points.
  • Most of the time, you’ll start with seed money and a short runway. More than a million dollars and you’ve skipped straight to series A.
  • It’s important to plan for growth. After too many rounds of funding, you won’t have much left to offer investors.

Further Reading

The Startup Fundraising Series: