Raising money for your startup is one of the hardest things you’ll do as a founder. It can be an intense and time-consuming process. It often involves many rejections before a round is successfully closed.
In this unit, we cover some practical tips to help you approach the right investors and streamline the process of raising a funding round.
Create an investor wish list
Most funding rounds involve more than one investor. Two to five investors is typical. It’s common for startup founders to approach dozens of investors before they get the small number of commitments needed to close a funding round.
How do you decide which investors to approach, and in what order?
The first step before you contact any investors is to do research and determine which investors might be interested in your company. Consider the sector focus, stage of investment, and geography. Most investors prefer to invest in companies located close enough that they can meet in person (although this preference has changed markedly over the last couple of years).
After you have a list of potential investors, rank them in order of preference. At the top of the list, are the investors that you most want to have as shareholders in your company. This ranking might be because of their sector experience, networks, or strong brand. Maybe you spoke with the founders they backed previously who told you that they’re great to work with.
At the bottom of the list, are the investors that you would be willing to have as shareholders. They might be less desirable because they have shallower expertise in your sector. Or, they’re general partners who don’t have experience as founders, or the feedback about them from other founders is less positive.
Don’t contact investors from whom you wouldn’t accept an investment; this wastes your time and theirs.
There are two schools of thought on which investors to approach first:
- If you’re confident of your investment proposal and your pitch is polished, start at the top of your list. Pitch the investors you most want to invest in your startup. If they agree to invest, your funding round closes more quickly and you avoid wasting time with less valuable investors.
- If it’s your first time raising a funding round, your pitch is a little shaky, or your company only just meets the investability threshold for your target investors. It might be a good idea to start at the bottom of your list.By pitching less desirable investors, you gain experience in pitching your startup. You also receive feedback and questions from these investors that you can integrate into subsequent pitches. By the time you make it to the top of your list, your pitch will be more solid and you can anticipate many of the questions you’ll receive.The disadvantage of the second approach is that it takes longer. You’ll have more meetings, and you might even receive investment offers from your nonpreferred investors. Many founders find it difficult to say no to an investment offer, because they run the risk of saying no and then not receiving offers from any of their preferred investors.
Make contact with investors
Almost all investors allow startups to send unsolicited pitches, either by cold email or through a form on their website. Well-known investors often receive many hundreds of unsolicited approaches that are of highly variable quality. As a result, your pitch might receive little time and attention.
In contrast, most early-stage investments come via referral from someone whose judgment the investor trusts. These pitches are often taken more seriously and receive a more thorough review.
After you decide which investors to contact, get a warm introduction via a mutual connection if you have one, or through a founder of one of their existing portfolio companies.
Building relationships with investors takes time. Most investors are receptive to having informal discussions with founders well before you begin the process of raising your funding round.
Investors are often happy to share their experiences with early-stage founders as part of their outreach and deal-sourcing activities. By getting to know you and your company, they’re able to offer you some light-touch input and connections to other founders or investors, potentially over a period of a few months.
At the same time, they get to see you in action. They get a sense of the speed and urgency with which you execute, and see whether you follow through on the advice and connections they offer. They can also gauge whether they might be happy in a long-term business relationship with you.
By building relationships with investors in this way, you increase the chances of them committing when you’re ready to open your funding round.
Approach investors in parallel rather than in series
One of the most common mistakes made by first-time founders is to approach too few investors at the outset.
After you contact an investor, it might take several months before you know whether they’re going to invest. If you only contact a handful of investors, you run the risk that all of them will pass on the round. Then you have to restart the entire process with another set of investors, which increases the time it takes to close your funding round.
Approaching investors in series also means you have little opportunity for competitive tension, so there’s less incentive for each investor to offer attractive terms. It can even lead to unfavorable terms if investors know that without their money, your company could run out of cash.
Finally, startups that are on the fundraising trail for an extended period start to look questionable. Investors will ask why your required funding is still secured after many months.
In contrast, if you make initial contact with 10 to 20 investors in parallel, you increase the chances of closing your funding round quickly. The up-front workload is higher, but this approach allows you to treat fundraising like a sales funnel and prioritize your efforts on those investors who appear most likely to proceed. Even if most investors pass on your funding round, you have enough candidate investors in the pipeline that you don’t need to restart the entire process.
You might also be able to achieve some competitive tension as investors realize they need to move quickly and offer attractive terms to not miss out.
Find a lead investor
Most funding rounds involve multiple investors, but in most cases one investor does most of the pre-investment work and is often the first to commit funding. This investor is referred to as the lead investor.
Finding a lead investor is important, because their commitment signals to other investors that someone they trust has evaluated your startup as a worthy investment. This phenomenon is noticeable when the lead investor is a top-tier venture capital fund or well-known angel investor. On many occasions, previously undecided investors commit within days of learning that a lead investor is committed to a funding round.
As a startup founder, one of your objectives is to find true believers who will make an early decision to back your company and help you secure the other investors you need to close your funding round.
Conversely, it’s rarely a good idea to spend time trying to convert potential investors who are on the fence, or who don’t show a sense of urgency in making an investment in your company.
Understand term sheets
A term sheet is a short legal agreement between your company and an investor that sets out the key terms of a proposed investment. Term sheets are normally not legally binding, except for clauses relating to:
- Confidentiality: You can’t disclose the term sheet to other parties.
- Non-solicitation: You commit to proceeding with the investment and can’t shop the term sheet around to other investors in an attempt to secure better terms.
After investors sign a term sheet, they commence due diligence, as discussed in the following section. If no major issues are identified, the transaction is documented in a more substantive set of legal agreements. Funds will only be transferred to your company’s bank account after these agreements are signed.
Term sheets are an important part of the fundraising process. They allow investors to make an in-principle commitment to invest, but without the overhead of negotiating detailed legal agreements. They also allow startups to have some degree of confidence about which investors are committed and on what terms.
The content of term sheets is beyond the scope of this unit. As a startup founder, you should be familiar with the key terminology and concepts contained in term sheets. You should also put some thought into preparing a term sheet of your own.
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