Fundraising: A First Glimpse
Stephen Gable, CPA, CA | Thursday, January 12th, 2017
ECONOMY STARTUPS TECHNOLOGY VALUATIONS
There are two types of entrepreneurs in the tech world: those who spent more time early on worrying about fundraising than building their product, and liars. Every startup I work with is perpetually in fundraising mode, it’s only the level of urgency that ever changes.
Much like the rest of the entrepreneurial game, fundraising can be all together a traumatic, yet exhilarating process, but has effectively become a rite of passage for tech startups around the world. The first step in this journey of understanding how the process works, and what you should expect going in.
Whether you’re involved in the community or have had the pleasure of watching David Fincher’s The Social Network or HBO’s Silicon Valley, you’ve probably heard some catchy terminology being thrown around like Valuations, Exits, VCs or Series A . These words quickly become a part of the comically cliché lexicon of tech founders everywhere as they brace for battle– sourcing capital to keep their entrepreneurial dreams alive.
Just like a pro baseball player going from the minors to the MLB, tech companies go through a series of fundraising rounds as they mature and grow closer to their profitable steady state.
Most companies begin their life on funds borrowed from the founder and their close friends and family, and for a fortunate few, angel investors. This part is pretty self-explanatory so no need to dig into it, but once those initial funds have run dry and after taking the company from an idea and core team to the embryo of functional business, it’s time to start thinking bigger.
The first major round of fundraising, or the seed round, typically occurs once the company has a viable monetization strategy in place, has validated the fundamental aspects of their service offering and has a functional product (but probably not ready for paying customers). Companies will likely be in the pre-revenue stage of growth during the seed round, with a target launch date in sight somewhere in the 6 to 12 month range depending on how much capital the founders were able to raise and taking into consideration their burn rate. Most companies should expect to raise anywhere between $50,000 to $250,000 during this phase, however you do see outliers like Dropbox walking away with $1.2M. The trick here (and in every financing round) is finding the sweet spot where you obtain the capital you need to grow to the next phase without giving away the farm.
After more than a few cash crunches and hopefully some government grants and GST refunds, companies that were able to survive the year or so since obtaining their seed financing will be looking for their next cash injection. During that time since, a lot will have happened to get them this far. The product will be now either in the early stage of generating revenue or damn close, the core elements like sales pricing have been largely validated, and the all-star team has been assembled. Now it’s time to think about going for the coveted Series A, or the less ambitious seed-extension round if the company is close but not quite ready for the big Series A leap.
The Series A is akin catching a wave on a surf board – you’ll either catch a glorious ride that makes everything real, or watch daylight slip away while you wait for each passing swell to form a crest but never does.
The reality is that fundraising is a slow and tedious process even in the best of times, meaning that raising a Series A round will take months of planning and cultivating the interest of strategic investors. The rule of thumb is to begin the fundraising process about 3 months before you think you’ll need the first cheque to hit your bank, but the timing rarely works that conveniently.
The Series A round should be designed to provide a company with about 12-18 months of unobstructed growth and pure focus on nailing down any of loose ends of the product. Typically Series A rounds begin at $1M, however this would be on the ‘very low’ end of the scale, with companies like Instagram bringing in $4.4M. The ethos here is if we’re going this far, let’s do it correctly. For many, this will be the first time the CEO is able to hang up their fundraising hat for a while and step back into the role they’ve spent years building. Coupled with this however is the vastly increased investor scrutiny, where it isn’t just your company anymore, and the tone at board meetings will shift towards reaching milestones and gross margins.
Due to the amount of capital required for this round, these raises will typically come from institutional investors, meaning teams of professional who are in the business of investing in companies. These teams are made up seasoned investors, ex-founders who have divested, and hungry business school graduates who model business in their sleep. Learning how to pitch to these investors is a whole other topic, but what I can tell you is prepare to have every aspect of your business dissected and challenged, and more than anything else it’ll be your story and vision that end up closing the deal.
Finally, if you’ve made it this far, your future is looking bright. Subsequent funding rounds may still occur, creatively titled Series B, C, and so forth, however the company will likely already be cashflow positive at this point but requiring capital for quick scaling. Eventually the pool of shares that the shareholders want to continue diluting runs out and debt financing becomes the most enticing option, or else the company might by ready to access capital from the general public through an IPO.
This summary clearly glosses over many of the intricacies and requisite tedium of the process, but covers the broad strokes of the fundraising journey in the tech world.