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A Primer on Seed Stage Fundraising
A friend of mine just completed a very successful fundraise for an institutionally led seed-round of capital. What’s interesting is that several years ago, this founder had raised $30M+ in venture capital before and knows the VC process intimately, but remarked to me midway through that “this process is completely different from every other fundraise I’ve been a part of.”
It was different across a few dimensions. First, the level of traction that seed investors often look for is substantially greater than it was several years ago. Today, many companies that are pre-product or pre-traction raise a pre-seed round or pretty significant angel funding before raising an institutional seed. Thus, the stage of companies seeking a seed round is more similar to the stage of series A companies in the past. Second, although the companies may seem more mature, the way seed rounds come together are still different from a classic VC-led series A or B round. Even with institiuonal seed VC’s involved, it is likely that no one investor will make up 75%+ of your capital, and the round itself will be more of a multi-party optimization exercises. In a given $2.5M round, there are often two, three, or more “funds” that are investing between $500K and $1M. Also included in the round are typically a series of individual angel investors or smaller funds that are included in the syndicate because of their relationship with the founder or specific value add.
Because of the various moving parts involved in these rounds, they are sometimes more unpredictable than one would think. In some cases, these rounds come together quickly and easily, but in most, it takes a bit of time, and feels a bit like this:
That said, to kick-off fundraising month on our blog, I wanted to lay out one basic roadmap for pursuing and managing a seed round raise.
How to Raise Seed Capital
First, a couple assumptions:
- This roadmap assumes that you are “ready” for the round to happen. Figuring that out is the subject of another blog post. This also assumes that you have a reasonable “ask” in terms of dollars, valuation expectation, etc.
- This also assumes that you’ve done some pre-work over the past 6-12 months to keep investors warm and aware of what you’ve been doing along the way. You are not going to only pitch funds that you have a relationship with, but it’s helpful to not be going from a standing start with everyone.
- Overall, I believe in very limited staging of the process. As Paul Graham has written, it’s a “breadth first” process, then you triage your list in a probability weighted way. So, even though I’m proposing a sequence of steps, the reality is that it should feel a lot more like a big parallel process.
A Broad Process to Follow
1. Line up support.
Know who people are going to call as a reference – your prior bosses, obvious people in the ecosystem that would have a strong POV on you or your idea, existing investors, early customers etc. Pre-wire them so that when the calls come, they are ready and/or you are least know what they are likely to think. Some investors will ask you before reaching out to folks, but some will just go ahead and make a call or two if they are closely connected to someone that knows you.
2. Get commitments from those who know you.
These are the angels that are your closest mentors/references or individuals that you want to have affiliated with the company. The idea is to get a small but solid commitment from these people, so that when you have your first conversation with a lead, it doesn’t feel like you are starting from scratch, and there is built-in credibility.
The way to mechanically do this is to just get these individuals to feel comfortable with at least an investment of X ($25K or something), and then remind them “only say yes if you are willing to have people ask you about it.” There is nothing more damaging that having a VC call an angel and have them say, “Actually, I’m not really committed.”
You can also give people the option to back out. Make it clear the commitment is “assuming reasonable terms and a round of at least X” so they don’t fear that they are investing on potential dumb terms or an underfunded round. This is kind of the equivalent of saying, “I’m in as long as you have a lead,” but it sounds a lot better. You want to be able to say, “They are in, assuming reasonable terms. Feel free to call them.”
You definitely want to get this squared away with the investors from your pre-seed round assuming you did raise one. If these investors are not investing their pro-rata, you want to be able to give a very crisp reason why not.
3. Find a lead investor.
These are funds that are willing to stick their neck out and be the first “yes” and issue a term sheet. There are ways to do this without a lead, but I’ll ignore that for now. Some thoughts on finding your lead investor:
- There are tons of seed funds, but way fewer than you think would actually lead. I’d say that only 10% or fewer of the seed funds out there lead (including Nextview).
- Leads tend to do fewer than six investments per year per partner (and I’d argue much less than this ideally). If they are higher velocity, I’d question whether they’d be able/willing to lead.
- Leads tend to do some real due diligence. The point of them leading is that they are doing the work to build conviction, not drafting off the conviction or social proof of others. This can be a time suck, but a good lead shows you their forward progress pretty transparently and can do their work in a couple weeks. Good leads tend to do their work with conviction, meaning you can see them making forward progress, and systematically answering questions or concerns that they or their team has. It’s not a haphazard set of due diligence requests that don’t really make sense. If someone isn’t showing that kind of interest, de-prioritize.
- Be willing to get on the road. I think it’s helpful to get some feedback in fundraising, so it’s worthwhile to hit a few markets like Boston, NYC, and SF. It’s less likely to find a lead outside your core geography, but it does happen. And it ends up being pretty unpredictable as to who really gets excited or doesn’t. I also think that getting some market feedback is helpful from investors that have a different vantage point than you, and it’s sometimes nice to assemble a syndicate of investors that represent a number of core geographies.
- Triage appropriately. As my partner Lee Hower often says, fundraising is about searching for true believers, not convincing skeptics. This is particularly true at the earliest stages. It’s easy to spend too much time focusing on skeptics.
4. Secure value-adding, non-lead investors.
This happens slightly behind your lead investor for all the reasons outlined above. Think of these as additional arrows in your quiver. These groups can augment the network of your lead investor, provide additional support capital if you need an extension, and hopefully be helpful.
Prioritize these groups for value-add, but keep in mind, these groups tend to be more clubby and care more about who else is in and social proof. In some cases, the other leads that you were speaking with can still become part of the syndicate. Many funds have some flexibility around check size and ownership targets (even though most will signal that they have less flexibility than they actually do).
5. Have good news to share along the course of the fundraise, if possible.
Even small pieces of data like successful small-scale tests, new hires/advisors, or a record day of sales can be meaningful and swing your fundraise in a positive direction. Unfortunately (or fortunately, depending on your circumstances), fundraising is much easier when there is a sense of momentum behind you, so do what you can to create some momentum. Investors tend to follow the flow of energy around an investment, whether that’s business momentum, fundraising momentum, or just notoriety in the market. You can’t really change that, so accept it and try to make it work for you. Also keep in mind that this works against you as well. If momentum stalls, the funding market figures it out very very quickly. So be careful about letting the process drag on too long, or sending out overly aggressive signals that will come back to haunt you later.
6. When you do get a term sheet, do some work to optimize the deal.
In my opinion, the goal at the seed round is to get a fair deal done quickly with the right partners, not to maximize valuation or terms. That said, there is always a bit of wiggle room in an investor’s first offer, and other investors will move very quickly if they learn that you do have an offer in hand. No investor wants their deal shopped with others, but they also realize that it will happen. I recommend treating investors fairly, but also looking out for your company’s best interest. That means not allowing investors to bully you into taking a deal if you think you need a bit of time to decide, but simultaneously moving quickly on your end and treating all parties with respect.
So that’s my basic roadmap. I didn’t want to be too prescriptive here, so I’m happy to get into more details in the comments if folks have specific questions. We’ll have subsequent posts this month that go a bit deeper on the different step in this process. For now, let me just finish with a few parting thoughts:
Fundraising tends to move slow until it moves fast. What you’ll find is that in the middle of the process, it might seem frustrating as some investors pass, while some investors feign interest but don’t really dig in. Or it just might take a while to get meetings with the key decision-makers. But push through it! Once a lead or two start to take serious interest, things will change quickly.
The challenge with seed rounds is that multiple parties can invest, even without being the first, lead “yes.” So unfortunately, it potentially rewards investors that hang around the hoop and then try to sneak in at the end (as lame as that seems). But once there is some demand for the round, the group of potential investors will swarm pretty quickly, because ultimately, many of these rounds end up way over-subscribed.
This might seem laborious, and it kind of is. Funny enough, raising a seed round might end up being as time consuming as raising a larger round because of the multi-party nature of the process. But if you manage it properly, you can go from start to a term sheet within 3-5 weeks and to a fully-closed round just a few weeks after that. Sometimes it can take longer, but beware of being in the market too long because a lot of seed investors are pretty chatty and word gets around fast about a company’s struggles to raise capital. (Some investors are independently minded and can see past that, but most investors tend to get hot and bothered about momentum and perceived traction.)