Why you should bootstrap your startup before raising money

Edited excerpt from After raising $125M at my last company, I’m bootstrapping PeopleSpark — here’s why by Mitchell Harper:

Bootstrapping or raising money aren’t mutually exclusive. There are immense benefits to bootstrapping before you raise money:
1. You’re 100% focused on generating revenue and profit as quickly and as efficiently as you can
2. You learn to keep costs low and keep an eye on anything taking money out of your pocket
3. Your employees adopt your mentality — careful where they spend money, resourceful with limited resources
4. You’re forced to experiment with different, low/no cost ways to win customers
5. You invest in your product, which matters more than anything else, and spend less on superficial stuff like a nice office, catered lunches and all the other crap most startups waste money on
6. You don’t have to spend time preparing board slides or attending board meetings
7. You can still get access to great (future) investors and pick their brains — the best VCs will understand that you don’t want to raise money right now, but will still work hard to build a relationship with you
8. Bootstrapping significantly de-risks your business in the eyes of future investors —“If they can get to a few hundred grand in revenue a year with no outside investment, imagine what they could do with $5M!”
9. If you can get to profitability, you have immense leverage when you decide to raise money, because you’ve done what probably less than 2% of startups have done

(1) Cf. Why you shouldn’t raise too much money in your early funding rounds
(2) Re. “If they can get to a few hundred grand in revenue a year with no outside investment, imagine what they could do with $5M!” — see The real difference between funding rounds

Why startups should raise money after finding product-market fit

Edited excerpt from What I’ve Learned About Venture Funding by Mark Suster:

I know in my bones that there is a magic moment where capital plays a hugely differentiating role. As in back-up-the-truck, load on $20-30 million and let me blast the market with all I’ve got.

I’ve seen it.

I’ve seen companies who raise the mega round after they’ve truly started to scale and put scale on steroids. I’ve seen the companies that had they not raised the big round would have evaporated. I’ve seen companies who avoided the big round and then struggled without enough resources to ship products on time and then missed market opportunities and sold in mediocre outcomes as others sailed by them.

How can it be that over-funding is bad, bad, bad and then the best possible outcome? And what is the inflection point? It’s subjective. I know many inexperienced market prognosticators claim “VC is dead,” “capital is a commodity,” “crowd-source to the finish line” or “stay lean for life”. But I’ve seen directly just how much capital can separate the winners from the losers when raised at the right time.

(1) Cf. The real difference between funding rounds.
(2) Cf. Raising capital as an offensive strategy.

Most VCs are momentum investors

Edited excerpt from The Hacker’s Guide to Investors by by Paul Graham:

This is how most venture investors operate. They don’t try to look at something and predict whether it will take off. They win by noticing that something is taking off a little sooner than everyone else. That generates almost as good returns as actually being able to pick winners. They may have to pay a little more than they would if they got in at the very beginning, but only a little.

Investors always say what they really care about is the team. Actually what they care most about is your traffic, then what other investors think, then the team. If you don’t yet have any traffic, they fall back on number 2, what other investors think. And this, as you can imagine, produces wild oscillations in the “stock price” of a startup. One week everyone wants you, and they’re begging not to be cut out of the deal. But all it takes is for one big investor to cool on you, and the next week no one will return your phone calls. We regularly have startups go from hot to cold or cold to hot in a matter of days, and literally nothing has changed.

(1) Cf. There are only two ways to raise money for a startup.
(2) Implications for startups: Don’t raise money if you don’t have momentum in your key metrics, or you’re at an early enough stage that you can “sell the dream”.
(3) Cf. What one early stage VC looks for when he meets companies.

Why you shouldn’t raise too much money in your early funding rounds

Edited excerpt from What I’ve Learned About Venture Funding by Mark Suster:

I believe firmly in capital efficiency in the early days of a startup. It forces innovation. It forces the founder to spend time in front of customers. It forces teams not to expand too quickly. I know it’s easier said than done when capital is floating around and feels like it will ease up everything. I don’t blame you for taking more than you need. But if you take $10 on $30, $40 or even $50 G-d help you if you need to raise your next round and haven’t demonstrated amazing traction or you raise after the next correction. You are building a one-option startup. And I can tell you that almost certainly you will spend your money inefficiently.

(1) Cf. Tom Tunguz’ five keys to building a successful company.
(2) Cf. Why capital efficiency is critical for SaaS and subscription businesses.

There are only two ways to raise money for a startup

Edited excerpt from 3 Startup Lessons I Learned the Hard Way by David Cancel:

You can only raise money by pitching the “Dream” or by selling “Traction”. So either bootstrap your startup, or raise money in the early “dream” (no code, no plan, just a dream) phase or in the “traction” (the model is working) phase of your business.

(1) Cf. The real difference between funding rounds.
(2) Re. You can only raise money by pitching the “Dream”— see Startup fundraising: Finding true believers vs. convincing skeptics.

Raising money is like any other selling — first, qualify your leads

Edited excerpt from What Do You Need to Do to Improve Sales? Here’s a Start… by Mark Suster:

I find that many entrepreneurs talk randomly to VCs about fund raising. But if you’re raising a seed round and talking to a billion-dollar growth-stage fund you’re not being very focused. Equally, if you’re talking with a $100 million fund about your $20 million round your hit rate will be low. So understanding the stage of a VC matters.

Also, you need to consider the type of investments each VC does. Can you look at their portfolio and see deals that are at least similar to what you do? Finally, you even need to qualify down to the partner level. If you are talking with a partner who hasn’t funded any gaming startups and you are a gaming startup it’s worth asking them the question before meeting whether they would consider investing in your sector. Or if you notice another partner in the firm active in that area it’s worth getting to the right partner to increase your hit rate.

So make sure you qualify before even making calls or asking for intros. The research you put into fund raising before you start the process will pay huge dividends in your efficiency and hit rate.

(1) To match the stage of your company to the type of VC, see Rob Go’s The real difference between funding rounds.
(2) Just because you get an inbound call from a VC doesn’t necessarily mean that firm is suitable for you. See David Cummings on What to do when an associate from a VC fund reaches out to you.

What to do when an associate from a VC fund reaches out to you

Edited excerpt from Entrepreneurs and Calls from VC Associates by David Cummings:

Here are a few thoughts on calls from VC associates:

  • Associates cast a wide net and engage with as many entrepreneurs as possible, regardless of whether or not they’re a good fit yet.
  • While associates source deals for the partners, most of the firm’s investments come from referrals and existing partner relationships — not from associates cold calling.
  • Know that associates aren’t the decision makers at the firm and that they spend a huge amount of time cold emailing and cold calling startups (not too different from a sales rep).
  • Before taking a call from an associate, ask a number of qualifying questions, and only take the call if raising money is on the horizon (remember that the best time to raise money is when you don’t need it).
  • If getting ready to raise money, associates can be a good testing ground and opportunity to practice the pitch.
  • Make an ask at the end of the call to be introduced to three portfolio companies that might be potential customers.

In the end, most entrepreneurs shouldn’t engage with associates unless they’re going to raise money in the near-term and they’ve pre-qualified the firm to ensure it’s a good fit.

Ask potential investors for advice, not money

From Kris Duggan, in The Second-Timers: Kris Duggan of Betterworks:

If you ask for money, you get advice. If you ask for advice, you get money. I spend 10x more of my time on customers than investors. For example, we don’t have an investor deck here at BetterWorks. If a potential investor wants to talk, I show them our sales deck so they know how we talk with prospects. Thinking that way makes me remember to stop ‘pitching’ and keep listening.

When no need for capital = negative growth signal

Excerpts from Never Raising Capital Ever Again by David Beisel:

Fairly often entrepreneurs will pitch investing in their seed-stage company and the projections state that this round financing is planned to be their last. Sometimes it’s even presented as an additional feature of the pitch itself: “We’ll never need to raise money again!”

Capital fundraising is to facilitate growth ahead of cash flows generated by the business. If there is truly a huge venture-scale opportunity ahead of a startup, there should be an appropriate cost of capital for future financings to expand which make sense for the company. But that “if” there is very important… perhaps in many cases the desire for the Seed round to be the final round of financing is a tacit signal that it doesn’t have the potential to be “venture scale” after all.

That is not to say that gunning towards cash-flow break-even isn’t a stated short-term goal of some of our portfolio companies… it empowers entrepreneurs to raise money on their own terms. Achieving cash-flow break-even early in a company’s life-cycle can be a means towards optimizing the growth trajectory and ownership for early constituents.

(1) Cf. Rob Go’s definition of a growth round, and Raising capital as an offensive strategy.
(2) Contrasts with Why your VCs want you to raise a large round.

Startup fundraising: Finding true believers vs. convincing skeptics

Excerpts from Pull the Plug or Keep Searching for the Believer? When Fundraising is Tough. by David Beisel:

My partners and I at NextView talk a lot about how fundraising is about finding the true believers rather than convincing the skeptics. The energy that it takes persuading someone who starts with a bias not to invest is much better suited searching for additional prospects who want to believe in what you’re building. We’ve observed it repeatedly in our portfolio as Founder/CEOs seek additional rounds of financing: the engaged skeptics just never quite get there, but the entrepreneurs who cast the nets wide enough find someone who believes.

Because of this learning, we counsel our seed companies when raising a Series A to run a full & synchronized process with a broad array of firm sizes, types, and shades to determine what profile will become believers. It’s not until you have had a broad array of conversations are you able to tease out the profile of (and subsequently specific) firm(s) which will be attracted to your company.

Why your VCs want you to raise a large round

From 5 Best-Kept Secrets About Venture Capital by Jason Lemkin:

Valuation increases really matter to most VCs, so they want you to go raise a big round.

VCs only make profits on an exit–an IPO or a sale of a portfolio company. But they make money on management fees too, and to get them, they need to raise multiple venture funds. They need to raise another fund. When they go to raise another fund, some and probably even most of their track record is still going to be illiquid, in companies that haven’t yet gone public or been acquired.

Those illiquid companies will be valued based on their most recent valuations. If you as a founder raise another round at 2x-3x the price of last one, VCs can tell their own investors, the LPs, how strong the return on this investment has been–even if it’s just paper gains. They can sell this when they raise their next venture fund. If there isn’t another fund, the venture firm just becomes a zombie.

(1) Since the size of a round is always proportionate to its valuation, this means it’s in your VCs’ interests to have you raise a large round.
(2) A large round has many advantages — capital can be used as an offensive strategy. But a large round is not always best for the company, the founder or the team. As Rob Go says there, “modest sized rounds focus a team and establish discipline”.
(3) So add this to the list of potential conflicts of interest between companies and VCs.

Raising capital as an offensive strategy

From Using Capital as a Weapon by Rob Go:

Capital gets talked about a lot in terms of things like runway, getting to profitability, solving the VC math equation, etc. But primarily, I think capital for early stage companies should be discussed in an offensive manner. As my partner David likes to say “capital is a weapon”. It’s true that sometimes too much capital creates tons of issues, but if wielded appropriately, capital is very much a part of a company’s offensive arsenal.

We think about this quite a bit with our portfolio companies as they scale. As seed stage investors, we find that we tend to prefer modest sized rounds early on to focus a team and establish discipline around being excellent at one thing and proving things out efficiently. But beyond the seed stage, capital is primarily about winning and winning big. We look to invest in [high potential] companies with capital efficient beginnings, and usually, those types of companies do take in a fair bit of capital and use that capital as a weapon. Typically, this happens in some combination of five ways.

1. Solidify Network Effects.
2. Geographic Expansion.
3. Data Scale.
4. Buying Credibility.
5. Boxing Out Competition.

What one early stage VC looks for when he meets companies

In this talk Investment Swarm at Hive53.com,  early stage investor Tim Jackson outlines what he looks for. The list:

1. Team: how good?
2. Traction: how fast?
3. Market: how big?
4. Barriers: how high?

and then…
5. Why did this deal come to me?
6. How can I help?

(1) Compare to A startup pitch should answer these 3 “why”s.
(2) Traction: how fast? is similar to Paul Graham’s point that startup = growth.

A startup pitch should answer these 3 “why”s

From Why Big, Why Now, Why You? by Anthony Lee:

Fundamentally, a good pitch is a good story.  In addition to understanding a business opportunity logically, investors need to feel a business opportunity emotionally.  A good story (told by a compelling storyteller) does just that. It activates our gut and makes us viscerally excited by the business proposition. “People buy on emotion and justify with logic.”

Many entrepreneurs love to expound on the “what” and “how” of their technology solutions.  That is all fine, but often what I really care about – and what I have come to see as a common thread in the best presentations – is “why”. Specifically, there are “3 Whys” that I want to see in every pitch:


On Why Now?, he adds:

This is one that entrepreneurs almost always miss and so it is one that I have come to feel is the most critical. So much of startup success is dictated by good timing. “Why now” – why market conditions, user behaviours, technology trends or other macro forces are combining in just the right way to smooth your path to success.

Pitching to VCs: market size

From Guerilla tips for raising venture capital by Richard Price:

When pitching a VC, you need to have at your command the macro stats for the industry, because that is how they compare your problem with another idea that someone else is pitching. Intuitions are not enough to make the comparison, and for the partner to pitch his/her colleagues – there needs to be some market data about the size of the market etc.

The reason entrepreneurs often skip this step is that it can be really hard to gather market sizing data. As far as I can tell, the only person who’s ever calculated the number of academics in the world is me. Collecting that data took a decent amount of time.

Many entrepreneurs who haven’t done this work will bullshit or semi-bullshit when a VC asks a market sizing question, and the VC is very used to this, and is very good at detecting lack of expertness “um, yeah, er, the market size is $9 billion’. A VC sees straight through that because they get exposed to it so much. You need to answer in a really confident way with as much material as possible to overcome any feelings of doubt from the VC.

Note: Accurately figuring out the size of your market isn’t only for VC pitches. It also allows you to calculate the key startup metric, according to Tom Tunguz — share of habit.

A better way to demo your product

From Why Most Demos Confuse by VC Roy Bahat:

Demoing a product by starting with the home page (or, actually, starting anywhere on the website or in the app) is like a realtor showing you a house starting in the living room… Consider, instead, walking through the front door — having come from somewhere, paid attention to the neighborhood, the cars on the street, the front porch.

Start with the first moment a user might learn of your product — maybe it’s an email invite, or a text from a friend, or a notification of a forced install from their IT department, or they heard about the app from someone. Then show what that first-user experience looks like.

If you think about the demo this way, you’ll gradually open the eyes of your audience so that when you do arrive at the actual service, they’ll be more likely to have that ah! moment.

And this goes beyond just the demo: most of us think of the entire product as what’s really only the “interior” of the house — the features, look, and flow of your site or app. We might be better served thinking of the product as including the “exterior” of how users will encounter it in the course of their day…

Pitching to investors: What truly excites you?

From Fundraising Mistakes Founders Make by Sam Altman:

A lot of founders get caught up in trying to follow a perfect template, and drone on and on about their competitors, the market evolution, etc. They’re bored and it shows.

The way to pitch well is to focus on the parts of the business that truly excite you. That will shine through, and it will get the investors excited. Conveying your passion for the business is almost as important as what you say, and it’s almost impossible to fake. Even if you’re an introvert, it will usually come through to a sophisticated investor. So start with the parts you’re really excited about.

…Remember that smart investors are looking for the really big hits.

This is more contrarian than it seems, but actually correct. A pitch to investors doesn’t need to be an exhaustive overview of your business. You need to get investors excited, and you can then follow up with details. And what gets investors excited is probably what gets you excited.

The core of a VC pitch

From Guerilla tips for raising venture capital by Richard Price:

Rule number one: You should be embarrassed by the sheer audacity of your vision!

Think big about what the company you’re building may be like in ten years if all your dreams come true. What kind of world would you want to create if you had a magic wand? That is what you want to be pitching to a VC, as that is the outcome that matters to them.

An entrepreneur will be thinking about today’s problems, and maybe thinking 6 months out, but you have to train yourself to look into the crystal ball and become eloquent about the ten year view. VCs know there is a lot of risk and they want to see what wondrous things will happen in return for the amount of risk that you are offering them. So offer them a lot of wondrous things…

VCs are looking for the ten-year level of discourse, rather than the six month level of discourse. Being in an investor meeting is actually the one environment where you can let you imagination rip. It’s not only acceptable to do that but its expected.

The mechanics of building a pitch for VCs

From Take Your Fundraising Pitch from Mediocre to Memorable by FirstRound Capital, quoting Oren Jacob:

Jacob readily admits that he usually starts off with 60 to 70 slides, and very painfully and thoughtfully molds his presentation to fit 12…

When you design your presentation, you want to make sure to emphasize the points that will drive people to the conviction that they should back your idea. If you believe the market opportunity is the most compelling thing you have to share, spend more time on it. If you believe the strength of your team is unmatched, take the time to dive into their bios and experience. You want to build your presentation and slides so that your argument only gets stronger and gains momentum as you go along…

…it’s also critical to not plan a full hour of material. You should be able to tell your whole story, in a compelling and detailed fashion, in just 20 minutes. “This will almost always expand to fill the hour…”

At the same time, you want to have hours and hours of nerdy details squirreled away in your head.

The important thing is to make the words your own.

Do great VCs need operating experience?

From What I Would Look for When Choosing a VC – Knowing What I Know Now? by Mark Suster:

I’ve sat on ad tech boards with board members who clearly knew little about impressions, fill rates, CTRs, RTB, eCPMs or the difficulties & opportunities of embedded mobile SDKs vs. HTML5. It felt like there was a wavelength with management and somebody wasn’t on it. I’ve been involved with SaaS companies with VCs who don’t understand demand generation, lead qualification, sales coverage ratios, sales forecasting or frankly when deals should be inside sales vs. outside sales.

I would think it would be a big f-ing nightmare to have a VC on my board who simply doesn’t get what I do and yet my perception is this happens often. I know many VCs who don’t have operating experience and frankly some of them are fantastic. Simply put – I’d be in search of a VC who had an intuitive sense of my product, my customers, my organizational issues, my competitors, etc.

In my experience, fantastic VCs have three characteristics: (1) They understand the company. (2) They believe in the company and the team, and express that. (3) They help in tangible ways (they don’t just express opinions). For each of these three, operating experience helps, but isn’t necessary.

What to look for when choosing a VC: smart isn’t enough

From Mark Suster’s blog:

Most VCs are book smart. It’s insanely competitive to get into our industry so most have degrees from institutions like Stanford, Harvard, Wharton and University of Chicago (blatant plug ;-). Smart is simply not a differentiator. In fact, book smart can be a negative. The last thing you want is a know-it-all telling you what to do when they are at 50,000 and haven’t had to deal with your exact circumstances.

I call them “VCs Seagulls.” (you know … fly in, shit on you and then fly away). VCs should be more of a coach than proscriptively telling you what to do. I’ve seen too many companies go off track by a VC hell bent on the team pursuing the VCs strategy which at times is about chasing the next shiny object.

You want a VC who will spar with you but then STFU and let you get on with things. Smart? Sure. But don’t over index on brains. In the end it will be up to you to figure out what to do.

The true cost of fundraising

From Sean Ellis:

It is obvious that the effort required to raise VC funds can be a major distraction from executing the business, but few realize that the repetitive discussions about financial outcomes can also shut down your ability to figure stuff out. In my 15 years in startups, I can’t think of a single breakthrough epiphany we experienced while fundraising.

Reid Hoffman on how to pitch your company to investors

Excerpted from Reid Hoffman:

Your investment thesis is either concept-driven or data-driven. Which kind you are pitching?

In a data pitch, you lead with the data because you are emphasizing how good the data already is. Investors therefore evaluate your company based on the data. When LinkedIn went public, it was a data pitch to public market investors. We showed investors a multi-year track record of data.

If it’s a concept pitch, on the other hand, there may be data, but the data supports a yet undeveloped concept. A concept pitch shows your vision for how the future will be and how you will get to that future, so investors will want to buy a piece of it. Thus, concept pitches depend more on promised future data rather than present data.

How do you know if an investor will add value?

Excerpted from Reid Hoffman:

Sadly, many investors actually add negative value, so an investor who adds no value (“dumb money”) but who doesn’t interfere with the operational process can sometimes be a decent outcome. But ideally you find an investor who can proactively add value (“smart money”).

How do you know if an investor will add value? Pay attention to whether they are being constructive during the pitch and financing process. Do they understand your market? Are their questions the same questions that keep you up at night? Are you learning from their feedback? Are they passionate about the problem you’re trying to solve?