Negotiating with potential investors about stock options, convertible notes, market sizes, product prototypes, and a whole lot of other things can be overwhelming for founders who never went through the capital raising process before.
Why have we written this guide? At the start of our first investment process, we found ourselves in the same position as you are right now, and we wished we had someone who could explain to us everything we needed to know about Startup fundraising- hence the motive for this write up.
But before delving into the „Fundraising for startups 101 Guide“, here are a few preliminary terms which we believe are critical for every entrepreneur to know.
Fundraising basics you should know by heart!
First things first – the journey you are about to take is called “raising capital.” Raising capital means finding an investor (there are many different types of investors you can choose from) who is willing to invest in you and your idea to get your venture started.
The most common way of raising capital during the first funding, called seed funding, is to issue convertible notes.
A convertible note is a form of debt and equity financing that is common for early-stage startups to raise capital.
In other words: A startup issues convertible notes investors can buy through loaning money to the startup. The convertible notes can later be converted into equity (which is also called stock) of the company.
The great thing about a convertible note is that you can use it for companies that don't have a valuation yet. Instead, you agree upon a discount or/and a valuation cap in the next round of financing.
Here is a little graphic that explains what a convertible note is:
The term equity is, in most cases, referred to as shareholder equity, which represents the amount of money that will be returned to its shareholder when the company or equity is liquidated.
Typically, the founder holds 100% of the equity, who is, in this case, the sole shareholder. If there is a team of co-founders who found the startup, the equity is homogeneously or unequally distributed amongst the team.
To close the circle, investors receive convertible notes in exchange for their investment and convert the note into equity at some point in time.
However, there are some crucial facts you must know before selling your company's equity.
It is common for startups to grant investors a discount, since from the investor‘s point of view, investing in early stage startups is very risky.
Equity dilution occurs when the company decides to issue new shares, which causes a decrease in the percentage of the shareholders‘ ownership (if they choose not to buy the newly issued stocks).
All steps to raising capital
Let's say BaseTemplates has two founders, Max and Julian. They came up with building a website where entrepreneurs can find all sorts of templates that will help them start their venture efficiently and cost-effectively.
Max and Julian are willing to spend all their time and energy into providing founders with the best templates possible and finally decide to incorporate BaseTemplates.
After finishing all the paperwork, they officially own their first company.
The two agree on splitting the company's stocks into half, so each of them owns 50% of the company.
Like most of the startups, the two decided to incorporate BaseTemplates with 1 million shares of stock. Why such a huge amount of stocks? Because they want to reach out to investors to get their startup going through the roof faster. If they succeed in finding an investor, it is easier to split the stocks into smaller pieces. Each of the founders now owns 500.000 shares of stock, 50% of the 1 million shares.
After a couple of months, the company starts to generate its first revenue. The two are very happy but already want to take BaseTemplates to the next level. They decide to extend their range of products by offering a "custom pitch deck service."
Customers can now hand in their first idea of a pitch deck, and BaseTemplates will design the slides, create the content, and develop a fundraising strategy for its customers. Since they want to guarantee very high quality service, they decide to hire a team of designers and content writers.
This will be a costly endeavor, which is why Max and Julian are looking for investors to raise capital.
The first thing they do is to create a pitch deck.
The importance of having an impressive pitch deck
Creating a pitch deck is a real challenge for most entrepreneurs. It would be best if you had a rock-solid presentation of your company to impress and convince your potential investors of investing in you.
It goes without saying: a great pitch deck needs careful preparation, and building one slide after the other on PowerPoint just won’t cut it.
Your goal here is to give your potential investors a general overview of what your company/idea is about. This means you are going to have to think about a lot of things you haven’t thought about before. It is therefore necessary to dive deep into the core of your company/idea before you can create an awesome pitch deck.
But not all hope is lost. Here is a list of five things you have to do before creating your pitch deck.
- You should start thinking like an investor
- You should know precisely how much money you need
- You should know how important a great pitch deck is when looking for an investment
- You should know which investors are likely to invest in your company and which are not
- You should collect customer feedback/reviews
If you follow these steps carefully, the chances of you creating a winning pitch deck that convinces your potential investors of investing in your/your idea increase immensely. You can read the full article about these five steps here.
How many pitch deck slides do you need?
You can read many different blog posts about this topic, and you will see a consensus of how many slides should be in a pitch deck: roughly about 10 to 18. There is no magic number of slides, but you should keep in mind that investors are not likely to read a full 40 pages long pitch deck since they do not have that much time to read such a deck in total length.
This is one of the most famous structures our pitch deck service customers choose to go with (click on each topic to learn how to build a killer slide):
Are you wondering why this structure makes sense for most startups? I will try to break it down for you.
- The title slide explains itself. It's your company's name and logo. Maybe including your claim.
- Your summary slide explains what your business is all about in less than 30 words. Why less than 30 words? Because this will guarantee that your customer will quickly understand who they are dealing with.
- Now you present the problem your customer is facing. This slide will build up suspense and make your investors curious about the solution to that problem.
- Boom! This is your baby. This is the solution to the problem many people face and don't know how to solve it by themselves.
- This slide explains how you are planning to generate revenue with your solution to the problem.
- The market slide shows how many potential customers and revenue is out there waiting for you.
- After showing how many people you can sell your product to, this slide explains how you will acquire your customers.
- Now you have to show that you have done proper research on the problem you are trying to solve. Show your investors who your competitors are and how your business will dominate them.
- The Team slide is one of the most important slides in your deck. With this slide, you show your investors why your team can solve the problem you address.
- Finally, you have to present your investors the amount of money you want to raise. Be prepared to be asked why you chose the figure that is shown on this slide!
This is the simplest and most comprehensive structure you can choose for your pitch deck. However, there are some slides you can add to these "10 slide pitch deck".
If possible, try to have your pitch deck reviewed before you hand it in to your investors. There is no room for mistakes. If the investor’s first impression of your pitch deck isn't right, he/she is less likely to invest in your company!
Who is your ideal investor?
Let's get back to the story. Max and Julian now have to build a great pitch deck, but they wonder who might be the right investor to send the deck to.
Not every investor is the right investor for your business. If this is the first time you are looking for an investment, you should know that there are six different investors types.
If you want to keep control- and maintain complete ownership of your business, self-funding is your way to finance your venture.
If your first fundraising round is self-funded, future investors are more likely to invest in your company. And in case you are wondering why, the answer is simple: Investors love entrepreneurs who fully commit to their idea/startup. And what shows more commitment than putting all the money you own into your business?
Friends and Family
This type of investment is a double-edged sword. Your friends and family are likely to trust you and your idea. Due to this, the chance to get funded by your closest friends or family members is high. However, you should be aware of the pressure and responsibility this type of investment comes with.
Imagine your venture fails, and you must explain to everyone that their money is gone. Is this a situation you can deal with? How will your friends and family react if their money is gone?
Make sure your family and friends understand the risk that is involved in such an investment. Most startups fail, and, likely, they won't get their money back.
Are you building your business around a product or service that needs a fair amount of money for research and development? Is the product destined to be sold in a vast market? If yes, you should think about starting a crowdfunding campaign.
By the time of writing, crowdfunding is growing in popularity among those looking for capital. It is not unusual for startups to successfully run a five-figure campaign on Kickstarter or Indiegogo.
Additionally, crowdfunding comes with many benefits for entrepreneurs:
- An impressive presentation of a project can raise the entrepreneurs' profile and boost their reputation.
- A successful campaign generates a lot of traction that is much needed in the foundation phase. This traction is a considerable argument for future investors to trust in your product and the high possibility of successfully entering the market.
- By giving your crowd instant access to your product, you will be able to collect high-value feedback.
A Startup accelerator is a closed group that provides selected startups with access to a network of investors, mentors, suppliers, vendors, consultants, and other useful contacts.
The program's goal is to accelerate the growth rate of your startup and get you ready for venture capital asap.
Angel Investors (Business Angel)
An angel investor(also called business angel) is usually a high net-worth person who is looking for an opportunity to invest in a startup. Business angels invest in your startup at an early stage of your venture when relatively small ticket sizes (size of the investment) can rapidly accelerate your growth. However, an angel investment is always a high-risk investment, so an angel investor receives much equity in exchange for his capital.
Important fact: Business angels do not only support your company's growth with money, but also with his expertise, his knowledge, and his network.
Venture Capitalists (VCs)
Having an investment from a VC can be highly valuable for your startup. Being funded by a VC shows that you and your team have put an incredible amount of time, effort, and work into your fundraising process. It also indicates that your startup has the potential to become a multi-million dollar company one day.
Venture capitalists are pools of private investors, business angels, and high net-worth individuals who have formed a limited partnership to invest in startups. These investments are usually high-risk investments with a small chance of high returns.
How to find an investor
After deciding what type of investor suits your startup’s stage, you can start looking for potential investors that might be interested in investing in you.
You should bear in mind that not every investor you contact will be interested in your business. This has nothing to do with you personally, but usually comes down to one fact: They do not have the proper knowledge of your market and industry to decide if your company can become highly successful. Do not let this frustrate you and keep on searching!
Looking online for investors can be a good start. LinkedIn, AngelList, Crunchbase, or Xing are great places to start looking for investors. If you have found a potential investor, you should send them a short message and ask if they are currently looking for an investment case. Please do not send them your entire pitch deck. Instead, keep the message short and ask for an appointment or video call to introduce yourself and your company. Many entrepreneurs have prepared an elevator pitch to master this situation and impress an investor within the first minutes!
However, getting introduced to an investor by a mediator is worth a hundred of cold emails. To not ruin this opportunity, you should check this medium article about the best way to ask for investor intros!
The pitch appointment
Let's get back to the storyline: Max and Julian decided to look for angel investors. They have contacted about 24 investors they found on the internet or heard of from startups they asked for an introduction. Ten investors never answered. Twelve thought their business wasn’t a suitable investment opportunity. But of those 24, two replied to their outreaches with an invitation to a pitch appointment.
Luckily the two have already created a pitch deck they are proud of, ready to be presented.
Pro Tip: Bring your pitch deck in different formats. Be prepared for technical issues! The software doesn't run your presentation; your laptop won't boot, or your flash drive isn't working – these are situations you should be prepared for.
It takes the two founders about 25 minutes to present the 15 slides of their pitch deck. The investor seems to be impressed and starts asking questions about the team, the company, and the vision. After another 20 minutes of deep-diving into the startup's structure, the investor signals his interest in investing.
This means that Max and Julian have paved the way for the next steps: the term sheet.
What is a term sheet, and is it obligatory?
The term sheet is the final boss of the fundraising journey. Typically the investor is preparing the first term sheet, which covers the main points of the final contract between the investor and founders. Usually, the term sheet includes topics like the startup's valuation, the investment sum, shares bought, rights and duties of both parties, liquidation preferences, guarantees, vesting, and other points.
Although it is said to be "Non-Binding," the points of this sheet define the final investment contract's key points. It is uncommon to start re-negotiating these points once the term sheet is signed.
The due diligence – screening your startup
In its simplest form, due diligence represents reasonable steps taken by a person to avoid committing a crime or an offence. It is a comprehensive appraisal of a business (usually done by potential investors), with the main aim being to determine its assets and liabilities, and evaluate its commercial potential. This includes a certain exercise of care that every reasonable business or person is expected to undertake before entering an agreement/contract with another party.
Understanding who you are getting into bed with in business is almost as important as conceiving the business idea in the first place. Having an investor or a partner whose values complement yours can lead to gargantuan success. It may not seem as an issue to make so much ado about, but when you consider the ability (or lack thereof) of one party to accept and process feedback, or the different core values and vision between both parties, then the writing on the wall becomes more visible- it is going to be a bumpy ride.
From the perspective of a founder, three things stand out when carrying out due diligence: understanding who your investor is, observing his day-to-day activities, and getting feedback from similar people in the network.
- As a founder, you want to ensure that your investor has a good reputation and that their core values are closely aligned with yours. In as much as they may not share your enthusiasm to the same extent, if they do not see the vision as well then clashes of opinion and frequent fallouts are bound to happen.
- A good question to ask yourself as a founder is “who is your investor outside ofthe business world?” The investment process usually takes some time before it is completed, so this presents the perfect opportunity to get first-hand experience of what working with the person will be like. Do they ask the right questions about your business and give meaningful feedback? Are they open-minded and willing to learn or take criticism? These things should be properly understood before putting the pen to paper.
- The next logical step will be to get references from people in your network. You want to know how instrumental the investor has been to their venture and how often they communicate. Similarly, getting feedback from people who have worked with a potential investor is equally important: did they create any room for doubt about the potential of the business? How do they react when the going gets tough? Knowing all these will help you choose the best fit for the dream you want to sell.
The notary appointment
If the due diligence was successful and your potential investor sees no reason to abort the investment process, you set a date for an appointment at the notary.
The notary appointment is where the deal is closed. Both parties will sign the contracts after it has been read out loud by the notary.
The final step is the exchange of the investors capital and your equity.