As you probably know by now, we just recently closed our Series A funding of $1 million for Freshdesk. Like so many other first time entrepreneurs, I had no clue of how to go about the fundraising process. In fact when we started, our plan was to bootstrap and we did not know if anyone would even fund us. I learnt a lot during this fundraising process and I would like to share some of my learnings here in the hope that other entrepreneurs will benefit from this. Most of this advice may already be something that I read somewhere else, but having information in one place helps. So here it goes..
Is my business fundable?
This is a question that every founder has on their minds and nobody really knows the answer. We certainly did not know whether a VC would fund us. But we did not care about that too much. We had some money and we had a small team (4 members). We focused on building the Product and had something to show the world in 5 months (Private beta). We did not talk to a single investor during that period. We borrowed some money from friends to the tune of $50K as convertible debt (which is the best way to raise small amounts of funding) just to have some extra money in the bank. Convertible Debt works best as neither us nor our friends knew how to value the company, so we deferred the decision. I believe we did the right thing in not worrying about funding when we were starting out. Just go ahead and do what you started out to do. Sramana Mitra’s 1M/1M program has some good pointers on what kind of business ideas are suitable for Angel investments and which ones are more suited for VCs, if you really want to get some general advice on whether your business is fundable.
Do not talk to investors before you get some traction.
We got our initial traction from a blog post that we submitted to Hacker News. I think we were lucky to get that traction. But in hindsight the reason we got that traction was because we told a true story (our story). People really like reading inspirational stories. Just writing a blog post as a marketing exercise is never going to get you any real traction. We realized that if you share your inferences, then people respect you for that.
A big disadvantage for us at that time was that our Product was not ready. We just had a Beta signup form and we got a lot of signups on those two days.
At that point of time we were still not looking to raise funding but we got a few emails from investors expressing interest. We also listed Freshdesk on Angel List after receiving an email from Naval Ravikant commenting on our Hacker News blog post. We started getting interest from Angels and VCs and the process of pitching on the phone began. Oh and by the way, do not expect that you can close a deal in two weeks. Atleast in India, there is a good chance that you won’t. Be prepared to do this over a period of several months. It is better to start the pitching process after you have built something meaningful and generated good traction from users/customers. In our case we had 500 beta signups when we started talking to customers. These are SMB companies and end users. For consumer startups the number needed may be much higher.
Assemble a good team.
We realized early on that one of our biggest strengths was our team. I have seen a lot of startups with just one or two founders and in many cases with employees who were fresh engineers with low salaries and no equity. People think that you cannot hire good people if you can’t pay them big salaries. Wrong. There are a lot of smart people who want to get out of their boring jobs and do something exciting in a startup. They are also willing to take a significant pay cut in exchange for equity. Of course getting such smart people to believe in you and join you in chasing your dream is something you have to learn how to do. Investors want to know that you have assembled a good team or have the capability to do so when required. Also I have heard from a fellow entrepreneur that top tier US VCs bet on the founders and the team and not so much on the initial business idea.
If you are building something good, VCs will find you and they will fund you.
A lot of startup founders think that meeting a VC is like meeting a movie star (no disrespect meant to VCs). I have seen people queue up during coffee breaks of conferences to try and speak to a VC analyst or partner and start pitching to them on their business idea. If you are doing it, stop. It is a complete waste of time. First understand that VCs also want to meet you and discuss your business. Get someone to introduce you to your VC. There are many people who are willing to do that. We got help from Angel List and Sramana Mitra. There should definitely be someone in your LinkedIn network who can introduce you. If you don’t have a network, then build one. Focus on building the Product, before you approach a VC. Apply to some startup events to demo your Product. These events are usually sponsored by VCs to see which new startups are worth talking to. Let the VC contact you. It usually works much better that way. Stop chasing investors at conferences. If you are building something good, they will find you and they will fund you.
Investors are comfortable investing in companies where the founding team is working close to where they are and are easily reachable. There is nothing extraordinary here, beyond just plain common sense. There are enough challenges in running a business and managing a long distance relationship is something that most investors would want to avoid, especially during Series A. So if your startup is located in a city that is not a start-up hub, seriously consider moving to a hub. You will be glad that you did. Also don’t waste too much time pitching investors half way across the globe. Your chances of getting funded by them are close to zero.
If you have written a detailed Business Plan document, please throw it away – you won’t need it anymore.
A lot of investors ask for your Business Plan. If you are like me then you will probably google for “Business Plan template” after the investor call. Bad idea. I think the advice I followed was from Venture Hacks. We did a 10 slide pitch. The content goes something like this:
Problem that we are solving
Execution – what we have accomplished till now?
Plan to acquire customers
How much money / For What?
Anything else you want to say
After your pitch you may also be asked for some kind of financial plan / cash flow projection. Prepare a simple excel sheet with cost and revenue projections for 2 years. Good investors know (everyone knows actually) that these projections are just guesswork and actual results may vary dramatically, but go ahead and do it anyway – you will definitely get some more clarity on your business.
How much to raise?
This is very difficult to answer. You can be very optimistic and raise too little. You can raise a lot and sit on unnecessary cash and lose valuable equity. Consider several factors. In our case our burn was quite low but that was because the founders (me and Shan) took no salary and our first 4 employees were working for 40-50% of their market salaries. We knew that this cannot continue forever and also we cannot predict when team morale will fall because of this. (It will fall many times, by the way. It is how you pick things up and run that counts). Also funding allows you to hire more employees and grow faster. Perennially bootstrapping may be great in hindsight, but can also be risky. We projected out our costs and fictional revenues and raised enough money to give us a 18-24 month runway. The learning here – there is no right or wrong answer. Raise enough money to give yourself meaningful runway. Dilute only what you are comfortable diluting. It’s ok to err slightly here, but being over optimistic can be fatal.
What about valuation? Dilution?
The best way to figure out your company’s valuation is to get competing term sheets from different VCs. You will quickly get an approximate range if you are dealing with reputed VCs. Venture Hacks calls this “clearing the market”. If you have only one term sheet, then you don’t have any leverage. It helps a lot if you understand what investors want and how they approach the valuation process. Investors look at your projections and do a conservative estimate of whether they can get a 2-3X return on their investment in a reasonable period of time (say 2 years or before the next funding round). There are some guideline valuation bands for companies based on revenue and growth, but that varies from industry to industry. VCs generally give you this information if you ask them.
Funding is like Dating. You have to like your partner. It’s never just about the money.
Since we were lucky enough to have significant investor interest, we had multiple term sheets and were in the enviable position of choosing whom to take money from. We had a tough time choosing as we really liked more than one investor. We did not choose the investor who gave us the highest financial valuation. We chose the firm who we thought had the best track record, the partner whom we felt the most comfortable with and whom we felt was smart and could challenge us to perform better. There are so many other things beyond just financial valuation. Pay attention to all those details. Make sure non-financial terms are clearly understood also. A good investor will clearly explain everything to you. We also talked to other entrepreneurs who had raised money with our investor and they all enthusiastically recommended the investor. That is one factor that made our decision easy.
Good luck with your startup!