As a startup founder, I frequently receive questions from friends, family, acquaintances, about how this mysterious fundraising process works. In short, raising venture capital funds is a business deal in which you exchange equity, or a percentage of company ownership, for the capital your business needs to grow, in the form of investment funds.
Rapidly just raised our Seed round in February and now I am currently in the process of raising our Series A in the midst of COVID-19 and a faltering economy. While Rapidly is currently growing despite an economic recession and has plenty of runway from our Seed round, it’s important for every founder to know exactly when they should be fundraising.
Generally, there are two positions that your company can be in when you as a founder are looking to raise venture capital. These are preemptive fundraising or reactive fundraising.
In a reactive fundraising process, you may only have 3-6 months of funds left in the bank. You may be in a position of going out of business if no further funds are raised. The goal of this funding round is to try to keep the company alive.
You may be trying to sell a story of needing another 18 months of runway to figure things out and optimize your company to be able to keep growing. This is where bridge rounds from previous investors may come into play, which can help buy time for the business as you raise a larger round.
Unfortunately, there is no or little leverage when your company is in this vulnerable position and teetering on the edge of closing. Investors are going to be especially particular about evaluating your business model to see if it could succeed in any way in the future.
If you are in a preemptive fundraising situation, your company is not running out of money yet and you are generally secure for the time being. You still have funds from your last round in the bank account, with a 9-18 month buffer of money. If no fundraising happens right now your business will be fine. If your company revenues are still growing month over month, you can feel confident in the business.
In this position, you as a founder have more leverage and have more room to vet potential investors to see if they’re really going to be a good fit for your business. You may have investors reaching out to you during this time who are hearing about you in the press. You are able to evaluate the value they could add to your business, from a stronger position.
How to vet your investors
As a founder, you don’t want to just take venture capital money from any interested investor. As much as they are vetting you and your business model, you should also be vetting them. When doing a preemptive round of fundraising, you will have the most leverage and can be more picky in what you’re looking for from investors.
A few questions that can help weed out the bad investors, double down on the good investors, and keep your options open:
Are they contributing to the growth and success of your business, or are they just asking about how numbers are looking each month?
How quickly do they follow up with you after your meetings?
How mutually respectful are they of your limited time as an entrepreneur and timely with follow-ups are they?
How communicative are they about whether they are interested in investing or not?
You are typically not directly asking for the term sheet, but following up asking them if they are interested in learning more about the company
How high is their interest level in your business and industry?
How is the performance of their investment portfolio?
The importance of investor relationships
Choosing your investors wisely is a crucial part of being a founder and raising money, as these are long-lasting business relationships. Typically in the process of investing from pre-seed to seed to Series A, you will be having different investors in each round. However, in each new funding round, your investors from previous rounds may have pro-rata rights, or the right to continue to invest in the company and not dilute their ownership. (Note: For these kinds of legal details, please consult your own legal counsel.) Your chosen investors will have longstanding ties to your business. They truly can make or break your business with their efforts or lack thereof.
As you move into Series A and beyond, you should have a clear vision of who you want to partner with. Your best bet is having a blend of vertical investors with various specialties.
For example: an investor specialized in Fintech who understands the highly-regulated and compliance-heavy nature of a financial product
For example: an investor specialized in growing SaaS business models will understand the revenue model and how to build a B2B sales team from experience
Regardless of which round you are fundraising and how many investors you have, you should get in the habit of sending quarterly investor updates and keeping the lines of communication open. This helps you get into the cadence and mindset of being a public company in which you are sending earnings reports to shareholders, which is the dream.