"Fundraising is brutal," Paul Graham, world renowned venture capitalist, said back in 2008. Over 14 years later, the sentiment is still the same. Yes, the startup investing scene has evolved since then, but at its core, raising capital for your startup is still (1) necessary to grow your business* (2) one of the hardest things you'll ever do.
*Some companies have bootstrapped their way to profitability, though this route requires a lot more of everything: time, resources, and luck.
This is more apparent for first-time founders because there's no playbook to fundraising. How much should you raise? What is your company's worth? What should you say to investors? What should you not say? How do investors decide what to invest?
With no clear directions (or even a starting point), founders often have to find their own answers as they go along. The bad news (as if being a founder isn't hard enough already) is that this is heavily normalised - especially in Southeast Asia. Unlike Silicon Valley, there's limited access to not just startup education, but also to experienced operators.
Founders are forced to figure it out on their own.
At Iterative, we're trying to change that. We want to make entrepreneurship more accessible, and help founders achieve their next milestone, even if the next step looks dark, fuzzy, or bleak.
Unfortunately, fundraising is one of those steps.
Fortunately, fundraising can be learned. Fundraising is a skill - and like any skill, it's something that you can practice to get it right.
To help you hone this skill, we'll be creating a series of fundraising topics over the next few weeks, starting with the basics: common questions.
From our past few batches, we've gotten recurring fundraising questions from founders, and we've compiled them in this article for Brian Ma and Hsu Ken to answer.
If you're new here, both Brian and Hsu Ken have raised $100M+ as founders - and over the last two years, Iterative's companies have also raised 100M+ after our program. But more importantly, they've been through the stuff you're about to (or already are): from raising money to getting investors to talk to them to making negotiations.
Here's their take on what you need to know about raising capital to build your business.
On Raising Money
I can't fundraise, what's wrong?
Brian Ma: The most common reason this happens is because (1) you’re confusing investors about what you actually do (2) you get across what you do, but aren’t getting across why it’s differentiated, or (3) investors don’t believe your TAM (Total Addressable Market).
Quick advice on how to address each one of these:
How to Not Confuse Investors — Test your pitch on your friends and see if they can summarise your company in six words or less. If they can’t, you’ve failed.
How to Differentiate – Same thing as above. Test it with your friends or other founders to see if they can name your top two competitors and why you’re better than them. What do you know that they don’t? See if they believe you.
TAM - This one is the hardest to get right because you probably don’t really know, are making up a big number, and investors probably won’t believe you anyway.
The best way to address this is to break it down into stages.
- What does it look like when you tap out of market 1 (maybe a geography or product)?
- Where is the adjacent market and how big is that?
- What will you do after that?
When and how much to raise money for my startup?
Hsu Ken: Typical advice is you want to raise enough money such that your company has 18 to 24 months of runway. This should include cost of growth (new hires, marketing, etc.)
In a cold fundraising environment (like we’re currently in), you should look to extend your runway 24 to 30 months if you can. Founders should also be more conservative increasing their cost. Only increase burn if you are reasonably certain you’ll get return on the spend.
In a hot fundraising environment (like we were in), founders would sometimes raise enough for just 12 to 18 months. This is stemmed from the belief that they could raise more money later on when they have more traction. Founders were also more speculative with increasing their cost - increase burn to experiment with growth.
What is my company's worth?
Brian Ma: The real answer is your company is worth whatever someone is willing to pay for it. VCs have proxies for what this should be, and a lot of times it's based on some multiple of revenue, or revenue run-rate.
For companies without revenue or very volatile revenue (which is almost every pre-seed or seed company), the real way valuations happen is VCs will just think about the other deals that they’ve done or seen in the market and compare you against them. Your valuation is the average of what a VC has seen in the market for your stage, plus other attributes they care about (founder background, competitiveness of the market, etc).
What makes a company VC-backable?
Hsu Ken: It's the potential to grow into a highly valuable company ($250M+) in a relatively short period of time (5 years). Currently, the only types of businesses that can achieve that are technology companies, because they have low marginal cost. As in, they can be used by a large number of users in a short period of time - and for very little cost.
For a coffee shop to expand, they need to open new stores, hire more people, etc. For a consulting company to expand, they have to hire more people so they can bill more hours. Facebook, every once in a while, has to add more services. This post explains it more in detail.
What are common mistakes in fundraising?
Brian Ma: I'll give two.
- Having A Monolithic View of Investors: Thinking all investors are the same is something we see a lot - and something you shouldn't do. Every investor has different interests and perspectives, and it's important to do your research and figure out if your company is a good fit. Think of it like publishing a book. Not every publisher will be interested in your genre, and you have a much higher chance of success if you look for the ones who do.
- Poor Preparation: You (often) only have one shot at impressing an investor, so when you don't do the necessary preparation (setting a target amount, having a plan for objection handling etc), you run the risk of coming underprepared, and losing out on your one chance.
On Meeting Investors
How do I connect with investors?
Brian Ma: Hustle! Nobody knows every investor, so it's important to figure out how to get an in. The most effective way is to use your friends to get intros, or use your friends to get intros to other friends who are portfolio founders of the VC to get an intro, etc. Figure out how to work the network. For example, Iterative has now funded 150+ founders in every geography in SEA. It’s probably not hard to find an intro to an Iterative founder to get the inside scoop on us who then will refer you to us to take a look. Do the same with other VCs.
If you’re struggling with this, an option is to cold email them (or use their application on their site if they have one). We have one and look at every single application.
What would an investor typically ask?
Hsu Ken: It varies from investor to investor, but here are some common questions you'll need to prepare for.
- What Problem Do You Solve? Startups exist to solve problems. If an investor doesn’t understand the problem your startup solves, they won’t understand the rest of your pitch or your startup. Be concise and specific.
- How Do You Solve It? Once they understand the problem they will want to know about your solution. Again be concise and specific. If you’re struggling to explain and people don’t get it, you’re either not being specific enough or haven’t setup the problem properly. A writing piece of advice that I think about all the time with pitches is “If you’re having Act 3 problems, it’s probably because you have Act 1 problems.”
- Who Are Your Competitors? If the problem and solution are obvious, there’s bound to be competitors. Investors want to know whether you’re early or late to the space. If it’s the former, they will be more skeptical about the potential size of the market since nobody has validated it. If it’s the latter, they want to know about how you differentiate yourself from existing players.
- How Many People Are Using Your Product? Traction is evidence you’re onto something. Investors ask because it’s the real world litmus test. If the problem you’re solving is that valuable, your solution is that differentiated and there’s no competitors or they suck, then people should be using your product.
- Who Are the People Using Your Product? Related to how many people are using your product, who are they? Investors like to ask this question to (1) figure out if there’s a lot more people like the ones using your product and (2) whether you know who’s using your product. If founders don’t have a strong understanding of who is using their product and why, it’s unlikely they’ll be able to get that many more people to use it.
What is something I shouldn't say or do in a meeting with investors?
Hsu Ken: I'll list five things you shouldn't do.
- Sign an NDA – Ask an investor to sign an NDA. If an investor signs an NDA, that could restrict them from making investments in a somewhat nebulous set of companies. Why would they do that before they even know if they want to invest in you? It’s an obvious sign that you haven’t done this before (which most of you haven’t!).
- Not Knowing Your Metrics – You must know your metrics (users, retention, etc.). If you don’t know them it suggests that you aren’t that focused on them.
- Being Defensive – An investor's job is to ask questions and be skeptical. They’re not trying to be mean (I hope!). Sometimes I take an opposing position from the founder (even though I agree with them) just to see (1) how well they’ve thought it through and (2) to see how they react to opposition. The best founders have an opinion but are open to being wrong.
- Thinking Money Is the Answer – We often ask companies why they aren’t growing faster (regardless of whether they’re growing fast or not). Often founders who haven’t really thought about it before, will say money. For early stage startups, it’s almost never true. If you’re thinking right now that you’re the exception, I’m 99% sure you are not. With the abundance of tools and resources available to founders today, it’s almost a certainty that you can grow to thousands of users without funding.
- Saying You Have Product Market Fit – When early stage founders say they have “product market fit” when they clearly don’t. It shows a lack of understanding of what product market fit is. Product market fit is not something that you obtain and always have. You’re constantly chasing it as you go after more and different users. You also can’t get product market fit from doing surveys, landing pages, etc. The only way to get product market fit is by having a product that’s growing fast and retaining users.
How do investors decide whether to invest?
Brian Ma: VCs will look at the things that matter the most to them. Usually, it's some combination of founder, market, and traction. They’ll probably break that down even more and score your company based on those attributes, then compare it to every other company they’ve seen.
VCs are looking for something very unique and can only make very little bets (we see thousands of applications and make ~50 a year - which is already a lot for a VC), so don’t take it personally if you get rejected. Even the best founders get 100+ no’s before they get a yes.
How do I interpret responses from an investor?
Hsu Ken: Any answer that isn’t a yes or they want more information now, is a no. ("You're too early," or "Love to see more clarity around Y". All of these are a no).
The good news is: no’s are never permanent.
How should I respond to rejections?
Brian Ma: First, don’t take it personally. You’ll be rejected a lot. If you had a good conversation with the VC, try to ask for honest feedback. What did they think was the biggest risk, and what would they want to see happen before they’d want to take another look at the company? It’s rare (but possible) to turn a rejection into a yes.
But sometimes, if you factor in return of your time, the best thing to do is to move on.
How do I negotiate?
Brian Ma: The best way to negotiate is to have more than one VC wanting to invest in you. There’s really no other way to do it well, because you don’t have that much leverage. If you’re in the awesome position of multiple term sheets, then there’s tons of stuff you can do! Figure out what you want from the deal (smaller esop pool, higher valuation, less board seats or control terms, etc) and work with every party to see who’s willing to move on what terms. At the end of the day though, while dollars and terms are important, the most important thing is to work with a great partner that can help you build a great company.
What are atypical terms in fundraising?
Hsu Ken: This is an important question because deals are less standardised in Southeast Asia, so it's important to know what is or isn't common.
- Interest – Charging the startup interest on their investment. Either needs to be paid in cash or with more equity at a later date. Startups are cash poor so this is like giving them money then slowly sucking it out of them.
- Tranches – For most investments, the amount invested is transferred in a single transfer. That way the startup knows they have it and can start putting it to work. Only when I started working in Southeast Asia did I learn that some investors transfer in tranches. Either because they don’t have enough money on hand or want to see how the startup does before transferring the rest.
- Performance Based – Related to the above. An investor might say they want to transfer $100K now, and if the company doubles revenue then another $500K but at the previous terms. This is a fantastic deal for investors but absolutely sucks for startups. If the company doubles revenue, obviously they’re much more valuable than they were at the previous terms.
- Program Fees – A number of programs do this so maybe it isn’t atypical but it sucks for founders. Some programs invest $X but charge a $Y program fee. As an example, let's say the investment is $100K but there is a $30K program fee. Effectively, this means they get $100K worth of equity but the startup only walks away with $70K.
We'll echo it again: "Fundraising is brutal." In fact, in Iterative's programs, we put our founders through a one-month fundraising bootcamp, where founders have to refine their pitch week after week after week until Demo Day.
But as Brian always said: "The founders who survive are often the ones who just keep going.”
On That Note... We're Open for Applications!
Our latest cohort is underway, but we’re already on the lookout for the next companies to invest in. We’d love to see what you’re working on! Apply now.