January 11, 2022
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7 Minute

The 8 Words That May Get you VC Funding

Growth & Scaling

“Raising venture capital is the easiest thing a startup founder is ever going to do,” says famous entrepreneur and investor Marc Andreessen. 

Well, maybe if you know what you’re doing and you’ve got the mentors to show you the way. 

In reality, most startup founders describe raising money as one of the most stressful parts of running their business. Only an estimated 4 percent of startups that seek venture capital funding eventually get it, and that number can change from VC to VC. 

But then, there are people like Andreessen who claims there’s nothing to it, but to do it. And that’s true, because these individuals know how to do things like:

  • Ensure they match a VC’s investment thesis
  • Leverage their network
  • Stay in touch with investors without wasting their valuable time as a founder
  • Perfecting the pitch 
  • Nailing down the narrative 
  • Stacking their meetings
  • Building relationships with investors ahead of the pitch

But perhaps the most important thing they know how to do is say (and back up) these eight magic words:  “Here’s how we’ll get to our next round.”

What exactly are the different funding rounds?

A venture-backable business is a high-growth, scalable business with the potential for network effects that maybe – just maybe – can take a $100 million chunk out of a billion-dollar industry. 

The trouble is that these big business ideas often bring more risk that a bank is willing to take. Whereas a bank is happy to lend money to someone with good unit economics or a solid business plan in a reliable industry, they’re less willing to plug their money into an idea. 

On the other hand, venture capitalists specialize in risky investments. They want to invest in 10 great ideas, knowing that 90 percent of them may fail. Why? Because they’re hoping the 10 percent that do make an enormous amount of money will make up for the others.

Venture capitalists invest money in startups in what’s known as funding rounds. As more venture capital firms open, and traditional institutional investors start joining the startup funding game as well, the lines between these categories have blurred. For instance, there’s been a steady increase in the amount of money available for early-stage companies worldwide. 

So how do you begin to make heads or tails of Series this and Series that?

Overview of funding rounds

  • Friends & family and angel round
  • Pre-seed round
  • Seed round
  • Series A 
  • Series B
  • Series C

Friends & Family and Angel Round 

An angel round includes personal funds, not institutional funds. This money comes from friends, family, and high-net-worth individuals who want to invest in promising ideas. These investors are focused on helping founders get their business off the ground, and while they hope for an eventual return on investment, they aren’t hyper-focused on profits.

Should you take money from your friends and family? That depends on how comfortable you are with mixing business and pleasure. 

In the beginning, friends and family are the easiest people to convince to give you funding. Unless you’re working with people from a finance or corporate accounting background, they’re less likely to grill you on the fundamentals of your business, scrutinize your business plan, or ask for detailed metrics. 

That said, there’s the risk of jeopardizing your relationships, especially if people have the wrong ideas about the risks involved or the amount of money they stand to make. 

Balance salesmanship with transparency about the risks involved when asking loved ones for money. You don’t want to raise money at the expense of damaging relationships with those nearest and dearest to you. (Unless you do, in which case, that’s your business!)

In all cases, be sure to document the terms of the money. If it’s a gift, get this in writing. A gift can quickly turn into a loan or an expectation of equity if your business becomes successful down the road. If people expect to receive equity or be repaid with interest, detail the terms of this arrangement to protect your business and consider getting a lawyer involved. 

A safe bet is to ask for a loan instead of equity and set up a payment plan so that your friends and family don’t scrutinize every trip you take or purchase you make. If you go the equity route, keep in mind that you’re essentially making this person your business partner, so document the terms of the relationship to avoid your dream startup turning into a nightmarish collaboration.

Pre-Seed Round

Pre-seed investors tend to be focused on specific niche markets, and scrutinize companies to understand whether they have a comprehensive understanding of the market, the opportunity, the competitors, product-market fit, and other early-stage indicators of a high-growth company. 

Once upon a time, the pre-seed round was considered the “friends and family” round, but with more venture capital firms turning their attention to extremely early-stage companies, it’s carved out a niche as its own category. 

This money is meant to help you get your business off the ground, especially if you don’t have friends and family to provide those first few dollars. But that doesn’t mean you can simply show up to investors and ask them for money.

In addition to a breakdown of the market opportunity, what you plan to do with the money, and how you plan to get to your next round (more on that later), you’ll need to also offer some indication of market interest. A few ways to do this are by showing presale or pre-registration numbers or demonstrating buzz around your brand through social media engagement.  

Seed Round

Despite firms starting to get more interested in pre-seed funding, the seed stage is usually when large, institutional investors get involved. These rounds can take a long time to close and come with ample scrutiny, but investing in this process is worthwhile. Seed-stage investors tend to focus on developing a long-term relationship with startups, providing strategic and operational guidance, and often provide follow-on funding. At this stage, startups will offer equity or convertible notes (debt that turns into equity at a discounted rate) to investors. 

Series A & B Rounds

These rounds are for early-stage companies that need to turn a large user base into a profitable customer base. Startups tend to focus on customer acquisition in the early days of their business at the expense of profitability. By the time they reach Series A and B, they need to be focused on turning revenue into profit and exploring opportunities to enter into new markets.

Series C Round

At the series C stage, companies are more mature, established and profitable. At this point, they’re seeking funding in order to develop new product and service lines. They’re focused on rapidly scaling and expanding their success. Series C round funding may also be used to acquire other companies in the startup’s value chain. These acquisitions either round out the company’s offering or absorb potential competition.

Sidebar
Are you an early stage company?
“A company that has less than a million in revenue, with a team of fifteen members or fewer, and working towards product-market fit is how we qualitatively benchmark an early-stage or seed stage company,” says Jonathan Lipoth, Lead Analyst at Broad Street Bulls.

Show early-stage investors how you’d get to the next round of funding

If you’re starting out, your focus should be on angel and F&F funding or pre-seed and seed stage funding. When you’re pursuing angel funding, focus on demonstrating that you are:

  • The person or people that should build this company due to your depth of knowledge, experience, and skills
  • Able to turn an angel investor’s initial investment into a liquid business down the road

When an angel investor invests into a pre-seed startup, their money is illiquid. Until that investment is converted into a minimum viable product and a meaningful number of customers, it’s hard to either sell the company or attract new investment. As a result, an angel investor’s money is stuck. While angel investors don’t expect immediate profits, they do want a clear roadmap for how founders will use their money to reach key milestones and get to the next funding round. This roadmap requires vision and a compelling story, since it can take anywhere from seven to ten years to reach liquidity. 

Figure out what your company milestones are and how much it costs to reach them

Investors want to know what you’re going to do with your money and how long it will take to get you to profitability or at least to your next round of funding. 

To explain this, you’ll first need to know what your cash burn rate is. This is the amount of cash you spend every month before making a profit. So if an investor gives you a million dollars and you spend $50,000 a month, your monthly burn rate is $50,000. 

Your burn rate also demonstrates how quickly you’ll burn through an investor’s money which is your runway. If an investor gives you $1 million and you spend $50,000 per month, you have a runway of 20 months. 

During those two years, what are the key milestones you’ll reach using that money and at what intervals? For instance, at the end of month 2, when you’ve spent $100,000, what will you be able to show for it. Will you have hired a UX designer that helps you complete your app and get it to your customers? By the end of month 7, will you have 100,000 paying customers thanks to this new app? 

If you can create these timelines and milestones in advance, you can paint a clear picture of where an investor’s money is going and reassure them that when you start raising money again in a little under two years, you’ll have something tangible to show for those 20 months of work.

This is also helpful for showing early-stage funders that you have a plan for moving from an idea to a liquid business.

“The liquidity period for a startup is generally between seven to ten years. Airbnb is a great example of a company that took close to 13 years to get to lPO. While different types of investors are often aware of this, many first time founders aren’t. Smart founders should be aware of investor liquidity timelines.” – Alex Gold, Managing Partner, Harvest Ventures

Marshall Ring, CEO of Manitoba Technology Accelerator, says his organization prefers a “tension-on-the-line”, tranche-based approach to funding that ensures each infusion of funding has a clear purpose and objective. 

“When companies are ready for money they’re able to give very tight deliverables for what they want to accomplish,” explains Ring. “We don’t want to finance someone to get all the way into the end zone. Figure it out a little bit and then figure out what the next steps are. People are ready for money when they can articulate the use of funds and the success metrics.”

Is it too soon for me to start fundraising? 

How do you know when it’s the right time to secure funding? Should you wait until you have a team? A prototype? A few paying customers? Generally speaking, if you’re a venture-backable business, it’s best to seek funding sooner rather than later. 

“We’ve always said, “If you have a plan or idea for what you could use money for, but you just don’t have enough, it’s probably time to start fundraising.”” – Trevor Phenix, Managing Partner, Broad Street Bulls

“Founders think they can slow drip things and get their business to a happier spot before finding funding,” says Trevor Phenix, Managing Partner at Broad Street Bulls, a Regina-based venture capital firm. “We often see people seeking funding too late or later than they should because they missed out on a pretty material time in their business where they could excel, grow, and leverage some of these very beneficial relationships. We’ve always said, “If you have a plan or idea for what you could use money for, but you just don’t have enough, it’s probably time to start fundraising.”

Key takeaways

  • Raising VC money is both an art and a science, and it’s worth understanding the motivations and strategies of VC firms
  • Investors want to know what companies are going to do with the money they give them, and more specially, how that money is going to get them to their next round of funding
  • While the categories of the different funding rounds have become blurred, each funding round comes with a specific set of expectations and deliverables for the business
  • The minute you have an idea for how you’d spend your money on your business, it’s time to start fundraising

Interested in learning more about how to raise money for your Prairie-based startup? Download our free Ebook “The Harvest Guide to Funding” to learn more.

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