Startup Fundraising Demystified

It's not that hard or complicated, don't be led to believe otherwise

I’m creating a few of these short lessons in an effort to concisely share information that was hard for me to find. It would have been useful to know these things as a first time founder and would have shaped my perspective prior to that as a startup employee.

I learned these lessons the learned the hard way and hopefully you don’t have to.

I used to think I understood how startup fundraising worked from watching Shark Tank and reading the news; I had no idea.

Often those of us outside of this process just see the press announcement many months after the actual fundraise took place. Here is an inside look at startup fundraising.

Note: many do an initial “friends and family” round before going out to raise money from angel investors and venture capitalists, but this requires having some wealthy friends and/or family members, so I’m going to ignore this step because you either have it or you don’t and if you do then that fundraising step is not hard.

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Startup Fundraising,
why do it? If you’re not independently wealthy, you can’t go very long without a paycheck, so the initial funding is the upfront cost of you paying yourself so you can afford to start the business.

That basic fact however, can lead us to make a poor decision if we don’t look at the economic picture of the exchange happening.

Taking on startup investment typically involves a founder giving up future upside so they have money to pay upfront costs. From a purely financial standpoint, one could think of being an entrepreneur as running an expensive experiment with lucrative potential. Some businesses, like ad agencies, have low upfront costs, for others the upfront costs are gigantic (e.g. SpaceX).

For a business with low upfront costs where you’re able to self-fund off profits, you probably should not raise money, because there’s a huge cost to having non-operating ownership in your business (only 14% of founders have not been pushed out by investors at exit).

For a business with large upfront costs, fundraising from investors early on is likely the only option.

what does it look like? Startup investing happens through an informal pitch process known as “fundraising” that consists of a bunch of (today) Zoom calls, emails, and in-person meetings.

Often the process is 2-3 months from the start to the final check being wired.

It is very unlike Shark Tank in that there is no formal structure around how it happens. It is more like a sales process where you have to go out and build a pipeline of potential investors from scratch, hopefully get an offer out of it, and nurture the deal over the finish line, it is all its own art.

Unlike the public markets, stock in a startup is very rarely sold. It almost exclusively takes place in a transaction that is the culmination of the above pitch process, known as a round.

Round: A transaction where the founder sells a portion of their company to investors. How much money the founder receives and how much of their company they retain afterwards is determined respectively by the round size and valuation. These have sequential titles, pre-seed, seed, Series A, B, C, D, E, F, each with semi-independent markets which fluctuate quite a bit.

Round size and Valuation: The “round size” is the total amount of money invested in a round. The percentage of the company that gets sold for the money invested is determined by the agreed-upon price of the company, the “valuation” as set in the termsheet.

Term sheet: An offer to invest in a startup which states the “valuation” and “round size”, this offer is given by a potential lead investor for the “round”.

Lead Investor: Investors that can write termsheets are typically partners at larger venture capital funds as the lead invests the most money and does the most due diligence. The prestige of the lead is a signal to other investors. Most other investors, “follows”, won’t invest until you have a “lead”. So the challenge in any round is securing your first “term sheet” from a “lead”.

Sometimes rounds will be co-led by two funds. In this case the founder trades for a broader network in exchange for less motivation for these investors to use their social capital to help with introductions.

Follow and Angel Investors: Other types of investors include “follow” funds, i.e. funds that don’t lead rounds, and “angel investors”, individual investors (rarely individual investors may lead rounds too, but this is an exception). Typically at least two thirds of a round will be raised from the lead and the remainder is for angels, follows, and previous investors in the company.