If you try to raise money before you can convince investors, you’ll not only waste your time, but also burn your reputation with those investors. — Paul Graham, How to raise money
Summary of post- Startups need to have a spike in Idea+Team OR product OR Traction OR an aggregate spike combining all of the three to be able to start talking to investors
“When to raise money from VCs” is one of the most common and vexing issues that a first time founder faces. It is usually difficult because
- Founders treat their startup as a baby, making it difficult to subjectively evaluate when they are in a position to ask for funding or is the startup investible at all
- VCs pile on to the problem with their over positive messaging to startups. It’s almost as if anyone with an idea can start approaching them. Eg — “It’s never too early to talk to Sequoia”.
VCs operate on power law which means only a few of their investments will generate all of their returns. They are not concerned about losing money on startups, but on losing out on a startup which can generate enough returns to make the entire fund highly profitable. In other words, they will need to find NEO (matrix) or their fund will go bust. Hence while they talk to any and all startups, their investment rate is extremely low (One Accel partner told me they met 2000 startups last year and only invested in 18 — less than 1%)
While it’s easy to get a meeting, it’s incredibly difficult to get funded. Hence it’s important to get the first contact right. In case the startup comes off as half baked, it usually enters the grey zone where the VCs won’t engage unless something dramatic happens.
So when should you start talking? Put simply, when one or all of the pillars of a startup (IDEA+ TEAM OR PRODUCT OR RESULTS) is really strong.
IDEA + TEAM —
IDEA is a homogenous term comprising of the innovative solution and the overall market. E.g. Uber was an innovative way to call taxis on app, however most other derivatives titled “Uber for X” like beauticians, tutors, yoga instructors, drivers did not take off. Here the solution was same but the underlying market did not support it
The minimum stage of a startup funding is IDEA + TEAM. A repeat founder (with earlier success) can raise money even without an obvious idea. E.g CUREFIT which raised money on a plank (one app for all health needs of a person) which has proven to be the death-knell for many startups. However the investors trusted the founders to do justice to this space and they did it. Kunal Shah also raised money at the idea stage with CRED though the idea behind CRED seemed powerful right from the word go unlike CUREFIT which became obvious later. UDAAN is another example of a startup which got funded at idea stage because of the almost-founding experience of its team who were leaders from Flipkart
Moral of the story — Avoid talking to VCs at idea stage for fund-raising unless you are a repeat founder or almost-founder of a successful startup with an exit. In which case, you would know this already! Discussions for feedback in case you know the VC can always be done.
Having a product demo is always useful as it brings alive your vision and puts the VC in the shoes of the customer who will see the value this brings in their lives.
I am surprised at the number of posts , even from VCs, which indicate a product is not required or simple screenshots will do to convey the idea. In reality, this is not the case and I learnt the following points the hard way both for my startup and the startups we meet
- While a demo may not be fully functional, it should not be messy and half baked with some clicks showing 404 errors. This signals to the investor that the founders don’t obsess about presentation. Presentation in a web/app like food, is important in conveying the quality to the user
- Well designed demos are absolute must for any hardware startup
Whether you can raise money at the product stage itself depends on how defensible the product is. E.g a consumer CRUD app even with a strong team like Swiggy, Ola or Facebook will not be able to raise money without showing results of adoption or usage.
It’s hard to raise money on the product alone as then, the product has to be outstanding (taking min of 6 months to 1 year to copy) and the team behind it has to have strong credentials to sustain the advantage. However deep tech and enterprise startups do raise money at this stage. BYJU’s also raised money at the app stage itself but the credentials of the founder were well established by then
Finally the stage at which VCs fund most startups as some data has started flowing in. Most startups anyway approach VCs after some test runs/results etc but important to prove at this stage is “Is there a clear path to scale?”
- Distribution — Many EdTech/ERP startups trip after a few dozen clients after which the cost of client acquisition doesn’t justify rapidly acquiring them. E.g. B2B classroom startups have found it difficult to grow beyond first dozen or hundred schools. Should have a clear organic or a cheap inorganic growth path
- Product — “Do things that don’t scale” is a well-regarded startup mantra in initial days of a startup. However things that don’t scale will need to be substituted by things that do. The path needs to be clear. E.g. Hiring marketplaces which claim to match jobs with profiles do that manually but the path to automate that is not clear
Finally, all of this depends on the startup environment. The good old days of 2014 (for startups) violated many of these thumb rules, while past few years VCs have become extra cautious. I hope this post helps startups know when to time their fundraising and avoid making some obvious mistakes.