The Fundraising Field Guide was written to help early-stage tech startup founders decipher and navigate the fundraising process. It provides an overview of the soft and not-so-soft challenges you will need to prepare for as part of your fundraising journey, including things like reaching out to investors, dealing with rejections constructively, preparing materials and financials, understanding valuations and deal terms, and how to manage the legal process.
I hope you enjoy the book and get lots of use from it. I’ve adopted a ‘free-to-download-and-donate-if-you-like-it’ model because hey, if you’re fundraising, you’re bootstrapped right? If you do enjoy it, however, please consider donating to one of the charities in the “Get & Donate” section of this site to support organizations that are helping people around the world with their social entrepreneurship challenges.
To download the book, go to the book’s main website –
SeedCamp’s hackathon, Seedhack, took place at Google Campus, London, on the 8th to 10th of November. It brought together some of the brightest talent in the startup community from 15 countries with one of the best accelerator programs in the world and mashed it up with awesome content providers like Twitter, Facebook, BSkyB, BBC, Getty, HarperCollins, EyeEm, Nokia Music and Imagga. There were a total of 12 teams working on interesting and exciting projects.
As part of this hackathon, Ali and Will helped me aggregate resources to help founders better understand the process of raising equity and the impact it can have to their founder stakes. We aggregated resources to help entrepreneurs to understand the numbers and implications of raising money and giving out equity. Valuing a company and calculation its impact on your equity is a very complex and confusing for entrepreneurs as well as being far from an exact science, this is the pain point that we wanted to address.
In the words of Seedhack attendee Will Martin (@willpmartin)
“Fundraising is one of the most difficult parts of the startup world, as first time founders this is an even more daunting process. Experience of raising a round and understanding the numbers and implications of that round and the related equity issued to an investor as well as employees in the form of an option pool is vital, but sadly is only fully understood by going through the process for real. Our intention was to give founders the knowledge required by being able to go through the process in a simple and easy way, thus giving the founder the confidence when it happens for real.
Ali and I are first time founders currently actively looking for investment. We know the total value we need in terms of money we want to raise as well the percentage of equity we are comfortable willing to give up to the investor. What we didn’t know and learned through the process is the implications in future rounds as a result of that initial funding round. Having an option pool for employees, advisors, board members etc. is something that complicates the issue and is often a requirement in the terms an investor is offering. This complicates the issue for the founder, so being aware of the impact of their shareholding as a result is vital for a founder as it is them that gets diluted in the first round but also any subsequent round, but it is often overlooked.
The changes to equity positions of the founders, investors, employees etc. is very important to understand as it dictates control and value of a company. Having this knowledge now gives us as founders a huge advantage over other founders we are competing with for funding and bridges the knowledge gap that exists for first time founders.”
In order to read some of the terms on this cap table model, below are some definitions which you might find useful:
Pre & Post Money Valuation –
“The pre-money valuation is the valuation that a company goes into raising a round of financing with. By establishing this valuation, it helps investors understand what amount of equity they will receive in the company in exchange for their capital. Once the financing round has been completed, the post-money valuation is the sum total of the pre-money valuation plus the additional capital raised. So, if the pre-money valuation of a company is $10 million and they raise $2.5 million from investors, their post-money valuation would be $12.5 million. Investors would own 20% of the resulting company.” – Dave Morin, Source Quora
“A PRE-MONEY VALUATION is the valuation of a company or asset BEFORE investment or financing. If an investment adds cash to a company, the company will have different valuations before and after the investment. The pre-money valuation refers to the company’s valuation before the investment.
A POST-MONEY VALUATION is the value of a company AFTER an investment has been made. This value is equal to the sum of the pre-money valuation and the amount of new equity.
The Post-money valuation is the sum of the pre-money valuation and the money raised in a given round. At the close of a round of financing, this is what your company is worth (well, at least on paper).
If a company is worth $1 million (pre-money) and an investor makes an investment of $250,000, the new, post-money valuation of the company will be $1.25 million. The investor will now own 20% of the company.
The only reason it’s worth spending time on this term at all is that it “sets the bar” for your future activities. If your post-money after your first round of financing is $4 million, you know that to achieve success, in the eyes of your investors, any future valuations will have to be well-in-excess of that amount.
Formula: New Investment * total post investment shares outstanding/shares issued for new investment. “
“An option pool is an amount of a startup’s common stock reserved for future issuances to employees, directors, advisors, and consultants.” – from startuplawyer.com
Option pools can also be formed by Restricted Stock Units, but whichever one you use, they are generally still called ‘Option Pools’.
The OPTION POOL is the percentage of your company that you are setting aside for future employees, advisors, consultants, and the like. Employees who get into the startup early will usually receive a greater percentage of the option pool than employees who arrive later.
“The size of the Option Pool as a percentage of the POST-MONEY Valuation and where ALL of it comes from the founder’s equity. This is the least founder-friendly way to present this, but it is also the point at which most early stage investors will start the negotiations. The expectation from traditional venture firms is that this will equal 15%-25% of the company AFTER they make their investment. The Option Pool is one of the most complex and, from the entrepreneur’s perspective, confusing terms in an equity financing scenario.” – source http://www.ownyourventure.com/content/tips/op.html
Round Size –
The investment, or money is how much money is raised in a given round of financing. However, the decisions (and their implications) surrounding this number are among the most important that a founding team makes. It is not just about how much money is raised, it is about the terms that the money is raised on and, maybe most importantly, whose money it is and what they bring to the table in addition to money. – Source http://www.ownyourventure.com/content/tips/inv.html
NOTE FOR MODEL TO WORK – It needs to run on Excel (Google docs coming soon) and with circular calculations turned on. This can be done by going to (Mac Excel) Preferences -> Calculation -> Iteration -> Click on Limit Iteration
If you are considering using Convertible Notes as part of your round, check out this variant of the cap table with notes on how to convert as well: http://bit.ly/17kHlSA
Additional Equity Calculation Tools (Thanks to Ali Tehrani for finding these – @tehranix) –
UPDATED (Nov 11, 2013) – Notes added on: Conversion Triggers section & attached Cap Table in folder updated to v2 to fix some bugs.
The “Convertible Note” gets lots of attention in the blog-o-sphere as an alternative to traditional equity financings; some of this attention is good and some of it bad. Some investors refuse to use them, while others love them as a quick way of getting a company the capital it needs.
Convertible notes are sometimes viewed as a “best of both worlds” compromise from both a company perspective as well as from an investor’s perspective: on the one hand, a note is a loan, so the investor enjoys more downside protection than would an equity holder in the event the company is forced to wind up or dissolve for whatever reason; on the other hand, if the company eventually raises money by selling shares to later investors in a typical early stage financing round, then rather than pay back the outstanding amount in cash, the principal and interest are “converted” into shares of stock in the company (usually at some sort of discount off the price offered to new investors – I’ll discuss that below). In other words, the investor enjoys the downside protection typically associated with debt lenders, but is also positioned to enjoy the upside opportunity typically enjoyed by equity holders.
As with any tool, before you use it effectively, its best to understand the pros and cons of each of its features and how they can be used for your individual circumstances. Fortunately, convertible notes typically have fewer moving pieces than do equity instruments (which explains, in part, why they’re sometimes favoured by early stage companies and investors – the negotiation and documentation for a convertible note round is likely to be far less time-consuming and costly than for an equity round), but before we proceed any further in dissecting this tool, let’s look at the headline basics of a convertible note:
1) Total Amount Raised by the Note – This amount does have a natural limit. Think about it this way… you have an amount ‘outstanding on your cap table’, that will be part of an upcoming round. If a new round in the future isn’t particularly big, having too much money outstanding can create a problem with your convertible note holders taking up too large a portion of that round. Example: a 300K convertible which converts as part of a total 600K seed round would loosely mean that the convertible note holders would have 50% of the round. If the round was supposed to be for 20% of your equity, that means your new investor will only get 10%, an amount that may not excite him that much… and also you only get 50% new money in the door. To limit the extreme cases of this being done, investors usually create a ‘qualified round’ definition within the Note’s terms for conversion (see bullet #5 below) which reduces the likelihood of this amount being disproportionally larger than a new investors amount as part of a new round.
2) Discount Percentage – Simply put, if shares are worth $1 a 20% discount percentage would mean that an investor would get the shares for 80 cents. For cases where the next round’s valuation is below your convertible note holder’s cap as set in point #3 below, a discount factor will yield the convertible note holder a marginally cheaper price for having taken a risk on you. Typically this discount percentage is likely to be between around 15-25%. Another Example: a round closes at 3M. Your cap is at 5m. Your convertible note holders have a 20% discount, so they get to convert into the next round at a valuation of 2.4M.
3) Limit On Company Valuation At Conversion (the so-called “Valuation Cap”) – In order to calculate the number of shares into which the outstanding balance on a convertible note will convert, you must know the price at which the next round’s equity securities are being sold. Price per share, as you may or may not know, is calculated by taking the company’s pre-money valuation (negotiated at the time of the equity financing between the company and the investors) and dividing that number by the total number of outstanding shares in the company (the company’s “fully diluted capital”). Recall, however, that convertible notes are typically entered into in anticipation of an equity financing round – thus, at the time a convertible note is issued, no one knows what the negotiated pre-money valuation will be if/when the company undertakes an equity financing. Consequently, no one knows exactly what the price per share will be at the time the notes are issued. This creates uncertainty and is a cause for some investor anxiety, particularly for those investors concerned that that the number of shares into which their note may convert may be insignificant relative to the other shareholders, particularly in the event the pre-money valuation at the time of conversion is especially high.
The valuation ‘cap’ is intended to ease investor concerns by placing a maximum pre-money valuation on the company at the time of conversion. with the use of a cap, an investor can effectively set the minimum amount of equity an investor is willing to own as part of having participated in your convertible note round. For example, if you have a 200K note on a valuation 5m cap, then the worst case scenario for that convertible note holder, would be 4% equity after the new round is over. A typical valuation cap for very early-stage companies will be around $4m – $6m, with most companies at the Series A level settling on $10m valuation caps or more. For more statistics on caps and other components of a convertible note, I have included a link at the bottom of this post to an article with additional stats.
One thing to note, is that in the USA, there is a rising prevalence of uncapped notes. Clearly this is a founder friendly outcome, and if possible, always nice to get. The flip-side, is that for the investor, the may feel a bit ‘unprotected’ in the case of where the company does exceedingly well and thus their amount converts to a much smaller percentage than originally hoped.
4) The Interest Rate on a Note – A convertible note is a form of debt, or loan. As such, it usually accumulates interest, usually between 4-8% between the point when you sign it and when it converts. This amount is usually converted as part of overall amount at the next round. For example, if you have an annual interest rate of 8% and you have a Loan Note of 100, then you’d convert 108 after a year.
Note: In the US, it’s highly advisable to include an interest rate, even if it’s simply a nominal amount equal to the applicable federal rate (most recently at less than 1%), b/c if not, then any amount that could have been earned via interest is taxed to the company as gain. So it’s not really an option to exclude it in the USA. In the UK, you don’t necessarily need to include it should you wish to omit it.
5) Conversion Triggers – The point of a convertible note is for it to convert at some point in the future, not for it to stay outstanding indefinitely. As such, it will likely have a series of triggers for conversion. One I mentioned earlier is the next ‘qualified round’. Basically this means that the round is big enough to accommodate the amount in the note (without washing out new investors) and also is the type of round that is typical for the next step in the company’s growth and will give the note holders the types of rights they’d expect for their shares once converted from loan to equity. Another conversion trigger is an expiration maturity date, whereby the note holder typically can either ask for their money back (although this rarely happens) or basically seek to convert the outstanding amount at that point. There are more types of conversion triggers that note-makers can add to a note, but these are the basic ones. Update: upon a change of control event in the future and before the convertible is converted, investors can sometimes ask for a multiple of their loan back as payment in lieu of converting to ordinary shares prior to the completion of the change of control event. You can see some examples of this in the wording of the attached examples later in this post.
Again, these are the headline terms of a convertible note, and not representative of all the terms. However, for early discussions with potential investors, you’ll rarely have to talk about anything more than 1-4. Beyond that, you usually start having to involve lawyers (or experienced deal drafters) to help you finalise the document.
Now that we’ve reviewed the basics of a Convertible Note, take a look at a recent report that has statistics of what common terms have been given to Valley based companies. If you are not in the Valley, you will likely have a different set of averages, so be mindful of that.
Now, let’s look at the headline pros and cons of using a convertible note.
Typically less involved and less paperwork than equity rounds; can cut down on time and legal fees
Investors enjoy downside protection as debtholders during the earliest stages of the company when company is at critical growth stages
Company can defer the negotiations surrounding valuation until later in the company’s lifecycle (i.e. for very early stage companies at the earliest stages of planning and preparation, valuations can be more difficult to define)
At conversion, note holders typically receive discounts or valuation caps on converting balance, thereby rewarding the earliest investors appropriately for their early investment in the company but without causing valuation issues for the company
If a convertible note is made to be too large, it can negatively impact your next round because it’ll convert to a disproportionally large portion of your next round, effectively crowding-out your next round’s potential investors from having the equity stake they may desire.
If a convertible note’s cap is made too low, in order to accommodate a larger round later, the Founders may need to take the additional dilution that would happen if they exceeded the convertible’s cap.
Because a convertible note can be made to be quite versatile, sometimes investors can add clauses in there that have greater implications down the road, such as being able to take up more of a future round than the actual amount they’ve put in, for example.
If not careful, you can accumulate various too much convertible debt which may burden you at a conversion point
Doesn’t give your investors (in the UK) SEIS tax relief, thus making it less attractive than an equity round. There may be some workarounds, but generally SEIS and Convertible notes are not seen as compatible.
Notes give convertible note holders the investor rights of future investors (say in a future Series A Preferred Shares), which may include more rights than those they would take for the amount of money they put in had they simply done an equity deal on Ordinary Shares with you today.
If the convertible note automatically converts at the next equity raise (i.e. the investor has no choice), investors may wind up being forced to convert into securities shares despite not being happy with the terms of the equity financing. The note holders may unfortunately have less influence in negotiating the terms of the equity financing, which partially explains why some investors are reluctant to invest with convertible notes.
Finally, while convertible notes allow the company to defer the valuation conversation until a later time (see discussion under “Pros” above), any inclusion of a conversion cap will raise a similar conversation, which defeats some of the purpose for why companies and investors alike originally favoured the convertible note as a quick-and-easy financing solution to begin with.
Now let’s explore a few more core concepts in detail.
Seniority – A convertible note is a form of debt or loan. Although its not too common to hear about investors asking for their money back, they in fact, do have that right… additionally, one of the privileges that having the Note act like debt is that it acts senior to equity in the case of a liquidation. What this means in practice, is that Loan holders will get their money back first.
Subscription Rights – Some investors like to have more equity than their invested amount would likely yield them upon conversion. So one thing to look out for is how much they want to take up of the next round as part of having been in the convertible note. Example: An investor gives you 50K, which converts at your next round of 1m on 2m Pre at 1.6% -> next to nothing for the convertible investor. However, that investor had a Subscription Right for up to 30% of the new round, so that allows him to participate on the 1m round with up to 300K thus affording him a larger ‘seat at the table’ in excess of the 1.6% he would just have without this right.
To conclude and to provide you with some practical examples, in the following Google Drive Folder I have added an excel sheet with an example cap table as well as UK & USA termsheet templates from Orrick* that are uberly simple, for review purposes only (they may not be fit for what you need, but give you an idea). A comment on the example cap table – it isn’t designed to be ‘fully realistic’ per se, as in, your cap table will likely not look like this in terms of founders and shareholders and number of rounds before a convertible comes in, but it serves well for you to play with the variables that make up a convertible note so you can see how they affect your fully-diluted stake after a round.
I hope this helps you decide what the best options may be for you. As usual, please give me feedback on all these materials as with software, there are likely bugs somewhere!! Thanks in advance!
*Regarding the Convertible Note Documents, a disclaimer from Orrick: The linked documents have been prepared for informational purposes, and are not intended to (a) constitute legal advice (b) create an attorney-client relationship, or (c) be advertising or a solicitation of any type. Each situation is highly fact specific and requires a knowledge of both state and federal laws, and anyone electing to use some or all of the forms should, prior to doing so, seek legal advice from a licensed attorney in the relevant jurisdictions with respect to their specific circumstances. Orrick expressly disclaims any and all liability with respect to actions or omissions based on the forms linked to or referenced in this post, and assumes no responsibility for any consequences of use or misuse of the documents.
Product / Market fit can be loosely defined as the point in time when your product has evolved to the point that a market segment finds it attractive so that you can grow your product / company scalably. In many ways, finding Product Market fit quickly allows you to focus on company growth rather than spending a lot of time and money on iterating your product to find that fit. Many companies linger in that limbo for quite some time unfortunately. Without this product market fit, it’s hard to inject nitroglycerin to generate the desired growth rate that all investors want when they invest.
Having spent time with several companies that have gone through the process of finding product market fit, I have observed that many get hung up on iterating only the ‘product’ part of product / market fit, rather than thinking of ‘product’ in a larger context. Speficially, the three things I notice are being omitted by several companies that have been religiously using the “Lean Methodology” product dev model alone to achieve PM fit, but failing to find it are:
1) A definition of a Minimum Viable (customer) Segment – As originally defined by Michael J. Skok
2) The testing of a well thought out positioning strategy alongside the testing of an MVP
3) The testing of a complimentary go to market / marketing strategy that tests your product vis-a-vis the chosen positioning strategy above
If you think of the three above as a bullet, visualise them as the lead pellet (product), the shell (positioning), and the gunpowder (go to market) that makes a bullet work. They only work when tested all-together, not separately. Testing only the lead pellet, doesn’t get your bullet very far.
In order to fit these three points into a more familiar framework, I have borrowed the Lean Methodology’s Build-Measure-Learn loop and expanded on it to create a larger loop designed specifically to help guide you achieve a series of test loops to achieve product/market fit. This isn’t perfect (and would appreciate any feedback on how to improve it) but I figure it’ll help provide a framework by which to test all in conjunction.
Here is the Product/Market Fit Cycle Model I propose (see attachment for illustration at bottom of post):
Start with a Product Hypothesis / Idea
This is effectively the way YOU think of your product the day you conceived it.
This should also have the rudimentary aspects of a defined value proposition for a set of customers.
Identify a Minimum Viable Segment (Customer Base)
The concept of an MVS comes from Michael J Skok’s observation of one of the flaws of the standard Lean Model. You can see his work on this here: http://www.mjskok.com/resource/gtm-segmentation. In summary, a Minimum Viable Segment allows you to test your product on a focused segment rather than leaving it too open ended across several segments, each giving your potentially different outcomes. The benefit of identifying a minimum viable segment is it allows for better differentiation of your product within your market segment, thus, you get easier referrals from this group as well as more efficient use of capital to acquire them.
Questions to ask yourself as you define your MVS:
*Who are my potential customers?
*How do I find them? (which blogs, which media, which social networks, which retail locations, which distributors, etc)
*What will they be willing to pay? (you may not know this off the start, but you’ll be able to determine this as you test it in the next step)
Build a Minimum Viable Business Model
The Business Model Canvas helps a lot in identifying a lot of the components needed for a fully operational Death Star, but what we are trying to test here is more ‘does it work’, rather than filling in all the components of the Business Model Canvas too early, and which you may not know at a start.
The three parts to the Minimum Viable Business Model include: A positioning strategy, an MVP, and a Go 2 Market Strategy.
*Build a Positioning strategy
As you create your positioning strategy, make sure it will resonate with your MVS and product hypothesis, or otherwise iterate these so that they are harmonious with each other. No point in having your positioning not be something that your MVS values, for example.
If you are not familiar with what a positioning strategy is, read the following book, it is the gold standard: Positioning by Jack Trout & Al Ries
*Build an Minimum Viable Product that fits the above positioning strategy
Most tech founders generally rock at this bit, so nothing I can really add here. However, take a look at my previous post on growth hacking summarising Traity’s experience in optimising their product to yield better conversions if you want to optimise your product for growth and reduce the potential of your product getting in the way of conversions: http://thedrawingboard.me/2013/04/15/on-growth-virality-loops-and-customer-acquisition/
*Build a Go 2 market strategy
A Go 2 Market Strategy is, simply put, a strategy that attempts to cost-effectively deliver the value proposition to the selected target segment(s). It is a strategy to help get the product or service out in the marketplace and includes pricing strategies, sales strategies, and marketing methods (internet marketing, direct marketing, PR, etc). It can include things like identifying key distribution channels and key partnerships required to get your product to the identified minimum viable segment. Clearly this will be different for B2B companies than B2C companies. The aim is to build a Go 2Market strategy that targets you MVS with your selected positioning strategy for best effect.
Once having completed and packaged the above three in a minimum viable form, assign a “cost” (what money you are going to spend on validating it) to the combination and set some expectations around target figures upon which to analyse your resulting metrics. How many users are you expecting, what constitutes an ‘active’ user? A churned user? A conversion? etc. Effectively, you want to have ‘targets’ for what you experiment will yield.
Test & Measure
As you know, a key part of understanding forensically whats happened after a test, you will need to have set up good tests to start with and also adequate data. A good book on this is: http://leananalyticsbook.com/ I’m in the middle of reading it, but so far it seems in line with what I’ve seen several startups doing.
Tests will include quantitative (Kissmetrics & http://newrelic.com/) and/or qualitative tests about how the product is perceived based on people that didn’t activate. Using the output from your tests find out how your users are behaving to gain intelligence.
However, keep in mind that testing will be different between the different phases of startups in how you can test. In the words of Andreas Klinger (co-founder of Lookk):
I personally see product dev as a spiral. The further you go outside (mature) the more quantitative your approaches can be, the further you are yet on the inside the more qualitative. You repeat the same phases (build,measure,learn etc) but you use different tools.
Most startups are in that inner core of that spiral but play games of outer ends. We can call this premature scaling or just inefficient behaviour (e.g. using metrics when there is no clear data). Many product hypotheses/ideas and especially customer segments can already be eliminated very cheaply before MVPs – eg by qualitative approaches (eg customer interviews).
Metrics are for me personally a bit further down the spiral.
* Arrivals & Acquisition – How many people landed on your website coming from a marketing campaign that you are tracking and then you acquire the user. For a SaaS product, this usually means a sign up.
* Activation – The user uses your product.
* Retention – What is your churn? How many of the users you have in your userbase are active? How many stopped being active and why?
* Referral -How many of the users that are using your product are willing to refer to others?
* Revenue -How many users are willing to pay you of the ones that are using the service?
Learn/Debug your Minimum Viable Business Model (MVB – yeah ok, too many MV* acronyms, but too long to spell out)
Questions to ask yourself as you are reviewing the metrics:
Are you having high arrivals but poor Acquisition/Conversion? – Perhaps your Positioning is working, but your product isn’t living up to expectations. Think about this as you talked about a great party but when people showed up they thought the party (product) was lame.
Are you having high acquisition/conversions but poor arrivals? – Perhaps your positioning/marketing strategy is not working, and for those few people that are in your MVS that land on your site by luck, convert because they find the product useful. Perhaps you didn’t allocate enough cash to your Go 2 Market, or rather the cost of acquisition of the chosen MVS is higher than expected so you are just aren’t getting enough eyeballs on the site, but when they do they convert.
Are you having so-so arrivals, and acquisition at your target figure? – Perhaps your Go 2 Market strategy is not cost effective, or you didnt find the most efficient channels. Perhaps you didn’t allocate enough money to the Go 2 Market strategy.
Are you having high Arrivals, high Acquisition & Activation, but poor Retention? Then likely your product is failing in delivering ongoing value. There is something wrong with it. Use product analytics to find key churn out points and qualitative studies to find out what is pissing people off.
Are you having a hard time monetizing? – Perhaps there isn’t enough value in the product hypothesis for the MVS if you can’t get anyone to pay even if they are engaged (not enough of a pain).
No referrals? Well, likely a function of the above as well. Perhaps you haven’t build enough virality into your product (see Juan Cartagena’s work on this).
Decision point & New Ideas
Now that you have the output and a series of metrics and potential red flags as to where things went wrong.. you can consider various options before you go through the loop again:
Do I iterate on one of the factors of the Minimum Viable Payload? (try a different positioning strategy, go 2 market strategy, or product revision?)
Do I pivot to a different product hypothesis?
Do I pivot to a different minimum viable segment?
In conclusion, I hope you find this framework useful in helping you diagnose what you should try out. Let me know what you think and if you’d add/subtract anything to it.