Initial Financing

“Dear Sir/Madam, To whom it may concern:

I read on the Internet that you were an investor in unicorn startups. I am a visionary whose ideas will generate billions of dollars in returns for you, so let’s discuss how you can work with me. I will share my ideas with you once you have returned the enclosed NDA.”

I get emails like these several times a week. It’s full of buzzword mumbo-jumbo,   shows a lack of understanding of the VC process (VCs never sign NDAs), and a total randomness in picking an investor to pitch (“Dear Sir/Madam”). Use this kind of email and your pitch will likely go straight to the bin.

Building a startup is hard, and there are so many factors that lead to failure. One of these factors is not understanding the basics of the “VC game,” or more precisely, the basics of VC math around pitch volumes and investment performance.

The probability of receiving VC funding can increase if you understand the basics. Here are some pointers to help get you started.

  • Most firms will receive a few thousand to tens of thousands of pitches per year, the vast majority by email. At this point, I would strongly recommend against sending paper business plans by snail
  • Investment staff, ranging from associates to partners of the firm, will read through the proposal and either reject it outright, ask for more information and still pass, or schedule a
  • I can’t speak for every firm, but here are the numbers at SoftTech:
    • Less than 20% of the companies reaching out to us will be invited to a meeting because of a mix of actual time capacity and fit with the investment strategy (stage, size, sectors, portfolio conflicts).
    • The first meeting, if successful, will yield additional meetings with other members of the firm, until due diligence Less than 5% of companies reaching out to   us will get to this point.
    • The due diligence phase is when we reach out to founder references, early customers, experts that will help us validate the technology, science, or market,etc. Only a small portion of companies will successfully pass that phase (less than 1% of our deal flow).
    • Finally, we’ll make an offer to invest and 85% of the time, we’ll close an investment; less than 0.5% that reached out to us will actually get funded.

Not only is the probability of raising capital pretty low, it takes time too. We coach our companies that they have to assume raising capital will take six months, so you start six months before you run out of cash at the very least. The key point that founders often forget is that fundraising is close to being a full-time job, so they need to plan accordingly. Don’t try to close key accounts, lead the development of a major release, and hope to fundraise at the same time.

The most critical thing to understand about VC funds is that performance is extremely uneven. In a portfolio of any size, less than 10% of companies will produce a multiple on capital invested that allows a fund to be returned multiple times. A winner for us returns 50% to 100% of a fund, which means a 20- to 30-times return on the company—implying an outcome of several hundred million dollars or more. That’s what we mean by VC scale returns.

As you think about the parameters of your company, you need to be honest about your prospects of building such a company that can scale to tens of millions of dollars in revenue, hundreds of millions of users, etc. Most startups will not have those characteristics, which is why you hear so often that a company is not “VC scale.” Other euphemisms for this include “It’s a feature, not a company” or “That’s a lifestyle business.” So what are the implications?

  • Raising capital from VCs is predicated on proving that your company has the potential of getting to “massive” scale and
  • You need to end up in the 1% of some fund’s deal flow to get an investment.

Out of the universe of hundreds of funds and thousands of angels or angel groups, there is a subset that is the right one for your company.

You just need to identify them, get the right introduction, and make the right pitch. It’s not easy, but it is feasible. In the last 12 years at SoftTech, 188 startups have succeeded at getting an investment from us.

As entrepreneurs, you’ll be spending a lot of your time raising capital. At every stage, you’ll present a set of achievements and represent a set of risks. Over time, achievements and milestones will increase and risks will decrease. That process will allow you to continue to raise larger amounts of capital at higher valuations from different sets of investors (seed, early, scale, growth).

Let’s walk through a real-life example: Fitbit.

We were the first institutional investors, alongside our friends at True Ventures, and remained active investors through the company’s public offering in June 2015. Here is Fitbit’s funding history:

  • $400K seed round in 2007 to research and build the initial prototype
  • $2M Series A round from True Ventures and SoftTech in 2008 to launch the product
  • $9M Series B round led by Foundry Group in 2010 to scale distribution in the United States
  • $12M Series C round led by insiders in 2011 to build new products and scale in the United States
  • $30M Series D round led by Softbank, Qualcomm, and SAP Ventures in 2013 to scale internationally

The whole funding ecosystem is important to understand, whether your initial round will typically come from the pre-seed or seed part of the market.

So how much should you be raising for your initial financing?

The very first round (the pre-seed round) will typically range from a few tens to a few hundreds of thousands of dollars, at a low, single-digit million valuation (e.g., $750 thousand at $3 million pre-money). This should give the company a runway of 12 to 18 months, enough to build an initial version of the product, hire a small team, get feedback from initial users, and raise the seed round. That seed round will have a range of a few thousand to a few million dollars at a valuation reflecting the amount of progress made ($2 million on $8 million pre-money is a very common round for software companies in our portfolio). It will also be used to launch your product and develop the traction that will allow you to raise your next round, the Series A, something like 18 to 24 months after the close of the seed round.

There is clear tension here: the more you raise, the longer your runway, giving you more time to hit the milestones of the next round. But if you raise too much too early, you as founders will be diluted so much that it will make raising the next financing difficult or impossible.

Old school VCs may tell you: “We’re partners  in this venture: you contribute the company, team, and product, we’ll contribute capital. How’s $500 thousand for 50% of the company—that way we’d be 50/50 partners!” Do not say yes to this proposition!

The other day, a company presented to me and mentioned they had given 25% of their company to an early investor for $75 thousand. That makes you question the judgment of the founders if they accept terms like this. The good news is that this investment was redeemed, and the company has a clean cap table as a result (where no investor has an unjustifiably high portion of the equity).

Here are examples of “normal” dilutions:

  • Equity given to accelerators/incubators should be in the 5% to 10% range, or less.
  • Early rounds should be limited to 10% to 15% for pre-seed, and 20% to 25% for seed.

What may be counterintuitive though is that investors do look at founders’ ownership levels before they make an investment decision, and they want to make sure there is “enough” for founders to be motivated; obviously “enough” varies based on the maturity of the company.

Who decides on your round’s valuation?

Wrong answer:

Entrepreneur: “We’re raising $1 million for 10% of the company.”

VC: “Oh, you have signed a term sheet with a lead investor?”

Entrepreneur: “No, why?”

VC: “Well, who set the valuation of the round?”

Entrepreneur: “We did, based on what we read on TechCrunch about company XYZ.”

VC: “Yes, but this company had an experienced team, a product in market, and some early revenue.”

Entrepreneur: “And?”

Right answer:

The market, i.e., people who will actually commit to write a check and help you build the company, not your buddies or advisors, unless they write a check too.

Let experienced investors, preferably institutional ones, offer a valuation for your round. If you end up in a competitive situation, with multiple term sheets, you may be able to play investors against each other (a bit) and leverage the situation to your advantage. But even in that case, my advice is to choose the investor who will deliver the highest value-add, the best brand value as opposed to just the highest valuation. Brand value is linked to the credibility a company gets by being associated with you. Value-add is all the support you’ll get from investors: strategy, execution advice, help raising the next round, hiring, marketing and sales, etc.

How to prepare for your round

Would you ever run a marathon unprepared, untrained, without advice from fellow athletes? And still expect to successfully cross the line? Your first financing is similar.

The ideal situation is to have anticipated the moves of the other side (investors) and feed them all the information they may need, both in the first pitch meetings, subsequent ones, and the due diligence phase (the steps we highlighted at the beginning of this chapter).

To get financing ready, you need to figure out what, how, and whom to pitch.

What to pitch

VCs will analyze opportunities through different lenses, but most commonly they use the mix “Founders, Product, Market Opportunity.”1 They’ll assess why the team in front of them is uniquely positioned because of founders’ personal interest, story, and challenges in tackling this opportunity. Then they’ll dissect why the product/service is unique, understanding that teams rarely come up with radically new ideas in a completely white space. Finally, they’ll ask the “scale” question: Can the company truly create a large outcome if it scales to massive revenue?

As already discussed, you’ll ask investors for a certain amount of capital (e.g., a $2 million seed round), and you will present a plan for using this capital over a certain period of time  (typically 12 months+ for pre-seed, 18 to 24 months for seed) that will allow you to hit the milestones of the next fundraising round.

How to pitch

You are going to put together a pitch presentation for the initial meeting, 10 to 12 slides, that will address VCs’ key questions:

  • What is the opportunity?
  • What was the genesis of the idea?
  • Why is it interesting, how big can it become? Provide some proxy number for the market size.
  • Who are the founders, and why are they uniquely positioned to succeed in this market (the “founder/market fit” question)? Who else is on the team; engineers with relevant experience can be listed, along with one or two key advisors, if they are truly engaged.
  • Why now? What are the technology, regulatory, societal, consumption changes that make this opportunity feasible (e.g., more than one billion smartphones in use, or FAA regulations on drone usage)?
  • Milestones hit to date? Think of them as elements of risk that you have already addressed or validated at least partially: parts of the product already built, key hires, or proving customers’ willingness to pay through early revenue returns or targeted surveys. Limited product/prototype demos will help validate the technical feasibility of your project.
  • What is your go-to-market strategy? State either what has been accomplished to date or the strategies that you plan to test or adopt post financing.
  • Who else is out there in your primary and adjacent market? Who is in your competition matrix, and how well are these companies funded? It is vital that you research your market, especially if it is an already established one.
  • Financing and revenues? Mention how much you have raised to date and from whom, your revenue traction if you have any, and how much you are looking to raise. Finally you’ll present a summary of the use of funds (how many hires, when, in which function), your targeted runway, and the milestones you plan to hit before the next For example, software as a service (SaaS) companies are expected to hit $1 million to $2 million in annual recurring revenue (ARR) before they can raise a Series A.
  • You can have a number of additional slides as backup materials, but don’t pack too many in the front of the deck so you have ample time for discussion during the meeting.

There is no specific order in which these slides should be presented; it just has to be logical, and narratives that flow as a story tend to work better. I personally like pitches that set the scene: “For the last couple of years, we have been building a product focused on addressing this need. The founders have this background, met that way, and have decided to work on this because of ‘X.’ We now have a prototype in the hands of 10 alpha customers.” This provides enough information to paint a broad picture of what you do, who you are, and why you do it. Then the pitch deck can be presented to dig into all the topics we discussed.

Other tips for successful pitching:

  • Practice, practice, practice the narrative of your deck so it flows well. If more than one founder is in the meeting, it is advisable to have one main presenter and bring in other people into the conversation only a few times (personal introduction, specific area of expertise, pointed questions). “Passing the mic” too many times becomes distracting.
  • It is vitally important that you practice your pitch, a lot. Practice in front of investors or entrepreneurs who have experience giving or receiving pitches. Listen to their feedback, summarize the key points, iterate on the deck, and pitch again until you feel that “it works.” And prepare for the disappointing realization that you weren’t ready once you started pitching VCs for real. It happens all the time. Don’t give up.
  • VCs respond to pitches very differently. Some will listen to your presentation and ask all their questions at the Others will ask questions at every slide or every sentence. If they ask questions about upcoming slides, it’s fine to ask them to hold onto the question or show that slide’s content and come back.
  • Some entrepreneurs like to have a conversation with no slide in the background. It’s fine, but makes it more challenging to have an engaged dialogue because you need to take more notes since there is no backup material (the deck) for you to rely on after the meeting. My strong personal preference is to go through the deck and take questions along the way, and I’ll state that at the beginning of the meeting.
  • Understand that the goal of the first meeting is to get to more meetings, then enter due diligence, then get to a funding offer, followed by more due diligence, leading to a close of the financing and a wire transfer. This can take days, weeks, or months, so pace yourself accordingly.

Whom to pitch

There are hundreds of VC funds and thousands of angels, all with capital to invest in startups. However it is critical to figure out which firms or individuals are the most likely to invest in your startups based on their filters:

  • Stage
  • Sectors
  • Geography
  • Round size
  • Have they invested in startups that are similar but that are not competitive or overlapping?

Most startups end up being listed on AngelList and Crunchbase, and these two databases are essential resources for a comprehensive list of firms and individuals who are investing in your space. CBInsights also publishes useful market maps that highlight all the companies in a given sector, as well as top VCs investing in it. Then each firm’s website or blog will give you hints about how, where, and when they invest. Yes, there is a lot of work involved in parsing all this information but it’s worth the effort.

Like every CEO in our portfolio does when she or he raises capital, you’ll create a spreadsheet listing firms, partners, relevant investments, typical investment size, whether they lead or not, etc. Then you will share it with existing investors, fellow entrepreneurs, and friends and  ask  for their input on which firms to add (or remove) and most importantly, who they can introduce you to.

The trusted referral

VCs rely very heavily on the trusted referral as an early indicator of potential quality of a startup, essentially using the credibility of the person who makes the referral as a key element in deciding whether they’ll take a meeting or not. Why? Because we typically get way too much deal flow not to use arbitrary filters. That’s unfortunate, but it’s the way this industry works. It does not mean that you won’t get meetings without that “magic wand,” but you’ll greatly increase your odds of success by “working the network”  and  figuring out these introductions. Just to give you a sense  of numbers, over the last 12 years, we have been pitched tens of thousands of times, we’ve taken thousands of meetings, and have closed 191 investments. None of these investments came “cold”: all were either brought from the network   or found through an accelerator (less than 10%).

Who is a trusted referrer? It is someone who knows our firm well and/or has a “nose” for good opportunities: typically, our founders (especially the alumni group), coinvestors (both upstream and downstream), or executives whose function leads them to see a large number of opportunities. How do you find these connections? LinkedIn, Crunchbase, and AngelList!

How do you make these trusted introductions happen? Assuming you have built your network (and LinkedIn connections), you ask someone who knows us for an introduction. You send an email introduction that can easily be forwarded, since no one but you should pitch your concept, on top of which the referrer will provide some context and if she or he is inclined, will add an endorsement. When I receive a strong endorsement from someone I trust, I pretty much automatically take the meeting, unless I already have an investment in the space.

Know your competitors’ investors. All too often    I receive an email from a startup aspiring to displace one of our (fully disclosed) portfolio companies—and this is not something we want you to do:

Dear Jeff,

I am very excited to share with you this investment opportunity in the on-demand space, which will directly compete with Postmates and other delivery. We’ll crush them because of . . .

It could be Postmates or any of our well-known investments. For some reason, founders don’t seem to check their main competitors’ Crunchbase record before blasting investors. Make sure you do that!

Often founders reach out complaining that they don’t have a network allowing them to get an introduction and therefore take a chance with a cold email. That’s ok, I can accept that, but the  law of large numbers is against you. That’s why accelerators like YC, TechStars, and 500 Startups are so useful in this case: they’ll become your trusted referral to the investor community. This is especially true for founders who don’t work in Silicon Valley or a core innovation ecosystem.

A few more prep steps

Once you have a target list of potential investors and connections who can introduce you to them, you need to define your priorities: P1 for the most likely to resonate with your opportunity taking the strength of the introduction into account, P2 for the next group, and P3 for the less likely. To be candid, if you have to dig into P3 VCs (the ones representing the least adequate fit on paper), it’s not a good sign for your raise.

We advise our founders to have no more than six to ten open conversations at any point in time—you’ll need to book meetings, more meetings, follow-up calls, make due diligence introductions, provide spreadsheets and memos in response to questions, etc. All this takes time, even if a lot of materials can be reused. So get your trusted referrers to offer these six to ten introductions using the material you provided; we always recommend doing this on a double-blind basis (referrer sends email introducing the opportunity and asking investor if she or he wants to connect, then cc’s you once the offer has been accepted). Once declines start arriving, open more new conversations.

What do you need besides your pitch deck? For a seed round, we typically ask a simple financial model showing how you will use the funds you are raising, a list of founders and customer/user references (if you have any), and any material you can share to justify the size of the market (such as industry reports, link to expert blog posts, etc.). As you raise additional rounds of financing, the list of due diligence materials will become much longer.

How long does fundraising take from start to finish? It depends.

Some founders get it done in a couple of weeks. They’re lucky to be the exception, the company that all VCs dream to invest in, and ends up getting showered with term sheets. That’s not the standard, even if these are the companies VCs always love to talk about.

Prep time (getting materials ready, refining the pitch, going through a few rehearsal pitches, developing your target list) may take two to three weeks. Getting your trusted referrals going and the first meetings in the busy investors’ calendars can take a couple of weeks too. So before you know it, more than a month is gone. You may pitch a few VCs and get a term sheet, or you may have to pitch 50; it’s never certain how the market will respond to an opportunity. It typically takes us two weeks from the second meeting to issue a term sheet; we’ve done it in a few days, and in a few rare cases requiring a lot of due diligence, a couple of months. Once the term sheet is signed, legal due diligence and document drafting should take no more than three weeks before cash is wired.

I’d like to conclude with a Top 10 list of things that will undermine your raise, based on what I have seen happen. Note that there is no specific order in this list.

1 Send “To Whom It May Concern” mass emails As noted, they ended up in investors’ trash or junk mail.
2 Saying “I am either selling to Google or raising a round” Shows you are interested in a short-term exit. Nothing wrong with that, but VCs are interested only in long-term commitments that yield a big, interesting company.
3 Not knowing your competition This is especially true if you claim being the only ones building something, and we’ve met three similar companies in the last month.
4 They don’t know what they don’t know That’s an expression we sometimes use about founding teams who try to operate in complex environments (science, tech, regulatory, etc.) and don’t understand the need for a specific expertise to be represented on the team.
5 Using too many buzzwords That’s one of my pet peeves. I have a hard time dealing with more than a handful per pitch.
6 Having a massive advisory board of “brand names” who barely know you, would not really vouch for you, or are irrelevant “What would you say to a pitch from entrepreneurs who have two Nobel Prize winners on their advisory board?” “What would you say to a pitch from entrepreneurs who have two Nobel Prize winners on their advisory board?”
Me: “I pass?”
We’re all about getting help and support, but often a board of advisors that is larger than five people is rarely engaged and relevant.
7 Trying to hide things Early-stage founders very commonly make some mistakes in the initial phases of their startup life. They may also start the journey with more cofounders, and one or two of them end up leaving because they were not the right fit. We deal with these issues all the time, and the consequences are mostly benign if they are fixed early. But never assume that they can be hidden under the rug—we’ll likely find out during the due diligence phase and may lose faith in the team outright if anything important is not disclosed.
8 Raising too little, raising too much, and getting a valuation that is too aggressive “I am raising $2M to $5M.”

One side of the range is a seed round, the other is almost a Series A. Understand the typical ranges that firms you pitch attribute to the stage you are raising for. And if you can raise a $5M seed round at a high valuation, more power to you. But understand the implications for the next round’s expectations in terms of milestones.

9 Acting strange, not following up on due diligence items, not showing interest Unless you have worked with the team in the past, a financing process will give both sides, entrepreneurs and investors, a glimpse of their future relationship. If anything feels “wrong,” whether it’s lack of transparency, ethics, or being truthful, either party will feel the enthusiasm decline and the deal might eventually not be consummated.
10 Get your tech ready, have backup solutions The CEO came into the conference room, opened his Mac, connected the HDMI cable through the connector we provided, and within seconds the computer crashed. It took 10 minutes to reboot, relog, reconnect, and get going with the presentation. During that time, the CEO would not start, stood up flustered, and lost composure for the rest of the pitch.

The good news is that we still invested, but that episode could have derailed the whole thing.

Have all types of connectors (HDMI, VGA) in your bag; standard cables typically work better than Apple TV. Try to have all the decks, videos, and if possible your demo on your laptop; you never know if Wi-Fi is going to work properly.


Jeff Clavier, Managing Partner, SoftTech VC