This is the first part of a two-part series post on startup funding.

Part 0. Introduction

A decade ago, I had no clue about startup funding. I read a book about Y Combinator and how startups must grow weekly and everything else will work itself out.  

As a first-time founder, I made every mistake. Somehow we raised funds, built a company, and eventually exited to Sentiance. I did it without being in Silicon Valley. I didn't think it was necessary to be there in 2013, and don't think so today either.

This post is about how startup investing works for everyone who doesn't want to move to SF/Miami to start their next company. This post is about founders, investors, and limited partners. It's based on my experience–your mileage may vary.

Founders are of many types...

Repeat founders, technical founders, sales founders, old founders, young founders, coders, hustlers, as well as anyone who wants to play startup is a founder. My lawyer is the co-founder of his law firm. A friend is co-founder of a real estate business from assets he inherited. My spouse and I are co-founders of our kids,... you get the idea.

Part 1: How founders pitch VCs

Our protagonist founder is someone who wants to build a high tech, high growth company, and chooses to raise money for their company.

The ultimate boss move is to not raise any money and build a high-tech high-growth company all on your own. But even people with great hits have gone on to raise money for their second company.

Why is that?

I asked a few exited founders with no need to raise (they made a few hundred million in their last exit), why they would raise money for their new company.

My hypothesis: Blindspot detection & talent networks

Their answer: Accountability & networks - no blind spots (we don't have those lol)

So let's say our founder wants to raise money, that founder walks into a bar, and says something like:

"I've got a dream. It starts with a trend in the market. The trend is emerging, and will change the way we do things. Our product is going to own the market by riding the trend, and we'll make a lot of money doing it by effectively creating a new category in the market. We've done something noteworthy before, and have a strong team that has been working together for many years. We're going to build a billion dollar company  and we only need $2m to spend on people, marketing, product as we knock out the first big risk"

Here's another post on presentation power ups to help you craft your pitch/memo.

When this worked well for me, the decision-maker of our firm (there's typically one at each firm) jumped out of their chair and gave me a hug. It's still a long way to go till funds hit the bank, but it's easier from there.

Most VCs have a good poker face, but behind it, if they don't feel like giving you a hug, please try again with someone else. There is another post on how to run a process to raise money (memo vs pitch deck, timing, etc), but here are some true but not obvious things:

1. You will need to reach out to a lot of VCs (likely 100). Just need one "yes" but it's hard to predict where it comes from, so pitch everyone like they will be the one that leads your round.

dont worry about confidentiality, instead focus on finding your blindspots quickly.

2. Do your research. Don't pitch a hardware company to a SaaS VC or someone who has a competitive investment. I pitched VCs randomly (probably >50) until one said "yes" <don't do this>

3. Warm intros > cold emails. This is why YCombinator works so well. It signals a minimum quality signal for most VCs.

two side notes:

If someone asks to be paid for intros, avoid them
avoid taking intros from people who have passed, unless you made a mistake doing your research

4. It takes a few conversations to get to a yes/no, and things should be moving forward (their confidence level in your company should be increasing) with each conversation. for example you go from Associate to Partner to another Partner.

5. The default answer is NO unless you convince the VC that you've got everything on their checklist. The best VCs will publish their criteria. Here are two examples:

tweet from David Sacks 
Pro tip: a lot of founders waste time trying to be the favourite student of their VC partner when they should really be talking to their customers. If you're building something great and are growing quickly, you will automatically become the favourite student of the VC.

Part 2: How VCs evaluate your pitch

So what's the VC thinking?

Is there a market? If there is a 1 in 10 chance that there is a billion-dollar company in this market, you're on to the next step. If they don't think so, you get the standard "we love your vision, but you're too early for us". The best VCs give specific feedback, but it's hard to find out exactly why someone said "no."

Pro tip: Unless you've got overwhelming evidence, trying to convince investors that there is a market is a waste of time.

Can you build it? Do you have domain/tech expertise or at least a technical team that can go super fast?

If you're planning to outsource the complete development of your project, it will likely be a quick NO.

I'm writing another post about this, but it's not worth the risk for most VCs unless you are a repeat founder and have some expertise that is very hard to copy.

Does this conflict with my existing investments? Typically, investors will ask the relevant portfolio company founders if they see conflict.

And then there's another type of VC–the followers. They will typically engage founders long enough to be friendly until they raise from a known investor, and then follow right along. They will invest on nearly any terms that you negotiate with the lead investor, so just do enough to keep them warm.

They're not the believer that you need early on as you start your movement, but they can still help with recruiting, distribution, etc.

Part 3: How much to raise for your startup

So, how much to raise?

Snippet from the second part of this blog post - The explosion of funding rounds in recent times:

Recently, I've seen more founders raise from top firms with no customers, no code and no revenue. I don't know what to make of it. Even their pitch decks were meh. It seems there is a lot of money chasing so-so ideas & founders. I will write more about this in the next part so let's just leave you with this 🔥 meme from @harryhurst.
the best meme from @harryhurst 
If the bar chases a founder down the road and gives them 3x their last valuation, they don't need blog posts like this one. So the question becomes: Do you raise/join a hot startup or start your own? If you start your own, do you bootstrap or raise money? This and more to come in next part of this post.

Okay, back to regular programming.

Funding rounds & what you typically need

Note: The ranges are imprecise, but the buckets are proportionally the same.

Okay,  back to the outsiders, and what they could be raising. Amounts are location-dependent, and that's changing as more funds invest globally.

0-1m: Pre-seed → "I'm just exploring ideas alone or with a friend"

People are betting on the person(s) and broad market trends. They need some track record and a general idea of where you want to go.

1-5m: Seed → "We have a pitch deck & some people lined up to work with me. "

The standard term sheet (available here) from YCombinator can have a valuation cap. A cap is the maximum the investment can convert to shares at, and can always be lower if things don't work out.

Recurring revenue also greatly helps at the Seed stage.

5-20m: Series A → "We have a product that works & sells consistently"

Repeatable ways to drive recurring revenue are emerging, and revenue has been growing fast. The team is growing to about 50 employees.

20m+: Series B → "We have growing product & distribution"

The team is growing to around 125 employees, starts to look more like a typical business with cross-functional teams & projects.

40+: Series C → "We have product + distribution & exploring new product/markets"

The team is growing to around 400 employees.

All the subsequent funding rounds look more and more like a Private Equity deal since the risks are a lot more similar to a typical private company.

Part 4. How founders get paid when things work

Founders get paid a lower end of the market monthly salary & give up ~20% of their company in each funding round. When the company exits (IPO or Acquisition) their shares are paid out in cash or stock.

Pro tip: What you made before you started your company has nothing to do with your startup salary. It will likely be lower, you can negotiate depends on your life stage.

When things don't work, the founders typically don't get anything, but when they do, the founders make a lot of money.

Take risks you understand

The highest concentration of risk/reward is with the founder, so before you start your startup, make sure you don't personally go bust in the process. I saved up a bunch of money before starting, and it still ran out and caused a bunch of financial anxiety.

Risk is multiplicative, and I took a lot of them as a first-time founder. It's like trying to do the highest difficulty routine (market risk, technology risk, team risk, financing, hardware, and consumer product risk) on your first time as a founder (first-time founder risk). As we scoped down the risk we were taking, we found success.

The most successful founders take risks they understand, and there is typically one big risk (technology, adoption, distribution,...) in their business.

Risks are also distributed by company funding stage e.g. take one big risk and knock it out per funding round.

Example risks for B2B app by funding stage

  • Identify/Solve pain point on an existing workflow - Pre Seed
  • Get paying customers on annual plans, growing 15-20% MoM  - Seed
  • Grow company to 50+ customers, growing 15-20% MoM - Series A
  • Grow customer average contract value size - Series B
  • Generate 100k and $1m deals - Series B & beyond

But one thing I learned is to keep away from debt. It is heartbreaking to advise people who have maxed out credit cards to build an app that has 100+ identical apps on the play store & no users.

Portraying founders as crazy risk-takers does more harm than good. Just because maxing out credit cards worked for the Airbnb founders, does not mean it will work for others.

On the flip side, I know a founder who sold his company for $30m. They had a growing family but they didn't have much savings, so they learned to code. They built a web application and grew it over 6 years. Then they raised some money to scale the business and got acquired within 2 years for a great result for everyone involved.  

In my experience, every business will have 3-4 moments where it could die, just before it soars. Debt will just make it harder to survive those times, and budget for some financial safeguards for when sh*t hits the fan, which it always does.

All that being said, it's easier than ever to build a billion-dollar company. You just need a great idea, avoid going bankrupt, keep it simple, and move incredibly fast to build things that people want, at scale.

The next part is about the investor's side of startups (how they work with their investors and get compensated) and what founders need to know about VC incentives to ensure everyone is aligned.

As always, feedback is a gift and is very welcome.

Thanks to Isfandiyar Shaheen, Dave Kim, Syed M Farooq, Joseph Mocanu, Haider Nawab, Ali Khokar, Jawwad Farid, Faizan Siddiki