The length of the fundraising process varies, no necessarily based on the amount raised, but based on the founders’ and company’s experience. Founders that are very well connected will be able to raise money faster, while startups may find that as their business model becomes increasingly safer and the validation has taken place, funding rounds become faster, assuming that the company meets its milestones. That is why at seed stage, without validation, even if the funds sought are low, it may take longer to raise funds, sometimes even well over a year from the first investor contact, to get the cash in the bank.
You should take this into account by leaving sufficient time and runway to raise funds. In fact, even with some interested investors, it takes some time to get the deal done. Here is an overview of all the steps in the fundraising process that you could encounter:
Before reaching negotiations, it is worth learning more about term sheets and being prepared on what you could expect, as well as knowing what concessions you are willing to give away.
The term sheet is a non-binding offer that is signed before a potential due diligence, then followed by a shareholder agreement, in case of an equity transaction. Be aware of the fact that most term sheets include these clauses, but ensure that they do not put you at a great disadvantage. Typically VC term sheets will be stricter than the ones presented by some business angels. The most well-known clauses are listed here:
- VALUATION: Pre-money/ Post-money/ Fully diluted
- FUNDING MILESTONES: Tranches may carry different valuation every time a tranche is paid and have conditions based on the business plan
- SHARES: Ordinary or preferred shares, conversion rights
- EXIT or SHARE TRANSFER: liquidation preference 2x, tag-along/ drag-along/ forced sale, special investors rights, IPO clauses; pre-emptive rights, lock-up, right of first refusal/ right of first offer, call options/ put options, clawback shares, incentive options, ratchet clauses
- FUTURE FINANCING dilution and financing rounds rules
- GOVERNANCE: board composition, veto and information rights
- PERSONAL LIABILITY and indemnification
- COVENANTS: IP assignment and non-compete, non-solicitation clauses
- TERM SHEET: Exclusivity, expenses, timing and drafting responsibilities, legal nature and confidentiality
One of the most important aspect to understand about structuring the financing deals is dilution, and how your stake and those of investors may reduce over time with new rounds, as well as different liquidity rights and options that alter the reward that each investor received in case of an exit.
Events and clauses that dilute or reduce shareholdings at the time of exit or earlier are:
- Vesting of ESOP (employee stock ownership plan)
- Investing of new shareholders and capital increase (how shares dilute for each shareholder is detailed in the term sheet)
- Maturity or options of convertible debt
- Liquidity preference of VCs or other investors in case of an exit
- Other clauses e.g. exit value under expected amount
You may own a much smaller stake of your company at exit, but it could be a small stake of a large company. However, ensure that this may be enough in terms of cash for all the work that you may put in over the years or that you don’t lose a controlling stake in your company.
Try it out yourself:
The valuation should be adjusted for dilution based on your expected future fundraising.
What documents and information are needed to approach investors?
These documents vary depending on the purpose (whether you’re looking to give away minority shares, to receive a loan or to sell your company) and on the type of investor that you’re approaching (VCs and other institutional investors, business angels, strategic investors).
Also, when companies require a business plan for internal planning purposes, or to introduce the business to a potential business partner, the document will look quite different in some sections compared to a business plan that you would send to an investor: the latter is a sales document and all information included should be adjusted for that purpose.
Generally, SMEs are able to hire consultants to prepare professional documents – usually a blind teaser (omitting the name of the company and with no recognisable information) and an information memorandum with detailed information on the company, history and financial transaction sought.
Startups, on the other hand, draw up their documents without much external help, they may outsource some work but they cannot purchase the whole advisory package: they need to know what documents they need, or can benefit from, before outsourcing any activity. In order of importance, these are your pitch deck and business plan. Te pitch deck could also be substituted with a simple executive summary or graphical teaser, but it’s more common to request a pitch deck.
All startups start compiling a business plan early-on, because they know that in many cases it is fundamental to have one to receive an investment. However, what is often forgotten is that the purpose of it is to sell your company, covering all the points with basic information just to have it ‘done’, does not bring you very far. As a startup founder, you need to motivate the receiver to invest in you, just showing that you have an average company and that it can somehow be profitable is not sufficient. Even better if the business plan is interesting to read, stick to an easy to read document around 25-30 pages.
More importantly, you should get the investor to open your business plan. As much as your product may be interesting, investors have limited time and receive a lot of requests. You should give them a reason to spend time on your business plan. If you have not met the investor before or have not been introduced, you may decide to send an email to a general address, which is often the case with institutional investors. Here you should include your elevator pitch, so craft your message to the investor in a way that presents your product, company, traction, team and potential in a short and effective way. Tell the investor why you are contacting them specifically, maybe referring to their past experience and investments: they would appreciate the attention.
Before looking at your business plan, they might want to read your pitch deck, which summarises your business concept and milestones in 10-15 slides. The pitch deck should be simple, focused on key information and sell the upside potential of your business. This is also a presentation that you can use if you decide to pitch at startup events.
You may not always need a teaser: this is also a short summary between 2-4 pages that explains the key features of your startup in a beautifully crafted document. You may use it instead of a pitch deck in an email, upload it on your website, or print it out to hand to potentially interested parties at a startup event.
Particularly when you are sending information about your business to an investor that has never heard of you, your introduction should be of top quality and should get their attention. Otherwise your business plan or even your pitch deck will not even get a second look. An introduction can go a long way, it draws some attention on the part of the investor and more consideration for the materials that you send.
You will still need to sell your company as a good investment. To demonstrate this, more so for more advanced and larger transactions and companies with traction, some investors would expect a financial plan. Very rare would be to expect a valuation: only investors in some larger companies or in risky transactions would expect to see a valuation report.
Featured image: Jochen Höller, The Boom, 2015, Mario Mauroner Contemporary Art, Vienna