Raising Investment: A Guide for Startups
This guide sets out the process and documents helpful for raising seed investment for a startup.
Seed investment is usually the first round of investment for a company.
Please note that the success of early-stage capital raising is predominantly driven by the work founders have done to identify and prove an opportunity, ahead of trying to raise money.
In this guide, we assume the decision to raise capital in exchange for equity has already been made. For founders who haven't made this decision with conviction, consider reading our blog post 'What to consider when raising investment capital' first.
Our mission at Mum's Garage is to make entrepreneurship accessible to more people. One way we do this is by breaking complex processes down into actionable steps. We hope we have achieved this with this guide to raising early stage investment.
In this article, we cover the following steps for raising early-stage capital:
Step 1: Make a decision about whether the company needs to raise investment, how much investment is needed (the Ask), and who are suitable investors.
Step 2: Prepare the necessary documentation, so the company is well prepared when it comes time to talk to investors. This includes a pitch and accompanying pitch deck, an Information or Investment Memorandum, and Due Diligence documents.
Step 3: Begin the process of engaging investors and moving them through an Investor Funnel.
Step 4: Closing the investment round by agreeing on the terms and completing the legal documentation.
An important question founders will need to be able to answer when approaching raising investment is 'how much and what for'?
This means how much money is the company wanting to raise, and what percentage of equity is it give away in return.
To know the answer to these questions, the founders will need to come up with an approximation of the company's current value. This is called a pre-money valuation.
We do not cover how to come up with a pre-money valuation in this article. To learn more about this process I recommend 'Valuation For Startups — 9 Methods Explained'.
Founders will also need to work out how much money the company should raise, considering the trade-offs we set out in our article 'What to consider when raising investment capital'.
Once the company's pre-money valuation has been calculated, one is able to work out how much equity the company will need to give away to raise the amount of money they need.
For example, if the company's pre-money valuation is $500,000, and they want to raise $100,000 to cover product development over the next year, the calculation will be as follows:
If the business is currently worth $500,000 and an investor pays $100,000, the business will become worth $600,000 in total ($500,000 pre-money valuation plus $100,000 cash). $600,000 is the post-money valuation.
Of that $600,000, $500,000 will be owned by the current shareholders and $100,000 will be owned by the new investors. This means the company will be giving away $100,000/$600,000 = 16.7% of ownership.
So the ask is $100,000 for 16.7%, with a pre-money valuation of $500,000.
Who founders take money from in their first round of investment is an important consideration for the following reasons:
- It will have an impact on the company's ability to raise the next round of capital. If founders can get good investors participating in their first round, they are more likely to get good investors in their next round. Smart investors are less likely to invest alongside bad investors.
- A company ideally wants one of the investors from their first investment round to lead the second investment round. This looks good to new investors because it means that someone who has already invested and worked with you has confidence in the business and the teams capabilities.
- Bad investors will have a negative impact on the growth and future value of the company. Founder should try their hardest to avoid taking money from people who do not have a good reputation. This can be mitigated by the founders doing work to find out who the good investors are in their industry, and knowing what warning signs to look for.
There are a few options to consider for a first round of investment, including 'Friends and Family', Angel Investors, high net-worth individuals and crowdfunding platforms.
The first face-to-face engagement founders have with investors will likely be for an opportunity to pitch to them. However, in saying that, smart founders I know have found reasons to get in front of investors ahead of needing to raise money, to ask advice for example. This is to build a relationship with them, so they're not going in cold. It's a good strategy. Read more about this in Mark Suster's blog 'Invest in Lines, Not Dots'.
Angel Networks will often have a screening call to figure out if it's worth inviting teams to pitch. If founders are well prepared for a pitch with the information below, they should be able to answer the questions the asked in the screening call.
A pitch should only be 5-10min. It should tell the high-level story of the company while ticking the boxes investors in the room will be assessing the company against. Founders should present a pitch deck with the necessary slides to back up the story they are telling. Investors will be looking for:
- A compelling purpose or reason for the company to exist
- The opportunity that exists for the product. This is usually positioned by explaining the problem, who has the problem, the market size, with validation to back it up. Often they will want to understand why this opportunity exists now. Timing is an important consideration when identifying and assessing an opportunity.
- A product or solution that is uniquely valuable, which the team has the capability to build
- A team with the capabilities to execute and build a valuable company
- A way to acquire customers that makes sense. Ideally, this is also validated.
- A business model that will make money. Ideally, this is also validated.
- A company that has the capability to grow to a size that suits the appetite of the investors your pitching to.
When it comes to the pitch, there are three important components:
- What is said. Make it a simple story rooted in truth. Avoid making comments that can't back up with data or experience as it will make investors doubt your credibility. Use words that make people trust you.
- What the slides show. Present simple, well-designed slides that validate what the speaker is saying.
- How the speaker presents themselves and answers questions. The speaker should be confident and certain.
Practice, practice, practice. Until the speaker is comfortable.
If the pitch is successful and investors are interested in the opportunity, they might ask for an Investment or Information Memorandum ("IM"), also called an Executive Summary. This document is also useful to send to investors as an initial introduction to the opportunity. Pitch decks are simple and require someone to be there pitching to give them meaning. An IM is more detailed, so it's useful for sending to interested parties. It's also a useful document for investors to share around their own networks.
Investors are busy people so founders should try to keep this document simple and straight to the point. The IM can include:
- The company's purpose
- The problem the company is solving and the opportunity that exists
- The solution and unique value
- Customer and market details
- Product details, including features, benefits, development roadmap
- Customer acquisition strategy (Sales & Marketing)
- Business model
- Key metrics
- Growth plans, including where the money will be spent (new hires etc)
- Any Advisors
- The Investment terms - these may be excluded in some cases, depending on who the document is being sent to.
This document doesn't need to be elaborate. It can be simple and to the point. Less is often more, as it encourages investors to focus on the important fundamentals of the business. If a company wants to attract investors that aren't going to waste their time, they should be advised not to waste time on activities that aren't fundamentally valuable, for example, creating an elaborately designed IM.
Have a look at the article below and the example they refer to, which is the Executive Summary for Youtube's seed investment round. It is a very useful reference.
A Template for Startup Executive Summary or Investment Memo for VCs, by Ali Tamaseb
Once investors are willing to invest in a company they will likely carry out due diligence ("DD"). This is to make sure the claims the company made are true, by checking them against relevant documents.
It's useful for a company to have these documents ready ahead of time and stored in what is called a 'due diligence vault'. This is a secure folder that can be shared with specific people, e.g. a Google Drive or Dropbox folder.
The DD vault should include the following documents:
- All material contracts, including contracts with current and previous employees or contractors, and co-founders. If a company has any big customers or prospective customers, or letters of intent and contracts may be necessary to validate the claims.
- Company Incorporation and Shareholding documents.
- Financial Model & Growth Metrics
- Product Specification and a Development Roadmap
- Marketing and Sales documentation, including strategy and any key metrics to show historical results.
- Any IP the company owns, including patents and trademarks.
Investors may want to do technical due diligence, which means reviewing product code to make sure the product is built well. To manage this, teams can prepare a high-level overview of the design of your product and it's advantages, with just some snippets of code. The general consensus seems to be to not let investors have access to all your code for risk of it being replicated. Use your common sense here, based on what you know about the investors.
Before completing Due Diligence, it is advised that the company have investors sign a confidentiality agreement. Simmonds Stewart provides a good template here.
The Investor Funnel
You may be familiar with sales and marketing funnels. An investor funnel is based on the same concept, however, instead of moving customers through the funnel, it's purpose is moving investors.
A simplified form of a sales funnel is as follows:
- Attract and add qualified leads to the top of the funnel.
- Nurture and move leads through the funnel with the goal of closing them as a customer.
- Service customers and create a great experience until they become evangelist or promoters.
The process for converting potential investors into actual investors in your company is similar. It pays for a company to be as structured about this process as they are or should be with their sales funnel.
The stages of the investor funnel are:
- Identify potential investors and investment organisations
- Set up the first engagement with investors with the intention of converting them to warm leads
- Actively follow up with meetings and ongoing correspondence to convert interested investors into committed investors, including one Lead Investor.
- Close the investment round by having all parties contractually agree to investment terms
- Ensure retention and referrals by keeping to best practices and performing well as a company.
Managing an investor funnel
Setting up a funnel
The first step is to set up a spreadsheet or use suitable software - Hubspot's free CRM tool works well - to track investor leads and the stages they are in the funnel. Label the columns or buckets based on the steps in the funnel, e.g. Leads, Interested Investors, Committed Investors, Closed.
We will call this the investor CRM.
Make a list of all the people and organisations that could qualify as investors. This is where the work that has been done to develop networks becomes valuable. Find key people and they contact details and add them into the investor CRM. hunter.io is a useful tool for finding email addresses.
Founders can also get in front investors by attending organised events such as demo days or pitch events. We provide a list of the organisations that provide these types of opportunities in our NZ Startup Ecosystem map under 'The Growth Stage' heading.
First touch point
To increase the chances of a successful first interaction, founders should do research to understand why an individual or organisation would be interested in investing in your company. Most investment organisations will have this on their websites. It's also evident by looking at the companies they have invested in before.
This information can be used to position the investment opportunity in a way that will be as compelling as possible and make it easy for them to say yes to the next step.
The next step could be an in-person meeting to pitch. How to go about proposing this should depend on how willing the investor is to give up some of their time. If it's hard to get time with them, propose something that doesn't require them giving up much of it.
Investors will be assessing the team's ability to execute, so going to great lengths to get a meeting, and being persistent will probably work in a founder's favour.
It will take a number of touch points to get investors over the line, possibly over many months. Founders do have a degree of control over this, however, primarily because the nature of investors and their desire to not miss out on a good investment.
If a founder has a compelling company, has done the work to position it as a good investment, and can create a sense of urgency for investors to get in on the deal, they will be able to turn around a deal quicker.
To achieve this, a team should take control of the process and guide it themselves, rather than letting investors control it at their own pace. Here's one way this can be achieved:
- Establish the company as a viable startup with a team that can execute. Do this by getting traction with customers and building relationships with investors and people they respect. One of the benefits of being a founder with a track record is that this credibility already exists. First-time founders can achieve this by getting traction so the product and metrics speak for themselves.
- Publicise the capital raise and send out a compelling email to relevant investors, letting them know the raise is taking place, and they are invited to book a time for a meeting. Set the dates for the process, including two weeks for meeting and two-weeks to one month to close the round. Let them know the cut off date by when you need to close the round. Investors who do not fit in, miss out.
I have started to hear stories of NZ company's closing their rounds without waiting for investors who haven't made the effort to fit into the company's timeline. This is great news, in my opinion, as it will start to set more of a precedent that companies hold the reins when it comes to investment, not investors.
If you're an NZ company raising money through an organised angel group, such as The Ice House, FKA or Angel HQ, they will help to manage the process of following up investors and closing the round for you. This is the value that they add, as well as having access to a network of investors.
Note that companies need to create interest from enough investors with enough money to be able to close the round they are hoping for. How much an investor is willing to put into the company should be understood early on in the process.
A company will also need to a Lead Investor, a role that we explain in detail in the Terminology section at the end of this article.
Terms, Structure and Legal Documentation
Part of the process of convincing interested investors to depart with their money is agreeing the terms they will be departing with it on. We strongly recommend that teams hire a founder-friendly lawyer to oversee this process, someone who has represented early stage startups before. Founders do not want to agree to terms that will trip them up or hinder growth later down the path. The terms that are agreed to and signed in these documents is really the only thing that is certain within the company when it comes to your relationship with your investors.
Simmonds Stewart, an NZ law firm that focuses on startup legal support, provides some excellent resources for becoming investment ready from a legal perspective, including:
READ THIS DOCUMENT THOROUGHLY.
Founders will also need to make decisions about the structure of the company and the transaction, which requires understanding the tax implications. For this reason, we recommend that teams seek accounting and tax advice.
Founders may need to negotiate the terms in the Term Sheet. If a founder doesn't have much experience negotiating transactions, having advisors who can help the founder through this process will be highly beneficial. Founders should take the time to do the work to understand all the terms in the Term Sheet and their implications.
Founders can also keep in mind that this is an opportunity for them to assess the investors involved. Investors who are only optimising for their own self-interests, rather than trying to come to an arrangement that is fair and best for the long term success of the company, are not the best people to have onboard.
The most valuable thing founders can do to increase their chances of successfully raising investment is to focus on building a valuable product in a valuable market.
The purpose of a company is not to raise investment. It's to fulfil a greater mission and create a product or service that provides value to its users. Raising money may be a necessary part of this process, in which case the CEO will have to devote some time to get the company investment ready and finding and converting the investors the team wants to have onboard.
We hope that this guide helps to give some clarity on what raising seed investment requires. If you are a founder, we also hope that it has made you feel more in control of the process of raising money, so you can make good, informed decisions about when who and how to go about it.
If we have missed something, you disagree with some of our points, or you have more questions and feedback, we'd love to hear them. Please contact us using the email address at the bottom of this page.
All the best!
- Cap Table - short for capitalisation table, it is a table providing an analysis of a company's percentages of ownership, equity dilution, and value of equity in each round of investment by founders, investors, and other owners. You can access our Cap Table Template here.
- Lead Investor - the first person to put money into your deal. They aren't necessarily the person that puts all the money into your deal, but they are the first step in the process that makes the rest of the process take flight. A lead investor provides social proof to other investors. Founders should try to build relationships with potential lead investors well ahead the capital raise to build their confidence in the business.
- Friends and Family Round - a smaller round of investment that comes from your friends, family, and connections, instead of from an accredited investor.
- Angel Investor networks - an angel investor is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. Angel investors usually give support to start-ups at the initial moments and when most investors are not prepared to back them. Angel investor networks are groups of these investors represented by one organisational front, so the assessment and management of investments can be centralised.
- High net-worth individuals - generally considered to be a wealthy person, in particular, one with investable assets in excess of $1 million. For individuals to invest in companies (that don't fit under the definition of Friends and Family) they must comply with the FMA's eligible investor criteria.
- Crowdfunding - a way of funding a project or venture by raising small amounts of money from a large number of people, typically via the Internet.