I’ve gotten this question in various forms from about 10 clients in the last month – so, as it is at OGS, we write a blog post about it. This is the way.
If you’re raising money from outside investors at your company, there are tons of things to think about, so please do not take this simple blog post as Gospel or, all inclusive, it is not. This post serves only as a starting point to percolate your mind and help you think about even more questions that you should be asking well before taking anyone’s money.
Why do I want to raise money? – What is the purpose of your raise? What will the funds be used for at your company? What will the infusion of cash help your company achieve, and (why) are the funds necessary to reach that goal?
This seems like a simple question – but its not. Oftentimes, Founders are conditioned to believe that raising money is something they must do no matter what, but that is not the case. Before raising any money, you need to have a plan for each dollar and know with specificity how said dollar will move the company closer to your ultimate goal (read, reason for taking investor money in the first place). If you’re wondering, “shit, I think he means I have to make a budget,” you’d be right.
Am I too type A to give anyone a seat at the table? – This matters a lot. So many Founders tell me, “I want to take the investors money but I don’t want them to have any decision-making authority.” Say what? Sure, in some instances (like real estate investing) there are times when an investor will agree to be “silent” and not have a say in how the business is run – but not in a new, nascent, startup. If your first inclination is to fear losing control (which, should never happen in your first round of funding, anyway) then you need to take a step back and think hard about whether or not investment is right for you. End of the day if you keep taking investor money – you will eventually lose control of the Company (at least from a shareholder voting perspective). Yes, some guardrails can be put in place, but you will never have the freedom of running the company alone\as the ultimate ruler of all – even after round 1.
Who will I raise money from? Is it a good idea to take that persons money? – Friends and family rounds sound fun and easy – but I tell every client who is thinking about it the same thing – “what is more important, your friends\family or this money?” Mixing business and family matters is almost always a bad idea. That said, if you are going to move forward with a friends and family round ask this next question, “will the money I’m taking (even if its only a few thousand dollars) make a difference to my friend\family member if its lost?” Said another way – if this is grandma’s last dollar – don’t you dare take it!
Outside of the friends and family considerations – the financial means and acumen of the investor you’re courting makes a huge difference. My recommendation is to always seek investment from Accredited Investors if possible. Doing so will significantly lower your costs to raise the money and provide the comfort that, no, this won’t be grandma’s last dollar.
Finally, you should also consider where each of your potential investors live. If you are a Wisconsin corporation raising money from Wisconsin investors your cost will be significantly less than raising money from individuals out of state (thanks, federalism). (Said another way, Securities and Exchange Commission will be involved in an out of state raise, they will not be involved in an intrastate [inside the state] raise).
What is the best vehicle for the initial investment and how much of the Company should I sell? – Hard to answer this question. That said, my suggestion on the “best vehicle” (SAFE, Convertible Note, Seed Equity) is to do your own research, ask your trusted advisors their opinion, and don’t be afraid to negotiate. Any investor who tells you “Lets use a Post-Money SAFE unedited from YCombinator” does not have your best interests at heart (and rightfully so, they are looking out for themselves). You should always negotiate. (And please….beware of the Valuation Capped Post-Money SAFE!)
On the how much to sell question – the rule of thumb I see often is “no more than 20% in your first round.” As a rule of thumb, I think its a good one – you certainly don’t want to sell more than 20% in your first round (unless you have a sweet valuation and are getting tons of cash). That said, going back to our “too Type A” point above, at 20% in round one…doesn’t take long before you’re below 51% ownership in your own company. (Remember, institutional investors will almost always demand a pool of 10-15% …so you’re not really selling 20%…you’re selling more like 35% from a dilution perspective).
Get Organized! – That could be the title of this post but…suffice to say, get your ducks in a row before you start negotiating a term sheet. Right after the fun part of signing the term sheet the investor will want to do his\her due diligence (*cough* look at all of your corporate documentation\financials etc). If none of that stuff exists, it will need to before you get any money. Nothing worse than having an awesome pitch, an awesome follow up conversation with the investor, an awesome term sheet – only for it all to bust into flames because your due diligence looks like amateur hour. Every investor is going to ask you for the following…so make sure you have:
- Articles of Incorporation
- Shareholder Agreements\Vesting Agreements
- Financial Statements (Balance Sheet, Income Statement at a minimum)
- Copies of Vendor Agreements
- Invention Assignments (agreements making sure any material produced by the Founders is owned by the Company and not the Founders individually)
- Any outstanding Notes, SAFEs etc.
Again, tons more to think about than just the few items above, but I hope this post was helpful and made you think of even more questions. Thanks for reading.