Starting a company is no small task, I think we can all easily agree on that, but it’s supposed to be fun and exciting while you build something you love and are passionate about. My guess is, having spent the last ten months working out of 1871, Chicago’s largest incubator with hundreds of member companies, that the part of the startup process most entrepreneurs loath is fundraising. One of my favorite shows these days, HBO’s Silicon Valley, hit this point perfectly when Richard, the show’s tech entrepreneur / founder / developer, says, “I hate [fundraising]! I just want to get funded so we can get back to building [our product].” Like it or not, though, raising capital is a necessary step for most new businesses, so you might as well figure out how to do it right.
Punch in a Google search for “startup raise capital” and you’ll literally find millions of results with expert opinions on how to go about identifying investors and structuring your deal. What I was frustrated to find, however, is that very few sources explained the entire process of fundraising. As an engineer, process is king, and understanding each of the steps in a process is equally as important. So allow me to provide one layman’s insights into raising capital based on my experiences. Before I dig in, my attorneys would probably kill me if I didn’t disclaim that this article is merely my interpretations of a process that is governed by local, state and federal securities regulations, and you should absolutely talk to an attorney before following any of the suggestions included below.
File an electronic Form-D before you start to solicit investors. The only way you’re able to take capital from investors without going through a full-blown IPO (think NASDAQ) is thanks to a couple of very important exemptions in Regulation D of the US Securities Act of 1933 (yes, they’ve been around for a while) that are typically referred to as “Reg D.” The three exemptions that most entrepreneurs will use are as follows, depending the amount you plan on raising: Rule 504 (up to and including $1mm), Rule 505 (more than $1mm up and including $5mm), and Rule 506 (more than $5mm). There’s more to these rules than just the dollar thresholds, but it has always appeared to me that the size of the raise is a primary decision factor for which rule applies.
I’ll assume that most folks fall into the Rule 504 bucket, since most of our first capital raises are usually a million bucks, but keep in mind that if you’re doing a $1.1mm or $1.2mm raise, you’ll bump up to the Rule 505 bucket. The Rule 504 exemption basically says that you are not required to provide a huge set of legal documents and legal disclosures to investors as part of your offering, which will help to keep your legal bills down, but it does require that all of your investors are “accredited” – net income of at least $200,000 per year OR a net worth of at least $1,000,000 (not including their primary home’s value). To raise capital under this exemption, you just need to file an electronic form through the Security and Exchange Commission’s (SEC) website, which they call EDGAR. The form itself is free to file, straightforward to fill out, and doesn’t take too long to do, so you have no excuses to not get this done. To be honest, the hardest part of this piece is simply getting your login credentials to become a “filer” on EDGAR. Save a PDF of the final form from the EDGAR website, and print a copy for your records; you’ll need it later.
Put together a nice two-page business summary. Ten years ago, entrepreneurs were expected to send investors a full business plan for investment consideration. Five years ago investors started asking for a 10-slide Power Point presentation. Now it seems that everything is being boiled down again, and most investors will ask you send them a two-pager or a “teaser.” My first inclination was to open up Word and crank out a concise two page document that would touch on the important highlights from our business plan. What I learned was, these documents are as much a sales tool as they are a means to transfer technical information about your business. That means you should worry just as much about how your information looks, as the quality of the information itself. Here’s an exampleof the one we put together for Breakwater Chicago recently. Ask a friend who does graphic-design or web-design for help putting this together, or use an online option like ConceptDrop to get the job done right, but make sure the final file is something that you can edit. As time goes on, you’ll probably need to update stats and add accolades, so you don’t want to be stuck with a two-pager that’s in Adobe Photoshop format when you don’t have Photoshop. Microsoft Publisher is a good option that most of us carry on our computers. Then print off a hundred or so of these on glossy paper so that it looks professional and legit; first impressions are critical.
Network your way into introductions to potential investors. Maybe you’re lucky enough to have a rich uncle who can fund your entire project, but I’d wager that most of us have to “beat the pavement” to find our investors. The name of the game here is networking. Most of our investors came from introductions from somebody who passed on our deal. This is a numbers game, so identify the types of investors who you think will do your deal and start with your own network first, but know that you’ll need to get in front of 100 or more investors to close a deal with 5-10 people. Use these folks as a safe way to start, practice your approach and your pitch, and gather feedback, but assume that none of them will actually participate. When they say “no thanks,” your next question should be, “Do you know somebody who might be interested in taking a look?” Don’t ask for intros to anybody; stick to your profile of the perfect investor and ask if they know people like that. When they say “Sure!” be ready to quickly follow-up with a short email introducing your project with your two-pager attached as a PDF. Ask them to use that information to help make an email introduction (in person is even better!) and then watch for the actual intro. Respond within 24-hours to keep the momentum going. Your ask here is a 30-minute meeting to share the vision for your company and explain the deal terms, which isn’t too much to ask, and you’ll have to be flexible to either do this in person (preferred) or via phone and screen-share. This is the first neck in your process funnel – gauging interest based on an email intro and your two-pager.
Deliver your presentation directly and never send your “deck” ahead of time. The first thing you’ll hear from potential investors is, “Send me your deck.” This just means they want to take a peek at your Power Point presentation before you actually get to present it to them. From my experience, this is a kiss of death most of the time. Even with the best deck put together by former McKinsey consultants, it’s nearly impossible to tell your story without actually being there to tell your story. It’s also critical to address questions immediately so they don’t fester in an investor’s mind. I think it’s easy for folks to talk themselves out of something when their mind is left to wander on its own, which is frustrating when you’ve probably already figured out the areas of concern. Not everything can go into your deck and you cannot add a thousand emojis to share your passion and emotions, so save the deck to deliver yourself, directly. Not all investors will like to hear this, though, so be prepared for some funny looks when you say you are not able to send your deck ahead of the presentation. Stick to your guns! This is the second neck in your process funnel – present your deck and ask if they’d like to look at the details.
After you successfully pitch an investor, open up the Virtual Data Room. Once you’ve shared your deck with an investor and answered their questions, you’ll need to ask them straight-up if they’re interested in looking at the terms of your deal. If they so, “No thanks” then you should ask the same question listed above about introductions to investors who they think might be interested. If they say yes, then it’s time for what’s typically called “Due Diligence.” This is just a fancy term for looking through all of your stuff to make sure: (A) you’re not full of crap, (B) you’ve got your ducks in a row, (C) any legal documents are ready to execute for the investment, and (D) you’re not full of crap. A Data Room is very typical if you’re Goldman Sachs and your brokering a deal to buy a huge company, but I’ve found that it’s less prevalent in smaller raises. I think it’s a critical tool, so I’d highly recommend having one, in some fashion or another. It can be as simple as a free Google Drive shared-folder and as elaborate as Merrill Lynch’s program for $10k per month. The program we chose is called OneHub and it’s about $100 per month for their Data Room software, which operates on the cloud.
Upload and organize documents like your business plan, pitch deck, financial model, securities documents, maybe a nice video, and other core documents. Start with the basics first, but have your supporting documentation ready to upload for when an investor asks to see it. Also, I’d recommend using some sort of number system for your documents so you can have a table of contents document, and so you can easily refer to other documents when needed. We use letters for folders and numbers for files, so a file in folder-A would have its name as “A1.Financial_Model”.
Then you can give investors access to the Data Room and, my favorite part, you get to monitor their activity from your control panel. Being able to see if investors are actually accessing your Data Room will tell you how serious they are, and therefore how much time you should devote to them in your sales process. You can also tell if folks are viewing, printing or downloading individual files, so if one investor is spending a lot of time on your financial model, you should think about a touch-point that’s relevant, like maybe some supporting stats published in a magazine that validate your revenue projections. And, a key to this system, is that a nondisclosure screen pops-up when you first access the Data Room, which simplifies the whole NDA issue greatly and helps to protect your intellectual property.
I think it’s important to set a time limit for each investor, so that you can keep the process moving forward. We’ve used 21-days and will typically extend up to 28-days (i.e. one month) if requested by an investor, but at the end of that window, their access to the Data Room expires and they have to make a decision. This is important because it’s healthy for both sides, in my opinion, to have a defined “go” or “no-go” point where a decision has to be made. If not, then our experience has been that folks will sit in limbo for months and you’ll spend a ton of time and resources trying to convince them to buy-in. I think you’re better off letting those folks go and spend your energy looking for new prospective investors who really want to do your deal. This is the third neck in your process funnel – due diligence.
Know the difference between a Private Placement Memorandum, a PPM, and an Offering Memo. Basically nothing – these documents are pretty much the same thing with different names, and each attorney seems to have their own personal favorite. Depending on if you’re filing under Rule 504, 505, or 506, you may or may not need one of these, but ask your attorney if it’s worth doing, regardless of your legal requirement to do so. We’ve found these to be a helpful tool and a good sign to investors that you’ve got your I’s dotted and T’s crossed.
Getting the signed documents and your check is not as easy as it sounds. If there’s one thing I’ve learned in raising funds, it’s that a “Yes” means very little – almost nothing – until you have an investor’s signed paperwork and their check has cleared in your account. Investors are busy people and while this is the biggest thing probably happening in your world, it’s just another to-do on a long list in theirs. Respect their priorities, but keep some light pressure on folks after they give the green-light until they submit their stuff. You’ll want to have your bank account ready to receive wire transfers, but some investors still like to shake hands in person and hand over a paper check. Either way, until the funds are in your account and the checks have cleared, don’t count any chickens before they’ve hatched. This means that you should continue selling your deal to investors and only “close the round,” or stop taking more investments, once you have your full raise in the bank. This is the final neck in your process funnel – collecting the checks.
File a copy of your Form-D with the individual states where your investors reside. After you’ve closed the round, go back into EDGAR and follow their process to close out the form. This is the official end to your raise and you can breathe a sigh of relief. As part of your documents with investors, they should have given you their home address. If it’s a solo angel investor or an angel investor who created an LLC (or other company) specifically to invest in your deal, you’ll need to check which state(s) each investor lives in. Look up the rules in each of those states and you’ll almost certainly have to send those states’ departments of revenue a photo-copy of the SEC Form-D you filed earlier, along with a small check (e.g. $100) to pay for somebody to stick that piece of paper into a filing cabinet. Some states have a 6- or 12-month leeway for submitting these documents, but others only give you a couple weeks, so check on this as quickly as you can upon closing your round.
Throw a small party and invite your team and your investors, and get their families involved. Investors are an important piece of your team’s puzzle, so after you’ve completed a round, take a second to show your appreciation and use this as an opportunity to strengthen the bond between you and your entire ecosystem. We held a small, private gathering at a local bar, and the bar was nice enough to host us for free and even create a signature cocktail for our event. Don’t be afraid to ask for this type of stuff, especially when you can tell a venue that you’re bringing in your investors; the venue will be happy to get exposure with that crowd. All this being said, do NOT spend much money on this party, as that sends a negative signal to your investors. They want their capital going to grow your business, not throwing a huge and elaborate party. Be sure to invite everybody’s significant others, as that only increases the relationships between everybody and it’s fun to see folks’ better-halves.
Now is when the work begins! It’s exhilarating to close a funding round, regardless of the size, but it’s not the end… it’s just the beginning. Now you have to deliver on your vision and your promises! There’s no doubt that you’ll be working around the clock, but be sure to take an hour every other week to write a quick summary of the “goings on” at your company and share that update with your investors. Communication means a lot to them, it’s a good thought and reflective exercise for you, and I can guarantee that this will save you from concerned emails and phone calls from investors wondering if you’re working on the company or if you’ve skipped town with their money and moved to Mexico. Plus, it’ll be a cool journal of your startup life, so when you’re ready to write your memoirs someday, you’ll already have a huge head-start :-)