Should you raise money or bootstrap? (By bootstrap, I actually mean raise < $250k from individuals or angels).
Having run a startup that raised money and now in running a VC, ironically, if I were starting a product company today, I would start out with the mentality of bootstrapping for as long as I could. And, maybe, just maybe, I might consider raising more money under a few limited circumstances.
I would raise more than $250k if I had a company that:
1. Was growing 30%+ MoM in sales and my operations could not keep up to fulfill those sales
I’ve noticed for operationally-heavier companies (i.e. not SaaS businesses but generally tech enabled services or similar), it can be easy to grow your sales quickly, but often these companies need to throttle their growth because they do not have enough people to fulfill these services.
2. Was a marketplace with high engagement
Marketplaces tend to be “winner take all” businesses because they are only valuable if both the supply and demand sides are both liquid and efficient. This happens when you have a lot of supply and demand, which means to really thrive, you need to be willing to invest in a land-grab on both sides.
This is why you see companies like Bird and Lime raise so much money. They need to saturate cities with scooters and with users (basically buy you as a user). In some sense, their businesses are “easier” on the supply side than the current ride-sharing market because they can manufacture more scooters and don’t rely on people to drive them. They can create infinite supply. In the ride-sharing market, supply is basically a zero-sum game. In other words, someone who is driving for Uber right this moment cannot be driving for Lyft or a food delivering company or what not. That person’s time is occupied. The ride-sharing market will change over time with self-driving cars, and that will also become a marketplace with infinite supply which is easier than trying to grab two sides of a market. But you still need tons of money to manufacture a lot of vehicles.
3. Was growing net revenue 30% MoM for many consecutive quarters where I felt confident to really pour big money in marketing channels
If your business gets past a certain threshold – call it past the $2m runrate (series A territory) – and you are still growing at a fast clip using a repeatable marketing channel or two that works, then it likely makes sense to step on the gas.
The caveat is that many companies have a difficult time crossing the $10m runrate – this is very difficult to do (series B territory). So you are gambling that, with more cash, you can get to series B metrics. It’s just really hard to keep growing 30% MoM with large revenue numbers. Also, running a company at that level involves a large team, and it’s tough to manage a larger team. Despite those risks, I would still raise money in this circumstance too.
So what are good bootstrappable companies?
I think the perfect profile of a boostrappable company is a SaaS company. There are often little to no network effects, and so your competitors affect you less. In other words, company A using product X doesn’t affect company B’s decision to use it most of the time AND company B being on the platform has no affect on the user experience or value that company A gets out of product X. There are low operational costs; software has high margins, so you can often pour profits back into the business to keep growing (at least to a good level).
I also think events businesses are good bootstrappable businesses. VCs don’t like to invest in these, and so it would likely be impossible to raise VC money at any point in time with this type of company. But, as I’ve mentioned, events businesses can actually have really low operational costs despite what most people think. If you can get the venue, food, staff, and content all free, then the costs are just marketing and your own salary. On the revenue side, you get your money upfront when people buy tickets or sponsors send you money ahead of the event. Plus, you can often pay vendors on a net 30 basis. You get money upfront and pay costs later in most cases. People often cite scaling as a stumbling block, but if you look at the truly efficient events companies – Web Summit comes to mind – they basically print money and have a scaled playbook to do events all around the world.
I think people often equate bootstrapping with low growth or “lifestyle” businesses (which somehow investors seem to equate with “no money” but not always true). But, I think that’s false. With the right conditions, bootstrapped companies can be super high growth, high revenue companies. It’s actually not true that you need VC money to grow really fast. With high margin and low cost businesses, you can grow really fast without much or any external funding. At the end of the road, you can decide what exit you want to take (if even). You have control over your own destiny in a way that most VC backed companies cannot.
I also think that people think raising VC money is sexy. It’s like a stamp of approval. The truth is, VCs are wrong most of the time! Most of their startups end up failing. The flip side is that there are a lot of great businesses that don’t need VC money to grow really quickly (for all the reasons mentioned above).
I think ultimately, very often entrepreneurs end up raising money for the wrong reasons or raise money too early. They think life will be easier if they raise money – the salary would be better and having more help would be better and pouring more money into marketing would be better. On the surface, I’d say that all of this seems better – of course we all want more money! But unless you have found fast growth channels, your people and marketing dollars end up not being put to very efficient use, and you are actually no better off than if you had bootstrapped your company but you have given away more of your cap table.
So from seeing things as both an entrepreneur who has raised money before and now being a funder of many startups, this is what I would do if I were starting a product company today.
We recently announced at Hustle Fund that we will start investing in Southeast Asian software startups, and my new business partner Shiyan Koh, who just moved back home to Singapore, will be leading the charge on that.
I was in Singapore last week, and I was blown away by the amazing opportunities that Southeast Asian entrepreneurs have ahead of them. It’s one thing to hear from other people that Southeast Asia (SEA) is up-and-coming, but it was totally another thing to go there and talk with so many people about the future.
Here are a few thoughts that come to mind from just my short trip there. I’d be curious what other people in-region think about this (and keep in mind, I won’t be doing the investing there; Shiyan will be :) ):
1. There are opportunities galore
People like to use chronological analogies, so if I had to do that here, I would put investment opportunities in SEA at around 1997. To add some context, I loved learning about all the low-hanging-fruit investment opportunities there are.
Basic infrastructure is just being tackled and getting strong traction right now. For example: payments via Grab and others such as AliPay are coming into the region. Basic marketplaces like Carousell are big or getting big, but there are plenty of opportunities for “large niche marketplace” plays to emerge.
In this first inning of software companies in SEA, major consumer businesses have started taking off, but so many other categories are just starting to emerge. B2B, for example, hasn’t even really started as a category yet (more on this below). Health is another area that has a lot of low-hanging fruit opportunities and, in some countries, is less regulated than in the US (for better or worse). Fintech, too, has many areas that have not yet been tackled – payments for the banked population is just the first step. This really resembles the era when in Silicon Valley, we had Yahoo, EBay, and Craigslist. PayPal was not around yet, but ideas were starting in payments.
I think if I were an entrepreneur who was location-agnostic, I would definitely move to Singapore and start a business there. I can think of 20 clearly big low-hanging fruit opportunities in Southeast Asia that would be great to go after, but in contrast, it’s really difficult to even think of one clearly big opportunity in the US. Obviously, the US still has plenty of big opportunities ahead of it (more on that below), but the low-hanging fruit around “infrastructure” has been established. Messaging and email generally works. CRMs and marketing tech generally work. Ads generally work. Marketplaces generally work. Payments work. People in the US can pay for things electronically and can get most services and goods today from the internet. Infrastructure and services in the US generally work, so improvements in these areas are all incremental. Entrepreneurs can still make money improving these areas, but infrastructure improvements in the US are incremental in contrast to SEA, which are right now binary opportunities.
2. Building for Southeast Asia is less about tech and more about hustle
All of that said, because infrastructure takes a lot of pure, brute force and hustle to drive adoption, the kinds of entrepreneurs who will thrive in this type of ecosystem are those with a lot of hustle and strong business mindset. All the low hanging fruit opportunities that I mention above are not tech revolutions; they are all about customer adoption. In many cases, the tech required to execute these businesses have been done elsewhere (payments, marketplaces, etc.).
Customer adoption is always hard wherever you go, but it’s arguably even harder in a place where there aren’t ready distribution channels. The interesting thing about the US market is that online customer acquisition these days is actually fairly straightforward for most customer audiences. You can build a SaaS company and get to $1m ARR fairly easily while 10 years ago this was very difficult to do. This is because we now have the infrastructure to do things like look up decision makers on LinkedIn or elsewhere and find online-means to reach people. In SEA, there are some pieces of infrastructure that have been established and exceed the US. Mobile penetration in SEA is much higher than in the US (on a volume basis). This makes it easier to do customer acquisition for a consumer-based company. For B2B, for example, decision makers for older businesses can’t be easily found online. In other examples, if you’re selling to unbanked populations, not only is the customer acquisition hard, but you also have to do operational things like collect cash, which US startups don’t have to worry about.
I think this explains why we tend to see consumer businesses emerge first; tech-savvy internet users are easiest to reach. Other customer audiences are laggards in adopting the internet. Startups formed to serve them need to wait until they come online so that the customer acquisition can be faster.
3. B2B requires selling to other startups
This brings me to my next point. Throughout my trip, lots of people (investors, startup ecosystem builders, entrepreneurs) told me that they are puzzled about why B2B hasn’t taken off yet, even though that seems to be the next opportunity.
Here’s my take on B2B: if you look at the US ecosystem, most of the high flying B2B companies got to their level of growth because of fast sales cycles. These fast sales cycles tend to come from selling to other startups. Slack, Stripe, Mixpanel, and Gusto grew by selling to software startups. The accounts start small but increase quickly when some of your startup customers become big within 5 years. I noticed this with my startup LaunchBit. We started by selling to startups too, and within a few years, the startups who found success both with us and just in general grew their accounts with us considerably.
In Southeast Asia, if you are starting a B2B company right now, you will likely need to be selling to older or slower-moving industries. That sales cycle can be long, but in 3-5 years or so, if a lot of startups emerge in the ecosystem, then the B2B sales cycle selling to SEA startups will become fast. Here’s a concrete example: we met with a health company based in Thailand who flew to Singapore to pitch investors. They showed us how they were communicating with their consumer customers – all through LINE messenger. There were literally hundreds of threads of conversations in LINE. At some point, as the startup grows, those conversations are going to become a real pain to keep track of. Can you imagine doing all your business in LINE? (I fully realize that a lot of people do all their business in WeChat in China). You can imagine that at some point, there will be new marketing automation companies that will start building marketing communication software to allow companies to communicate in a more organized manner en masse via LINE to their customers. However, this will only become a big opportunity if there are lots of startups using LINE. So, I think we are probably 3-5 years out for large B2B opportunities to emerge because a lot of startups need to get started first.
That said, we are definitely interested in looking at these types of opportunities even as early as now because they take time to build. :)
4. Southeast Asia is fragmented
It’s fun to just lump every SEA country together, but the reality is that SEA is quite fragmented in a way that the US is not. (by language, culture, regulations, etc. – though sometimes the US seems quite fragmented – hah).
I think it’s great if startups have big ambitions of serving audiences globally, but it’s really important to tackle one market well first.
The market that everyone seems to hone in on is Indonesia. Indonesia has 250m+ people, so it’s close to the size of the US. However, it’s important to segment further. If you’re trying to go after a banked population that has disposable income, then the addressable segment is probably more like 100m people. This is still a really large market, though.
Once you start talking about population numbers closer to 100m people, then other countries start to rival Indonesia in size. Vietnam, for example, has strong tech adoption and has nearly 100m people. Thailand has nearly 70m people.
From our perspective, while it’s important to be cognizant of market size (for example, Singapore has ~5m people but is a great hub for building a business even if not a large addressable market on the island itself), I met a lot of people who were overthinking the SEA market landscape. As a startup, focus is super important, and nailing your product or service for one market of 5m people or 50m people is already really hard to do. And that one market – whatever it is – should be the focus before trying to dabble in many markets that all have completely different languages, culture, and regulations.
However, this seems counter to the advice that many entrepreneurs seem to receive in the region. If other investors are looking for you to expand to Indonesia even when you’re still tiny, then you may need to think through your strategy on fundraising. I fully realize that sometimes you have to adjust your plan to make your company more amenable to fundraising, but at the same time, VCs don’t always have the best advice either. This is a tough balance. So maybe you start with Indonesia if you’re familiar with the market. Or maybe you start conversations with VCs well before you start your company to understand how people think about addressing one market really well before expanding.
Garden by the Bay Mid Autumn Decorations
5. Liquidity opportunities for investors are unclear
Ultimately, as an investor, I think about how a company can eventually get liquidity. And right now, even though some of the markups of high flying SEA companies are good, it’s unclear what the “typical” path of a successful large startup looks like in this region.
In the 90s, going IPO was a common liquidity path in the US. After consumers became wary of IPOs, M&A became the much more dominant path, though IPOs are coming back in favor again in some cases.
What this looks like for SEA is unclear, and what’s even more unclear is the timeframe. In China, the path to liquidity can be 5 years or fewer. In the US, our darling unicorns often take a decade and sometimes longer to exit. Will large US or Chinese tech companies be purchasing companies for large amounts in SEA? Is that strategic to them? Or will these companies go IPO? And depending on the country, will investors even be able to get their money out once they’ve made money? These are all questions that we have discussed and frankly don’t know the answer to, but we are betting this will be figured out in the next few years while our investments mature.
6. What are opportunities in saturated markets?
This trip got me thinking about opportunities in saturated markets. In the US, I’d argue that most categories are crowded. Crowded markets aren’t necessarily bad; it proves demand. If entrepreneurs can get to a certain level, any exit is good for them. For VCs, it’s different. This is where entrepreneur and VC incentives don’t align. A lot of VCs – especially microVCs like us – will generally sit out of crowded markets because they don’t have the capital to pour into their companies to compete and become big winners. Smaller exits are not good for VCs because they really need their winners to make up for their losers plus return more. We can debate the VC model all day, but that’s another topic for another day.
In the US, the big opportunities as I see it are:
Products and software for unserved consumer populations along the lines of gender, race, and ethnicity; fashion tech, for example, is an area that has been long ignored
“Super high tech” that alters how we live life dramatically; think flying cars and everything that Elon Musk dreams up
Providing software to a new generation of tech savvy people in the workplace OR consumerizing B2B software for the phone; for example, every doctor and construction worker today can use technology but 10 years ago, that was not necessarily the case
This means that entrepreneurs need to be more specialized in skillset than in a landscape like SEA. For example, if you are an entrepreneur building a new kind of autonomous vehicle, you really need to have a strong engineering background. On the other hand, if you are building a new kind of ecommerce product for an underserved customer segment, in many cases, you may not need to be technical at all, but you really need to know how to go after your customer persona to be able to out-target more general competitors who are going after a broader segment.
What this means, I think, is that we will still continue to see a lot of really interesting technologies emerge from the US as well as even more products and services that will serve just about every consumer and B2B demographic. All of these are all still large opportunities, but I think the ideas that win here will just be much harder to come up with.
Just my $0.02. Would be curious for your thoughts.
I should have known that when we picked a company name like Hustle Fund, it would lead entrepreneurs to introduce themselves as “real hustlers”. But, I think my definition of hustle is very nuanced, and it’s not what most people think it is.
Very often, most people think of “hustlers” as people who are:
super sales-y
slick talkers / great at talking
doing 100 different things all at once
working really hard and wearing that hard work as a badge of honor
One entrepreneur even told one of my business partners that he didn’t think of himself as a hustler because he wasn’t doing anything illegal! Hah!
But this is not what “hustle” means to me. To me, hustle is about scrappiness to achieve to focus. The key word is focus.
I think the hardest part about running a startup is having focus. Focus is the key thing needed to grow a business. Because you have limited time and money, you can’t afford to invest in many different facets of your business. You can usually only afford to do just 1 thing really well otherwise a whole bunch of things will end up turning out mediocre or half-heartedly done – even if you are burning the midnight oil and working really hard.
This is easier said than done, though. What this means in practice is saying no to just about everything. In fact, taking on LESS at a startup in many cases is actually better than taking on more. This means saying no to meetings that will lead nowhere. It means not pursuing partnerships that will only produce incremental returns or revenue. It means simplifying product and reducing features. Ignoring lots of emails. Etc.
As a founder, even with all activities reduced as much as possible, it’s still difficult to truly focus, because there are some activities that need to get done in a business that take up a lot of time but don’t actually contribute to the growth of your company. Such as reviewing legal paperwork with your counsel. Setting up new accounts and adding 2-factor authentication. Setting up a checking account. Applying for a credit card. Etc. These are all activities that need to get done and take up time that don’t actually help your revenue (or whatever your KPI is).
Compounding time management issues, startups also have a lack of resources. E.g. how do you move your lead gen number when you have no marketing budget? Even if you are good at time management and saying no? Being scrappy to achieve focus is just really hard.
My last thought on this is that the good news and the bad news is that being able to successfully hustle is somewhat of a level playing field (though difficult for everyone!). By this I mean, I’ve found that the best hustlers come from all walks of life. People who go to Ivy League schools or worked at Google and Facebook are not necessarily good at hustling (some are and some are not). Often, people from these places actually are given a TON of resources, so scrappiness is not actually something they know how to hone. I went from being a marketer at Google where every news outlet wanted to cover all of our product launches to a bootstrapped 2 person startup where no one cared at all. In addition, people who go to top schools are often very good students. They are often good at being on top of projects and doing everything. Unfortunately, at a startup, you have to deliberately drop the ball on a lot of tasks in order to free up time to really really knock 1 thing out of the park. This is a difficult skill for people who are perfectionists who otherwise excel at non-startup jobs. On the flip side, I’ve also met entrepreneurs who were not good at following directions at school or work, but are able to do incredibly well with their own startups because they have relentless focus on what matters most to the business at the expense of other things.
Working on improving my own hustle is something that I strive for everyday – since Hustle Fund is a startup in itself, we, too, have a bajillion and one things that we need to take care of but really should only be focused on 1 thing at a time. This means, for example, if we are focused right now on saying helping our portfolio companies, it means that we can’t be responding to everyone who has sent us a pitch deck. This is fine balance, but something I’ve thought about everyday for the last decade or so since embarking on this startup journey.
A few months ago, I was talking with a friend of mine who is a successful serial entrepreneur. He has done incredibly well financially on his past two startups, and he’s now building his third company. When we were talking, he expressed frustration in raising his series A round. This was surprising to me. I asked him about his metrics, which are good, but they were not at series A level. I asked him who he was pitching, and he rattled off a list of usual suspects on Sand Hill. All of those investors told him that he was too early. It turned out he was going after the “wrong” group of investors. People he would have pitched 3 years ago had all moved downstream now that they had raised much larger funds, and he really needed to be pitching “post-seed” funds.
It struck me that a lot has changed about the fundraising landscape even in just the last three years. So, I thought it might make sense to take a step back and talk about all the stages of early stage fundraising here in the Silicon Valley.
In early stage investing, at least in Silicon Valley, there are basically 4 stages: pre-seed, seed, post-seed (or pre-A), and series A. In the “old days,” there were only seed and series A, and before that, only series A! All of these changes have created a lot of confusion.
Here are my thoughts on these stages:
Pre-seed
This is really the old “seed.” Very typically at this stage, little to no traction is needed, and investors are looking for lower valuations than seed investors for taking on extra risk by going in so early. Another consideration here is that, in the minds of pre-seed investors (who are very often small funds and will be allocating most of their capital in the first round or two), valuation matters a lot more to them than a larger fund who might invest in you at this stage as an option for later. If a startup comes to me looking for a $3m effective pre-money valuation vs another company who comes to me looking for a $7m effective pre-money valuation, basically what is being suggested here is that the latter company has to have a 2x+ greater exit in order to be just as good of an opportunity as the former. The outcomes of both companies are, of course, unknowable, but that is essentially what goes through the minds of investors who are looking at lots of companies with different valuations.
Also, to be clear, pre-seed doesn’t mean that one just thought up an idea yesterday and has done nothing. There’s a lot of work to do to prepare to raise money at this pre-seed stage. It could be building an early version of the product, or getting your first set of customers, or even doing pre-sales or lead generation well before having a product. In fintech or health, it could be in dealing with regulations or getting particular approvals even if you’re not able to launch.
Investors at this stage are very much conviction-investors, meaning they either bought into you and your thesis or they did not. It’s very difficult to convince an investor at this stage to change his/her mind. This is a bit of a crap shoot because even if a pre-seed investor has bought into you as an awesome operator, if he/she has not bought into your thesis, it will be difficult to land an investment.
These rounds are typically < $1m in total.
Seed
Today’s well-known seed investors may have previously invested at an earlier stage with smaller checks, but because many of these funds have now raised $100m+ funds, they are now writing much larger checks. Typically this is $500k-$1m as a first check. This means that they have to really believe in you and your business-thesis in order to pour that much capital into a business. As a result, this stage has created a fairly high traction bar. It can be upwards of $10k-$20k per month or more!
Seed rounds today are quite large – typically $1m-$5m! I believe that some of these seed rounds are way too large, and there’s a looming market correction on the horizon for everyone. I’m of the belief that early ideas can never effectively deploy $4-$5m in a very cost effective way.
Post-seed (pre-A)
This is a stage that was created because the bar for the series A has gone sky high. This really is what the series A used to be. A few years ago, people touted that in order to raise a series A, you needed to hit $1m runrate. Now, you typically need a lot more traction to raise a series A round. This magical $1m runrate number is now the rough benchmark for the post-seed stage, but it’s not series A investors who are investing at this stage. New microfunds have cropped up to invest here. They are looking for $500k-$1m runrate level of traction. This was my friend’s problem; he wasn’t quite at series A benchmarks and needed to pitch post-seed investors.
These post-seed rounds are also quite big these days, sometimes upwards of $5m+.
Series A
This is really the old series B round, but Sand Hill VCs who are known for being Series A investors are serving this stage. This is typically a $6-10m round. Companies typically have $2m-$3m revenue runrate at this point.
If you do the math, VCs are buying roughly 20% of a startup, so valuations can be upwards in the $50m+ range for today’s series A rounds! On the low end, I haven’t seen a valuation of < $20m, and that would be for a really small series A round.
Some additional thoughts:
1. There are lots of caveats around traction.
If you’re a notable founder, have pedigree, are in a hot space, or you run your fundraising process really well, it’s possible to skip a stage. I’ve seen some really high flying series A deals happen lately with friends’ startups, where they are not quite in series A traction territory, but they have so many investors clamoring for their deal that they can raise a nice big series A round. They’ve run their fundraising process well, and they generally have great resumes and are in interesting spaces. Same with the seed round – if you are notable or have pedigree, you can often raise a large seed round with little to no traction on your startup.
2. Sometimes the line between post-seed and series A is quite blurry, but the valuations are very different.
I have a few founders I’ve backed who are just on the border of post-seed/series A metrics and are able to get term sheets from both series A and post-seed investors. There’s a huge difference in valuation. The post-seed deals tend to be $10m-$20m effective pre-money valuation, and the series A deals are at least $20m+ pre-money if not much much higher. So, if you’re on the border, running a solid fundraising process is especially important in affecting your valuation.
3. Large Sand Hill VCs are doing seed again – selectively.
Sand Hill VCs who tend to invest at the later stages have now found series B to be too competitive to win. They are now starting to do series A deals and seed deals to get into companies earlier. In many cases, the deals they are doing at seed are large deals with little to no traction.
You may wonder, “Doesn’t this contradict what you just wrote?” What’s really happening is that the world of early stage investing is becoming bifurcated. If you have pedigree and are perceived to be an exceptional high signal deal, you can raise a lot of money without much of anything. These are the deals you read about in the news that make people think fundraising is so easy. “Ex-Google product executive raises $4m seed round.” This goes back to point #1.
If you don’t have that pedigree, then you basically need traction to prove out your execution abilities at the seed, post-seed, and series A levels.
4. Lastly, with the definition of “seed” expanding, more fundraising is done on convertible notes or convertible securities.
I’m now seeing more rounds get done with convertible notes and securities for much longer. This is actually good for founders because it means you have a much larger investor pool to tap. In the “old days,” if you couldn’t raise a Series A from the, say, 20-50 Sand Hill VCs out there, you were dead in the water. Now, you have a lot more flexibility to raise from angels and microfunds without a formal equity round coming together. I think this is a really good thing for the ecosystem because at this stage, it’s still not clear who is a winner based on metrics. There’s still a lot of pattern matching around who gets funded at these early stages. By the time you get to the series B level, it’s pretty clear who is on a tear and who is not, and that is much more merit-based investing. Short of that, the more angel investors we can bring into the ecosystem of startup investing, the more companies will get a shot to prove themselves.
You may wonder, “Well, are there actually companies that are being overlooked by VCs in earlier rounds who later are able to hit series B metrics and raise a VC-backed series B round?” Having looked at a lot of data around this, the answer is definitely YES! While it’s true that the vast majority of companies who end up raising a series B round from VCs previously had notable institutional VC backers even as far back as their seed rounds, VCs still end up missing a number of companies at the earlier stages. These actually go on to do well without them and end up coming out of left field and raising money from late stage VCs.
A few years ago, a friend asked me if I could forward an email to Abc VC. I told him that since that Abc VC didn’t invest in my company, I wasn’t sure if Abc VC thought highly of me.
Now that I sit on the other side of the fence, I realized that my thinking was flawed. In many cases, if a VC declines to invest in your company, it isn’t a knock against you (caveat being this is true unless you’ve acted really rude to them and/or their team). In most cases, rejections happen well before even meeting a team, so that VC doesn’t even know you!
Here are a few reasons why an investor will reject you that has nothing to do with you.
1. Your idea is undifferentiated
Investors see thousands of businesses a year. Your idea is the 50th social networking site this week. Unless you have a differentiated angle and approach to the problem and/or significant traction, an investor won’t be able to understand why you stand out and why they should back your horse instead of someone else’s. This is especially true at the early stages.
Note: by differentiation, I’m not talking about product or feature differentiation but outcome differentiation. For example, if you’re creating a new Mailchimp competitor, you might think your product is differentiated if your product has better tracking than they do. That’s a feature difference. The outcome-differentiation is probably lacking; people use Mailchimp to increase revenue by selling more products and services via email. So unless your feature can increase that outcome – and not just incrementally by 20% but a serious differential like 10x – it’s unlikely that a current, happy Mailchimp customer will want to switch to your product. Think about it. If you’re using MailChimp and make, let’s say, $100 in sales for every send, it’s going to be a real pain in the neck to move to a new product. Your whole list is set up and everything for just an additional $20 per send.
Often as an entrepreneur, it’s hard to know whether your product is differentiated because you don’t know what other startups are out there. This is something I personally faced when running my company LaunchBit. There were and are so many freakin’ ad networks, ad exchanges, and ad platforms out there that LaunchBit was just undifferentiated. A business like ours will have a really hard time raising money at the early stages, and if that’s feedback you are getting from at least 2 people, you may want to consider adjusting your plan and raise from angels and/or bootstrap for a long time. It doesn’t mean it’s a bad business. In fact, it could be a very good business for you. It just means VCs will shy away from it.
2. Your idea is not the right fit for the stage or industry.
Your idea is not a good fit per the investor’s thesis or mandate. Sometimes this can be incredibly difficult to see. For example, a lot of software investors don’t invest in e-commerce companies (we do not.). The products are physical things that cost a lot to store as inventory, and fundamentally, this makes e-commerce companies a very different profile from products that are entirely digital (software, software platforms that don’t house inventory, digital products, etc.).
A lot of investors call themselves “early stage” investors and aren’t good fits for pre-seed companies. Many of these investors mean “series A” or “post seed” when they say “early stage,” even though they will do a handful of pre-seed deals with founders they already know or with successful serial entrepreneurs we’ve all heard of.
What I’ve found to be most annoying about the VC industry, as an entrepreneur, is that you can never pin down what VCs like. This is because VCs are always hedging so they can see everything just in case there is that rare exception that they would potentially invest in outside of their thesis. The best way to assess what VCs actually like is to look at their portfolio. If a VC says that they invest without traction, you should find out when they’ve done so and whether it’s because they already had deep relationships with that team or because that team has incredible pedigree. Play out the probabilities in your head of who will actually be likely to invest in a random company at your stage.
3a. Your business model seems flawed OR is not the right fit
I talked a lot about unit economics and sales cycles in my last post. For me, I personally think very heavily about the unit economics of a business, and if I can’t get conviction around the potential customer acquisition, that’s an immediate pass for me regardless of the team, market size, or product. I do understand that teams can pivot, but we are already so early in the lifecycle – often first check into a company – that I can’t count on pivots.
VCs look at unit economics in different ways. For example, some VCs have such deep pockets that they can throw a lot of money at a company and wait out a long sales cycle. That’s not Hustle Fund. We are currently a small fund, so when we back a company, we need to believe that we can help that company get downstream funding from other investors with deep pockets OR that the company can bootstrap its way to success.
In order to bootstrap your way to success, it largely means you need high margins and fast sales cycles. These are companies that we can get behind as a lone ranger if we see hustle, focus, and a differentiated solution.
If you’re in a category where you have a long sales cycle or smaller margins, then I need to think that I can “sell” your deal to other investors, either people who will invest alongside us or after us. We talk with and do try to understand what a lot of our early stage investor peers are interested in to help inform our decision. The point is, when we are looking at companies with these type of customer acquisition qualities, we cannot make decisions in isolation. We need to believe other investors will buy into you as well, even if we are still the first check into your company.
3b. The market size is not big enough
For a VC portfolio to work out, a VC’s winners need to compensate for all the losses of the losers plus much more to provide great fund returns. Not only does the fund need to be net profitable, but it also needs to outperform other assets that our would-be backers could be investing in, such as other VC funds, real estate opportunities, the public stock market, etc. No one really talks about how VCs differentiate themselves and what they need to deliver to their investors, but this is a big factor affecting how they invest in companies.
For a VC, it’s not good enough to have a winner “only return 10x” even though that would be a phenomenal outcome for a founder or even an angel. Most VCs need their winners to return 100x (or ideally more).
This is why it seems that every VC is harping on billion dollar markets. If you do not think you have that big of a business, VCs are not going to be the right people to raise from. Angels might be a better fit.
For me personally, I think the problem with market-sizing exercises is that you just don’t know whether a market is big or not! Airbnb is probably the poster child example of this. At the seed stage, it seemed like a weird niche idea to sleep on someone else’s air mattress. What is the market size for this? Basically zero. But sleeping on a bed in someone’s house is an alternative to getting a hotel room, and the hotel market is huge. It’s just very difficult to know whether the market size is big or not in the early days, especially for seemingly “weird” ideas.
This is why I don’t care to ask founders about their market size. Their predictions will be wrong, and so will mine. Moreover, even if a market is big, it doesn’t mean the company can grab a lot of that market share. This is why I very much focus on a bottoms-up approach to analyzing a marketing and look at unit economics, sales cycles, and customer acquisition. If the unit economics and sales cycles are rough, I don’t care how big the market is; it’s going to be a long and difficult slog to capture the market, and that means a very capital intensive business. Then that goes back to the question of whether I think I can round up co-investors with me or downstream investors to fund this.
In short, these are 3 reasons why a VC might reject your business when they haven’t even looked at your team or anything else about your company. It doesn’t mean you necessarily have a bad business; it just might not be the right fit for that particular firm or the VC industry in general. In most cases (caveat being you were rude to someone on our team), when we decline to invest in companies, we would very much welcome seeing a different business that the founder starts later and would be honored if the founder wanted to take the time to refer a friend who is working on a different startup.
At Hustle Fund, we back both first time founders as well as repeat founders. One thing I’ve noticed is that almost every repeat, previously-successful-founder focuses on the same thing for their respective startups: customer acquisition. These founders not only think about customer acquisition first, but in many cases, they will even:
Abandon a startup idea altogether if the customer acquisition strategy isn’t strong
Pre-sell or generate leads well before building a product to try to validate demand
Some thoughts on customer acquisition from my own learnings over the years both as a startup operator and talking with a lot of startups:
1. Unit economics matter A LOT.
Unit economics are something I’ve found most entrepreneurs (and investors!) don’t think about at all. Forget about traction and hockey stick growth. It’s hard to get there without ideal unit economics. Very simply, your cost to acquire a customer needs to be lower than the value of that customer (lifetime value).
This is obvious. Diving in a bit more into some thoughts here:
a. Ad-based revenue streams generally have terrible unit economics.
A typical ad-based revenue stream on a media website is around $5 per 1000 eyeballs ($5m CPM and give or take $1-$20ish CPMs). In other words, if you can get 1000 people to come to your website consistently for under $5, then this business model works for you. This is incredibly hard to do, and most sites cannot do this at scale. As always, there are exceptions: if you build a viral consumer product (such as an Instagram) where people are just coming to your site or app in droves at no cost to you, then you’ve got a great business. If they are not, it’s very hard to use paid acquisition to generate that type of traffic for under $5.
As a result, second time founders very often shy away from ad-based consumer ideas, but when they do, they think about what viral mechanisms you can implement first and engineer the product around that mechanism. Marketing first. Product second. Here is a good case study on LinkedIn (scroll down to see how they grew). Second time founders focus on lucrative verticals that pay more per eyeball or focus on ad formats that pay more (such as email newsletter sponsorships).
Ads can also be cost-per-click or cost-per-action ads. Although you can make more money by running per-click or per-action ads on a per conversion basis, it’s also a lot harder to bring about these actions. In particular, one thing to consider if you’re trying to make money off affiliate ads is to think about how unique the product/service is in the ads you’re running. For example, if you are running affiliate ads for hotels, you might get 3-5% on a sale. So if someone books a hotel at, say, $100, then that means you might make $5 on that transaction. If this is a generic hotel, then there are likely other affiliates who are doing paid marketing to try to get users to their sites/apps to convert users as well. Moreover, the hotel itself may be running ads to drive traffic to their site/app, and for them, a conversion is worth far more than $5. You will likely get outspent on any paid marketing channel you may use to drive traffic to you at scale if there are other people trying to drive traffic to the same property.
Even if you are not scaling with ads, partnerships and SEO also cost money, and your competitors or even complementary companies are all spending money on partnerships and SEO in order to drive as much traffic as they can. One way to make an affiliate-ad-based revenue stream work is to have access to unique products that no one else online is trying to sell. This could mean partnering exclusively with someone who makes products offline (and who is not tech savvy to compete online with you).
Another way is to have unique promotion channels, but these must be scalable. Honey, for example, is a browser extension that is always in your browser and helps find coupons for you for any site you browse. This allows them to retain users for a long time and make some affiliate revenue by directing you to particular offers that they get paid for. There are some hardware companies, for example, that make money based on affiliate revenue. They sell their hardware at cost – say, a new refrigerator. When you buy food on a recurring basis, they make recurring revenue by your buying food through their affiliate channel. You will use your fridge for a decade or more, so the retention here is high.
There are clearly many companies making money on ads of some sort, so this is not to say that you cannot build a big company with ads. You definitely can, and there are many who do. Remember, the key insight is you need your revenue stream to be much more lucrative than the cost to acquire your customers who generate that revenue.
2. B2B startups have high margins. Sales cycles matter though.
Many serial entrepreneurs tend to gravitate towards building B2B startups. I can’t tell you how many founders I know whose first company was a consumer company and then built only B2B companies after that. B2B companies can have great unit economics. Business customers, depending on the problem, are less price sensitive than consumers.
HOWEVER, the length of a sales cycle is a strong consideration for most repeat successful founders. For repeat founders, this can actually work BOTH WAYS.
Longer sales cycles
On one hand, I know some really successful founders actually opt for a longer sales cycle. (I use “sales cycle” loosely; by this I mean the time it takes to get a product paid for, and so this involves both product development and time to get a check from a customer). Some successful founders would prefer to go after a REALLY lucrative revenue opportunity that has a “longer sales cycle” because they can capitalize their company long enough with their own money + friends’ money to gain the sale. In some sense, their moat is capital because most people will not be able to access enough capital (either by raising or by bootstrapping) to go after a similar opportunity. Examples of this include startups that are building a new airplane, car, rocketship, power plant, etc… Most first time founders cannot just start bootstrapping a new rocketship startup.
Sales cycle, as a consideration, also works the opposite way. Many repeat successful founders would also actually prefer to go after opportunities with a much shorter sales cycle. If we use Christoph Janz’ animal framework for building a big business to identify types of customers you can be going after, these founders won’t be hunting elephants, but they might go after rabbits or deer business customers.
Because these companies are often able to move a lot more quickly than elephants, founders can often pre-sell before a product is ready. Or at a minimum, generate a lot of leads before generating momentum and starting to validate a business opportunity with real people and real money. This pre-sales strategy, of course, can also be used for consumer businesses that sell things.
As a side note: many companies in our portfolio at Hustle Fund, regardless of what they’re building, have pre-sold their products before building anything.
3. Does your business have naturally short retention?
Repeat successful founders also think a lot about retention. Some ideas seem like a good ideas but actually are not because of the retention component (or lack of). Here is an example:
I used to run some wedding-related sites; there’s obviously a real need for products and services in the wedding space. Plus, engaged couples pay a lot for weddings! On the surface, this seems like a good space to be in, but the retention is terrible or non-existent. Once someone gets married, in many cases, this person won’t ever come back and generate revenue… at least not for a decade or so later (Although I did once have a customer who bought from me, then called off the wedding, and then a few months later came back to my site to buy more because she was now engaged to someone else. The vast majority of my customers were not in this camp). This is not to say that you shouldn’t do a wedding-related startup, but it’s important to think about how to retain a customer and convert him/her towards other things.
The Knot is a great example of a site in the wedding category that tries to retain people. The Knot would not consider themselves a “wedding company.” They would consider themselves a “lifestyle company” – they retain their users by moving their users to “The Nest” and later “The Bump” as you start settling down into married life and then having children. This allows them to make money on their users for a much longer timespan.
Retention applies to B2B companies as well. For example, there are a lot of startups who offer products/services to startups. When their customers outgrow them and become big companies, can they grow with them and offer products that make sense for larger companies? Hubspot is a good example of this. Initially, they focused on SMBs, but today, a lot of enterprise businesses use them. They still do partnerships with startup organizations/accelerators so that startups can start using their platform and grow up in the Hubspot ecosystem.
If you are starting a company around a person or a business’ stage of life, think about how you can retain your customers and users over time.
4. It’s nice when someone else pays for a customer.
This is a very rare customer acquisition situation, but in some cases, a company can jump on the opportunity where a consumer benefits but someone else pays on behalf of the consumer. This is nice because the consumer gets something for free and is still your user/customer. The customer acquisition is easy because this person doesn’t need to pay money. Rather, someone else is footing the bill and must do so. This is a fantastic customer acquisition situation.
This type of scenario often happens in weirdly regulated situations. In health, for example, almost all online pharma startups are in this category. A startup gets a consumer to sign up for service to get his/her medication for free. His/her insurance pays for it.
This type of inefficiency happens in other industries as well and is something that I personally look for. We’ve backed a couple of companies that fall into this category (they are not all in health). The customer acquisition is incredibly fast and high growth (i.e. easy to convert users when something is free to them and that something is awesome).
In summary, when I evaluate startups, a big initial criteria for me is evaluating how deeply the founders have thought about customer acquisition (and retention) and whether they are customer acquisition-centric founders. This does not mean the founders need to have marketing and sales backgrounds; in fact, most of our founders do not have this background. Thinking about the unit economics as a business owner BEFORE building your product is incredibly important regardless of your background.
It’s been about a year since I started working on Hustle Fund with my business partner Eric Bahn. People often ask me what it’s like to start a micro VC and whether they should do one too. (Hunter Walk just wrote his perspectives here)
Here are some of my learnings from the last year.
1. It is absolutely the best job in the world for me.
I enjoy learning about new technologies and ideas – and you get to see a lot of them in this business, especially in early stage investing. I enjoy working with founders immensely, but most importantly, I love fundraising. I know – that isn’t what you thought I was going to say (more on this later).
Much like running a product-startup, you’re your own boss, so you sometimes end up working really hard and at all hours depending on where you are in your fund life cycle. If it’s work you enjoy, then it doesn’t feel like work. There’s also a lot of flexibility, and I’ve definitely taken advantage of that. You can whimsically pick the most powdery day of winter and go up to Tahoe to ski. Or go to the beach or lake midweek in the summer, and no one will be there. It’s great.
2. Starting a micro VC is just like starting a product company. Except harder.
Probably 10x harder. If you go in knowing that with eyes-wide-open, then it’s totally fine, but most people don’t do enough homework before deciding to start their funds. I would talk with at least 10 micro VCs before deciding to do this.
3a. In particular, there is no money in micro VC!
Hah – this seems ironic, but I’ll explain.
Most people think VCs have a lot of money. That’s if you work for an existing large established VC. If you are starting a VC, this is definitely not true. I’ll break this down across a few points, but the gist is that you have to be willing to make no money for 5-10 years.
If you are not in a solid financial situation to do that, this business can be terrible for your personal life.
This is surprising to a lot of people. Even if you have, say, a $10m fund, most of that money needs to be used for investing – not for your livelihood or for other things.
In fact, the standard annual budget that VC funds have is 2% of the fund size for the life of the fund (typically 10 years). If your fund is, say, $10m, then that means you have a yearly budget of $200k. To be clear, this isn’t your salary; this is your budget to run your company. Your salary does come from this number, but you also need to cover the salaries of everyone else on your team (if there are others on your team). If you travel, those costs come from this number, too. If you have an office, that cost also fits in here. Health care and benefits also fit under this. Marketing – t-shirts, watches, swag, parties – all of this fits under this budget. There are also fund ops costs that need to be factored into this number, too. When you factor in all these costs, $200k actually doesn’t go far. To give you some perspective, my salary today is less than what I made at my first job out of college… in 2004.
You need to be willing to bootstrap for about 5-10 years. In contrast to building a product company where most people bootstrap for maybe 2-3 years and then either raise some money or build off of profits or throw in the towel, when you sign up to do your own VC, you are committed for 10 years (the standard life of a fund). You can’t throw in the towel. And if your fund does well – i.e. your companies either raise more money or they grow their revenues a lot – you also don’t make more money because your salary is based on a percentage of your fund size. Your salary (or lack of salary) is stuck for years – until you raise your next fund and have new budget from that fund.
Some Micro VCs write into their legal docs that they will frontload all of their budget in the first few years. Under this model, instead of taking, say, a $200k budget per year for 10 years, some funds will do something like frontload the budget – say, $400k per year for 5 years. This can help increase your budget, though there are still fund ops costs every year for 10 years, so I’m not sure how these funds end up paying for those costs in years 6-10 if they are taking the full budget up front. This is not something we do at Hustle Fund.
Other micro VCs will try to make money in other ways by selling event tickets or whatnot. In many cases, depending on how your legal docs are written, consulting is discouraged. It actually is very hard to bootstrap a micro VC because on one hand, you get virtually no salary but are also mostly prohibited from making money outside of your work.
3c. You also will make General Partner contributions to your fund.
At most funds, you will also invest in your fund as well. This allows you to align with your investors and have skin in the game, and this is standard practice. In many cases, fund managers invest 1-5% of the fund size. So, if you have a $10m fund, you’d be expected to invest at least $100k to the fund.
Not only are you not making money on salary, you are also expected to contribute your own money to the fund.
There are some funds that don’t write this requirement into their legal docs, but it’s something that a number of would-be investors always ask about (in my experience). They want you as a fund manager to be incentivized to make good investments because you are staking your own cash too. And this makes sense.
3d. Sometimes you need to loan money to your fund.
There have been several cases over the course of the last year where either Eric or I have had to loan Hustle Fund money interest-free to do a deal that needed to be done now (before we had the fund fully together).
One thing that is different about raising money for a fund (vs a product-company) is that when investors sign their commitment, they don’t actually send you the money right away. So, let’s say we raise $10m; we don’t actually have the $10m sitting around in a bank account. This surprises a lot of people – VCs don’t actually have cash on hand!
The way investors invest in a fund is they sign a paper committing to invest in the fund. Later, when the fund needs money, the fund does a capital call. Typically, capital calls are done over the course of 3 years. So, if an investor commits to investing $300k into a fund, then on average, that fund will call 1/3 of the money each year over the course of 3 years. In this case, that would be roughly a $100k investment each year from this individual. The capital calls are not done on a perfectly regular cadence because sometimes a fund will need money sooner than later. Most funds try as best as they can to do regular capital calls.
This also means that there’s a lot of strategy and thinking that needs to go into capital calls. For example, when you’re first starting to raise money and have very little money committed – say $1m – it can be tempting to call 50% of the money right away to start investing $500k into a couple of deals. However, as you continue to raise, subsequent investors will be required to catch up to that 50% called amount. Let’s say you round up another $6m in capital; this means that all of a sudden, you have $3m that you’re automatically calling to catch up to the proportionate amount that the first set of investors contributed. And if you’re writing small checks out of your fund, much of that $3m will then just sit around in your bank account, not earning interest, and will negatively affect your rate of return. Instead of doing a capital call, loaning your fund money is a way to ensure that you don’t have capital just sitting around in your bank and counting against your rate of return.
There are bank loans you can get once you are fully closed and up and running, but very few banks will loan you money in the very beginning when you have raised nothing – hah.
3e. And even if your fund does well, you still make very little money at the end of 10 years!
First, most VC funds are failures. In fact, much like startups, I’ve heard that 9 in 10 VCs will not even get to 1x returns!
But, if you happen to be in the lucky 10%, there’s a range even here. The “gold standard” for profitable VCs is a “3x return” benchmark. If you’re above it, you’re considered excellent. This is very hard to do. Just getting into the profitable category is an accomplishment in itself.
Let’s suppose for a moment that your fund is excellent (because we all believe that our funds are excellent), and let’s say that we return 5x on our fund. On a $10m fund, a 5x fund return means the fund will return $50m. Using a standard 20% carry formula, and after returning most of the gains to the fund’s investors, it means that the team will receive $8m. If you have 2 managing partners, that’s $4m per person – but 10 years later. Considering that you’ll make no salary for much of that time, there are many other professional, tech, and established VC jobs at big Sand Hill firms that will make you more money or the same amount of money on salary alone (not including benefits or stock) with greater certainty. You don’t have to be a 90%+ performer as a Director of Product at Google to accomplish the same outcome as an exceptional micro VC manager. Think about that – you risk so much, much like a startup, but your upside is equivalent to working a steady job at Google for 10 years!
For all of these reasons, microfund managers who are able to raise more money on subsequent funds end up doing so because for the same amount of work and risk, you’d much rather be paid more in salary and in carried interest later.
4. You should love fundraising.
I think most people think that, as a VC, you spend most of your time looking at deals. The breakdown of a given week for me is something like:
15% looking at deals (talking with co-investors and referrers, emailing with founders, looking at decks, talking with founders)
10% working with portfolio companies
Of course, it varies a bit if you’re at the beginning of a raise or if you have closed your fund. The point is, you will spend a solid chunk of your time as a micro VC on fundraising activities. Even if your fund is closed and you don’t have a deck to pitch, you are always in fundraise-mode.
If you have never fundraised for anything before, you will probably think that this process is horrible. Having raised money before for my startup and having coached a lot founders on fundraising over the last few years, I’ve grown to love it. And part of that is just lots of practice. The more you practice, the better you get, the more you like doing something.
5. Fundraising for a micro vc is exactly like fundraising as a product-startup. Except more involved.
Prior to raising a fund, it never occurred to me to ask where fund managers raise their funds. That was just not something I had thought about before. For the big Sand Hill VCs, most of them raise money from institutionals. These are retirement and pension funds at government entities, endowments at universities, or similar. As you can imagine, these entities are pretty conservative, and rightly so. The pension check that granny is counting on for her retirement shouldn’t be frivolously thrown away on a fund that invests in virtual hippos recorded on some blockchain.
As a first time manager, often it can be difficult to convince these types of institutional funds to invest. It can be done if you have a strong brand already. Even if you are an experienced angel investor or worked at a well-known VC fund, you’re still starting a new fund with a new brand, and there are still questions about whether you can repeat your past success on this new brand.
This means that much like product-startups, you end up raising primarily from individuals, family offices, and corporates. Much like with raising money from angels and corporates for a product-startup, angels and corporates don’t have websites announcing that they are funding vc funds. You have to hunt for these folks. Often these “angels” whom you can access are folks you know or folks who are 2-3 degrees away from you whom you don’t know yet (see my post on raising from friends and family).
And much like a product-startup, the check sizes are going to be smaller if they are from individuals (unless you know lots of very, very wealthy individuals). When we first started fund 1, our minimum check size was $25k – much like the minimum investment amount for a typical product-startup. Except we were raising tens of millions of dollars, not $1m. $25k doesn’t go far on say a $10m fund.
This means you need to be doing lots of meetings, and this takes time. The average time for a microfund manager to raise a fund is ~2 years. We felt fortunate and incredibly thankful to our investors to be able to raise our fund in < 1 year. When you think about it, that’s still months of active fundraising (see point #4).
6. And you have a limited number of investors you can accept.
When product-startups set a minimum check size, it’s usually arbitrary. If you’re raising $1m for your product-startup, it won’t hurt you to take some investors at $1k or $5k checks here and there, especially if they are value-add. With a fund, every slot counts.
So when we started with $25k as a minimum check size for some friends, we knew we needed to quickly raise that bar in order to raise a significant enough fund and still maintain 99 investors. We ended up having to turn away a lot of great value-add, would-be investors who could not do a higher investment. I would have absolutely loved to bring in more investors if I didn’t have this restriction.
In other words, you cannot just accept $5k here and there from friends and claw your way to momentum.
To get around this, some funds set up a “1b” fund. For example, Hustle Fund 1a and Hustle Fund 1b split startup investments equally between the two. That would be one way to get bring in more investors, but because the costs of this setup start to go up, we decided not to do this.
7. Ok, so there’s no money. You also cannot change the world on fund 1.
If you can get past all of the above, and you’re still “yay yay yay – I want a life of making no money and want to fundraise all day and night for whatever cause I am trying to support,” the last piece is that you should know that you cannot change the world overnight.
I know so many aspiring micro VCs who go into this because they want to fund more women or minorities or geographies or some vertical that is underfunded. I think those are all awesome worthy causes. And me too – the reason I’m doing this is that I don’t believe the early stage fundraising landscape is a meritocracy, and I want the future of funding to be much more about speed of execution rather than about what you look like or how you talk.
But, you absolutely need to go into this with a 20-30 year plan. If you’re a small little microfund with, say, $5m, you won’t be able to change the numbers in any of these demographics because impact happens at the late stages when VCs pour tens of millions of dollars into companies – not $100k here and there. What does affect change is having lots of money under management. That happens by knocking fund 1 out of the park. And then fund 2. And then fund 3. And growing your fund each step of the way. And growing your believers who start to hop onboard your strategy – not only your investor base but other VCs. That is a 20+ year plan.
Moreover, you need to be contrarian to have a good fund, and at the same time, you cannot be too contrarian on fund 1 because you need to work with other VCs in the ecosystem. You need your founders to get downstream capital. To a good extent, I do care a lot about what downstream investors think and how they think about things. You can only start to be very contrarian once you have more money under management (i.e. have proven out the last couple of funds) and follow on into your companies yourself.
In short, you will not make any money on fund 1. You might need to loan money to your fund. You will need to have money to invest into your fund. You will constantly be selling your fund as an awesome investment opportunity for this fund and the next fund and the fund after that, etc… You will not change the world on fund 1. But, if you still love all of this and go in with eyes-wide-open on all of these things, and if you believe you want to do this for the next 20-30 years, then I would highly encourage you to go for it. I think it is the best job in the world.
Most VCs won’t invest in startups super early. There are some exceptions: my company Hustle Fund tends to invest quite early, and so do a few of our peer funds at the pre-seed level. However, there are only a handful of us, and 99%+ of startups won’t be able to raise money at this stage. Alternatively, if you are a successful entrepreneur or have great connections, multi-stage VC funds will also invest super early in these types of founders.
For the vast majority of entrepreneurs, doing a friends and family round of funding during the earliest stages of a company is the primary way to raise money. I know for many people, raising from friends and family doesn’t come naturally. Many entrepreneurs may feel like they don’t know enough rich people to raise money from their network. Many people – would be investors – whom you ask to invest may also feel like investing is only for the really rich. It can also be confusing and awkward to ask people close to you to invest. How do you even broach the topic? Will the person be taken aback? Will it ruin your relationship?
Here are some tactical tips from my personal experience that might be helpful:
1. Dedicate lots of time to fundraising.
Fundraising, in general, takes a lot of time, and, raising from friends and family is no different. As I’ve written about previously, one of the biggest challenges in fundraising is that it just takes so much time to balance running a company and raising money.
2. Set up “catch-up” meetings with friends and family.
It’s really hard to know who will be interested in investing in your new venture. Set up “catch-up” meetings with everyone who is smart, has means, and/or is well-connected. In each of these meetings, you’ll certainly “pitch” your new venture, but you are not necessarily looking to raise money from each of the people you meet with. In some cases, you may only be looking to get introduced to more people who may be good to meet.
Pack these meetings into a limited period of time to maximize FOMO as well as maximize the efficiency of your fundraise.
3. Be creative about your meetings.
Your meetings could be coffee catch-ups, but in other cases, maybe you cook brunch at your home and invite people over. Maybe you invite a lot of people over at the same time. In other cases yet, you may want to do a group social activity; it could even be bowling! Whatever works for you and what you think your friends, friends-of-friends, and family may like doing to make your meeting less formal.
Your meetings don’t have to be stiff coffee meetings.
4. You are always “pitching” even if not formally.
You should always have a deck ready to show on your phone or computer, but you don’t always need to use it. I find that at the earliest stages, people are mostly investing in you.
Make sure that at some point in all your catch-up meetings you mention:
You are starting a new company
One line about why it will change the world – think very high level here
You are raising money for the company
You are raising only from friends and family
Casually ask if he/she would like to invest or if he/she knows 1-2 people who might be interested in potentially investing or may know other potential investors
It is important to get each person you talk to very excited about your business. I find that one of the biggest mistakes entrepreneurs make in pitching their high level ideas is that they say too much about what their product idea does. For example: “I’m starting a new social network that will combine Facebook, Snap, Instagram, WhatsApp, WeChat, and LINE all in one place.” Or, “I’m starting a new AirBnB for retired people.” This isn’t very exciting. The only person excited about your product mechanics is you. However, you can get people excited about outcomes: “I’m building a new social network that will bring people globally closer together – so that people in India can talk with people from Japan.” Or, “I’m starting a new type of housing platform so that older people don’t need to live in stodgy sad retirement homes and can live a vibrant independent life.”
When pitching to people who do not invest for a living (i.e. non fund managers), it’s important to explicitly mention that you are raising money and that you want their help. This could mean that they could help introduce you to other people and/or that they could invest.
There are a lot of people on the internet who say you should ask for advice and not money. IMO, this is really awful advice. Most people who do not invest for a living – even active angels – don’t realize they are being asked to consider your idea as an investment if you don’t ask for their help in raising money. If you are talking with your dentist about your new startup, his/her first thought is not, “Oh I wonder if I can invest?” or even, “I would never invest in this.” His/her first thought will be, “Oh cool, John/Jane Doe has a new career. I’m going to make a mental note that he/she has left Cisco and is now working for himself/herself.” They don’t see themselves as investors, and so you need to explicitly make the ask if you want an investment. You cannot just assume that people will volunteer to invest.
Your conversation might end up going something like this:
“So yeah, lots of new changes. I left Cisco, and I’m now starting a company. We are trying to do ABC in the world, and if we’re successful, DEF will happen. Right now I’m raising some money from friends and family to achieve XYZ goals. I wanted to see if you might be interested in potentially investing or know 1-2 individuals who might be interested and good to talk with?”
(Please don’t monologue. Those are only the rough talking points that you need to bring up.)
At this point in the conversation, you are making the ask only to see if the person will consider investing (or knows someone who might be good to talk to). You are not asking for a commitment.
It is important to mention that you are raising money from friends and family. A lot of people have in their heads that entrepreneurs raise money from funds and don’t realize that at the earliest stages, friends and family have the opportunity to invest in your company and also get the best deal. This is what you need to communicate to would-be investors.
A lot of people also think that investors need to be super rich in order to invest. This is also not true and also what you need to inform people about.
When you are first starting to raise money, my personal strategy is to set a lower minimum check size and generate momentum. This makes investing very accessible to many professionals. I know lots of “angels” who invest $1k-$10k per deal. I think many people think that angels need to put in at least $25k per deal, but that is simply not true anymore. Now, you as an entrepreneur may not want a lot of people to put in less than $25k because it will mean you have to do a lot of meetings. However, when you are first starting out and you don’t have a strong investor network, it may be worthwhile to accept some smaller checks to get the flywheel going and also to say Bob or Mary has invested in your company to generate buzz with subsequent conversations. Once you start to get checks in the door, you may want to increase the minimum. As a result, investing in startups is actually accessible to many people in your network. They just don’t think about it that way, and it’s your job to change that mindset.
5. You are selling more than your company
At the earliest stages, people are investing in you. There are other things you can do to sweeten the deal. One of the things that we do at Hustle Fund is host a meetup for all of our investors in our fund multiple times a year. It’s an opportunity for them to meet and get to know each other. In general, well curated and exclusive networking events are a really good draw for people to participate in things (as I wrote about here as a tip for getting speakers for a conference). People always want to get to know other rich and well-networked people. If your initial minimum is, say, $10k, then not only is someone buying a stake in your company, but he/she could also potentially be buying into a network. And you can facilitate this for free or really cheap. You can host these in an office space for free. Plus, pizza, wine, and cheese and crackers are pretty cheap.
People who invest in you – especially friends and family – are buying an experience. They are not just buying a transaction. Make that experience a good one.
6. Do a formal pitch & call-to-action if someone is interested
From the catch up meeting, if someone is interested in learning more, you can either dive into details right then and there (preferable if you all have the time) or set up another time to talk.
This is where it’s important to have a pitch deck and materials ready. At the end of this pitch, try to push for a yes or a no. In many cases, people will need to think about your deal, but, if the person you’re speaking with is ready to commit, have a SAFE or convertible note ready to sign.
7. Be transparent
If an investor has committed but hasn’t invested in a startup before, it’s important that you clearly outline the risks. I would say something like this: “I am flattered that you are going to join our round. And I think this is a great opportunity. But I really want to emphasize that investing in a startup like this is an incredibly risky endeavor. I could potentially lose all your money, and there is a high probability of failure.” People usually appreciate this level of transparency, and I’ve never known anyone to back out. I think that it’s important to highlight this in case/when things go awry down the road. Moreover, psychology suggests that in many cases, when things are slightly pulled away from you, you only want them more.
8. Re-assure friends/family that it’s ok not to invest
If you sense that someone feels awkward when you’re asking for his/her help, it’s important to re-assure him/her that it’s OK to not participate. You might find yourself in a dialogue like this:
“Oh…oh. Well, I don’t really have any money to invest.”
“A couple of thoughts – 1) First off, I value our friendship/relationship above all else. So, I don’t want to put you in a tough position. If this isn’t a good fit, that is totally cool. I just wanted to give you an opportunity that I think is great. 2) I also want to mention that since this is a friends/family round, we have a low-ish minimum of X. I don’t know if that changes things, but just wanted to highlight that.”
It’s really important for the sake of your relationship with the person to re-assure him/her that it’s OK to not invest. You are presenting and opportunity, and that’s it.
9. Don’t run out of leads
The best piece of advice that I received when I was raising money for Hustle Fund was from Charles Hudson, who also runs a pre-seed fund called Precursor. He said, “Don’t run out of leads.” This is very good advice. If you have infinite leads (and time), you won’t have to worry about being rejected as you go along, and that is exactly the mentality you should have going into and throughout your fundraise.
When I was a first time entrepreneur years ago, I remember being incredibly afraid of rejection. I didn’t push people to a yes or a no for most of my raise. By having the attitude that you have infinite leads, you will force all potential investors you’re talking to into a “yes” or “no” answer. This is a good thing. A “no” means you can stop wasting your time with someone who isn’t going to commit.
It also means that you need to keep generating leads to have enough potential investors fill your round. As you go along, this gets harder because you’ll start with people in your network who are closest to you and then work outwards and chat with people who may be friends of friends of friends who don’t know you at all. This is why it’s so important to constantly ask everyone you talk with for introductions or 1-2 names of folks they would recommend talking with… because you can’t run out of leads.
Now another typical piece of advice that you often hear is, “Never take an intro from someone who doesn’t invest.” I would say this is true of VCs. This is NOT true of non-professional investors: angels, friends, and family. VCs have funds to invest from, and it’s their job to invest money. If they pass, then they didn’t like something about your business, and that’s a negative signal. If I were running a startup, I would not take an intro from a VC who passed. But angels are different. They don’t necessarily have pools of money that they need to invest. If an angel passes, it could be because he/she wants to set aside money to repair the roof on his/her house. Or save some extra money for his/her kid’s private school. Or take a fancy vacation. Or buy a new car. Angels can do whatever they want with their money, including not invest. So, if an angel passes, that isn’t a knock on your business per se, and most people understand that. Also, angels run out of money all the time. They may have been active before, but until that portfolio becomes liquid, an angel may be tapped out of funds even if he/she wants to invest in your business. So, definitely ask for intros to other potential investors from individuals.
I usually try to ask for 1-2 introductions because it’s a small but anchored request. If the ask is too broad, such as, “If you can think of anyone who might like to invest…”, then no one will think deeply about it. Try, “Can you think of 1 person who might be interested in taking a look at this?” Asking for just 1 or 2 leads is a small task, and almost everyone can think of one specific person he/she knows who may be interested in chatting with you.
Pulling together a friends and family round is a bit of a crapshoot and takes a long time. Part of the challenge is in identifying which people are interested in investing in you and has some money to do so. I’ve found that it’s hard to predict who will end up joining your round. The richest people are not necessarily the most bought into the opportunity nor are they necessarily investing a lot into startups. In fact, many super rich people are a bit risk-averse because they want to preserve their wealth. Conversely, many people whom you may discount as not having much money may actually be really bought in. In fact, I’ve found that people who are not super rich tend to also be more risk-taking because they want to become super rich. In the end, you’ll just need to meet with a ton of people. You’ll need to do a lot of meetings, but raising a friends and family round even if you’re not well-connected can be done.
I grew up here in the Bay Area during the dot com boom. I went to college during the bust. And when I graduated, it was booming again. From that perspective, things have been mostly rosy in the Silicon Valley for startups! (except for 2008-2009, which is another story).
Now, I think we’re in trouble, Silicon Valley. I think we are on our way down as an early stage startup hub unless we start to fix some of the problems around here.
These days, although my VC fund Hustle Fund is based in the San Francisco Bay Area, I actively seek to invest in startups outside the Bay Area (to be clear, we do invest in companies here opportunistically, but we do not actively scout here).
1. Silicon Valley and San Francisco are too expensive
With the high cost of living in the San Francisco Bay Area these days, a lot startup capital must now go towards founders’ rent. In fact, people here qualify for low income housing if they have a household income of $117k! This is absolutely insane. This takes capital away from investing in companies themselves.
At this cost-of-living level, the Bay Area is no longer affordable to many founders who are not already rich. As much as people love the $8 avocado toast and the sunny weather around here, these are all less attractive when you’re crammed into a small room with 9 other people on bunk beds in a small apartment.
Given the choice – based purely on economics – of whether to start a company in the Bay Area vs say Austin, Austin makes a lot more sense. This is a no brainer.
Other places like Austin have always been cheaper than the SF Bay Area, but previously, the cost-of-living delta was not as great as it is today. In addition, not only is the Bay Area becoming prohibitively expensive, other cities are becoming more attractive as startup ecosystem. This makes the decision to start a company in the Bay Area even less compelling when there are equally attractive options elsewhere.
In fact, my favorite place to scout for startups is in Toronto and Waterloo. Not only are the people there nice as all hell (and the dollar exchange rate works in my favor), but there is incredible talent. This is because large tech companies have established serious offices there, including Google and Facebook. Additionally, startups in this ecosystem have now grown large (Shopify is TO’s poster child unicorn), and the experience that tech workers get at a growth startup is good fodder for the next generation of startups (Note: I know everyone in Ottawa is going to be mad at me for calling Shopify a TO startup, but to be fair, there are massive numbers of Shopify employees and former employees in TO). Other cities that I like are LA (basically my backyard), Boston (oldie but goodie), and Atlanta. I need to spend more time in Denver, Boulder, Salt Lake City, and Austin. I also look at the “pan-midwest”: Chicago, Cincy, Indy, etc.
The rise of “other startup hubs” will only continue to trend upwards as today’s startups become large and talent from those companies eventually find their way to new startups. This will make it harder for SF to compete for startup founder talent.
I would say, though, the SF Bay Area is still on top for growing a company at the late stages today. It still has the most experienced talent for this stage because there have been a lot of high-growth companies successfully built here. Those people all learn from each other. In addition, a lot of the multi-stage tech VCs are also still here. It might be doable to raise an angel or micro-seed round locally outside the Bay Area, but for the late stages, there’s still much more capital being invested in companies here. Lastly, M&A is also still big here. The tech companies who are doing big acquisitions are in the Bay Area (though this is changing too).
3. So, where should you start a company today?
At this point in 2018, I think what makes the most sense is for a startup to start where he/she wants to be. Personally, where do you want to live? Use free content from the internet to learn new skills and focus on growing your business. If your company ends up getting to a certain growth stage, then it makes sense to open an office in the SF Bay Area. This is probably true only after the series A, in my opinion, where you’re doing perhaps $300k-$1m per month in revenue.
Many startups these days are successfully using a distributed model. This can work depending on the type of culture you want to set for your company. Do your employees like to socialize with each other? Or do they like to just focus on their work and socialize outside the office? Are your employees good at written communications? Documentation? Companies like Automattic, for example, have established a truly distributed work model, but this works because that is part of the culture and is important to the people who work there. In some sense, this is also tied to your business model. If you have a heavy sales model, for example, having a whole team of remote sales folks probably doesn’t make sense. You need camaraderie and in-person energy.
A hub and spoke model might also work, where there are small offices in a few places so that people can still socialize with their co-workers but then are tied back to the mothership in San Francisco. Intercom and Talkdesk, which both have European founders, have HQs in San Francisco but also significant offices in Ireland and Portugal. I think models like these are the wave of the future regardless of whether there’s an international tie or not.
4. But VCs don’t get it
Unfortunately, many VCs, ironically, are the greatest laggards of new trends. Many VCs will still only invest in their backyard because they believe they have to meet people in person even though video conferencing solutions like Zoom are really good these days! Many VCs are also averse to new ways of working (e..g, remote working) even though the costs at the early stages work out way better for companies like these. This is a risk; you might not be able to raise money from some VCs if you have an “unusual” work model.
5. What the future holds
I think that an increasing global trend is that a number of cities will (and already are) emerging as startup hubs. I think that the good news is that entrepreneurs can now start a company from almost anywhere. In the long run (20+ years from now), even at the late stages, we will see new funds that will invest outside the Valley as well as new multi-stage funds popping up outside the Valley to invest in growth stages outside the Bay Area. If the SF Bay Area cannot get its act together on lowering or maintaining the current cost-of-living, my prediction is that the SF Bay Area will RIP as a startup ecosystem (except for rich entrepreneurs) altogether.
I hope that doesn’t happen. But that trajectory is on its way. That is why I invest outside the SF Bay Area.
Last Friday, I attended the 5th Hustle Con. I could not be more proud of The Hustle team. It was the best Hustle Con to date in my opinion. Perhaps even the best event I’ve ever attended.
The Hustle, the company that runs Hustle Con, is a fast growing media company that serves up tech news in an edgy way. Today, they have around 1 million subscribers, are doing multimillions in revenue per year, and have only 20 employees. It all started with just one event. Here are my learnings about events from the last 5 years:
1. A simple event with simple value-proposition can lead to a scalable company.
The Hustle is best known for its avant-garde daily newsletter. In the beginning, they started out with just one event called Hustle Con that happened once a year. The premise or mission for Hustle Con was to provide tactical company-building advice for non-technical founders. That first event in 2013 was held at Intuit, and less than 200 attendees paid between $100-$200 per ticket.
Photo credit: Lesley Grossblatt
Compared to the 2500 people – both technical and non-technical – who come from all over the globe to attend Hustle Con today, the look-and-feel back then was janky as all hell. But the value has remained the same every year. You will learn at least one tactical thing from each talk to help you with your business.
Photo credit: Eric Bahn
Early adopters can easily overlook bugs and janky-ness as long as you are providing a clear, differentiated value proposition. Even in that first year, Hustle Con delivered on that.
2. It’s easy to get feedback on events.
We know the first Hustle Con went well because of the concrete feedback that came back from the attendees. At the first event, all the attendees were asked to fill out their feedback right then and there on index cards at the close of the event.
The #1 thing that people thought could be improved was allocating more time for bathroom breaks. People were so engaged with the content that they felt they could not leave the room.
It is from this feedback that you can build upon your value proposition online beyond the event.
3. People pay to be in your audience when they attend events.
The interesting thing about events is that they are a good way to jumpstart your audience for a new product. And in fact, people will pay you to be a part of your audience to whom you can later market other products and services.
This is unlike any other marketing channel where you, as the company, need to pay to get potential users.
4. People will help you with your event for free
There is no other marketing channel where people will help promote your company for free. In fact, volunteers often make all the difference in running an event, and for a good event, volunteers sign up in droves because they want to attend for free.
5. Being an event organizer allows you to meet influential people.
Organizing events is one of the best ways to meet influential people. People love being asked to speak at conferences – no matter how famous they are. If you can get your speakers in front of a high quality audience, it makes them feel extra special. This is one of the easiest ways to meet influential people! As it would turn out, The Hustle ended up raising their first angel money from many Hustle Con speakers.
Entrepreneurs work so hard to network with investors and potential customers, and it’s hard to get attention. Instead, run an event. It’s one of the best hacks ever. Even if an investor or potential investor isn’t able to attend, chances are, he/she will at least respond to you to decline. That response opens the door for you to get to know him/her.
6. Influential people like meeting other influential people.
For that first event, you’ll have nothing to offer your influential speakers. Why should they speak at your event? You probably won’t be able to get that many attendees. That first event may have a lot of bugs or flaws. But speakers like networking, too. That’s a big tactic that many events use to try to draw in influential speakers.
At Hustle Con, for example, they hold a speaker dinner, which happens the night before the event. This dinner is invite-only, and they invite all the speakers to have dinner together as well as other people they think the speakers would like to meet. Most large events do similar “VIP dinners” as well.
One tactic I’ve used over and over again to get people to speak at various events is to name drop other people who have already committed to speaking. Landing that first speaker (usually from within network or close to network) is critical because all your other speakers will come as a result of that first person being there.
7. You have to get creative when cold-emailing.
Warm introductions are, of course, great if you have them. At some point, cold-emailing is necessary in order to get star speakers. Sam Parr, the CEO of The Hustle, used a great cold-email to get speakers in the early days of Hustle Con.
He even included personalized gifs like this:
Gif credit: Sam Parr
8. Engage your list and build off of it.
After an event, you have a captive audience (assuming you pulled it off well). You need to engage your list of attendees immediately (make sure you have the proper permission from them to do so). If you are doing an event to get people to do customer development, you need to stay top-of-mind. Don’t let your list sit around and become obsolete.
One strategy is to put everyone in a FB group and have them ask each other questions. Another strategy is to create a relevant news digest to send to your list.
9. Culture is set at that first event
What I didn’t realize 5 years ago is that the culture and tone of The Hustle would be heavily influenced by that first event. In that first event, there was gender balance amongst the speakers: 4 women and 4 men. Even in the audience, there was a fair percentage of female attendees. As part of the culture of that first event, there was also a “no asshole” rule.
At the 5th Hustle Con on Friday, I noticed that there was near parity on gender balance (the ticket purchases show 55% men and 45% women). The attendee makeup was fairly racially diverse as well. Attendees came from everywhere globally and held just about every job occupation (though primarily from tech).
Most importantly, the ethos of Hustle Con has always been about sharing – sharing information and genuinely trying to be helpful. And even though the conference now has thousands of attendees, that ethos is still there. I learned so much about various fields from other attendees. Unlike at other tech conferences where I often feel like people are trying to size each other up or talk about how they are killing it with their startup, people at Hustle Con just want to share knowledge and learn from each other. This may sound cheesy, but every year when I walk around the venue of Hustle Con, I get this feeling of happiness, a feeling of “this is how the world should be.”
Setting a tone for culture is a lot easier at an event than online, and you can carry this audience and ethos over to your online product afterwards.
10. Events are overlooked.
Events are overlooked. I’m not suggesting you necessarily run an events business (though those are lucrative bootstrapped businesses in themselves), but I rarely see startups doing events as a way of customer acquisition to jumpstart a new product or a new company.
If I were to start a company today, I would start by amassing an audience by running an event. It could be a small event, maybe only 1 to 3 hours, like a meetup. It could be held at a corporate office for free. I could have that audience pay to attend and then follow up afterwards with each person individually to do customer development. Then, I would build out a product and would continue holding these events to amass a larger audience and eventually start to sell to all of these people as my first customers.
Events allow you, as an entrepreneur, to really convey who you are as a person. Ultimately, this is how you gain followers for your brand. In the beginning, your company is less about your product and more about you. Your potential customers want to support you because of you, and this is a lot easier to convey in person with that first group of early adopters.
Tactical fundraising by Elizabeth Yin 