Only in exceptional circumstances is fundraising a joy ride —-quick and painless. More often, it is an arduous journey with twists and turns so saddle up and get ready.
This post aims to demystify the fundraising process and arm you as a founder with practical knowledge which will give you endless options and advantages through the fundraising process.
Sections are sequenced in alphabetical order (for no overarching purpose other than the author’s satisfaction) and split into two parts, A to L (Part 1) and M to Z (Part 2).
I would advise you to read through each of the sections eventually but I am aware we live in a “TLDR” world, so feel free to skip to sections that are most important to you in the first instance.
It is a precarious enterprise to simplify the intricacies of fundraising in one post but we must proceed anyway.
Business-as-usual. Who is in charge when you are not?
Even with all the help in the world, fundraising can be quite time consuming for a founder. Amongst many other things, investors expect quite a bit of face time with you (and rightly so).
We understand that you believe you can do everything and all at once, otherwise, you would not be foolish enough to be a startup founder, but despite all your superpowers even the best gets tested during a fundraising process, especially a prolonged one, like most of them are.
You are always walking a tight rope of running your company, delivering on business targets and trying to secure funding to keep delivering on said targets; one does not work without the other.
To keep walking the proverbial rope, a business continuity plan needs to be put in place with your co-founder(s) or senior team outlining the fundraising objective and the expected time you will be (sort of) out of action.
As a broad rule, when you are engaged in a fundraising process you will need to devote perhaps 30–50 per cent of your time to it, and when you are in the peak period of advanced investor discussions, due diligence and negotiating a term sheet this could easily take up 80 per cent of your time.
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Assign one person as your proxy when you’re not present — be clear about what they can and cannot sign off on, the latter being only major life and death decisions.
Since you can’t be out completely, perhaps allotting certain days in the week to focus on the business is useful but of course, you will have to be flexible to external requests.
Capital structure
The capital structure of a startup evolves through its lifetime.
- You start off with ordinary shares for yourself and your early employees along with some stock options (converted to ordinary shares in due course);
- As investors start coming in, they ask for preferred shares with certain preferential rights attached to them;
- Sometimes, the path to preferred equity might go via a convertible note, effectively an interest-carrying debt instrument which is either paid back at the maturity date or can be converted to preference shares either at the time of investors’ choosing or at the next priced round at an agreed discount and/or a valuation cap;
- You might even do (YC-pioneered) Simple Agreement for Future Equity (SAFE) which is a simplified version of a convertible note — it will get converted to preference shares at a discount and/or cap tagged to the next round but is not a debt instrument;
- Venture debt is another increasingly popular form of funding with different types emerging out of the woodwork, the “OG” venture debt was a simple term loan with an equity kicker (e.g. warrants) but now you can get venture debt secured against revenue, inventory or your own shares and might come with a personal (founder) guarantee ask.
The idea is to set the right foundation (precedence) and consistent structures as you move through subsequent fundraising rounds.
More of this is in the Term Sheet section.
Due diligence and data room: The must-haves, the should-haves, and the nice-to-haves
The due diligence process and requisite information vary subject to funding stage, type of investor, and geography.
However, our aim is to slightly over prepare for the “median investor”— keeping in mind that no investor would complain about the data room being too comprehensive and answers being readily available but being well prepared might just save you weeks in the back-and-forth.
Here is a standard checklist of key documents you should have in the data room. For ease, items have been assigned a priority tier from one to three —-one being essential, three is a bonus while two is everything in between; and a phase either one or two — one to be provided before and phase two to be provided after the Term Sheet is signed.
Treat it as a guide rather than a strict framework to allow variability.
In terms of hosting the documents, I highly recommend you use a specialised virtual data room (VDR) provider versus a Google Drive/Dropbox.
Now, this is not a must for early-stage fundraisings but does help to build a cadence. More of this is in the Resources and Tech Tools section.
Employee Stock Option Pool (ESOP)
Employee Stock Option Pool (ESOP) allows your employees to become shareholders in the company and participate in the upside.
When done right, it is one of the most important tools to hire, incentivise and retain great talent. An ESOP’s fundamental purpose is to align the interests of employees and shareholders.
You should carve out about 10–15 per cent for the option pool at the time of your first fundraising round. Incoming investors may have differing preferences for the following rounds but if up to you, you should maintain this ESOP level at least until Series B.
One to two per cent for key senior hires and less than 0.25 per cent for junior hires adjusted based on the need of a particular skill set (e.g. you may prioritise engineering over marketing).
The traditional schedule is four years vesting with a one-year cliff —-employee gets 25 per cent immediately after a year then proportionately until year four either on a monthly or quarterly basis.
Some of the alternative schedules which promote retention and performance are back-loaded vesting — granting a higher proportion in later years and performance-based vesting — granting shares based on achieving certain performance targets.
Performance-based vesting usually complements the time-based vesting schedules (either, front-loaded or back-loaded).
Financial model
There are many variations of a financial model and most of them get the job done in terms of investor evaluation and due diligence. Below is a checklist of items that are essential to any variant of a financial model.
- The Big 3: Profit & Loss (P&L), Balance Sheet and Cash Flow —-all three integrated with each other, i.e. when a line item moves in one, it moves in the other.
- Financial forecast covering at least three years ahead on a monthly basis, five is even better (following two years can be on a quarterly or even yearly basis).
- Historical accounts in a similar format to the forecasts, going back since inception, which provides unit economics evidence for forecasts and is readily reconcilable with the company’s management accounts or audited statements.
- Revenue build sheet with robust drivers either built from bottom-up (better option) or top-down, bonus if you can build from bottom-up and validate from top-down. From a bottom-up point of view, what is most important is to be able to see the drivers of revenue growth, e.g. X number of customers buying Y volume of products at Z price. This is generally referred to as “unit economics”, and depending on your stage of growth will be a topic investors will want to deeply understand, along with the cost of acquiring those customers.
- Cost build sheet with high-level assumptions for general operating expenses and detailed assumptions for key cost buckets (e.g. marketing, tech) tagged to revenue where applicable; common pitfall — understatement of the forecasted cost structure vis-à-vis forecasted revenue resulting in an overstatement of margins and early breakeven.
- Some of the Balance Sheet items should be tagged to items in the P&L or Cash Flow Statement e.g., accounts receivables from revenue and cash in the bank from closing cash respectively.
- Similarly, some Cash Flow Statement items should be connected to the P&L items (e.g., net profit) and Balance Sheet items (e.g. accounts payable).
- Use of funds should be driven from operating expenses, working capital and capital expenditure in the P&L and/or Cash Flow Statement. Remember to adjust for funds from operations (gross profit), external financing for working capital (if any) and interest expenses.
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Financial Advisor. Not every company needs one
The decision to hire a financial advisor should be based on certain factors such as funding stage, due diligence sophistication, team bandwidth, sector, shareholder base, founder’s network and fundraising experience.
- Stage.A company raising a typical Seed or Pre-Series A round does not need to hire a financial advisor — your target audience (Early-Stage VCs, Accelerators, Individuals, Family Offices) do not expect to be dealing with a financial advisor, don’t need the sophistication in terms of DD or materials and expect it to be a founder-led raise.
- Due diligence sophistication. Will you pass the litmus test of investor due diligence? Refer to DD and Data Room section to check if you have everything in place. Then ask yourself; do I need to hire an advisor to do this or is this easily done in-house?
- Team bandwidth. How built out is your finance and corporate development function particularly in the context of a fundraising campaign — do they have time for (and experience in) managing a fundraise while doing their day jobs? If you are not sure — consider hiring an advisor.
- Sector and investor appetite. Do you operate in a niche or emerging sector where the number of deals is fairly low and the investor universe is relatively limited? Hire an advisor with an established track record and investor network in the space. There are several boutique advisors which specialise and have deep expertise in certain sectors —-find yours.
- Established shareholder base. If an established VC with proactive portfolio management and a fully built-out team (e.g. East Ventures) holds a significant stake in your company —-you will probably get sufficient help from them in terms of preparing for a transaction and investor introductions. Shareholder support combined with in-house expertise may be enough not to hire a financial advisor.
- Founder network and fundraising experience. In the fundraising context, there are two types of founders, the superstar fundraisers and the rest. If you are a second- or third-time founder on the back of successes or “good failures” — chances are you have a universe of investors who will back you at least for the first two rounds or even if as a first-time founder you have managed to raise a bumper first round, the second one is a relative cakewalk. However, if this does not apply to you — consider hiring a “well-connected” financial advisor
- Market perception. Bankers sometimes have a bad name (a few bad apples, as they say) and we often hear that having an advisor representing you in an early stage fundraising is considered a red flag and turns off investors. I say, you decide for yourself by commensurately factoring in the “perception risk” along with other (arguably) more important considerations mentioned here — no serious investor should pass on a good opportunity because of this reason.
Governance and reporting. But aren’t startups exempted?
As an early-stage startup, you will get a lot of leeways but as a relatively mature startup, there are certain things that you are expected to have in place by institutional investors. Why not start early?
- Board oversight. Quarterly board meetings to set clear objectives and KPIs (OKRs, sorry) for the company and senior team and monitor progress with the maintenance of proper records.
- Shareholder reporting.All shareholders should be invited to Annual General Meetings (AGMs) and receive materials in order to update them on annual performance and future plans.
- Employee morale and wellness is the single biggest asset of a growing start-up. Hire an expert (internally if you can) to put a scalable program in place and personally monitor its effectiveness.
- Impact evaluation is not easy for private markets as there is no standard framework. However, VCs in Southeast Asia are now taking a more proactive approach in understanding and developing frameworks, perhaps with a little push from their own investors (LPs) which means it will eventually become an essential ask for you. IIX Values provides a simple self-assessment tool for you to get started.
- Some other items you may want to consider is the additional insurance coverage (e.g. director’s insurance), tight employment agreements (e.g. IP assignment, see Telio) and proper treatment/disclosure of related party transactions (e.g. if founder has an interest in a key supplier, see WeWork).
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Holding company
If you run a startup in Southeast Asia, Singapore is the go-to destination to domicile your holding company. The Singapore Government and its agencies such as the EDB have made a concentrated effort to make it so.
A supportive regulatory framework, low tax rates, friendly treaties with most countries, access to world-class professional services and talent — some of the reasons why investors and founders alike prefer a Singapore-based Holding Company, even if the operations are elsewhere.
It is of course easier if you have this from the start but fret not, it is quite common to do it (corporate restructure) later when you start picking up more traction (and money).
Investment notes
Increasingly, investors have started to release their investment notes outlining the thesis and investment rationale after making an investment. Think of it as a “public appropriate” version of the investment committee paper.
The basic format is as follows —-the major problem being solved/opportunity being addressed, the dollar value of the market opportunity, how is the company uniquely placed to succeed, what are the future growth engines, traction to-date and in the future, valuation justification (if public).
I would ask you to put yourself in the investor’s shoes and write one yourself in addition to asking your major shareholders to share their “investment note” from the time they made the investments (if they didn’t have one, request them to create one)
Several reasons to do this —
- To a certain extent, you are doing the work for the investors, making their jobs easier and allowing them to move faster.
- You are gaining a different view of your company, from the other side of the table — force yourself to be unbiased.
- It shows your shareholders’ conviction of the business and covers some potential blind spots which you didn’t cover in this or your marketing materials.
I really like how Chamath Palihapitiya does it — simple as it can get. If you want VC specific examples — check out some notes released by B Capital and Square Peg Capital.
Lawyers. Run…
Lawyers are often underrated actors in fundraising drama. However, having a good lawyer by your side is absolutely essential for so many reasons (some of which you might not want to learn about first-hand).
What you have got to remember is that investors belt out term sheets for a living, you don’t. They know all the ins and outs which you are expected to not know about.
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A good lawyer will really focus you on what to negotiate hard on and what to let go of — this will save you a lot of pain while negotiating but much more in the future.
An inexperienced lawyer (from a fundraising standpoint) could not only be out-negotiated but might frustrate your future shareholder (or board member) by focusing on minor issues which don’t matter, not to mention drive up costs for both sides.
You need a lawyer who has done has done multiple fundraising transactions in your sector and someone you can completely trust (no, your litigator friend from poker night does not qualify for the former) — so if you don’t know a good lawyer, please get a warm introduction here.
Bonus if you can get someone who has experience working for both sides.
I am acutely aware that you need to be cost-effective and not squander away cash before you’ve even got it.
The good news is that there is a suitable fit lawyer for every budget and stage. From a Singapore standpoint, early-stage fundraises will cost you about S$5,000 – S$30,000 while the growth stage can cost you about S$30,000 – S$100,000.
The big range is really a result of the complexity of the transaction, the time required to close and brand/size of the firm.
You will get charged by the hour (on “discounted” rates, of course) and typically have a fee cap. You must get a fee cap.
If you want to know more and can’t wait for the sequel — you don’t have to.
Refer to Part 2 (M to Z) here where I cover off topics such as marketing materials, outreach strategy, term sheet and valuation amongst other things.
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