First, some bad news: Early-stage funding is harder to come by than it used to be. The seed-funding market has collapsed, with seed deals dropping by nearly 50%, by some estimates, since 2014. Venture capitalists are putting more money into later-stage deals, leaving early-stage startups scrambling to grab investors’ attention.
The good news is that founders can do that largely by avoiding the missteps many of their peers are making. The precondition, of course, is to build a great business first (that part’s up to you!), but if you can fend against these common mistakes startups make while raising early-stage capital, you’ll be far ahead of the pack–and better-funded, too.
Mistake No. 1: Your Team Dynamic Is Off
At the early stage, it’s all about investing in the team. What does that really mean? Obviously, investors want to see a passionate leadership team that’s capable of articulating and executing a big vision. So you should ideally have founders with complementary skill sets and a track record of working together. That much is a given.
But keep in mind that investors may ask to meet your whole team right from the get-go, rather than back you while you assemble it. And a strained team dynamic is a big red flag for seed investors. When founders disagree or talk over each other, or when one founder does all (or none) of the talking, questions of compatibility are bound to come up. So spend time preparing your team to speak knowledgeably and confidently about their roles and the company vision.
Related: This Is Why Your Startup Will Fail
Mistake No. 2: Your Cap Table Has Issues
Investors want to see that founders and key employees are financially motivated to go above and beyond to make the business succeed. And the startup ownership structure–represented by your capitalization (or “cap”) table–should reflect that shared goal. Red flags include:
- When founders don’t own a majority stake in the company during the seed stage.
- When major stockholders (with stakes of 20% or more) aren’t part of the business.
- When the cap table is so crowded that it looks like founders are giving out shares like candy (Tip: be judicious with those “adviser shares”).
You need to demonstrate that you’re making well-considered decisions about adding, incentivizing, and removing team members.
Mistake No. 3: You Pitch The Wrong People
Many startups pitch VCs without understanding what it means to be “VC back-able.” To qualify, you’ve got to be a high-growth business with the potential for at least a 10x return within five to seven years. If this doesn’t describe your business, don’t bother pitching VCs.
Beyond that, you need to target investors who fund businesses of your stage, industry, business model, and return profile–otherwise you’re wasting everyone’s time. So if you’re a SaaS seed-stage company, don’t go pitching a consumer-focused Series B investor.
Mistake No. 4: Your Market Size Is Too Small
Institutional investors are looking for billion-dollar market opportunities–and sometimes even higher than that. And the best way to convince VCs that your market size is compelling is simply to do the calculations yourself.
There are two ways to build a market-sizing analysis–bottom-up and top-down–and you should understand the difference. Top-down analyses are easier to calculate (which is why entrepreneurs like them). Bottom-up analyses tend to be more complicated but more realistic (which is why investors like them even better). Here’s a good primer on market sizing if you want to delve deeper on this topic–which you should!
Mistake No. 5: You’re Just Unprepared
Do your research on investors and their priorities so you can speak about how your company fits into their portfolio. Be on time and respond to emails and calls in a timely manner. These are the basics, but early-stage founders fumble this stuff all the time.
Finally, before you start fundraising, create a “data room” with information an institutional investor will want to review during their diligence process. Put the following six documents in a shareable folder (Dropbox, Box, etc):
- Charter documents (certificate of incorporation, bylaws)
- Founder and key employee stock-purchase agreements
- Confidential information and invention-assignment agreements for founders and employees
- Cap table (showing all outstanding and reserved shares, plus any outstanding convertible notes)
- Latest pitch deck
- Financials (past performance and future projections)
That way, when you start to have investor conversations, you’re prepared to handle information requests pretty much immediately.
Fundraising is hard, and it can take a long time–especially right now. So do yourself a favor and leave plenty of time and runway to get it done. And avoid those dumb deal-breakers.
Clara Brenner is cofounder and managing partner of the Urban Innovation Fund, a venture capital firm that invests in the future of cities. The fund provides seed capital and regulatory support to entrepreneurs solving our toughest urban challenges, helping them grow into tomorrow’s most valued companies. She is also the founder of Tumml, a startup hub for urban tech. Follow Clara on Twitter at @clara_brenner.