The Seed Round Guide: Is Big Always Better Than Small? (I/III)

In Fundraising by Sébastien FluryLeave a Comment

Some time ago, I discussed with Penny on the different challenges of raising money for an early stage tech startups. She has gathered a lot of practical experience of startup investments, both in her professional activity at Swisscom and in private, by doing angel investments on her own.

Startups are hard. Raising money is even harder. And even if there is a lot money in Switzerland, most of it is “sleeping”… So if you’re a startup entrepreneur and you need to raise funds (best way is to close commercial deals, of course, and you may not need financing early on – but that’s a different debate!), you’d better manage the process wisely and without doing too many mistakes. Once you have managed to raise interest of potential investors, you should be aware of how to do. As a first-time entrepreneur, you can learn from fellow entrepreneurs AND you should read stories shared by people who have exprience in this process. So, that’s the idea behind this blog post serie called “The Seed Round Guide”!

This Penny Schifferis a guest post by Penny Schiffer a Zürich-based energetic woman, passionate by the startup and investment world. She’s currently managing the startup initiatives of Swisscom and in charge of the « Swisscom Startup Challenge » and also part of Swisscom Ventures and a member of the business angel club Go Beyond.

In my role as an early stage investor, I meet many startups in the seed stage and I would like to share my view: What is the best amount of money to ask from investors? Which valuation makes it likely to have a smooth financing round without giving away too much equity?

After the first FFF round (family, fools & friends) of 50-150K for setting up the company, many startups need to do a bigger round to achieve the next milestone. This could be to actually build a product, to create a substantial sales pipeline or to achieve initial user growth.

Before you think: OK, this is coming from an investor who will only care about optimizing the investor’s perspective, I would like to stress my believe in a good balance: Investors should have an incentive to invest. Yet, more importantly: Founders have to keep a big enough stake to have enough “skin in the game”. Otherwise, there is no incentive to work like crazy for the next couple of years!

Here’s the question startups keep asking me: Should we go for a (complex) 1–1.5M CHF round that will be sufficient for 12–18 months – or should we accept a smaller amount to get going?

There are a few good points for a bigger round above CHF 1M

  • Efficiency: Fundraising takes a lot of time and energy from the actual business of the startups. So, it makes sense to minimize the fundraising activity by raising enough cash in a proper round rather than going around investors every few months.
    More cash will enable faster product development and growth, which can be crucial in many areas with well-funded competitors and/or a small window of opportunity.
  • Funding requirements: Oftentimes, startups underestimate how much money they need to achieve their first few milestones. If they raise too little, they will have a hard time to convince current or new investors to give them more cash.

My First Million However, I can see some downsides to asking for a big amount before you can prove traction: if you want to keep at least 70% of your startup (you might need this for subsequent rounds), you’ll have to ask for a pre-money valuation around CHF 3–4.5M. If you haven’t achieved significant milestones in product development and/or user growth, you will have a hard time convincing investors to accept this valuation.
Moreover, for a fundraising amount above CHF 1.5M, startups need to address another type of investor: this is often too much money for the typical business angel / early stage investor consortiums you can find in Switzerland. That’s more serious VC money. However, VCs are even more difficult to convince to take a risk (no market proof / high technology risk). They prefer to do bigger rounds in more mature startups.

Following are a few approaches that can help mitigate some of these effects:

  • Splitting the round in two: Raise 1/3–1/2 of the desired amount now and plan ahead for a second round to raise the rest of the funds. You should discuss the timing and terms of this second round with the investors up front so that they can set the funds aside. Doing a 2nd seed round instead of a series A round is becoming quite popular.
  • Lower your valuation expectation for some of the funds in order to make it attractive to invest. If you can achieve the milestones, you’ll increase the chances that subsequent investments will be made under a higher valuation. If you raise a lower amount than initially hoped for, the lower valuation will “eat” only reasonable equity.
  • Ratchet Provision: Tying the valuation of this round to achieving certain milestones will make it easier for angel investors to “swallow” a higher valuation: if you can prove the value of your business by achieving the milestones – everything’s fine. If you can’t, you will need to transfer more shares to the investors. In effect, this will lower the valuation of your startup. Plus: It may be difficult to define milestones that will prove meaningful a couple of months down the road.

Whatever your conclusion: don’t wait too long to adapt your financing needs to what you can get from investors. I have seen startups come to this conclusion only after months (or even years) of investor conversations – time that they should have invested into… building their business!