How to Raise an Early-Stage Round in 2024
Event management, artificial scarcity, and incentive alignment
Let's assume you're a founder who's done the hard work of customer validation, you've chosen a big market, you have the kernel of a great team, and you need additional capital to hire more talent and perform outreach. You may not have a whole product or 100% product-market fit, but you have a pretty good idea of how to get there now that you’ve poured in a ton of sweat equity. This post is for you!
Fund-raising = Event management
The first thing you need to know is that a founder raising a round is an event manager. What does an event manager have to do? Make sure everyone arrives at roughly the same time and enjoys themselves when they get there.
Most failed rounds look like failed parties. People trickle in, find nothing exciting, and leave before they see anyone else arrive. Sometimes this goes on for months, until every knows that the event is a flop and they don't even want to trickle in any more. Avoid this!
With a successful event, people line up at the door. Strangers passing by on the street decide to stand in line just to see what's inside. Great events generate FOMO because they engineer mimesis — i.e. they set the scene so that people see each other wanting a thing, and so they all want that thing more — so do fast rounds that attract great lead investors.
Getting many investors to consider your startup, and to realize that they are not alone in doing so, is one tactic in a bigger strategy of creating artificial scarcity.
Artificial Scarcity: Ratios, Time & Allocation
FOMO is a numbers game. You have to generate interest at volume. Here are a few ways to approach that:
Find investors at the right stage (e.g. angel, pre-seed, seed) who have invested in your sector in the last few years. Investors should be active, they should be focused on the stage you're raising for, and they should be able to quickly understand the problem you address. CrunchBase (which usually lists the investors in early rounds) and the press releases of startups you consider adjacent or comparable are good places to find those names. Many of the people you want on your early-stage cap table are folks you’ve never heard of, because small deals don’t get much coverage in the news.
Track them down on LinkedIn and get a warm intro from a mutual connection if you can. Or extract their contact info from LinkedIn with tools like Rocket Reach, ContactOut or Gem, and message them cold.
Do this all day at speed. If you want people to arrive simultaneously and en masse, you have to devote significant hours to getting the fund-raising ball rolling. You are a sales rep hawking your equity, and you have to make quota. You should have targets for the number of calls and emails you do per day. Postpone other necessary tasks even if it is painful. Track investors in an ad hoc CRM (a.k.a. a spreadsheet) and make sure you follow up.
Debut off Broadway. That is, first pitch to the investors who don't make the top of your wish list. Use those calls to iron out the kinks in your pitch and figure out which objections investors are likely to raise. It will show you how to improve your deck and data room. (Ideal scenario: an investor asks you a question so good that it leads you to rethink some part of your plans or strengthen your startup. It’s more than just the parry and thrust of making a sale!) You have to get numb before you get good. Calls that don’t end in an investment are rehearsals. That’s how I learned to think about and be grateful for them. And you’re not alone: Peter Thiel had more than 100 pitch meetings before he raised PayPal's first round. So don’t despair! This process will ensure that you have something to offer your party guests when the important ones start to arrive.
That’s one way to ensure that many investors see you at almost the same time. The other way is to get into a great accelerator like Y Combinator and present at demo day. But getting into YC is as hard as raising a round, which is one reason why investors line up at demo day: YC is social proof. They did some of the hard work of filtering already.
There are two other ways to create artificial scarcity: limited time and limited allocation. They’re both power moves that work when a round already has momentum. That is, they’re useful to get a round over the finish line, but not to get it started. If you do them at the wrong time or in the wrong way, you’ll crash and burn, and investors will shrug and walk away without even telling you why. If you combine all three they lead to what Charlie Munger called the Lollapalooza Effect.
Limited time means saying: "We'll be done fund-raising in three weeks. At that point, I'll need to know if you're in or your out." There is an art to making such confident pronouncements. First, you can't keep redrawing the line in the sand without losing credibility. Don't set a deadline lightly, and especially if you don't have momentum. It will only make you look foolish.
Limited allocation means saying: "We're raising $1 million and we already have a lead and $700,000 committed. It looks like we'll be oversubscribed, so please keep that in mind."
Serial founders with great connections can land a lead to take more than half the round and set the terms, and then fill in the rest, all without trying that hard.
New founders who are building a reputation may pull together a relatively small pre-seed round, realize they have momentum and go for their stretch goals; i.e. they may raise $500,000 and then decide to raise a million with $500,000 left in the round. This is called “moving the goal posts.” It works especially well with so-called party rounds.
Investor-Startup Alignment
Party rounds are rounds that have no lead, cobbled together from a bunch of small checks. If every investor you’re talking to is waiting around for a lead, a party round can light a fire under them. They allow you to build momentum, and sometimes make the potential leads aware the opportunity is slipping away, so VCs start calling again. Happened to me! But I actually think party rounds are a bad idea, because I've raised them myself and know that you need to play a long game.
Failure Mode 1: While party rounds build momentum when a lead won't commit, they're not a great way to build the ideal cap table. The downside of a party round is that you're left with a bunch of investors whose careers and funds do not depend on your success. The money they gave you is a token, a way to diversify their risk, maybe a way to gather intel about the exciting new sector you're in. They see you as beta, not alpha. I’ve seen companies with smart founders and good ideas diminish their chances of success by raising at a valuation that's a little too high, and attracting a bunch of checks that are a little too small. Who's going to take your call when you're in trouble? Incentives are everything.
Failure Mode 2: Well-known behemoth VC firm with multiple billions under management says they will "lead" your pre-seed round with a check of $200,000. This is actually an awful signal. They are showing next to zero conviction, and even if they quintupled their check size, the firm would not blink if you went to zero. They mean everything to you, but you mean nothing to them. A hallmark of bad relationships! If a behemoth firm is offering to lead by taking less than half your pre-seed round, you're being offered "sandbox" money by unserious people who are guilty of something close to malfeasance.
Success Mode: You want a lead or anchor investor who will take your calls late at night, ride at dawn, and call in favors to make your next round happen. They will only do that if their incentives are aligned with yours. They should take well over half your round, while leaving a slice for strategic angels and institutions who will increase your chances of success. That lead investor is most likely to be at a seed firm with a fund of less than $100 million who is taking some material portion of that fund, and a chunk of their own reputation, and betting it on you. Ideal early-stage round: you get a firm that focuses on your stage and sector that is willing to take a big bet and fight for you. Needless to say, that investor should be upstanding and have a great reputation among founders.
(Of course, the real failure mode in fund-raising is not raising any money at all. But if you have choices among investors, keep the situations above in mind. You may even want to build a company that investors can’t ignore, which is a deeper level of problem solving! :)
The Language of Silicon Valley
One of the things you will pick up as you pitch to angels and VCs is the language of Silicon Valley. You’re not hawking real estate to retirees, or penny stocks to retail investors out of a boiler room. That is, there’s such a thing as coming on too strong, and it’s easy to send an off-putting signal.
Calling your round an “investment opportunity” is probably overreach. It’s only an opportunity if the VC decides it is. Just call it a round and give them the details as matter of factly as possible. Then focus on the opportunity you yourself are chasing, the huge market with an unsolved problem.
You’re also not selling to consumers when you market equity to VCs. You don’t need to emote all that much. Investors get sold to all day. They usually like data. They want to know, say, how software automated something tedious but important, and why that’s actually going to disrupt a large market to create billions in value.
The more compelling and granular your view of a large market, the better you know what has worked and failed, the more potential customers you have spoken to, the more likely you are to convince VCs of your vision.
A Cap Table Is a Social Network
You may think this is all over-optimizing a bunch of secondary issues that you might as well ignore so that you can get back to building and selling. You’re wrong! :)
A cap table is a social network. In fact, it’s a stack of social networks, with each investor being a gateway to a different set of allies, customers and talent. It’s a network of networks. If you end up in failure modes 1 or 2, where the incentives of the social network are screwed up, don’t be surprised if investors who expressed interest early in your process back away.
Pulling an ideal round together means building a network that will support your growth, which is your whole job as a founder.
Housekeeping
Do yourself a favor and raise on a standard YC SAFE if you possibly can. (Your lead or anchor investor will set the terms with you and specify the vehicle. Until they do, you can tell people you’re leaning toward a SAFE and will work out the details with the lead once you find them.) SAFEs are easier and cheaper than a priced round, because they require fewer billable hours from your law firm, and they make sense at the earliest stages. Throw your investors a bone by offering MFNs and pro-rata — doesn’t hurt you and protects them.