I’m a fan of the real Silicon Valley and HBO’s Silicon Valley. My favorite episode this season, titled “Bad Money,” features the boys of Pied Piper crisscrossing Silicon Valley pitching investors as they raise their first round of funding. It ends with the show’s heroine pleading with the Pied Piper founder not to take all the investment he’s been offered.
In real life, raising that first round should be about a lot more than pitch decks and VC presentations. Entrepreneurs should think about that first round in the same way they think about building out their senior team.
Investors have to add more than just money to your bank account. They should have years or even decades of experience that can be put to work to help you avoid the pitfalls you are destined to face. They should have extensive Rolodexes that can help you recruit talent, create partnerships, and get distribution for your products. Beyond the money they invest, your investors need to feel like they are an extension of your executive team, making a real difference in the operation of the business.
We had one goal when we raised the seed round for our company. We didn’t want one VC firm to fund our seed round. We wanted several, because with each we were essentially adding to my executive team. It’s part of a good strategy in the early stage of a company to make decisions that add to an unfair advantage to succeed. Let’s face it, startups are hard and you have to make decisions that are defensive as well as offensive. Companies should strive at every turn to build this unfair advantage to succeed.
Like the boys on Pied Piper, you don’t want to “over-raise” at any stage but especially during that first raise. There’s a lot of money in the marketplace right now and this should drive caution, not greed. I’ve seen too many businesses raise too much money early. The result is often that these startups never learn the financial discipline necessary for growing a long-term, financially successful business.
We were looking to raise a small seed round in the $2 million to $3 million range. That’s the level needed to launch and test the business in the most financially responsible way. And we wanted a handful of experienced investors to be part of the round.
Fundraising kicked off in October 2014 from the offices of Amplify.LA, an accelerator where we had incubated my startup. Within about 30 days, we had signed commitments from three firms all as co-leads. Investors in this round included Accel Partners, Upfront Ventures and CrossCut Ventures. Each of them committed $500,000, and each agreed to the same convertible note structure, a unique founder-friendly financial arrangement.
I had worked with Accel for almost 10 years and their deep experience with internet consumer businesses made them a value-add from day one. Upfront was founded under the name General Retail Partners (GRP) and their experience should help as we expand with online retailers. CrossCut is an LA-focused fund made up of operating executives; and they have already helped as an extended business development team.
All of my investors have already been helpful in getting the word out, helping us recruit additional senior talent, helping us strategize the best way to launch the business. And they were instrumental in helping us land partnerships.
The best vehicle for raising the most founder-friendly seed round is the convertible note with a Cap. In short, you take in the investment in the form of a loan that gets converted when you raise a priced Series A round. The Cap sets the maximum price investors will have to pay for the stock when the conversion takes place.
This convertible note with a Cap is extremely founder-friendly for a few reasons: The legal documentation is about six pages so no large legal fees; the money sits on the books as debt until it’s converted in a future funding, so there are no preferred stock classes, no preemptive rights etc.; and none of the investors are given board seats, so the founders really remain in complete control of the company.
Given how attractive these terms are to founders, you have to have a pretty good team and a pretty good idea to get top tier investors to sign on. But you’ll never get these terms if you don’t ask for them. So give it a try.