08:45 11th Sep 2021

Notes: 7

How to raise investment

Update: I am no longer personally angel investing - I’m focussed on other things at the moment. Please don’t ask me to invest in your company! 🙂

I started angel-investing in 2021, and a large proportion of the companies I put money into asked for help raising an investment round. So I wrote up my standard advice as a guide here.

This guide is based on my experience raising about $400m at Monzo over the last 6 years and investing in about 75 seed deals as an angel in 2021.

It will be most relevant for founders who are raising a Seed or Series A round, with some amount of product development and early customer traction.

I believe the following advice is mostly correct as of September 2021. The market is changing so quickly that it may not stay correct for long. I plan to update it periodically.

General Approach

First, a couple of warnings.

If you build a strong business, fundraising will normally be easy. If you’re too focussed on fundraising, you may never actually build a strong business.

It’s very easy to get sucked into the competition of raising at the highest valuation of all your peers. This may feel like winning, but it is not. Seed-stage valuations don’t correlate well with success. Success to me means building a sustainable, profitable company that makes something people love. Investment is just a tool to help you do this.

Airbnb raised its first round out of YC at a $1.8m valuation. They’ve done pretty well. An extra 3-5% dilution isn’t going to matter if you build a very successful company.

Conventional wisdom says you should aim to raise enough money to fund your business for the next 18 to 24 months, or until you hit a major milestone that’s going to create a step-change in the valuation of the business. If that next milestone is “reaching breakeven”, you will have a dramatically easier time fundraising in future - you can decide whether to raise more to grow faster, or run the business for profit. You have all the power.

I have always spent approximately double what I’ve forecast (oops), so I’d advise doubling whatever you estimate.

Fundraising is extremely distracting. If you have multiple founders, nominate one to run the fundraising process. He or she should be the primary point of contact for investors. VCs may want to meet all the founders once or twice, but all founders don’t need to be in every meeting. As an angel investor now, it’s normally a red flag if there are 2 or more founders on the initial phone call. It typically makes the conversation more awkward as the founders talk over each other, or one person sits silently in the background.

If you have a CEO, this is the obvious person to run the fundraising. If you don’t have a CEO, you’re in for a potentially awkward discussion about who runs fundraising. This is one of many reasons I recommend deciding on a CEO earlier rather than later. We did not do this at GoCardless and it was painful.

Fundraising will become all-consuming, so you need to ensure your day to day job is covered by others for the duration of the process. If you are responsible for sales, for example, expect sales to dramatically slow during fundraising unless someone else covers it.

The VC Business Model

Before diving into the details of fundraising, it’s worth briefly understanding how the venture capital model works.

VC returns are extremely skewed by a tiny number of outsized successes. a16z’s shareholding in Coinbase at IPO was worth about $10bn - roughly equivalent to all the funds a16z raised during their first 10 years of existence. Passion Capital’s Monzo shareholding is worth about 5x the size of all their raised funds combined. The initial investment in Monzo has currently increased in value by approximately 100x, even after dilution - and I believe that will continue to increase (I may be biased).

VC returns are driven by outlier companies.

So VC investment decision-making is driven by fairly straightforward psychology. It’s the fear of missing out on one of these apparently “hot” deals. This can then create a very aggressive bidding war. A hot round may get done in a handful of days.

Conversely, a VC doesn’t really want to look stupid in front of all their buddies by investing in a crazy idea that comes to nothing. However, economically, it’s much better for a VC to invest in a few extra “duds” than to risk missing out on the single hot deal of the year.

There’s a second factor here - a massive global over-supply of capital. Recently, late-stage investing has been dramatically shaken up by investors like Softbank and Tiger Global deploying astonishing amounts of money into growth-stage companies in just a handful of days. Traditional growth stage investors are finding that they’re too slow, or being consistently outbid on price. Their response has been to invest more money, faster, and into earlier-stage companies. This then squeezes the Series A investors who are now doing more and more seed deals.

The combination of these factors has lead to a massive rise in “pre-emptive” termsheets. VCs will try to offer termsheets to founders before they’ve had the chance to talk to a wide range of VCs in the market, with the aim of avoiding an expensive bidding war. Predictably, this just further increases valuations.

Raising with just an idea

This is this biggest mistake I see first-time founders make. Especially non-technical founders without a very strong CV. Trying to raise money from VCs with just an idea and a pitch deck is extraordinarily difficult unless you’ve successfully started a company in the past (or maybe been an early employee at a successful startup).

Instead, you should spend your time developing a prototype of your product and testing it out with customers. If you can’t build it yourself, you should learn to code or recruit a technical cofounder. If you can’t successfully do either these, you’re probably not going to persuade investors to give you money yet. You could think about applying to an incubator like Entrepreneur First.

As an investor, it’s basically the first filter I apply to exclude people who can’t get stuff done. Of 50 investments I’ve made this year, 45 had a working product and active customers. Of the remaining 5, 3 had a working prototype and launched to customers within weeks of my investment. Only two raised on the strength of the founders and the idea alone - and in each case the founders had previously started businesses worth more than $100m.

Even the most minimal prototype and customer usage is better than nothing. I’ll write a separate guide to building and launching a prototype at some point in the next few months.

So, as well as a great idea and impressive founders, you ideally need….

Traction

Traction is a phrase that investors seem to love. It reminds me of a medieval torture device, but perhaps that’s because I have spent too much of the last 10 years fundraising.

You want to show investors some early metrics that can be extrapolated to show that you’re going to build a very big business very quickly. This is “traction”.

The best kind of metric is profit. This is very uncommon for early stage startups. The next best kind of metric is revenue - especially recurring revenue (if it’s recurring, you don’t have to keep acquiring users to simply maintain stable revenue levels). If you can’t show revenue, try to show active users plus a coherent plan of how you’re going to make revenue in the future. Total signups, app downloads or waiting-list signups are the next best metrics in order, but they’re much less compelling than revenue or active users. Waiting list signups are widely ignored unless they’re absolutely explosive. Monzo had a peak waiting list of about 300,000 people in the UK.

Letters of Intent for B2B companies are a bit like waiting list signups. Mostly useless.

The absolute value of your metrics is less important than the rate of growth. Hitting £100k monthly revenue after three years is much less impressive than £10k monthly revenue that’s doubling every month.

“A good growth rate [at seed stage] is 5-7% a week. If you can hit 10% a week you’re doing exceptionally well. If you can only manage 1%, it’s a sign you haven’t yet figured out what you’re doing.”

Tactics

With this in mind, you want to think about how to create a sense of scarcity and urgency about your round. You should aim to appear to be the hot deal of the year.

I would start by developing close relationships with perhaps 5 of your top target VCs. You might meet them for coffee every 2-3 months and share your plans, but say “We’re not raising yet - maybe in 6 months”. Share awesome product demos, social media buzz and impressive new customers. You can include them in your monthly shareholder update emails, and (hopefully) show metrics going up month after month, along with any major milestones you’ve hit. This is evidence of your “traction”. I find this much more compelling than a polished pitch deck.

If you already have angel investors, use them to backchannel into VCs. They’ll say “this is going to be an exceptionally hot round, you need to get in before they run a full process.”

You want to project quiet confidence, huge ambition and relentless determination. UK founders often come across as extremely understated when compared to US counterparts. The front page of Monzo’s first pitch deck said “We’re building a powerful financial control centre for a billion people around the world”.

You will know if you have succeeded in creating this buzz because you will have 5 new best friends. You’ll get phone calls every day and they will reply to your emails in seconds. I have had VCs show up at my house to try to get into deals. They’ll take you to fancy restaurants and buy you drinks.

Some of these VCs might try to “pre-empt” your round by offering you a termsheet before other VCs have had a chance to learn about your business. In general, companies that run a process with multiple competing VCs tend to get better terms than companies that accept a pre-emptive termsheet. But you may still consider accepting the pre-emptive offer if it is ridiculously good. I have done both in the past.

Running a Process

As you’re raising a seed round or Series A, this process can be pretty lightweight. As you get into Series B and onwards, it may get more complicated.

First, start with a list of perhaps 8-10 relevant VCs. These should be funds who you know will invest in your industry, geography and company stage. It’s pointless pitching a sovereign wealth fund for a seed stage investment, or a B2B SaaS fund if you’re a consumer-focused company. This is one of the most common mistakes I see new founders making. You’re wasting your time.

Pre-seed and Seed investors tend to focus on one geography, while later-stage investors are often more global. Having said that, funds are investing earlier and more globally than ever before. I’ve seen Index and Sequoia recently making a bunch of seed-stage investments in Africa, for example. This would not have happened even 3 years ago.

Next, put together a deck. YC has a great Series A pitch deck guide here. I think that advice still applies for seed rounds.

I would practice your pitch on 2-3 friendlier (or lower value) VCs first and ask for their feedback. Make a note of the common questions they ask, and make sure you have good answers to these. If you want to tweak your deck, do it now. This should take 2-3 days max.

Then, without too much delay, get introduced to the remaining VCs on your list. This is where early angel investors can be extremely useful. You want to avoid cold emails if at all possible.

Your aim is to schedule as many of your first meetings in parallel - perhaps the same week or two-week period. This creates a competitive dynamic that works in your favour.

If your round is dragging out over several months, you’ll lose this advantage. It’s still entirely possible to get the round done, but it will be harder work and your valuation will be lower. Probably 30% of the rounds I’ve raised have been “hot” - and very fast. 70% have been hard work, slow and stressful. This latter kind is normal. But we generally only read about the hot rounds in the press, so popular opinion is skewed towards thinking most companies raise money in 1 or 2 weeks.

Initial Call / Pitch Meetings

You generally want to be pitching the most relevant General Partner at the fund. That’s the most senior partner who covers your area. Larger funds will have pretty rigid specialisations, so a certain person does all the fintech deals. That’s fine - just figure out who that is.

Associates, analysts, “venture partners”, or EIRs (entrepreneurs in residence) will almost always carry less weight. Try to get introduced to a full partner if possible. Some funds have tried to combat this tactic by calling almost everyone a “partner”

It can be useful to build relationships with associates before raising, especially if you can’t get to a partner directly. Our first VC investment at GoCardless happened because I was introduced to an associate at Accel called Tyler several months earlier.

Since the Covid pandemic, almost all initial meetings are conducted on video conference. I would recommend that everyone spends ~$200 on an external camera, mic and lighting. Make sure you have somewhere quiet to take the call and a good internet connection. It makes a massive difference and it’s surprising how many founder neglect this.

The best pitches start with an element of story-telling (perhaps 2-3 minutes) and then develop into a great conversation. If you are delivering a monologue for 30 minutes, you’re doing it wrong. Engage the investor in the conversation by asking them questions - how would they think about a potential challenge you’re facing, for example. Try to figure out what gets them excited, and double down on that. Don’t feel like you need to cover your whole pitch-deck in the intro meeting.

Follow-Ups and Monday Partner Meetings

If your meeting goes well, the investor will ask you follow-up questions (perhaps for some additional data) and may ask to meet you again, or have you meet with another (or several) of their partners. These are all good signs, and will usually happen rapidly.

If the investor doesn’t get back to you pretty quickly (within a couple of days), it’s normally a bad sign. You can send one polite follow-up email, but it’s usually pointless after that. If you’ve not heard from the investor in weeks, I wouldn’t bother chasing. They’re a) not interested (fine) and b) disrespectful of your time (not fine). The best investors always reply promptly (whether it’s positive or negative).

Conversely, you should make sure to reply promptly to any follow-up requests they have. If you promise to send something by a certain day/time, make sure it happens. It’s the investor’s first impression of how you do business. Keep all your contacts in a spreadsheet (or lightweight CRM) and track what you’ve promised to each investor and by when.

Investment rounds are getting done faster and faster - it may only take a couple of partner meetings over a handful of days to get a termsheet for a seed round.

How you get to a “yes” decision - an offer to invest - varies from fund to fund.

Some funds will let any single partner make an investment if they have conviction. For solo-GP funds this is always the case!

Other funds will require a majority vote or (near) unanimous consent from amongst the partner group. This is quite common.

The worst funds have a strict hierarchy - the deal won’t get done unless the top guy (sadly it is almost always a man) says “yes”. I’d avoid working with these funds if you have a choice.

The fund may ask you to present to their whole partnership at a Monday Partner meeting. I have no idea why these are always on Mondays. I’ve done one of these Monday Partner meetings perhaps 4 times ever in my life, and I’ve raised probably 10 rounds of investment across various companies. It feels like they’re getting rarer.

If you get a “no” from the investor, it can be emotionally tough. But I’m afraid that’s part of the process. A normal company might get 20 “no” responses before they get a “yes”.

Unfortunately, many investors will send quite a lot of bullshit reasons for a “no”, rather than reveal their true rationale - which is normally that you did not sufficiently impress them, or your traction is too far behind comparable peers. Unless you really trust and respect the VC, take the “no” part onboard and discard the rest. I found Michael Abramson at Sequoia and Angela Strange at a16z both exceptional for writing really thoughtful rejection emails.

If you’ve been fundraising for 3-6 months and you’ve had 30-40 “no”s from decent VCs, then you’re in a tough spot. What you are doing isn’t working, and so you probably need to change your approach. There’s a point past which perseverance becomes destructive.

At this point, you need to become a cockroach - impossible to kill. Reduce costs, seek out revenue and keep burn to an absolute minimum. At this stage, it’s worth looking for the 1-2 common rejection themes from the VCs and working to fix them. For early-stage companies, this is generally that you don’t have enough traction with customers - people don’t seem to care about what you’re building. You need to find product-market fit, possibly by changing your core product. This is a subject that deserves more time in another post.

Termsheets and Legals

If a VC wants to invest in your company, they’ll issue a termsheet to be the lead investor.

It will contain the main terms of the investment - pre-money valuation, investment amount, board seat, and perhaps 2-3 other key terms. You should have talked about the approximate amount you’re looking to raise before a VC issues a termsheet, but I would suggest letting the lead VC suggest the price first.

The exception might be an ultra-early pre-emptive offer, when you really don’t need the money yet. You might say “we don’t need money for the next 12-18 months, and at that point we will be targeting a £1bn valuation, because we will have hit all these milestones. So for me to accept money now, that’s the valuation I’d be looking for. Otherwise, it makes sense for me to wait”. In this case, just think of the most outrageous price you can say with a straight face.

The termsheet will often leave room to bring in additional investors. Eg, the VC might offer to invest £1m in a round of up to £1.5m total, at a pre-money valuation of £4.5m. You can work with the lead VC to bring in other angels or VCs for the remaining £500k.

A termsheet is not binding on the VC (they can still technically back out), but prohibits you from soliciting investment from other VCs after you’ve signed it, usually for a period of 30 or 45 days.

Personally, I have only experienced investors reneging on signed termsheets once - as COVID took the world into lockdown. It’s very, very rare for a top-quality VC to pull a termsheet. Shitty VCs may pull termsheets more often, but they quickly develop a bad reputation for doing so.

You will usually be given a few days or perhaps a week to sign the termsheet, or decline it. It is considered bad form to share the contents of a termsheet with other investors, but it is pretty standard practice to let any other firms in the running know that you’ve received a termsheet. Doing this with some level of deniability (eg, get an angel to do it for you) is sometimes useful. This will spur other VCs to make a faster decision, and potentially trigger a bidding process. It’s a very useful forcing function.

You do not want to be seen “shopping around” your unsigned termsheet, but you can say something like:

There are two other interested firms, and they’ve already put in a lot of work with us, so I want to respect that work and give them a chance to get to the end of their process. They’ll need another 5 days. Is that ok?

This is why it’s important to keep a small number of VCs regularly updated. If you get a very early pre-emptive termsheet, other firms may be too far behind to get up to speed in 5 days from a standing start. This is less of a problem at seed stage - since it’s more of a gut judgement about the quality of the founders, rather than any detailed analysis of business metrics, it can be done in a few hours.

You generally want to avoid naming the other VCs who are in the running, because it can encourage collusion. The VCs may just get on the phone to each other and agree to split the round at the already-agreed price. Instead, you ideally want them bidding each other up.

Only bad VCs will ask who else is looking at the deal, and you can just reply with something like “the usual folks you’d expect at this stage”. If they insist, you can simply refuse to answer. Treat this as a big red flag.

Picking a VC

If you’re in the fortunate position of having multiple, competing termsheets, you need to think about how to pick.

Along with the money, you should pay attention to the individual leading the investment from the VC firm. Arguably, choosing the right person is more important than the choice of the VC firm itself. You will be spending a lot of time with this person over the next 5-10 years, and it’s almost impossible to get rid of them if you don’t get on.

A fair valuation with clean terms and a VC you like is much better than a market-leading valuation with horrible terms, or a VC who behaves badly.

The first data point is the way the investor has behaved during the pitch process (and previous interactions). Did they show up on time? Did they follow-up promptly? Were they inquisitive and courteous during your pitches, or distracted and disrespectful?

I’ve worked with some fabulous investors over the years - Eileen and her partners at Passion, Anu at Y Combinator, Sonali at Accel, Adam Valkin at General Catalyst, Ed (now at Alpine) and Chi-Hua at Goodwater, Miles at Thrive (now Benchmark), Michael Moritz, the Stripe team and many more. I recommend them all to the entrepreneurs I speak to.

I’ve honestly also encountered some shitty ones. There are VCs who’ve verbally offered me terms and then tried to back out weeks later. I won’t ever work with these folks again.

One particular example of bad behaviour that I will name is Softbank (at least the London team). Like most growth-stage founders, I’ve pitched them for investment multiple times. They passed - no hard feelings. But it seemed like standard practice during my visits to the London office to make me wait in the lobby, often for an hour or more after the meeting was supposed to start. I heard of one founder who’d flown in from another country and was made to wait for the entire day in their lobby.

Their behaviour during pitches was worse. The lead partner took meetings barefoot, and would pick his feet incessantly. During one meeting, he lit a cigarette and smoked it in his office, windows closed. He finally put it down in his lunch plate, and poured his coffee over the cigarette to extinguish it. I didn’t know if it was some weird power play, or if he just lacked any kind of manners. Looking back, I wish I had the guts to ask him to stop, or to simply get up and walk out of his office. But my company really needed the investment and I didn’t want to blow my chance.

Blind reference calls are also crucial here. The founder calls that the VC offers are less likely to give you a fully rounded view of the firm. They’ll pick their winners. But, especially for portfolio companies that have failed or are doing poorly, you want to know how the VC behaved. It’s easy for everyone to be founder-friendly when times are good. During a crisis, behaviours sometimes diverge….

Example questions for founders:

Tell me about a time when you were really struggling to raise money to keep the company going.

Did the VC offer to participate in the round? Or even lead the round if you couldn’t find new money? Were they helpful finding new investors? Did they push for a valuation cut, or attempt to introduce onerous terms? Have they tried to sell or transfer their stake in the company before you were ready? What was their language and behaviour during the tough period? Did they roll their sleeves up and help out, or did they ghost you?

What’s their behaviour during board meetings? Do they add useful insight, or just like the sound of their own voice?

What are their regular information requirements? Do they bombard your finance team with constant ad-hoc queries?

Have they ever gone above-and-beyond what you expected to put in work for the company? (I had an investor who interviewed a bunch of ex-execs from all our competitors to gather intelligence)

If you don’t have the good fortune to have multiple, competing termsheets, I think it’s still worth doing the reference calls - you need to know what you’re about to get into.

It’s really tempting to skip the reference calls and just celebrate your termsheet. Don’t do this.

Legals and Diligence

Once you sign a termsheet, the lead VC will do some basic “due diligence” (this will be less onerous in seed/series A compared to later rounds). This will involve reference calls to previous employers or colleagues, and checking your company documents, employment contracts, IP assignments etc. Any other (non-lead) investors should be able to piggy-back on the lead investor’s diligence, rather than doing their own.

It’s worth getting your corporate paperwork in order & up-to-date in a single Google Drive folder before you start fundraising, so that you can share with investors when they ask. This speeds things up a lot.

You’ll need to appoint a lawyer - you can ask other founders or angels for recommendations. Your prospective investors will often ask you to cover their legal costs (the money just gets subtracted from the investment amount). This is annoying, but seems to be standard practice. For Seed or Series A, maybe try to keep it to $15,000-$25,000.

The VC’s lawyers will put together an Investment Agreement, and modify your Company’s Articles of Association (or create them from scratch if they don’t exist). Your lawyers will review the documents, and raise any points with you that they think are contentious or non-standard. Good VCs will make this process very simple. Shitty VCs will try to sneak in all sorts of garbage.

One term that sometimes gets left until late in the process is the option pool top-up. Ideally, this should be covered in the termsheet. It’s standard for investors to require the unallocated option pool to be topped up to a level that will equal 10% (sometimes less) of the post-investment shares, but for this to happen immediately before the new investor puts money in. Essentially, existing shareholders get diluted by the top-up, but the new investor does not get diluted. Again, it’s a little annoying, but seems to be market standard.

This whole process might take 2-6 weeks, depending on how efficient the VC is, and how quickly you reply with the requested information.

The investment is only final when the money hits your bank account.

Congratulations. You now need to get back to building a successful business!

Angel Investors

“Angel investors” are rich individuals who invest small(-ish) amounts of their personal money into early stage technology companies. They have often (but not always) been founders or early employees of successful startups. A small angel cheque might be £5,000 or £10,000, but some “super-angels” make investments in the millions.

People take different views on how useful angels are. I’ve seen a seed round recently consisting of 56 separate angel investors. Other founders almost never take money from angels.

People talk about several different advantages that angels can bring.

If you get a number of angel investments early in your fundraising process, they can help by making warm introductions to VCs.
If you’re a B2B company, the founders of potential customers can help with product feedback and sales.
You can sometimes get other, more general business advice from angels who’ve been operators or founders themselves, but the quality of this advice is extremely variable.
Some founders seem to collect angel investors for their “brand name” or PR value. This is mostly bullshit, unless the angel is Jay Z. Journalists honestly don’t care that I’m investing in your company.

Very active angel investors may make 50+ investments a year, so realistically it’s hard for them to be super involved in your company.

The downside of taking angel money is that managing a group of angels can be like herding cats. You will need their signature on every official corporate action for the future of your company (ie future fundraising). If one angel has decided to go on a month-long ayahuasca retreat in the Peruvian mountains, it can be very inconvenient. If you really want to include angels, I would stick to the 5 or 6 highest value people, and enforce a reasonably high minimum cheque size.

You may also come across angel syndicates - this is generally for groups of angels who want to invest less money - perhaps £1k - £5k per deal - and as such find it hard to get individual allocation. So they all club together and offer to invest £50-100k as a syndicate. This is good for the entrepreneur because you only need the signature of the syndicate lead in future, but the value-add of each of the individual investors tends to be even lower. There are exceptions.

You can either try to pitch angel investors early - before you start talking to VCs - and aim to get a handful onboard who will help to make introductions. Or you can carve out a proportion of the round for angels after you have a termsheet, and then go and select angels you think will be most valuable.

Personally, I always steered away from taking money from angel investors. They are usually not as valuable as you think. And I say this as an angel investor myself!

Crowdfunding

I was involved in raising about £35m (?) in crowdfunding at Monzo, across 3 or 4 rounds. It is probably the slowest, hardest and most expensive way to raise money.

If you’re struggling to raise VC funding, it’s almost never a good fallback option.

But it is useful, I think, for deepening the engagement you have with your early customer base or community, especially where you want to get them involved in product or brand development.

Whether it’s a Kickstarter campaign, Steam Early Access or an equity platform like Crowdcube or Seedrs, it’s a great way to set expectations that this is a prototype product and invite customers to engage with a constructive and forgiving mindset. If you are open and communicative with these early supporters, they’ll turn into your most loyal customers and vocal advocates.

I would keep it as an option and discuss it with your lead VC - perhaps reserve £1m of a Series A round for crowdfunding if you think you have a product that’s suitable; normally something consumer-facing. It usually makes less sense to crowdfund for a B2B product.

I’ll repeat this - crowdfunding is generally a very tough way to raise funding if your other options aren’t working.

Investment Advisors

You may think about paying an Investment Bank or some other kind of advisor to run your investment process. They’ll offer to help you put together a pitch deck, introduce you to relevant investors and negotiate key terms.

In general, you should not do this. Especially for a Seed or Series A.

Generally, only the weaker companies need to use advisors. By using an advisor, you are signalling to investors that you are one of these weaker company.

Instead, you should be able to get useful introductions and advice on your pitch deck from your existing VC investors or angels. If you don’t already have useful investors, programmes like Y Combinator can be really useful for getting in front of VCs at Demo Day.

You might reasonably consider using advisors if you’re raising a $500m pre-IPO growth round. But even at this stage, many of the best companies raise without advisors.

Secondaries

A VC investment in your company is sometimes called a “Primary” investment. It involves the creation of new shares in your company, diluting all existing shareholders, and the investor pays the investment money directly to the company. You can then spend that investment growing the company to hopefully make it more valuable. That’s how investment normally works.

“Secondary Share Sales” or “secondaries” are slightly different. It’s when founders, early employees or angels sell some of their existing shares directly to new investors. It doesn’t dilute existing investors - no new shares are created - and the money goes to the person selling the shares, not to the company.

It can be useful in a few different scenarios, but it should always come after you’ve raised enough primary investment to comfortably run the company comfortably for the next 18-24 months. You should normally only do secondaries when there’s excess demand from investors for more shares in your company, and your existing shareholders don’t want to dilute any further.

The first situation in which secondaries are useful is to quietly remove an angel investor, early employee or even cofounder who’s leaving the business. Allowing someone in this position to sell some proportion (or all) of their shareholding can make tricky conversations go a lot more smoothly. There are situations where you might want to do this at Seed or Series A.

The second situation is where founders or early employees have been working for several years on the company with relatively low salaries, and the business is starting to see some real success. You want to keep these people motivated to work hard - an exit might still be 5+ years away. In such situations, it can be incredibly stressful to know that approximately 99.9% of your total net worth is tied up in the business.

VCs have a portfolio of investments, and they want each company in the portfolio to make value-maximising (rather than risk-minimising) decisions. They want to maximise the value of the portfolio as a whole, and can accept several failures. On the other hand, founders’ wealth is normally extremely concentrated, and the failure of their startup is financially catastrophic. This dynamic can lead founders to be overly cautious, which is not what other shareholders want, in general.

So, selling 5-10% of your shareholding as a founder or early employee can secure your financial position - perhaps you put a deposit on a house. This frees you up to take the decisions that you believe will maximise the expected value of the company, and benefits all shareholders. These kinds of secondaries are getting more and more common.

It‘s tricky to set hard-and-fast rules about this, and the market standard is always changing. With founder secondaries, for example, it doesn’t feel to me like this would be appropriate in a seed-stage company that’s been around for 12 months. Selling so early may suggest that the founders don’t really believe in the future of the company.

On the other hand, I recently helped a company raise only their second-ever investment round at a £100m valuation after 8 years in business. This is a great time to allow the early folks to do secondaries.

I also firmly believe in the value of secondary offerings for the wider employee base - I wrote about it back in 2017.

If you’re thinking about doing secondaries, it’s important you get a termsheet signed for the primary investment first, to make sure the company has sufficient funding! You should then carefully broach the subject with your new investor. Maybe they will buy the additional shares, or know another investor who’d take it. If not, perhaps one of the other VCs in the process might take the additional secondary allocation.

It’s normal to investors give some small discount for buying secondary shares because they generally don’t carry all the full investor protections. Eg, the new shares in the primary investment might get a 1x liquidation preference, whereas the shares being sold in the secondary are often common, with no liquidation preference. A discount of 10-20% to the primary investment price might be normal, but secondaries with zero discount are possible if the round is very heavily oversubscribed.

Standard Pre-Seed / Seed Terms

You may be able to raise a small pre-seed round on the strength of the founders plus an idea, but it’s really very hard. At this earliest stage, some founders are able to raise £50-200k from friends or family, but it mainly depends on having enough rich people in your network, which really sucks. Instead, Entrepreneur First is a great programme for people without a cofounder or prototype.

Being a coder, or having a technical cofounder is so important at this stage because it enables you to build your prototype and test it with users. It gets somewhat easier (only relatively easier - it’s still hard) to raise money with even a minimal amount of traction. £1m at £5m valuation might be a typical pre-seed round at the moment for first-time founders in London who’ve not been through an accelerator.

If you’re a repeat founder with even moderate previous success, or you have some amount of traction, these numbers will be a lot higher - I’ve seen seed rounds of £3m on £30m in London this year. It also helps to have been an early employee at a successful startup - people from Wise, Revolut, Monzo Deliveroo etc may find it somewhat easier to raise money in London at the moment.

In SF, the hottest seed-stage companies coming out of YC might raise $5m on a $50m valuation.

A round like this usually involves giving away 10-25% of the company’s equity, depending on how competitive the round gets. You can use this seed money to build out the team, improve the first version of the product and build on your initial traction.

If you’re a second-time founder, it’s sometimes better to raise a seed round pre-launch. If you raise post-launch, and the metrics are more sluggish than expected, you may struggle. Pre-launch, there are no metrics - investors will often get carried away imagining your huge future success. It’s all based on the quality of the founders, and the strength of their vision.

If you do have explosive initial metrics, these are obviously very helpful. While I was doing YC in 2011, Codecademy launched mid-programme (after pivoting from building a travel guide) and signed up 150,000 users in their first weekend. They raised a lot of money off the back of this.

Standard terms right now might be;

1x non-participating preference shares.
4 year founder reverse vesting
Standard pro-rata rights, drag & tag along rights
Broad-based weighted average anti-dilution

(Read more about what all these terms mean in the excellent Venture Deals Book)

Do you want to do a priced Equity round vs a SAFE (with a cap)? SAFEs can be a bit faster, and let you do a rolling close (eg close each tranche of money as people say yes), whereas equity rounds need all the money to be committed before you sign binding documentation.

If you are a UK-based company, you should look whether you qualify for SEIS or EIS tax relief for investors. These schemes are extraordinarily favourable - an SEIS investment of £10,000 will only (eventually) cost the investor about £2,500 if the company fails, due to all the income tax relief. And if the company succeeds, the capital gains are normally tax-free. It’s genuinely astonishing. Please don’t just take my word - go and get professional tax advice!

There is a category of particularly bad seed investment funds in the UK that only invest in SEIS-eligible companies. As an investment strategy, this just seems foolish - as a professional seed investor, the only thing that matters is ensuring you’re in the (very few) big winners each year. You should therefore be selecting companies based on whether you think they will be one of those winners. Treat any tax relief as a secondary benefit. If you took the SEIS-only strategy, you would have missed Monzo’s seed round; we weren’t eligible because we were aiming to become a regulated bank.

Series A Terms

The market is very hot right now. £10m at £50m might be a “typical” Series A in London, but this changes extremely rapidly.

For Series A, you will need strong proof of product-market fit, rather than just an interesting idea and strong founders. You’ll want to aim for at least $1m ARR as a SaaS company, or very strong user growth as a consumer company.

Investors will have more of a focus on metrics - customer growth, revenue, evidence of stickiness (ie low churn) and strong unit economics. While the assessment will be more metrics-driven than a seed round, your product vision and mission are still very important. By the time you’re doing a series B or C, this balance shifts even more towards the metrics.

As well as the standard seed terms, the lead VC at series A will almost always ask for a board seat.

They may ask founders to reset all (or a portion) of their stock vesting schedule. I would try to avoid this.

After the round

Make sure you file your new investment docs somewhere safe. You’ll need them for diligence in the next round.

You should have a rough plan of how you intend to spend the money over the next 18 months. It’s worth putting this into a monthly forecast spreadsheet, and then pulling together simple management accounts every month (either in a spreadsheet or Xero), compared to your budget. You should be able to see pretty quickly if you’re spending too quickly (revenue is slower than predicted) or more slowly than planned (usually because hiring is taking longer than you thought).

Your investors may want to release something to the press - usually in an outlet like Techcrunch. This may be your first press appearance. It’s not really worth stressing much about this. Funding announcements usually don’t drive very much customer attention.

However, these articles do often drive more inbound interest from (lower tier) VCs who missed out on the round. They may offer you more money, and even an increased valuation. Generally, you should ignore these requests. If they come from a very high-quality VC, add them to your list of interesting folks for the next round.

If you get a lot of additional interest, you might consider taking a few million more investment on an uncapped convertible loan note (or SAFE). If you’re going to need to raise money again in future, this is a way of getting that future valuation today. It’s an extremely favourable way to raise money, and only happens rarely. The main danger is that you now have so much money that you over-hire and increase your burn rate too fast, without having the business to back it up. Or you could convert this excess demand into secondaries (see above).

With fundraising done, now is the time to get back to work! Your focus should be on making something people want, not impressing VCs. Hopefully you don’t have to think about fundraising for at least another 12 months.