Treat your fans well

Substack and Clue have both announced that they are raising capital from their users (also known as equity crowdfunding).

Historically raising equity crowdfunding after having raised venture capital has been a sign that the company isn’t doing well enough to able to raise from traditional investors.

I think it can make sense for community-driven services like Substack and Clue to raise capital from its users. But as always there are a bunch of caveats. For fundraising from a community it, in my mind, boils down to “treat your fans well”. Especially when the fans might be neither rich nor financially sophisticated.

Substack is raising $5 million at a $585 million valuation (extending its Series B round from 2021). This seems like a stretch, given what has happened with the valuation of low revenue/high valuation Series B companies since 2021 (Substack did about $11 million in gross revenue in 2021, and my guess is that it likely did less than $30 million in 2022). A company should reveal current high level financial information like revenue, profit/loss etcetera when raising capital. Especially when it must be assumed that old investors have access to that information.

Clue has only put out initial information that it will do an equity crowdfunding round, so the full terms are not known yet. One thing that seems to better than in the Substack raise is that crowdfunding investors will be joining a March 2023 round led by USV and Balderton. It is much fairer for small, new investors to invest a current valuation (if done at arms’ length) than a pre-crash valuation from 2021.

Consensus and right

Tren Griffin has a good collection of quotes on the argument around how to make money when investing.

Andy Rachleff (former partner at Benchmark) is quoted: “Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.”

For venture capital backed startups I think A16Z partner Alex Rampbell’s comment better captures what is needed: “Again, you have to be right because if you’re wrong, not going to work. But the challenge with being non-consensus right is if you think, “Okay, this is a very, very interesting field. It’s going to require a hundred million dollars of capital for this business to actually get to the promised land and get enough customers and get enough revenue and get enough scale. I’m going to invest in their $10 million Series A, which means they’re going to eventually need to raise another $90 million in many successive rounds.” And this is a crazy, crazy idea that nobody except for me on planet earth believes in. Well, then who’s going to lead the Series B? This is the challenge. So it’s fine if you’re a non-consensus and then it trends towards consensus, but if the investment is non-consensus long enough, that’s actually great for public markets, typically. It’s not great for the private markets because you tend to need somebody else to believe and actually coalesce around what is your consensus.”

In my mind a founder raising capital should always want investors to see the startup as consensus and right (i.e. many firms believe “this will be a winner and therefore I want to invest”), as that should lead to the highest valuation and best terms.

An early-stage venture investor can live with non-consensus and right, if the startup can reach milestones before the next funding round that makes it consensus and right (as Alex Rampell argued).

Chief Executive Fundraiser

One of the biggest jobs for a startup CEO, if the founders decide to use external capital to invest and grow, is fundraising. It is not something that is done instead of “working on the real business”, it is the real business as much as product development, sales, marketing, recruiting etcetera (just consider that early-stage CEOs will often raise more money from investors than their sales teams will have sold to customers for a long time).

Being a great fundraiser is an enormous advantage when building a startup, as it gives access to more money (at a higher valuation) that can be used to shape the market and hire a great team. One later-stage example of this is Elon Musk and Tesla. By being a great fundraiser and storyteller, he solved very real financing challenges for Tesla so the company could invest in gigafactories and inventory.

As investors meet CEOs raising money everyday, and over time they start to be able to identify great fundraisers. No professional investor would invest in an early-stage startup just because the CEO is great at raising capital, but a good startup significantly increases it chances to raise if it has such a person and a great startup becomes extremely attractive.

It is not only the fact that the person is more likely to convince investors (she is), but also the fact that having a great fundraiser as CEO increases the likelihood of the company, in the future, will raise more capital at a higher valuation. And that is highly attractive.

What makes someone great at raising venture capital? I don’t think there is one formula, but some ingredients are: having the right type of business in a big market, being in a market venture capitalists want to fund (“consensus and right”), some traction, a big vision, interpersonal skills, presenting the right information and being able to run an effective process. And being able to take those and other ingredients and combining them in a simple story that makes it seem inevitable that you will build a very large company.

Simple stories

Building a company has a lot of nuance and dealing with people and technology is complex. But when it comes to fundraising from venture capitalists (and others) a big advantage is to have a simple story of what you are going to do. Not shallow, but simple (and ambitious).

To take every different variable affecting the future into account when making an investment decision is not possible. Thus investment decisions, in practice, are based on a combination of a plausible stories of the future and numbers.

Three advantages of a simple story are:

  1. easier for an investor to understand when reading a pitch deck (increases the chance of an initial meeting)
  2. helps focus the investor on the right things
  3. makes it easier for the investor to re-tell your story to other partners at the venture firm (higher likelihood of getting to “yes!”).

When VC isn’t right (to start with)

Venture capital is often the most founder-friendly way to fund a startup (normally highest valuation, most founder friendly terms, lowest company and founder risk). But it is still not always the best or most appropriate option, as a company might not fit the venture capital model of very rapid growth and global expansion.

One model that isn’t widely used that I find interesting is the model, created by Bryce Roberts and others of OATV (O’Reilly AlphaTech Ventures). Bryce wrote a longer post about it called We’re Selling Entreprenuership Short.

I understand the model as a strategy to get venture-like returns on a portfolio level without decacorn (10 billion dollar) outliers. After six years has performed very well with a 51 % IRR and 4.3x TVPI (value of fund investors paid-in capital, i.e. investors have made 4.3x). That is likely to a quite some extent the result of OATV being very good investors as much as the model applied by more investors.

Basically what does was to combine the mechanics of a convertible note with a revenue-based loan (before they became popular).

If a company has invested in raises capital, the convertible note converts into equity and things are the same as with traditional fundraising.

If a company does not raise capital, it starts to buy back the convertible note with revenue. Indie.vs asks for a 3x return (so the company will pay 3x the amount invested to buy back its shares, limited to that it can buy back 90 %).

Like traditional venture capital the model isn’t for everyone, but it is interesting to compare alternatives.

Investor coherence

There are many type of individuals and organisations that invest into startups. They share the same label, “investors”, but the way they think about how a startup should be financed, growth vs profit, acceptable levels of risk, if the startup should be aiming for a small or large outcome etcetera can differ a lot.

I.e. a typical early-stage venture capital fund will think differently about those things than a typical family office will and both will likely think differently from a private equity fund.

While beggars can’t be choosers, it is highly valuable to have investors that think the same way as the founders and the other investors about fundamental aspects of company-building on the cap table. Coherence will allow the founders to focus their time on building the company instead of managing investors.

Good time to raise

I believe 2023 will be a good time to found a startup in the Nordics and to raise pre-seed or seed capital from venture capital investors. At those stages my sense is that valuations have stabilized and investors and founders are able to on meet valuation and terms.

It doesn’t mean raising money for most companies will be ‘easy’ though. In normal times it rarely is.

The pitch deck

As a venture investor, and previously as a CEO raising capital, the pitch deck is a central document to learn about a startup. Often it is the first introduction to a company, so saying it is important is to understate it.

The advice from venture capitalists on the content and structure of a good deck is quite similar and have been for a long time. See Inventure, Sequoia, Creandum and Local Globe.

Instead of reformulating all of this solid advice, I’d add some thoughts.

  • My personal preference is when the deck tells the reader on slide 1 or 2 what round/how much the company is raising. This helps me to evaluate the rest of the deck (which is different if you’re raising a pre-seed or Series A, don’t wait until the last slide to give the reader this information).
  • The team slide should go early, probably the first content slide, at pre-seed and seed. There’s no startup to invest in without the founders at those stages. And for a meeting it fits the normal flow of introducing yourself.
  • If you have traction, show it no later than slide 4 or 5. Especially in a deck you share to get a meeting. Traction says “this is working”, and that is an attention-grabber.
  • Keeping the deck short (12 slides) is a good way to keep it simple. Adding more slides often leads to more complexity, not more understanding. Once you have a meeting, have additional supporting slides in an appendix.
  • Even if you’re sharing via Docusend or Pitch, always provide a downloadable PDF option. It makes it easier for investors to share internally and move forward with a decision. It also makes it easier to invest in lines and not dots. Watermark the presentation if you’re concerned the investor will share the deck externally.