Startup Fundraising Guide - Ep. #2 - Types of Investors

Hey everyone, I'm John Coogan and welcome to the second installment of my guide to startup fundraising. Last week I talked about how to decide when to raise money and about some of the trade offs involved in that process. Today I'm going to cover seven different common sources of funding in the startup world and hopefully by the end of this video you'll have an idea of which would be best for you to target during your next fundraise. As always, the best way to raise money is to build a great business. If your company is making its customers happy, growing the customer base significantly every month, and has a giant pool of potential customers, all seven of these different funding sources will be easily available to you. The seven fundraising sources I want to talk about are as bootstrapping, crowdfunding, friends and family, accelerators, angels, seed funds, and venture capital funds. Each one of these has unique trade offs and there's no single best source of funding. It all depends on the stage of your business and what your plan for the long term is. Let's start by talking about bootstrapping. Obviously this isn't a funding source in the traditional sense, but it's very important to talk about anyway at the earliest stages. Essentially all startups are bootstrapped, even if it's only for an extremely short period of time. And nearly all the investors we discuss today will expect some sort of progress to be made before investing. In some cases, you might be forced to bootstrap your company simply because you can't find an investor who wants to put money in, but that can sometimes be a blessing in disguise. Early rounds are always the most costly in terms of dilution, so by bootstrapping for at least a while, you might wind up owning a lot more of your company in the long term. Mailchimp famously bootstrapped their way to becoming one of the largest email service providers, and the company is still owned by the founders. They have focused on growing off of revenues from their customers and maintaining a profitable business model instead of taking traditional financing. Many entrepreneurs struggle with the idea of bootstrapping. Every day there are companies raising millions of dollars before they even launch, so how can you be expected to compete? The secret is usually to develop your career to a point where you either have enough money saved that you can support yourself while you work on the new business, or let your startup grow out of your existing business directly. That's what the mailchimp founders did. They were running an ad agency focused on email marketing that generated positive cash flow, although the agency model wouldn't scale very well it gave them the insight they needed to build the software product that would eventually become mailchimp. Bootstrapping can be extremely difficult, both financially and mentally, because you have so much on the line if things don't work out. But it can be motivating to have skin in the game and know that there's only one forward Crowdfunding is basically just a pre order campaign for a product that doesn't exist yet, and it can be a great way to both fund your business and validate the underlying idea of what you're building. Instead of convincing investors to buy shares in your company, you go directly to the consumer and try and convince them to give you money months or sometimes even years in advance to let you go build the product. Crowdfunding works great for physical products, usually between $100 and $1,000. The best example of crowdfunding I can think of is Oculus. For their first product, the Oculus Rift, they set up a crowdfunding campaign on Kickstarter and raised over $2 million from nearly 10,000 backers. This crowdfunding campaign not only validated that there was real demand out there for VR headsets, which had been tried many times before, it also gave them cash in the bank to start manufacturing Oculus headsets. Lots of electronic parts require you to purchase in bulk, and suppliers usually want to be paid up front. If you're a young company, crowdfunding has the added advantage of not diluting your ownership in the business. Backers who fund your campaign don't get shares in your company. They only get the promise of a product. High profile crowdfunding campaigns can also attract traditional investors, and that's exactly what happened with Oculus. Within a year of their crowdfunding campaign, they had raised $90 million from Silicon Valley venture capitalists. There is a separate category of crowdfunding where you do give up shares in your business. This is generally called equity crowdfunding, and it doesn't have very many high profile success stories, so I'm not going to go over it in detail. Equity crowdfunding basically lets lots of small investors buy shares in your company, but it can create legal headaches and has yet to be widely adopted in Silicon Valley. The next common funding source is friends and family. This is a contentious one, because as soon as someone says, go ask your rich uncle for $100,000, everyone says, but I don't have a rich uncle, and that's legitimate. Not many people can ask their family for money, but it can be a source in more ways than you think. Jeff Bezos raised the first $1 million to start Amazon from friends and family, and 250k of that came directly from his parents. Now, not many people are going to be able to get a $250,000 check from their parents, but trying to raise money from your inner circle can be a good check on your conviction. If you don't believe your idea is good enough to risk your family's money, why would an investor trust you with their money? Even if you don't have any rich family members, there are other ways to have your friends and family help your business. It's not uncommon for your former boss to have enough money tucked away to take a risk on an investment, and you can also call in friends and family to support you in other ways, like providing housing at reduced cost or even letting you piggyback on their Wi Fi. If you do wind up raising from friends and family, be sure to treat it like a real investment. Show up to a meeting prepared and share all the same information that you would with a traditional investor. And also don't take advantage of them and make your grandmother give you 10k at an insane $10 million valuation, even though she might not know better. Accelerators at the Early Stage an accelerator like Y Combinator or techstars can be a great source of funding. Accelerators typically pair funding with an educational component. You might receive $100k in funding, but be expected to attend sessions with partners at the accelerator and incorporate their feedback into your plans over a few months. Dropbox is a great example of an accelerator success story. In 2007, Drew Houston applied to Y Combinator with an early demo of the file synchronization software that's now used by millions. In the application, Drew had to articulate what his plan was for the company and how Dropbox would be different from the competition. The YC partners liked the pitch and gave him funding to build the product. In 2018, Dropbox went public and is now worth $8 billion. If you are going to do an accelerator, make sure it's run by people who have actually built a business before. There's been an explosion of accelerators over the past decade and lots of business people jumped into the arena with very little real world entrepreneurship experience. It can be dangerous to take specific startup advice from people who haven't themselves built a company before, so be careful. Angel investors are essentially just rich people, and I don't mean that in a bad way. They invest their own money, which does align them with you, but it all depends on how much they Invest getting a $10,000 check from a billionaire probably won't get you much of their time, but getting 10k from a founder who hasn't fully exited a company yet will probably mean that they'll try and help you as much as possible. Many angel investors were entrepreneurs themselves and they just want to pay it forward and help the next generation of entrepreneurs succeed. Others are trophy hunters looking for a big company that they can add to their Twitter bio, and some just have family money and want to be involved in startups because it's trendy. These angels can still help you fill out a cap table, but be careful about taking too much advice from them. When Uber went public in 2019, their angel round from 2010 got a ton of attention. Angels like Jason Calacanis made over $100 million on an investment of just 25k. Since Travis Kalanick had already exited a tech startup before founding Uber, he was able to go directly to an angel round and raise over a million dollars pre launch. Angels are great for a few reasons. They're typically very founder friendly, only helping when asked and not needing board seats or other control provisions. They can usually make decisions quickly and often have a strong network of other investors that they can connect you to to fill out your round. Seed Funds Partners at seed funds are also often recent founders, but they've raised outside money, meaning that they are accountable to other people and might have a slightly longer process for getting to a decision. Typically they have employees and offices along with a dedicated fund and target investment size. First Round Capital is one of the most high profile seed funds in Silicon Valley, and their investment in Ring serves as a good example of this category of investment. Jamie Siminoff, the founder, had built and sold a small software company before starting Ring, and he had worked with the First Round team before, so when he came to them in 2013 with the idea for a connected video doorbell, he already had a relationship and was able to close a $1 million seed round. Seed funds don't invest in many first time entrepreneurs straight out of the gate, which is why accelerators and angel investors are such a popular source of early funding. Once you've made a bit of progress and can prove that what you're building is working, seed funds are a great way to raise larger checks in the $250k to $1 million range. Venture capital funds are the last major source of startup funding and they are by far the biggest. Some VC firms like Andreessen, Horowitz and Sequoia, have billions of dollars under management and have dozens of people on staff. While it's possible to walk into a VC firm with an idea and walk out with a term sheet, it's much more common to raise a Series A, B or C from a VC firm after raising a seed round from smaller investors and finding product market fit. Occasionally a VC firm will have the conviction to take a company all the way from inception to to acquisition. And that's just what Sequoia did with WhatsApp. As early as 2010, Sequoia partner Jim Goetz had cultivated a relationship with the founders of WhatsApp. Even though they weren't actively raising money. Sequoia was able to invest $60 million across two rounds and ultimately make $3 billion from the investment when Facebook bought WhatsApp in 2019 for $19 billion. So if you know a partner at a VC firm, it might be worthwhile to keep them informed on what you're working on. But don't expect to jump straight to Series A without some serious traction and conviction from that partner. VC firms operate much differently than other investors. They have outside investors themselves, and large partnerships that need to agree on investment decisions. In my next video, I'm going to go into detail about how to meet investors and what a typical pitch looks like. So please hit the subscribe button if you're interested in seeing that video when it goes live. And if you've found a different way to fund your business that I didn't mention here, please let me know in the comments. At the end of the day, your job as a founder is just to grow your business, so never lose sight of that. It doesn't matter if you have 10 of the most high profile venture capital firms backing you or just some cash you've saved up in a mattress. If everyone loves what you're building, you'll be successful with enough hard work. Thanks for watching.