Fundraising Fundamentals: key takeaways

Jonathan Ellis
10 min readSep 15, 2020

On August 21 2020 we kicked off the midwest.tech/connect 2020 programming series with our first webinar, covering Fundraising Fundamentals, featuring moderator Jonathan Ellis (Founder/Managing Director of Sandalphon Capital and midwest.tech) and panelists Michael Gray (Partner at Neal Gerber Eisenberg) and Nicole Staple (Founder/CEO of Brideside).

We discussed three core topics: 1) the general fundraising process, 2) deal and term structures, and 3) legal due diligence, and conducted a Q&A with over 200 attendees.

Disclaimer: this summary is provided for general, informational purposes only and should not be relied upon — you should seek appropriate advice for your specific situation.

Here are the key takeaways:

General Fundraising Process

Fundraising is 100% a relationship-based business. Building trust is key. Do this by sending a monthly newsletter of your goals, objectives, and metrics to investors to show your transparency and disciplined approach. Make the product-market fit obvious and help early-stage investors relate to your business and product by framing it in a way that creates a common ground and language. Be prepared to build trust over a long period.

Investors look for strong business fundamentals. Sharing your vision is not enough to win investors, especially in the Midwest. Show early leading indicators to give investors confidence. For example, Brideside adopted a metrics-driven approach even when they were pre-revenue and then focused on showing two key performance indicators: 1) conversions from sign-ups to sale and 2) customer lifetime value increasing. Metrics not only tell a great success story, they also build founders’ credibility by showing that they can navigate through tough times with discipline. Adopt metrics early, track them regularly, and improve them over time. At the pre-revenue and early revenue stages, focus on the top-of-the-funnel metrics, then focus on doubling or tripling your top-line metrics such as revenue each year to showcase high growth.

Fundraising is never a straight line. While the Magic 8-Ball cannot tell you who will invest and when, you can learn from potential investors even if they say “no.” Listen to the questions they ask you, take notes, and reflect on how to give better responses. Too many founders take rejection as a failure when it is a great learning opportunity and another step closer to accomplishing the goal. Take this chance to get feedback, add them to your outreach list to build your relationship, and get connected to other investors. Do not hesitate to ask, “Who do you think we would be a good fit for?” and request to be connected to specific people you find in their LinkedIn network, or on Crunchbase, Pitchbook, AngelList, and other databases.

A big lead list lays out key stepping stones to finding your initial investors. Do not be afraid to tap into your academic alumni lists, executive networks and professional networks early on. A cold email to Jennifer Olsen (then CMO of Crate and Barrel, current CMO at UNTUCKit, and Kellogg MBA ’98) resulted in not only one but two critical angel investments for startup Brideside, as Jennifer connected the team with Rob Chesney (then COO of Trunk Club, current Partner at Chicago Ventures, and Kellogg MBA ‘98). Technology incubators are another great resource to plant your seeds and build breadcrumbs. Investors will follow a good lead. Securing the lead anchor (i.e., one to two big checks) is key to securing the follow-on capital.

A multi-channel strategy can help you get your foot in the door. VCs often rely on warm introductions to filter through the barrage of startups knocking on the door. One of the most direct ways to obtain a warm introduction is to connect with a founder in the VC’s portfolio to learn about the investor, find a point of relevance, and get an introduction. Cold emails can work if you do the upfront work: get feedback from your initial soft sells to people in your network, make your story and pitch deck compelling, and customize your email to show that you have researched the fund and its recent investments. You can also reach out via the “Contact Us” form and sign up for open office hours on investors’ websites. Do not be shy about following up!

Pay it forward. In the current remote working environment, there is a much larger world of people willing to chat. As you seek introductions, consider who you know that you can introduce to people because the more you give, the more you get back. You never know when a referral from somebody you’ve once helped may come in handy, whether it’s now or in 20 years!

Time box your fundraising to about 6 months. Fundraising is a friction-heavy process. Beyond legal transaction costs, fundraising diverts founders’ time and focus away from successfully operating the business. Decide on a start and a target end date for fundraising and communicate a clear timeline and process to investors. Be thoughtful about balancing urgency with reasonable time frames though, and do not create artificial deadlines when a critical mass of interest has yet to be achieved.

Get quick “no’s” and segment your investor list. If investors adopt a “wait and see” approach, consider it a “no” and focus on investors that will help you gain momentum. If the investor continues to ask follow-up questions, be clear about your timeline. Bucket investors who are interested but do not want to be your first money in and offer to follow up on due diligence at a later time frame. Smart investors value founders’ time.

Employ creative negotiation to finish raising the round. If you do not have a lead investor yet but have raised 80% of what you need, invite the committed investors to write a bigger check. Clearly communicate the capital you need and let them know the path forward. E.g., “I can focus 3 more months on finding another $200K, or if each of you put in $25K more, I’m done fundraising and can focus on running the business.”

B-corporations can also seek VC funding. A good number of consumer-oriented B-corporations, largely in food, have worked with VCs. B-corporations are considered in a similar manner as C-corporations; the key difference is that B-corporations are impact-bounded.

Your smallest investor can sometimes be your most difficult investor. Institutional investors understand the full risk profile and have a large enough portfolio to mitigate risks associated with a deal, whereas friends and family may not. Before reaching out to friends and family, check how comfortable you are having someone you know invest with a real needed return. Manage expectations with friends and family; let them know that they may not see the money again, and any returns are an upside.

Deal and Term Structures

SAFEs vs convertible note. SAFEs and convertible notes are often used in early-stage deals where it does not make sense to issue preferred stock as they are less complex and costly to negotiate and do not require fixing a valuation. There are a few key differences between SAFEs and convertible notes. Convertible notes include an interest rate and maturity date (typically 1–2 years), while SAFEs do not, making many companies prefer SAFEs. Also, convertible notes are treated as debt, which leads to tax and accounting differences between the two instruments. For example, in Illinois, your investors may be able to get angel tax credits that would be unavailable if they had bought convertible notes. Do not just pull a SAFE or convertible note off the internet; work with a lawyer to understand which instrument to use and how to structure the terms and customize the instrument for you. Most SAFEs and convertible notes convert at a 20% discount to the price negotiated in the next round of financing or they convert in at a negotiated valuation cap, whichever is better. There are many subtleties that get missed in negotiating these instruments (for example, with pre-money vs. post-money option pools) that can have huge economic consequences.

Valuations do not mean much in the early days. What actually matters is who your investor is, how supportive they are, and the terms on control rights, participation, and preference. Startup Brideside took a slightly lower valuation in their Series A, but negotiated a significant options grant for the founders to make up for the low valuation. Outperforming and proving that you are priced too low are key to increasing your negotiating power around the term sheet and adjusting your valuation in your next round. Investors want you to run the company well and will adjust the valuation based on proven results.

Pre-money vs. post-money valuations. Pre-money is the valuation of the firm before investors invest, and post-money is the pre-money valuation plus the capital that is invested. For example, if you raise $3M and have a pre-money of $7M, the post-money valuation is $10M, and investors own 30% after the round closes. In other words, you increased the assets on the balance sheet — or the value of the business — by $3M. The pre vs post math is complicated by option pools and SAFE or convertible note conversions, however. Make sure you and your investors are speaking the same language and your term sheet is clear whether your valuation is pre- or post-money and what is included and excluded from the pre-money value. Run a pro-forma cap table to be sure you are on the same page and use your lawyers to ensure it is correct.

Founders can set their own terms on early notes. When you seek early capital (e.g., friends and family, SAFE, or a convertible note), work with a lawyer who knows venture to establish terms and create reasonable documentation. Having this in place demonstrates your seriousness and avoids issues in your later rounds. When you attract a larger investor, you can work with them to adjust the existing terms or negotiate new terms. Do not make the mistake of being overly aggressive on the valuation or terms (such as founder voting rights that are 10x everybody else!) but do be strategic in establishing early-on key founder protections — these are much harder to establish as time goes on. Also, keep in mind that founders almost always give up 20–30% of their equity in early rounds no matter the size, so don’t set your round size too low. Being practical will help you move forward.

Fixing founder’s equity and options grants can be costly. It’s important to properly allocate equity among the founders and think about the terms of this equity from the beginning. If a founder’s equity is not subject to vesting and he/she leaves, trouble is afoot as the founder would walk away with all of his/her equity and there would be no way to reallocate it to other team members needed to grow the business going forward. The right time to divide equity depends on the facts and circumstances — often it is best to do it at founding but there may be reasons to wait for when the startup is up and running, you raised a successful round, or you achieved sales Equity can be split in different ways based on how you define the co-founders’ relationship and when the co-founders come in. For example, startup Brideside brought on a technology co-founder for 10% of the company. Another problem that frequently arises is founders giving out options without proper documentation. This may result in having to cancel every single option and reissue them at a higher strike price — a situation no founder wants to be in.

Explore 1202 stock, also known as qualified small business stock (QSBS). Work with a professional to understand the rules and take advantage of this portion of the federal tax code. Basically, if you get stock directly from eligible c-corps, hold the stock for 5 years, and meet the other requirements, you can receive the greater of either $10M or 10x the amount you invested in the company tax-free. To learn more about 1202 stock, check out NGE’s website.

Form a C-corp if you plan to pursue venture funding. Do not start with a S-corp because it eliminates the option of the 1202 stock without complex legal maneuvers. Although LLCs provide flexibility, there can be a large legal bill attached to setting one up and getting VC money because converting profit interest or equity grants into a normal option plan is a very expensive and complicated process. If you plan to raise just with friends and family in a capital-efficient manner, explore the LLC structure and the tax differences between LLCs and C-corps. Note that it is much harder to convert from a C-corp to a LLC, compared to converting from a LLC to a C-corp.

Start in Delaware. If you want to raise money, form the company in Delaware to reduce complexities. If you start in Delaware as an LLC, you can easily convert to a Delaware C-corp . Starting elsewhere such as Illinois or Missouri, will force you to complete copious paperwork and usually pay thousands in filing fees. Moving your company from one state to another may not be highly complex, but will cost legal and filing fees for joining and leaving the states.

Legal Due Diligence

Pay attention to intellectual property (IP). Many deals break down due to poor documentation around IP. In certain cases, a lot of people, including third parties, have touched the product, and the IP has not been properly assigned to the company. Make sure to document your IP!

Founders often mess up on data privacy and cyber protections. Work with a legal professional to ensure that the fine print in the terms of service and other policies and agreements are in order. For example, you not only need the rights to use customer data, but also the ability to transfer data such as email addresses. Tricky terms in commercial contracts can break the deal and cost a lot of money to fix.

Maintain good corporate governance and organize ALL documents in a secure data room. Avoid running around looking for data in old emails, get “deal ready,” and make sure you do not leave out a key piece of information. What does this include? Everything! Keep the following in your data room: board minutes, formation documents, contracts with employees and contractors, documents and approvals for option grants, income statements, balance sheets, and financial documents. Write down key processes (e.g., hiring and terminating an employee) and manage key templates (e.g., NDAs, employment offer letters, etc.) to ensure consistent processes and file structures.

More information

You can check out the full webinar recording here.

Additional resources:

You may also be interested in this Fundraising Best Practices webinar hosted by Jonathan Ellis, MD at Sandalphon Capital, part of Twin Cities Startup Week’s Founder track.

If you are interested in learning more about startup fundraising, contact one of our speakers below.

Thank you to our MTC2020 sponsors: TriNet, Signature Bank, Neal Gerber Eisenberg, Calculated Risk Advisors, Objective Paradigm, and Carta.

About Neal Gerber Eisenberg

Neal Gerber Eisenberg is a leading law firm dedicated to handling sophisticated matters for entrepreneurs, public companies, and private businesses and their owners. The firm has built over thirty years of trusted partnerships with clients that span the globe, and we meet each unique client need with the same personalized service and collaboration that provide the most practical solutions for every matter.

Summary by Julia Wong, MBA Associate Intern at Sandalphon Capital.

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Jonathan Ellis

Sandalphon Capital, a Pre-Seed to Series A stage Midwest/Midcontinent-focused early stage VC firm