16 min read

By Alan Chan

In my last article, I shared How we grew Primary Metric in YCombinator. In this article, I’d like to talk about how we raised 1.68 million USD from investors in Silicon Valley at the end of our YC Cohort.

We have just finished our seed round(March 2022) previously and raised about $1.68million from HOF Capital, Y Combinator, Kleiner Perkins, Moving Capital, Tonic Fund and some angel investors who were also start-up founders, since our company started in September 2021.

If you haven’t started fundraising, or you have already raised some pre-seed funding, this article can help you understand:

- Whether your company is suitable for fundraising

- Understand different round of funds and their usage difference

- Determine your seed round funding plan, choose the correct valuation and amount to raise

- Choose the right time to raise funds and avoid meeting investors too early or too late

- How to prepare for fundraising pitches

This article is based on my personal experience and I am targeting companies who want to raise a seed round in Silicon Valley, so it might be biased or limited in content. The best fundraising plan and approach would be different based on timing, market circumstances, the target market/focus of the company and the experience of the founders.

If you are not sure about whether the content of this article is suitable for your company, don’t forget to consult an expert who is specialised in this field.

Judgement

When the founder started fundraising for the first time, you need to determine whether or not your company is suitable for investment or not.

The simplest way is to ask yourself:

Do you think your company can be revolutionary in 10 years like how Facebook changed networking, Uber changed transportation, Airbnb changed travel and Notion changed collaboration in companies, while making annual recurring revenue(ARR) more than 100 million dollars?

If you think your company can achieve this, you can consider fundraising for your company. If you think you can’t, then fundraising might not be suitable for you. Of course, you can still make a perfectly functioning company with stable revenue without raising any funds.

But once you raise funds, your goal is set to grow enormously, and quick.

Some notes from the translator: I personally don’t appreciate the hype of how the market reacts and talk about fundraising. I have come across many investors and said no to many — I have come to a point where — didn’t want to raise any funds when I was not sure. Accepting funds is a big thing — there are pension funds and institutional funds behind VC and you are becoming someone else’s asset custodian through the medium — VC. Do you trust yourself to be someone else’s asset custodian? It is simply irresponsible to not consider it.

Stage

Early stage start-up’s fundraising cycle is separated into Pre-seed, Seed, A round, B round and C round. After the C round, some companies would prepare for IPO and some companies will raise D, E, and F rounds before IPO.

For investors, the earlier they invest, the higher the risk. And the rounds of fundraising are like peeling off the skin of onions. An investor would evaluate the risk of a company, and whether or not the risk can be accepted in this round when they are evaluating a start-up. After the start-up raised capital, it will use the money to eliminate the associated risk in its current stage.

- Pre-seed: Help founders from 0 to 1, from idea to MVP and obtain early users.
- Seed: Help the founding team find product-market fit(PMF) and iterate to a product that users are enthusiastic about and fit their actual needs.
- A round and B round: help companies who found PMF to scale, expand market share and develop a mature business model.
- C round and further: help companies reach the standard for IPO and prepare for IPO.

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Most of the pre-seed and seed round funding came from Angel investors, accelerators, venture capitals or Angelist syndicates. Take an example of funds raised by Heptabase, our proportion of fundraising sources are venture capitals(800k)>Accelerators(500k)>Angels(210k)>Syndicate(170k).

Looking back, I think the methodology of fundraising from different investors is largely the same in pre-seed and seed round. The important part is how many cards you have on the table, the timing and whether you can converse with investors. I will talk about all of them later in this article, but now, let’s focus on how to plan for success before fundraising.

Plan

Once you determine that you wanted to fundraise, the next step is to set out your fundraising plan. In Silicon Valley, SAFE is widely used during pre-seed and seed. You don’t need to negotiate the term sheet with investors, but to determine how much money you need and the valuation. These two numbers are your fundraising plan for pre-seed and seed.

Before setting out the plan, I asked myself four questions:
1. How much money do I need to keep my company default alive?
2. How much money do I need to help the company achieve the revenue and metrics needed for A round in 18–24 months?
3. In the same market circumstances, what are other similar companies’ valuations when they are raising funds?
4. After the seed round, how much shares will be diluted?

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You can set the fundraising target by answering the first two questions. The first question was to answer what’s the least amount of money we need, whilst the second answer is how much to raise ideally. The third question was to determine what’s a plausible range during fundraising. The fourth question was to help me to avoid diluting too much share. We can look at how to consider these four questions in detail.

Q1: How much money do I need to keep my company default alive?

Default alive means your company needs to break even before the money runs out and ensure the company can survive without raising any funds. You can use the Startup Growth Calculator to know how much you need before breaking even, by inputting current monthly spending, current monthly revenue and revenue growth rate.

Q2: How much money do I need to help the company achieve the revenue and metrics needed for A round in 18–24 months?

Benchmarks: Revenues and metrics needed for A round. Investors care more about if you can scale your product systematically and keep good Unit Economics. Consumer subscription companies usually need to reach the benchmarks listed below before A round in a bull market in Silicon Valley:

a. LTV/CAC > 3

b. Continuous monthly recurring revenue growth > 20% for more than a year**

c. Annual Recurring Revenue > $500k-4million**

d.** Payback Period < 6 months

You can have a quick evaluation about how much money the team needs to operate for 2–3 years to know how much you need before A round. And you can think about do you need to hire key employees to help the company speed up its growth and whether there is another essential spending in key resources.

Q3: In the same market circumstances, what’s the other similar company’s valuation when they are raising funds?

When you are raising funds for a pre-seed or seed round, your valuation is simply a number that you and your investor can both agree on and your current revenue does not directly affect this number but several factors below:

1. Market:

During a bull market, a ton of investors and hot money would flood the market — the supply of money will exceed its demand, so the start-up founder can choose a higher valuation to raise funds. But during a bear market, there are less hot money and investors tend to be risk-averse. You will likely need a lower valuation to raise your round.

2. Founder’s background:

• Your valuation tends to be the highest if:
  - have built a company that went IPO,
  - founded a company and exited,
  - been selected for famous accelerators like Y Combinator or a16z
• Investors are also willing to pay for a relatively higher valuation if you:
  - have worked in a senior position in one of the FAANGs,
  - graduated from Ivy Leagues, Russel Group Schools or other globally famous ones
  - being recommended by other famous start-up founders
  - have other important experiences that are difficult to be neglected

3. Growth potential

Does your company have the potential to grow into a billion-dollar business or a trillion-dollar business? Will you become a relatively good business in your industry or become something revolutionary?

4. Product

Do you have a small group of enthusiastic users who are crazy about your product? Do you have a high user retention rate? Do you have high usage stickiness and audience attention? Does your user willing to pay? Do you have organic growth?

Q4: Share dilution after the seed round

In an ideal scenario, you want to keep more than half of the share after your A round, but SaaS company usually sell 17–28% of their shares after the A round. In another word, it is best to keep your dilution between 22–33% before A round. A reasonable share distribution in each round might look like this:

• Pre-seed: 5–10%
• Seed: 5–20%

Before I made the fundraising plan for Heptabase, my answers to the above four questions were:

1. Heptabase has broken even and we can survive without raising funds.
2. I think 600k — 1.8million USD would be enough to let us reach the benchmark for A round. This figure was calculated by 3 years of employment cost and our SaaS subscription service. And 600k USD is enough for hiring employees in Taiwan, 1.8mil USD is good for hiring employees in the US.
3. During the bull market in March 2022. YC’s companies are usually valued at 15mil-20mil USD when they are raising the seed round.
4. We have used 9% shares during pre-seed(2% for angel investors, 7% for YC) and raised about 200k USD. So it is best to control the share dilution within 13–24% during the seed round. YC’s suggestion was to keep it below 15%, but I personally hope it’d be below 10%.

After answering the 4 questions above and discussing with YC Partner, our fundraising plan was settled at:

• Valuation: 18mil USD
• Raising: 1.5mil USD
• Share dilution: 8.33%

The amount we raise would be enough to support us to have a 10-year runway if we only hire employees in Taiwan, even if we hire US employees, we’d have about 3 years to reach the standard for A round. After raising our seed round, the share diluted was 17.33% — way below 22%.

Leverage

After setting up the fundraising plan, you’d be ready for fundraising. Start-ups need to consider two things to take advantage of during fundraising. The first is leverage. The second is FOMO(Fear of missing out).

Let’s look at leverage first. Leverage from a start-up includes recurring revenue(MRR, ARR), growth rate, retention rate, runway, market sizing, previous investors and etc.

Photo by Klim Musalimov on Unsplash

If your revenue is low; growth is slow; retention rate is low; the runway is less than a month; only target a small market — you will have relatively small leverage and investors who are interested in investing would be less. But if you reached MRR 10k USD in three months; the weekly growth rate is higher than 7%; cash reserved in your bank account is enough for you to burn for 2 years; your users come from everywhere in the world, then you’d have higher leverage when you fundraise.

The higher the leverage, the better terms you can set during fundraising. This is also why companies need to fundraise when they have good performance, rather than when the performance is bad and they are desperate for funds.

When you don’t have enough leverage, PLEASE DON’T MEET INVESTORS.

You should be focusing on making the product, talking to users and trying as hard as possible to increase revenue, user number, increase growth rate and retention rate to produce high leverage. You might be receiving investors’ letters and every one of them wants to meet you as soon as possible, or they tell you that they are interested in helping you. But when you don’t have enough leverage, these investors would lose interest in you very soon.

I think this is another counterintuitive fact in seed funding: the lesser chance you’d be invested if you spend more time with investors, and give investors more useful information related to your company. Investors know this better than anyone else — the companies that are hot in demand won’t have time to talk to every investor. On the contrary, the more your focus on running your own company and the less you need investor’s money, the more interest you’d draw from investors. If you can have revenue and retain high growth, your leverage would be much higher.

FOMO(Fear-of-missing-out)

Other than leverage, the second thing you need to consider is FOMO(Fear of missing out). Not many start-up teams can grow big and investors are scared that they can’t invest in the teams/companies that can grow big.

So when you are fundraising, you need to make sure investors know two things:

1. You are a team with high growth potential and a lot of leverage.

2. You will finish raising this round very soon and if they don’t invest in you, they will miss this round. So it will push the investors to make decisions in less time.

In YC, every company spend all the time making product and talking to users. If there are investors who want to meet us, we’d schedule it to be in two weeks before demo day. So when the demo day is approaching, you will meet more than a couple of dozen of investors in two weeks, and every investor can feel that ‘This company is performing very well and meeting a lot of investors, after Demo Day they will be meeting more and more investors. If I don’t invest in them now, I can’t get in this round.’

This is particularly beneficial for start-up founders. When you are taking things in charge, you will be able to pick the investors you’d like to work with rather than being selected by investors. When I am fundraising, I will try to figure out if the investors can align with our vision, whether they have used our product, whether they can introduce users to us and what kind of help they can offer other than money. Once you accept the fund, you will be working with the investor for a really long time. So when investors are interviewing me, I’d be interviewing them as well.

If you are not a YC company, you might not be able to create the FOMO phenomenon like YC Demo Day, but you could take a similar approach — when you are fundraising, schedule all the investor meetings in one month and let them know you are talking to a lot of investors and planning to finish this round in this month — pressure them to make decisions with a tight timeline.

Pitch

Once you finish setting up your fundraising plan and scheduling all the investor meetings, the last thing you need to do is to prepare how to pitch your company to investors.

Photo by Teemu Paananen on Unsplash

Investors might look at thousands of start-ups every year. So when you are meeting him/her, he/she might have already met 20+ start-ups in that week, and your job is to stand out from that 20+ companies.

For most of investors, they’d consider two main points: how big can your company grow (1 billion USD or 1 trillion USD), and the risk of investing in your company. You will need to show investors your growth potential when you pitch and give them enough evidence and figures to eliminate their concerns regarding risk.

There are four key elements in a good pitch: confidence, highlight, logic and to be conversational.

First of all — confidence.

When you are raising funds, do keep yourself in an excellent condition/mood. The same content’s delivery would vary a lot depending on your confidence level, or personal condition and it’d make a direct impact on your fundraising result — because a pitch without confidence would simply look a lot riskier than when you do. To build your confidence — you need to truly believe that your company will succeed. If you have a lot of leverage, this leverage could be the source of your confidence too.

The second is highlights.

Before talking to investors, you should prepare 3 to 5 highlights of your company or strong points that worth to be mentioned. Take an example, if you can make high revenue in a short period of time; you have a high user retention rate; your founding team has strong experience; you can explain why you are the best person to build this; how big is your market; what are the key advantage that you can achieve but other companies can’t. There is so much more to this. The key point here is: some highlights would eliminate concerns in relation to risk (ex: product maturity, revenue, team experience) and some others would let investors know your growth potential(ex: existing growth rate and potential market sizing).

The third is logic.

The logic of your pitch must be clear and let investors know who you are, what are you making, what’s your primary matrix, how did you improve your primary matrix, what’s your long-term vision and etc. A good pitch is short and succinct. If your pitch is constantly diverging and the investors can’t see key points and you have used 10 sentences to explain something that could have been told in 1 sentence, you will become less persuasive.

The fourth is being conversational.

An ideal pitch would be a one-to-one, back-and-forth conversation between you and the investor. Investors would ask you some questions and you might ask investors some questions too and you can discuss, and bounce back ideas on certain topics. During the conversation, you need to show your leverage like playing cards — show them one by one during the conversation. You need to make investors feel excited in the first 3 minutes so that you can extend the conversation to 10 minutes. Likewise, you will need to get them excited in the first 10 minutes to extend the conversation to half an hour.

During my investment pitch, I usually use a one-liner to introduce our company and target users and then jump into our first highlight — growth rate and current revenue. Investors would pay more attention after they listen to this and become more engaged with the conversation later on.

After getting investors’ attention, I will tell the story of this company. Normally I’d start with my two-time drop-out and talk about my individual research during the time when I was not going to school and the journey of searching for vision; how I met my co-founders and why we are building this company; how much time we have spent on thinking about the problem we want to solve and what’s our long term vision and etc. This part is to help investors understand why are we the best to build this company in the world and solve the problem that we are solving.

After I tell the story, investors might start to ask for some product details. I’d show the demo and how to use our product straight away and let investors see the core value of the product. I would ask them if there is anything unclear and be open to suggestions and ideas when I play the demo video. Investors might be curious about our user’s actual usage behaviour and ratio — I’d open our data platform Amplitude, demonstrate very clear how it is and show our second highlight — the extremely high user retention rate. If investors want to know more, I’d use Amplitude to do data visualisation at the scene.

When topics around team, product and users are about to finish, investors might start to ask questions related to the market. At this time I will share my opinion related to the market, long-term goals and potential, let investors engage in the conversation and I will listen to their opinions. If investors have founded a company, I might ask him/her if he/she is the one to operate our company, would he/she be making any decisions different from us. If investors have invested in successful companies in a similar market, I might ask him how does he think about their success stories and if there is any chance that Heptabase would be able to replicate these experiences or even walk on a road not taken.

Overall, a good pitch is a confident, back-and-forth conversation which delivers a clear story with multiple polished and prepared advantages with the investor.

If you are just flicking through your decks during the pitch and have no conversation, you will lose investors’ attention, not to mention raise any funds.

Conclusion

The things above are what I consider important for start-up founders who are fundraising: set up a fundraising plan, accumulate leverage, create FOMO and deliver a story with confidence and make it conversational with investors — and of course show your unique selling points/highlights. If you can do all these, it is basically you have done all you can do and the rest is luck.

Of course fundraising itself is related to luck. Take an example, sometimes even the best start-ups can’t raise funds during a bear market. Even when you are fundraising in a bull market, you can’t control the investor’s own condition during the pitch and their opinion of the market, all of which will have a direct impact on your fundraising result. Even the best investors would make 90% investment mistakes — sometimes they don’t realise a company is good for investing. So when you are raising funds,

Your task is not to let the investors who don’t trust you trust you, but to let the investors who trust you invest in you.

As a start-up founder, I think keeping a healthy and stable mindset or attitude is the most important for you — don’t let your fundraising results overly affect your mood.

The investors only have half an hour to know your company, but you have several decades to run your company. If you know that your company is worth to be invested, then even if you don’t raise any funds, you’d have a chance to succeed in the long term.

Ultimately, it is down to you and your team to create your future, but not your investors.

Ending notes by translator:

This article is translated by Zhao. To see the original article written in traditional Chinese by Alan Chan, you can see it here. Zhao skipped the part he introduced about Y Combinator as most of the information is available on the internet. Alan and Zhao have both agreed that an English version would be beneficial to a broader range of audiences. Alan founded Heptabase, and his company was accepted to YC in the 2022 Winter Batch. Although his articles inspired Zhao in deciding what to do with Zhao’s start-up, his opinion doesn’t represent Zhao or the related company’s opinion. The translation was done objectively.