What will it take for your tech startup to raise a $500,000 seed round?
It’s kind of a magic number — I’ve been investing in dozens of tech startups per year for the past few years and $500,000 is about the minimum amount of money you need for one year’s worth of runway. If you don’t get at least that much money at one time, it’s hard to make any big investments or key hires because you never know what your real budget is to work with. What will it take in terms of team, market, product and customer traction for a first-time entrepreneur to raise enough money to take a real run at it?
Before you pitch angel investors you don’t already know for a significant amount of money, there are a few things they will expect to see. This list is approximately in order of importance—having a strong team trumps everything else but having really strong customer traction can also make up for a smaller market or crappy product.
- A Team to Believe In
- >$1 Billion Growing Market
- Meaningful Customer Traction
- Social Proof from a Key Investor
- Minimum Viable Product
If you have these 5 things then you have a pretty good shot at raising at least $500,000 in Austin. I’d love to meet you at the next How to Meet Investors in Austin meetup!
Why $500,000?
$500,000 is just a minimum number you will need for the next 12 to 18 months to pay the founders, make some key hires and do a minimum amount of marketing to gain revenue generating customers. It’s a floor not a ceiling. Most startups who raise that much will end up raising 2x or 3x more in their angel round before attracting a $2–3 million seed round from a VC.
One Big Check is Better
In the past 10 years, the rise of convertible notes has made it more common for entrepreneurs to raise angel funding in smaller chunks without the traditional “closing date” where everyone signs the documents and wires their money at the same time.
I’ve seen too many startups end up fundraising $25,000 this month and $50,000 the next — which means you are always fundraising and never know the total amount of funding you will actually raise. This eats up a lot of time and also prevents you from efficiently planning for use of the funds because you never know how much money is actually coming or when. It’s a negative signal to investors—having a firm closing date signals to the market that you are confident in your ability to close the round.
The main use of funds is usually to make one or two key hires and sign up enough customers or users to attract a $2–3 million seed round of funding from a Venture Capitalist. It’s hard to hire someone if you aren’t sure that you can pay their salary for at least one year. Smart employees will ask how much funding your startup has raised and much money is in the bank.
Raising Money Takes Time
It usually takes 6 months to raise a successful round of funding so you need to be prepared to last that long (preferably longer) going into it. How can the founding team survive through this undetermined length of time? Do you have money saved up? Can you do part-time consulting to make some extra cash? Don’t get stuck agreeing to bad terms for the next $25,000 you need to pay the bills to keep fundraising.
1. A Team to Believe In
The team is most important and overrides all other factors. Investors bet on people and relationships matter a lot—they are more likely to invest in people they have worked with before and trust. If you don’t have an impressive track record of success then the other factors all become even more important.
If you are a serial entrepreneur with multiple successful exits under your belt then you probably wouldn’t be reading this. It’s very easy for people like that raise angel funding—previous investors and customers practically throw money at them.
If you are a first-time entrepreneur, it can feel very unfair. How do you get someone to believe in you? How do you get a first chance? Start with people who know you well—family members, previous employers, or anyone else in a position of power who you have made a positive impression on. It’s quite common for CEO’s of successful big companies to be angel investors in their best employees as they leave to go start their own companies.
That’s also why most entrepreneurs apply to Accelerators such as Capital Factory, Techstars and Y Combinator. This worked for Chuck Gordon and Mario Feghali, two seniors graduating from UCLA in 2009 who moved to Austin for Capital Factory with Sparefoot and received Seed and Series A funding from Silverton Partners. It worked for AJ Bruno and Matt Allison from Trendkite when they came to Austin for DreamIt Ventures after working together at Meltwater News and also received their Seed and Series A funding from Silverton Partners.
One of the first questions a potential investor will ask is, “What have you accomplished before?” The best answer is, “I built a company from scratch by myself and sold it for $1 billion” but what about the rest of us? As a proxy for having a successful exit under your belt, here are some other proxies:
- I have built a similar business to this in the past
- I worked on this at Amazon / Google / Facebook / etc.
- I have been working in this industry for the past 5+ years and am leveraging some relevant experience and contacts that I gained there
- My family has been in this industry for generations so I grew up learning about it.
- I went to some extraordinary lengths to study this topic or come up with the idea for the business
- I was in another profession that requires incredible discipline such as a professional athlete or the military.
Another early question will be, “Why are you doing this? Is it more than just financial motivation?” No high quality investor wants to build a company “so we can sell it.” Most investors want to see an exit path but they know that if the only thing driving you is financial motivation then it won’t last when the going gets tough. Smart investors look for an entrepreneur who is obsessed with a problem, not the solution.
- I was personally affected by this
- Someone in my family or close friends was affected by this
- I’ve been passionate about this topic since I was a kid
- I was knee deep in this problem and saw a solution and had to bring it to market
- I solved this problem in an adjacent industry and it translates to a new opportunity here
Experience is valued greatly by investors. Any company that Brian Sharples or Brett Hurt is a founder of will get instantly funded at this level with minimal consideration of market, product or customer. They have earned that benefit of the doubt by consistently performing time and time again. There is a huge spectrum between them and a first-time entrepreneur. Where do you fit in?
Ask yourself: Does my team stand out above most other startups? Really? Make sure to look around at the subset of the startups who are the ones getting funded — how do you compare to the other entrepreneurs? Don’t make the mistake of comparing yourself to all startups — remember that most startups are not successful so being above average in the broadest category isn’t that interesting. How does your team stack up to the other teams you see getting funding in the news? Who would you need to add to your team to make it even better?
Many entrepreneurs don’t realize that the easiest way to improve their company is to add other great people to the team.
Pretty much the only way to overcome a team that doesn’t stand out is with exceptional traction. In particular, showing progress month over month.
2. >$1 Billion Growing Market
If you want to raise funding from angel investors you’ll need to convince them that there is a market for your product big enough to produce “venture returns” which means being able to exit the company for more than $100 million dollars — usually by acquisition.
These are all estimated numbers but a $1 billion market is a rough minimum for producing $100 million exits. Angels are a little less focused on this than VC’s but you’re still going to have to prove this isn’t a “lifestyle business” and the investors have a chance of producing a 10x return on their capital.
Being in a big market means having a lot of big companies who might acquire your company some day—not just one company. At least 5 big potential buyers if they are “acquisitive” and do this a lot or at least 10 if there isn’t as much M&A in your industry.
Being in a big market means that it’s growing quickly. How much? I’m not sure of an exact number but it’s probably more about investors’ impressions of the industry than anything else. In 2017 I expect that Virtual/Augmented Reality, Health Tech, Artificial Intelligence and Transportation/Mobility will all continue to be big.
What does a company look like that sells for more than $100 million dollars? It probably has $10-25 million in revenue or a few million highly engaged users combined with viral growth. It has probably raised less than $15 million at that stage and had a valuation of less than $50 million at its last funding round.
You’ll hear many investors say that they will take a great team and a crappy product over a crappy team with a great product. The great team will figure out a way to pivot the crappy product and the crappy team will often screw up the great product.
Being in an exploding market can make up for a lot of product limitations or mistakes by the team. When there is incredible customer demand many entrepreneurs think they are smarter than they really are and give themselves credit for strong execution when in fact what they had was good foresight in selecting the right market to start with.
I’ve seen this firsthand a few times — first with SKYLIST and email marketing from 2000–2005, with Bazaarvoice and eCommerce from 2004–2008, and again with WP Engine and Wordpress from 2010 to 2016.
You can overcome being in a smaller or less exciting market, but it will raise the bar on customer traction dramatically. Basically, you’ll need to be able to say, “I know you think that the market isn’t that big, but I’ve already got the beginnings of a big business.”
3. Meaningful Customer Traction
It is extremely rare for a first-time entrepreneur to receive any significant angel investment before showing some customer traction. The best kind of traction is money in the bank from customers, but you can work backwards and talk about contracts signed, letters of intent and repeat usage activity.
Traction is very different when you are talking about B2B Saas, B2C mobile apps, or an IoT device for the home. In all cases, you’re probably going to need to show some kind of progress on your own before you get >$500,000 commitment from angel investors.
People get funded all of the time without traction—but it’s usually from someone they know already (Friends, Family and Fools) or it happens $25,000 here and $50,000 there which means you’re constantly fundraising. If you’re fortunate enough to have a contact who is interested in writing a big check you should take it — but I wouldn’t spend a lot of time pitching angel investors for money until you have something to show first.
Business to Business (B2B) startups are most commonly Software as a Service (SaaS) businesses who maintain a website that other businesses pay a monthly fee to use such as WP Engine Wordpress hosting or Chiron Health telemedicine. With this type of business it doesn’t take a lot of customers or a lot of money to count as meaningful traction as long as it is obvious that there are many more customers in the market to go after. 20 customers or $10,000/month in recurring revenue is a good target.
Business to Consumer (B2C) startups are most commonly either mobile applications such as Aceable driver’s education or games such as Togga fantasy soccer. Consumers pay to use Aceable so it can still be be measured by customers and revenue — it just needs a lot more customers—hundreds per month to generate tens of thousands in revenue. Togga is more like a game and although it has revenue channels coming the focus at the beginning is on user acquisition and engagement. In that case you’re looking at Daily Active Users (DAU’s) and Monthly Active Users (MAU’s). Downloads and signups are one thing, but are people actually using the product over and over? Are those numbers growing? At this stage repeat usage is usually more important than growth.
Hardware startups are most commonly Internet of Things (IoT) devices such as the Plum home lightswitch, NoiseAware sound monitor, or Curb energy meter. The challenge here is that it often takes $500,000 just to build an initial prototype and deliver the first round of product to beta testers. The best way to show traction is to run a successful crowdfunding campaign that brings in >$100,000 in revenue and provides a clear indication of customer demand. Sometimes it’s hard to do a Kickstarter without some funding first, but I’ve rarely seen consumer hardware products that are successful without some form of early crowdfunding. One recent Austin success story is Virtuix with their virtual reality treadmill.
Marketplaces are often both B2B and B2C at the same time (but not always). Filling up one side of the market place is a good start and it’s reasonable to raise money needed to drive traffic to the other side of the marketplace. Usually that means attracting the supply side first — in the case of Sparefoot that was building a database of storage units and in the case of Cratejoy it was creating a wide selection of subscription boxes for consumers to pick from.
If you have no customers and no users, then you might convince someone to write you a check for $25,000 but you probably aren’t going to attract a significant investment. Think hard before you waste your time and their money.
4. Social Proof from a Key Investor
The first check is the hardest. Who it comes from is usually significant so think about it carefully. Another early question every investor is going to ask is, “Who else is an investor?”
One great place to find an investor is a former employer who you worked for and knows you well. Many CEO’s are also angel investors or know other CEO’s who are. Their endorsement of you is one of the most impressive kind to show to other potential investors.
If you don’t know any investors, that’s a good reason to apply to a funding accelerator such as Capital Factory, Techstars and Y Combinator. They make it easy for anyone to apply online and go through a screening process where they interview you and help you prepare to present to investors. Being selected by a prestigious program is a form of social proof and comes with exposure to their network of investors. Take a look through the list of Capital Factory Mentors for some examples.
The Central Texas Angel Network is one the largest and most active angel groups in the country. They have 5 application cycles per year and anyone can submit an application online to get a coveted spot in their pitch night in front of the entire group. If they invest in your deal they can syndicate it out to other angel networks for even more funding.
One of the best sources of social proof is from a VC making a rare seed investment of $250,000 or so. Silverton Partners and Live Oak Venture Partners are known to do this on occasion and it’s a strong signal for a young startup to have one of them investing early.
5. Minimum Viable Product
A Minimum Viable Product (MVP) is a basic product that does just enough to be valuable for customers to pay for or customers to use. MVP doesn’t mean crappy or low quality. Quite the opposite — in order to get people to use it the first version often needs to look nice and be easy to use (especially if it’s consumer facing). The definition of what goes in the MVP or not is more about this feature or that feature than high quality or low quality.
My instinct was to include an MVP as the 3rd requirement in the list but then I took it out as I tried to decide exactly where it fell in the priority list. I rarely see a startup raise funding without an MVP — the MVP is not actually the requirement. It’s just that you usually need an MVP in order to show customer traction or attract angel initial investors. So I put the MVP at the bottom of the list, even though in practice it is almost always required as well.
What If I’m Not Fundable?
All of the biggest businesses in the world do end up raising funding from angel investors and venture capitalists at one point or another, although many bootstrap at the beginning. It usually wasn’t obvious for the first 5 years that they were building one of the biggest companies in the world. If massive scale is important to you, then you might want to look into a different business.
Not every business is fundable by angel investors and not every business needs that kind of funding. As the cost of building and running a tech startup is driven down by cloud computing, open source software, and social media, there are more and more businesses that can be “bootstrapped” with little or no outside capital at all.
In addition to bootstrapping or going the VC route, there are other options that have arisen in recent years such as customer funding with Kickstarter and Indiegogo or crowd funding with SeedInvest or MicroVentures. These open the doors for all kinds of businesses that might not have been possible before.
If you’re committed to the VC route but aren’t hitting the bar for angel investors yet, here are some tips to extend your runway or change your situation:
- Keep your burn as low as you can — keep it simple and defer costs
- Do consulting work half-time to pay the bills
- Line up employees who are ready to join as soon as you get funding
- Add a key person to the team who makes your more fundable
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About Joshua Baer
Joshua Baer helps people quit their jobs and become entrepreneurs. He’s the founder of Capital Factory, a coworking community and accelerator designed to help startups find their first investors, customers and employees. Josh founded his first startup in 1996 in his college dormitory at Carnegie Mellon University and now teaches a class at the University of Texas for student entrepreneurs. He was recently recognized as a Henry Crown Fellow and Braddock Scholar at the Aspen Institute, a member of the National Committee on US-China Relations Young Leaders Forum, and an Eisenhower Fellow. Josh lives in Austin with his wife Amy and three children. The best way to reach him is on Twitter @joshuabaer
About Capital Factory
Capital Factory is the center of gravity for entrepreneurs in Austin. Last year more than 50,000 entrepreneurs, programmers and designers gathered day and night for meetups, classes and coworking. We meet the best entrepreneurs in Austin and introduce them to their first investors, employees and customers. Capital Factory has been the most active investor in Texas since 2013, according to Pitchbook.
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