How Do You Raise A Little Bit of Capital – Part 2

One of the fun things about co-authoring a blog is that you get to modify / improve or even disagree with the responses of your co-author.  Jason and I have been working together since 2000 so we’ve had plenty of chances to discuss, argue, and disagree – one of the things that I love about our working relationship is that we understand how to do this in a way that makes both of us smarter.

Yesterday, Jason wrote a post that answered the question “How Do You Raise A Little Bit of Capital?”  The question was “Our company is trying to close series A funding of approx. $1M by April 30. VC’s we have spoken to say the amount is too small and to contact them at B/Mezzanine stage? What does this mean? Are there options for us?

His fundamental answer was a good one – “Your options are to seek angel funding, or find a VC that does seed deals.”  However, the lead in to the answer wasn’t as nuanced as it could have been.  Bijan Sabet – a partner at Spark – wrote a nice add on post where he explains that it’s not so much about the size of the firm, but the style of the firm.

The key nuance is an important one.  Some VCs are comfortable doing seed / early Series A deals; some aren’t.  History is a good guide here – if the partner / firm has a history of doing Series A investments under $1m, they are a good target for you.  If not, they aren’t.  When I started doing VC investments in 1996 (after a two year stint as an angel investor), a typical “VC Seed Investment” was $250k – $500k.  This was plenty of capital to fund a small team (three or four people) on low salaries to get from “idea” to “something more substantial that could justify a real venture financing.”  The mortality of these deals was pretty high – many times either the VC, the entrepreneur, or often both realized that the deal wasn’t going anywhere and it was better to spend time elsewhere.

In the 1999 – 2000 period, a “seed deal” became a $5m financing.  I know situations where a VC led a “seed round” of $20m with a $10m financing.  That’s not a seed deal – but if you are investing a $1.5b fund, it’s hard to get your mind around doing a $250k investment.  Of course – we know how that cycle ended – so it’s pretty safe to say that the strategy of “over funding seed deals” is not a particularly effective one.

Seed / early Series A investing has had a nice resurgence since 2004.  In addition to established funds (Jason mentions CRV in his post) “going back to the basics”, a number of new firms, like Bijan’s (Spark), Union Square Ventures (Fred Wilson and Brad Burnham) and the guys at True Ventures have seed investing as a key part of their strategy.

I’ve always been a active seed  investor – I’m sure some of it comes from my roots as an angel investor and some of it comes from a few of my big successes that were seed deals (I define big success as a 20x or greater return.)  I’ve also been through the “this isn’t working – let’s shut it down now” cycle on a number of seed deals.  So – I agree with the notion that Bijan adds – it’s definitely style – and seed investing is a “different sport” than Series B+ investing. 

The key – as with most fundraising – is to make sure you are targeting the correct audience.  Trying to raise $1m in a seed deal from a late stage investor is a waste of everyone’s time.

  • thanks for a very interesting dialogue – i wasted a lot of time approaching the big institutions and to appeal to them i scaled up my business plan when the reaction was: “sorry, you want too little money” – this scaling-up of my original plan to make it appear relevant to the big vc’s simply corrupted my original plan and thus compromised it/meant it lost its original focus.
    so, following advice from a local seed/incubator firm i reverted back to the original pragmatic plan (which required substantially less initial funding), approached local seed/incubator firms and have provisionally struck a deal to develop a prototype ––?cq=1&p=809
    so, we’re nearly there, fingers crossed …!

  • pete

    This disturbs me from the Charles River Ventures site;
    “What is your sustainable unfair advantage?”
    realistically there are no unfair advantages when you are talking web apps, to bring that kind of jive talk into the game so early is quite telling of what type of partners they would be. after all youtube was just a http upload site.

  • Acceleris Principal

    Is there a list or could you recommend some mid-Atlantic angel investors/funds?
    Per the dialogue, we’re in a similar situation and are pursuing some early stage capital to fund our prototype.
    This blog has been invaluable!!

  • I think both posts miss the biggest inflection point for the amount of investment. The cogent point is not just how much you are raising, but how much the business is likely to need.
    There is a -very- different thing between putting in $1m to start an investment but your business plans looking for a $6m B in 18 months after you prove x, y, and z. Everyone from Spark to Sequoia does that and it is a great way to reduce risk for the firm.
    But that is quite different for those startups that actually plan to hit profitability with $1m and don’t really plan to raise much more. I’m not sure whether Bijan would still invest in particular, but my gut is that this entrepreneur’s options become much more limited.

  • Since I asked the initial question, possibly I supplied too little information. Our company has a product which it is selling and turning a profit on in a very intersting agriculture application in California. The software and hardware are developed, tested, implemented, and working, not prototype.
    Lead investor fell through after initial A investment due to non-business involved losses that they sustained. In order to meet demand, we need to quickly close A and move forward. Does that change the equation very much?
    Thanks for the valuable insight into the philosophy of investment and strategy!

  • At the end of the day, I think the underlying message is “know your audience.” If you’re well connected to the VC community, it’s fairly easy to know which firms are well suited to your field of interest and capital needs.
    But all too often there are entrepreneurs who aren’t sure where to turn.
    What advice would you give to entrepreneurs who themselves aren’t sure what their ultimate capital needs are? Good friends of mine made the rounds a few months ago and were fortunate to have no lack of interest from a number of east coast VCs. But they were being pitched to take in a lot more capital than they were looking for ($5mm versus $1.5mm) and came away really disenfranchised about the process as a result.
    I don’t think the VCs were wrong for pitching them the $5mm, because $1.5mm wouldn’t work in THEIR operating models. But to heed Brad’s advise, this sounds like a case where my friends were pitching to the wrong audience. But absent those VCs giving them recommendations for angels/seed VCs to speak to, what were they to do?

  • Robert – while I’m a little confused by the “turning a profit” and “needing to quickly raise money”, it probably doesn’t change the equation too much. The key message is to figure out the set of investors that are appropriate leads for funding your company and focus on them. Every situation is different and you need to be crisp and clear why you are raising money and what you are planning on doing with it.