It’s all a bit hazy really. I had just stepped out of my bosses office. I couldn’t believe what I had just told him, “Yeah, I’m sorry to go, but our first investor just wrote us a $50,000 check and I’m off to start my own company.” The funds from our first investor had just hit our bank account. We were off to the races to start our own company. I couldn’t contain my excitement. I had already called my parents in Chile, all my siblings, and even a few aunts and uncles. My dream was about to begin.
But I want to take us back a few weeks. We had actually already received two offers to invest in our business but had only accepted the one.
Your First Investors
After successfully deploying our product and running if for a number of months with great user traction we began to think about finding investors. Our timing was good since the economy was beginning to come back quite strongly in mid 2013. Our first meeting was with a private equity firm that did a bit of venture work on the side of a fantastic real estate investment company partially focused on college housing. They were nice investors, but wanted us to “just move in with them and we’d figure out the details later.” That smelled like crazy cats to us, so we got a second opinion.
One of the investors in my previous company took a meeting with me and I explained what we were up to. He liked the deal and said he was in. I thought, “Wow, that was easy! We’ll have this round of financing carved out in a couple of weeks tops.” Boy was I wrong. He then said to get docs ready and send them over while he just checked up on a couple of things. He sent me to pitch a few of his friends. While the meetings went “okay” nobody said they would invest. Days turned to weeks and we still hadn’t seen any money. I served him the docs, but he continued his research. I continued taking all of this meetings and occasionally he would come with me.
Finally, after 3 weeks, he called me to tell me he’d sent the docs and the money was on the way. I’m not sure I’ve checked my bank account that many times in a 24 hour period in my life. From what I hear this is actually fairly quick, but it felt like an eternity to me.
That investor continued to send me to his friends and I had a couple of meetings a week if I was lucky, but still no additional money. I remember calling him one day asking for advice as to what I could do better, he said “Jordan, if starting a company was easy everyone would do it. Keep pushing, the investors like that.”
Looking back now I see that he was totally right. I had a couple of investors that really just watched me, and our business, progress for 3-4 months. I’d call them and tell them about our successes/ask for advice. Eventually all of these wrote me a check but one.
We found investors in other ways too. Everywhere I went I tried to make connections with investor profile people. Fortunately our first couple of investors were good enough names that just dropping them got me good meetings once I had a foot in the door.
Valuing a Company
To be honest, I am still a little lost about the valuation process. In fact, one of our investors recently told me that practically over night Seed round financing valuations had been cut in half in the Bay Area earlier this year. Quite literally companies with a $1.5 million valuation one day were told they had to drop to a $750,000 valuation if they wanted the investment dollars they had originally planned on. There's more than simple math involved here in my opinion, but here is what I have learned.
Investors want to leave the founders with enough skin in the game to make it worth it, but they also want enough skin in the game to make it worth it for them. Many know that another round will be needed, so taking more than 30 percent from the founders of the first round is heart rending if the founders want to maintain a good enough chunk of the business long term. I felt it was important to remember that you don’t want to resent your investors after financing you, and you don’t want them to resent you. Don’t think you are the coolest thing since sliced bread. Do convince investors that their investment is worth every penny, then go make it so!
The very nature of angel investing is a risky business. I think it is wise not to take angel money from an investor that has no experience with angel investing. These are high risk investments. One investor put it this way “Jordan, when I invest like this I tell my wife ‘We probably won’t ever see this money again, are you okay with that?’” These kinds of investors keep a cool head when things get difficult and they have been around the block a time or two. You’ll be glad you have them with you in good or bad times.
The Purpose of the Seed Round
During a phone call one day one of our investors told me that “the purpose of the Seed round is to allow you to swing at every pitch.” At the time I was being a bit stingy with the way we were spending our money. He corrected me, and I am grateful for it. He taught me to see the Seed round as an opportunity to experiment and prepare for the Series A. We experiment a ton! At any given time we have at least 4 or 5 different experiments going on to see which will provide the most bang for our buck. Consequently, we have seen a lot of experiments fail since starting our business, but we have also seen a number of experiments succeed. When it comes to our next round of financing we are preparing ourselves to show exactly what worked and what didn’t.
“Startups fail because they run out of money.” One of our investors shared these insightful words with me. As a very successful investor he is often asked the question "Why do startups fail?" His answer is always the same, because they run out of money. Given enough money and enough time I believe most entrepreneurially minded people would find a way to make a business succeed, but you don’t have infinite amounts of time and money. You have to make things happen on a budget and within a time frame. I think that is worth remembering. Don’t dilly dally with your Seed round. Learn. Fail fast.
Key takeaways for me -
- Your lead investor is key. He’ll help you get the other meetings you need. Push hard to get that lead investor and don’t be afraid of treating them well. We gave our a nice convertible note, a board seat, and a bit of equity just for being the first.
- Don’t stop pushing, and make real relationships. When I met a lot of these guys I was honestly just excited to have their phone numbers in my phone. “Is that Jeremy from our Stats 500 class? No, that’s Jeremy Andrus the CEO of Skull Candy. You know, the headphones you are wearing…” But they became much more than a fun contact. I got to know them well and they have become phenomenal mentors.
- Honesty is the best policy. One Monday morning I was on my way to work when I got a phone call from a potential investor. He said “Where are you? Are we still on?” I was 45 minutes away from a meeting that was supposed to start 5 minutes ago. I was lucky he even called. This was my moment of truth. “Jeremy, I totally spaced it! My bad, I am so sorry!” About 30 minutes later I was at his doorstep thanking my lucky stars that I hadn’t been pulled over. He invited me in and told me a funny story about one time when he spaced a super important meeting and assured me it was no big deal. Be real and genuine. We all put our pants on one leg at a time.
- Be teachable. Some people say there’s a fine line between confidence and being egotistical. That might be true, but a confident person has no reason to not learn from people more experienced than he or she. I learned a ton from almost every investor I pitched whether they invested in my business or not. One investor told me that our idea had some gaping holes in it and that he wouldn't invest. I asked why and he explained his reasoning. Five months later he wrote me a check for $100,000 after I took what he had previously said, made the necessary adjustments, and showed him we were at least smart enough to listen to him.
A few important definitions if you are getting ready to try and raise your first round -
Pre-money valuation - how much your company is valued at before the injection of capital
Post-money valuation - how much your company is valued at after the injection of capital. The percentages each investor receives, and how much the founders give up is taken out of this number, not the pre-money valuation.
Cap table - a table showing the ownership stake of each investor