A primer for founders on how to raise that first round of venture capital from Harvard Business School professor and Flybridge general partner Jeff Bussgang
1. Basics of Financing
HBS Startup Bootcamp
Jeff Bussgang
General Partner and Co-Founder, Flybridge Capital
Senior Lecturer, Harvard Business School
@bussgang
JANUARY 2021
2. Context For My Perspective
Professor @HBS:
- Launching Tech Ventures
- Rock Venture Partners
Venture
Capitalist
@Flybridge
2x Author:
- Mastering the VC Game
- Entering StartUpLand
2x Entrepreneur:
- NASDAQ: OMKT
- Upromise (acq: SLM)
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Fundraising Patterns and Players
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$250-$500k pre-seed
- Convertible note/SAFE at $5-$7m post cap
- If your friends, family and ex-colleagues
won’t back you — why should I?
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Fundraising Patterns and Players
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$250-$500k pre-seed
- Convertible note/SAFE at $5-$7m post cap
- If your friends, family and ex-colleagues
won’t back you — why should I?
$1-$3m seed at $8-$15m post
- Either note, SAFE/SAFT or priced round
- Micro-seed funds, seed funds, super angels
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Fundraising Patterns and Players
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$250-$500k pre-seed
- Convertible note/SAFE at $5-$7m post cap
- If your friends, family and ex-colleagues
won’t back you — why should I?
$1-$3m seed at $8-$15m post
- Either note, SAFE/SAFT or priced round
- Micro-seed funds, seed funds, super angels
$5-$10m Series A at $20-$50m post
- Priced round, board, control structure
- Seed, Series A, Series B funds
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Fundraising Patterns and Players
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$250-$500k pre-seed
- Convertible note/SAFE at $5-$7m post cap
- If your friends, family and ex-colleagues
won’t back you — why should I?
$1-$3m seed at $8-$15m post
- Either note, SAFE/SAFT or priced round
- Micro-seed funds, seed funds, super angels
$5-$10m Series A at $20-$50m post
- Priced round, board, control structure
- Seed, Series A, Series B funds
$20-$40m Series B at $80-$200m post
- Priced round, board, control structure,
seniority?
- Series B funds, growth funds, crossover PE
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Expectations and Milestones
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Have well-documented milestones
that represent what you expect to
achieve during the initial funding
period
- Team building
- Technical progress/product
development
- Customers, revenue
- Budget
Talk to the investor about
the next round before you
close this round
- Expectations, amount, price
What experiments are you
going to run and what
results do you expect
from those experiments?
Informs how much you
raise: get to a valuation
inflection point
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Investor Decision
Making
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- Most VCs and Angels have ADD — operate on
“BLINK” instincts
• Want to SEE everything, but actually INVEST in very, very
few deals
• Make their decision within the first 10-15 minutes
- Typical VCs and Angels will invest in one out of
every 300-500 deals they see
• Long odds — you need to really stand out
• Like college applicants — triage quickly
Blink: The Power of Thinking Without Thinking, by Malcolm Gladwell
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Unconscious Bias
- Behavioral psychology research shows that our
brains are “prediction machines”, which helps with
pattern recognition but frequently leads to bias
• E.g., HBS study that male and female entrepreneurs get
asked different questions by VCs
• E.g., “Harvard dropout in a hoodie” founder
- As an entrepreneur, you want to be aware of these
biases to avoid some and exploit others
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VCs vs. Angels
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Can be total disasters
Will want some control (voting,
board, veto)
Will want to own 10-20%
Very actively engaged (they get
paid to do this), leveraging the power
of the firm’s network
Can add tremendous value and be
great business partners
Typically, rational actors, commercially-driven,
but if inexperienced can do great harm
VCs
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VCs vs. Angels
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Can be total disasters
Will want some control (voting,
board, veto)
Will want to own 10-20%
Very actively engaged (they get
paid to do this), leveraging the power
of the firm’s network
Can add tremendous value and be
great business partners
Typically, rational actors, commercially-driven,
but if inexperienced can do great harm
Can be total disasters
Will want no control (“send me
an annual email”)
Will want to own 1-10%
Maybe engaged or not (often a
hobby, sometimes a personal mission)
Can add tremendous value and be
great business partners
Typically, rational, but if unsophisticated:
naïve, irrational, emotional
VCs Angels
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VC Is Not the Only Option
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VC Decreases Runway
VC is raised to fund higher burn rates. An increased burn
rate is a great investment when used to fuel a working
model. More often, burn is used to search for a model that
works, and the company quickly learns that capital has no
insights. When startups cannot sustain the burn, and
cannot manufacture enough VC enthusiasm to keep the
dream alive, crash landings ensue.
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Venture Capital increases risk for founders in two ways
VC Limits Exit Options
Probabilistically, the most likely exit for a startup is an
acquisition for less than $50 million. This outcome has little
benefit to VCs, and they will happily trade it for an
improbably shot at a bigger outcome. Billions of dollars have
been outright wasted by founders selling future value that
didn’t materialize, while surrendering present value that
could have been navigated to great success.
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A Game of Outliers (“Power Law”)
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0
10
20
30
40
50
60
70
0-1X 1-5X 5-10X 10-20X 20-50X 50X+
Right-Skewed Distribution of U.S. Venture Returns
By % of financings in companies going out-of-business, acquired, or IPO 2004-2013
n=21,640 financings
%
of
Financings
Gross Realized Multiple Range
Ridiculously large returns (> 10x) are very, very rare
(4%) — but are always the goal
In statistics, the power law is a functional relationship between two quantities where one quantity varies as a power of another.
Source: Includes data from Dow Jones VentureSource and other sources
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VC Fund Math 101
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Prototypical, $100M Early Stage Fund
($ in mm) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Fund End
AVG Deployment Pace 19.4% 20.1% 15.7% 16.4% 9.8% 7.0% 3.2% 2.2% 2.7% 1.0% 1.3% 1.3% 100.0%
AVG Proceeds from Exits 0.0% 0.1% 0.9% 1.5% 2.2% 4.3% 6.8% 8.5% 13.1% 18.9% 21.8% 21.8% 100.%
Capital Called $19.4 $20.1 $15.7 $16.4 $9.8 $7.0 $3.2 $2.2 $2.7 $1.0 $1.3 $1.3 $100.0
Gross Proceeds $0.0 $0.6 $.3.3 $5.7 $8.5 $16.6 $26.1 $32.6 $50.0 $72.2 $83.4 $83.4 $382.5
Management Fees $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $0.0 $0.0 $20.0
Carry $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $13.1 $13.1 $13.1 $13.1 $52.5
Net Proceeds for Distribution ($21.4) ($21.5) ($14.4) ($12.7) ($3.3) $7.6 $20.9 $28.5 $32.3 $56.1 $69 $69 $310.0
Net IRR (10.%) (8.7%) (3.8%) 2.2% 9.9% 25.6% 51.1% 82.5% 116.4% 173.8% 242.8% 310.0% 310.0%
Gross Return Multiple
Net Return Multiple
Net IRR
3.8x
3.1x
20%
To achieve target of 3x the fund, need to
see multiple big exits (>10x) in years 9-12
Source: Industry Ventures
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When Do You Talk to Investors?
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- Never too early to build a relationship (and get advice) — especially
when you’re not asking for money.
- That said, there is no such thing as a casual meeting — every meeting
with an investor is a pitch/presentation.
- Leave them with your next milestones…and achieve them!
- Only when you’ve established a relationship and operational
credibility should you ask for money.
“Ask for money, get advice.
Ask for advice, get money
twice.”
- Pitbull, Musician
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Find the
Sweet Spot
Don’t downplay risk
Mutual due diligence is fair play
Arrange for a warm introduction
Scope out the firm size matters, as does the
— individual
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Prepare, be brief (VCs “BLINK)
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Kiss Many Frogs
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58
Investors
Contacted
40
Investor
Meetings
$1.3 M
Capital
Raised
12.5
Weeks
to Close
Stats From an Average Series Seed Raise
Source: Docsend
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VC Introduction Algorithm
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Entrepreneurs who have made them money
1
2
3
4
5
6
Entrepreneurs in their portfolio
Entrepreneurs they respect
Customers/Partners they respect
Service providers they respect
Existing investors
- Cold emails/social networks
- Investors who are not investing
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Investor’s Decision Tree
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Worth 3 minutes (email, phone)?
Yes
No
Ignore/decline to engage
Worth 30 minutes (phone, in person)?
Yes
No
Pass gracefully
Worth 60-90 minutes (in person)?
Yes
No
Pass but stay in touch
Worth follow-up meeting (in person)?
Yes
No
Pass but be helpful
Serious Due Diligence
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Elements of the Pitch
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1 2 3
Intro
- Who are you?
- Why are you here?
- Why are you special?
Problem
- What is the customer pain?
Solution
- What’s your disruptive, breakthrough
compelling solution?
- Is the “Gain vs. Pain” ratio 10x?
4 5 6
Opportunity
/Market Size
- Top down and bottoms up
Competitive
Advantage
- What is your unique differentiation?
- What’s your “competitive moat”?
Go-to-Market Plan
- How are you going to reach
the customer?
7 8 9
Business Model
- How are you going to make money?
Financials
- What’s the bottom line, what are your key
assumptions?
- How are you going to make ME money?
The Ask
- How much do you want, how long will it
last you and how much will you achieve?
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Top 3 Things to Do
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Set Context Be Crisp and On Point Know Your Stuff
- Tell your narrative to prove
founder-market fit – i.e., why
you?
- Tell industry context to prove
why now?
- Personal intro < 5 minutes
- Team intro < 5 minutes
- Make it relevant — don’t go off
on tangents
- If you can’t show good
summarization skills, how will
you handle a board room?
- Know competition, show
domain expertise
- They will push you to test
you
- John Doerr/Upromise case
study
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Top 3 Things to Avoid
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Do Not Exaggerate There’s No “I” in Team Do Not Name Drop
- Assume everything you say
will be verified in due
diligence
- Assume the listener is a
cynic and a professional BS
detector
- If you are self-aggrandizing,
investors will assume you can’t
build teams, attract great
talent
- No one is going to be
impressed with who you
know unless the
relationships are both real
and relevant
- Assume everyone does
their due diligence
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Typical Investment Criteria
- Tangible things investors like to see:
• Very big market (> $500M? $1B? —
support $100+M revenue)
• Unfair advantage (why you? why now?)
• Attractive business model
(recurring, high margins,
network effects)
• Unique technology or business
model approach
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- Intangible things investors like to see:
• “Pied Piper” — an ability to recruit and
retain a great team, partners
• Interpersonal chemistry
• Movie, not a snapshot
• X-Factor/Super power
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So You’ve Had a Good
Meeting…
Then What?
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- Treat fundraising like a sales process — build a pipeline, work
people through the pipeline, build up to crescendo
- VCs get distracted — typically only pursue 2-3 high priority
new investment opportunities at any given time
- Stay connected, top of mind, build a sense of momentum
- Need to sell the individual “champion”, then the help them
sell the partnership
- Address objections with specific data
• Make the investment case for them
• Give them tools/materials to share with their partners
• Create a sense of urgency (run a competitive process)
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Then, Expect More Due
Diligence
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As you would do in a sales process,
package up the information, make it
easy on the VC — provide reference
list, financial models, detailed
market size analysis — all in
readable, compelling, digestible form
Customers
/Partners
Team
Business Model Market
Size/Analysts
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Partners Meeting
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Ask your champion where they’re
at (Strong positive? Slight
positive? Still questioning?)
1
Ask your champion for the
main objections in advance
2
Customize your pitch
to address them
3
Command the room
4
Be open about risks — and
your plan to mitigate
5
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The Vote
Partner A Partner B Partner C Partner D Average
Market 4 4 4 4 4.0
Team 4 4 3 5 4.0
Product/Tech 2 4 4 2 3.0
Business Model 5 5 3 3 4.0
Competition 4 3 3 4 3.5
Deal/Cap Markets 4 4 3 3 3.5
Disruption 4 4 4 4 4.0
Network Effects 2 3 4 4 3.3
Total 29 31 28 29 29.3
Two most important criteria Who’s your champion? Know what they think beforehand
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Term Sheet Time -
FAQs
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1. Should I include VCs in my seed round or just
angels?
2. Should I do a convertible note/SAFE with a cap,
no cap or a priced round?
3. How big should the option pool be?
• How much do I set aside for team, advisors,
board?
4. How should I think about valuation?
• “Promote” definition
5. How should I think about control?