Startup Investing 101, Part 1

Kareem suggested to me this week that I should blog a bit on Startup Investing from a beginner’s perspective. In other words, let’s say you’re an entrepreneur and this is your first start-up company. What should you do to raise money? Had a lunch with a friend earlier in the week and he has a great product (crazy cool viral growth) but he’s never raised money before and isn’t very experienced in terms of what to do. So I’ll write some posts that would be a close proxy to what I’d tell a guy like him over a series of lunches. Enjoy!

First Things First: Figure out how much money you need.

Figuring this out will help you to determine where you need to go to get the capital. If you only need $20K to push your idea forward there’s little reason to get outside investment. You can probably just get a line of credit from your bank (you’d be surprised at how much they’ll give you if your credit is good) or take out a few credit cards. Giving up valuable equity early on for that little bit of money doesn’t make sense.

But let’s say you need more…how much more? $100K? $1MM? $10MM? This depends so much on what you’re building. Best thing is to find comparables in your space. The average web 2.0 start-up probably doesn’t need much more than a few hundred thousand to get going (most often much less). However, if you have an idea for the next great bio-tech company you’ll need much more than that.

I think a good rule of thumb is to raise enough money for 12 months of operations. Raising too much further out than that makes the fundraising process a little more tricky and also puts you in a position where you may spend money excessively just because you have it. On other hand, raise less than 12 months worth of capital and you’ll find yourself finishing up a round only to be going out soon to raise more capital. The last thing you want to do is be perpetually raising money. You need to spend most of your time and energy building the biz.

OK, so let’s say you’ve figured out how much money you need.

Next step: Figure out who to raise from.

This is a very rough guideline but should prove somewhat helpful in terms of getting you started.

$0 - $50K = Bootstrap/lines of credit/credit cards/etc. - Don’t give up equity if you’re only going to raise this small amount of money. There are quicker ways that don’t require you to dilute yourself. You can even look at a site like Prosper to raise some money (I have a friend doing that to fund his business).

$50K - $300K = Friends and family - If you need more than plastic and the bank will give you then the obvious next choice is to look to people in your personal network. This varies quite a bit from person to person as some people don’t have the network to raise $50k and others could raise $50 million from people they know. But in general most people probably have enough people with money to raise a small six-figure amount. Friends and family are a good choice because they typically will move pretty fast and be fine with fairly entrepreneur-friendly terms. Of course they can be a bad choice for what I’ll assume are obvious reasons.

$300K - $1 MM = Elite angels or early stage institutions - If you’re looking for more than your personal network can provide then it’s time to step up to people who can put healthy six figure investments into a company. Examples of angels like this would be guys like Ron Conway or Jeff Clavier or groups like the Tech Coast Angels. These guys are regionally focused so you’ll have to dig around to see who’s appropriate depending on where you live. At the institutional level there are people like Josh Kopelman at First Round or Mike Maples that will put in seed rounds. There aren’t enough of these types of people out there but the number is increasing given the dynamics of the VC biz.

$1MM+ = Venture capitalists - If you need more than a million bucks then VCs are the typical people you’ll raise money from. The best thing to do here to help whittle down your list of potential funders is to closely read what their investment areas and philosophy are and (perhaps most importantly) see what they’ve already invested in. A VC that typically funding B2B infrastructure companies might not be a good candidate for your consumer facing web app. Likewise, don’t go to early-stage Web 2.0-focused VC to pitch your bio-tech investment. This seems obvious but as someone who has wasted the time of a few VCs in the past pitching them ideas that were out of their investing paradigm I figured I’d pass it along.

OK, enough for now…in the next part I’ll cover raising money through a priced round vs. a convertible note as well as common vs. preferred shares in priced rounds. If you have other things you’d like to see me cover please add them in the comments.