How to Raise Venture Capital

George Doriot

Georges Doriot, former Professor at Harvard Business School, founder of American Research & Development Corporation, and the father of venture capital.

By Ryan Allis

For the history of iContact and our funding rounds, see this November 2011 article on “From Dumpster Diving to Running a $50 Million Company.”

In the last ten years, I had the opportunity to build iContact from a two-person startup to a 280-employee company with a million customers and $50 million in annual revenue. At iContact we raised $53 million over the course of three rounds of funding ($35M to the balance sheet and $18m in secondary liquidity). During the process, I learned a lot about venture capital.

One of the most important principles about raising capital, at least from my perspective, is to get as far as you can without raising capital. Oftentimes, an entrepreneur will come to me with an interesting idea, but really nothing more. He or she will say, “I just need $250,000 to get started.”

I’ll reply, “That’s great. However, before you go out and seek $500,000, which you might be able to raise after nine months of work, you’re probably better off incorporating your company, getting your domain name set up, creating business cards, getting your website going, creating a product prototype, and finding your first customers. Yes, that will probably take you a few months to do, but if you raise capital after creating an initial product prototype and finding your initial customers, you’ll be able to raise that capital to a much higher valuation than if you’re just raising capital off an idea alone.”

Instead of planning to raise $500,000 and then getting started, plan to raise $20,000 from your own savings and close friends and:

  1. Incorporate.
  2. Figure out how to convince people to work for you for next to nothing (in exchange for equity and deferred salary).
  3. Create a product or service that you can sell.
  4. Start selling.
  5. Use the revenue you are making to finance future product improvements and development.
  6. Once you get to $20,000 per month in sales (or 50,000 users in a consumer web/mobile startup), then go look for seed funding to improve your product scale up your model if needed.

It can be very challenging to raise capital until you really have a team established and a company that has a product. So it’s important to learn how to bootstrap. Bootstrapping simply means bettering oneself by one’s own unaided efforts, building something from nothing. The act of “creating something from nothing” cannot be modeled in a Goldman Sachs spreadsheet. It is the magic that entrepreneurs and entrepreneurial engineers have. This is, definitionally, what entrepreneurs do–bring together the resources of land, labor, capital, and entrepreneurial ability to create something of value that is greater than the cost of the sum of inputs and sell it to the marketplace.

It may take you a year or more to get your business to $20,000 per month in sales. That is okay. Generating revenue for your business without much outside capital is really hard. It is supposed to be. There are millions of people with great business ideas, but only a select few, perhaps 2-3%, can take their idea and execute by turning them into something that people will pay for, over and over.

This difficult process filters out talkers from doers. Most people are talkers. Investors know that investing in someone who has figured out how to create something from nothing (creating a solution to a need that people will pay to have solved) provides a much higher chance of generating a return than investing in someone who just has an idea and “needs” your money to even get started. Entrepreneurs who simply “can’t” get started on anything until they get lots of funding must learn to become much more resourceful and figure out how to pull together an initial product that customers will pay for or at least a prototype that proves there is demand.

Once you get to around $15,000 per month in recurring revenue, it will be so much easier to raise equity funding. Don’t wait until you are there to start building relationships with investors—but do wait until your business has existing revenue before you actually ask for their money. You will receive much better terms and give up a lot less control and ownership. Firms like Instagram that sell for hundreds of millions of dollars without generating revenue are extraordinarily rare and unfortunately have the side effect of inspiring lots of companies to get started and invest time in a product that has no way of generating revenue.

How to Bootstrap at the Beginning

At iContact, we bootstrapped for the first three years, from 2003 to 2006. I met my business partner Aaron in October of 2002 at the Carolina Entrepreneurship Club’s first annual meeting at UNC Chapel Hill. We began working right away on turning the his Preation list builder into IntelliContact which later became iContact, an email marketing software program.

In the summer of 2003, after my freshman year, I decided to live in the office, sleep on a futon, and cook on a George Foreman Grill. We did everything we could to keep our expenses low while we built up our revenues, built out our product, and built up our customer base.

At the end of my first year of college, I had saved $12,000 and I was living on about $1,000 a month between my car payment and food. I didn’t have to pay rent as I was staying in the office. I lived on that $12,000 I’d saved, and both Aaron and I deferred our salaries for the first three years. It was a great moment when we got to a million dollars in sales three years later, which contractually stipulated that we would get paid the salary that we had deferred.

Learning how to bootstrap—how to live on just a little—is very important to entrepreneurial success. Because we bootstrapped for the first three years, when we finally did raise capital, we were able to raise it at good terms. That’s what enabled us to control the company and direct it for years to come.

In the beginning, do whatever it takes to keep costs low and make as much progress as you can on as little capital as you can. Even if you have to use some personal funds or funds from friends and family, keep your costs to a minimum and get along the path towards success before you go out and raise angel capital or seed investment capital.

Pre-Selling Product Through Kickstarter and Indiegogo

A new trend is pre-selling your product on Kickstarter and Indiegogo as a way of raising money for your firm. Kickstarter usually only allows technology/hardware products. If you are building a technology/hardware/art product go with Kickstarter. Otherwise, check out Indiegogo. Pebble pre-sold $10.5 million worth of watches in 2012 through Kickstarter. My friend Lisa Curtis pre-sold over $50,000 in nutrition bars to launch her company Kuli Kuli. The downsides of crowdfunding campaigns include having to reveal a lot about your product to competitors months before you’re ready to deliver and that you are then tied into a promise to deliver product at a pre-paid price before you are sure what your unit costs will actually be. The upsides include a relatively easy way to raise $20,000 or $30,000 to get your first sales, find press, and attract new team members into your business.

AngelList, Fundable, and WeFunded

Recently, a new wave of sites have come out following the passage of the JOBS Act in the United States that allow individuals to invest directly in private companies. You can now raise money for your startup online using AngelList, Fundable, and WeFunded. There were over 1,900 startups currently raising funding on AngelList the last I checked.

When You’re Ready for Outside Capital

After you’ve bootstrapped for as long as needed to develop your product and prove that users are actively using your product, you are ready for capital. Or you may come to a point where you just can’t get any further without some additional expenditures—whether you need to pay people or purchase certain intellectual property licenses or purchase hardware. When this moment comes, where you look for capital depends on how much you need and how far along you are.

Where should I look for capital? This is a question I often get asked by aspiring first-time entrepreneurs. So I created what I call the Green Matrix, which shows where to look for capital, depending on how much you need and what stage you have reached. If you’re looking for less than $25,000, credit cards, your personal savings, friends and family are great places to start.

A Chart of the Various Forms of Capital Available At Each Stage of Your Company

A Chart of the Various Forms of Capital Available At Each Stage of Your Company


Some people say, “Well, I’m just starting my company and I’m going to apply for a $10,000 loan from a bank.” What we found at iContact and what most people find is that unless you have an asset to securitize that loan, to provide collateral in case you default, it’s often very difficult to get a loan until you have revenue.

Once you have revenue, and especially once you have profits, banks will lend you a lot of money. As the saying goes, money is only available when you don’t need it. Banks are often the most conservative institutions, which we appreciate when it comes to being able to safely deposit our life savings with them. But that doesn’t help startup businesses. So initially you’ll need to turn to credit cards, your savings, and your friends and family.

Angel Investors

Once you’re looking for more than $25,000—which might be after you’ve built your initial product prototype and you have a couple of employees who are working for sweat equity—then you can start going out to what are known as angel investors and super angels.

Angel investors are high net worth individuals who will invest between $25,000 and $500,000 in your company in exchange for an ownership interest. That can be done through an equity investment or something called “convertible debt,” which is a short-term loan that is turned into equity if and when the company raises further venture capital in a Series A offering of shares through an institutional firm like a venture capital fund.

Super angels are just super high net worth individuals. Whereas most angels might be hard pressed to put in more than $50,000, I’ve seen super angels who are able to invest $500,000, or even $1 million, in a venture. These are often people with significant assets who can put up that kind of money, knowing that it represents only 1% or less of their total assets.

Getting to know those super angels and angels is often quite difficult. It takes an investment of time spent networking in the community, talking to other entrepreneurs who have been successful in raising capital and building relationships with them. You can also go to venture capital conferences or  other gatherings that bring together investors with entrepreneurs. Incubator programs like TechStars or Y Combinator are another way to connect with angels and super angels. Angellist is one of the best ways to share your pitch directly with high net worth individuals.

Venture Capital

Once you have raised your seed round of funding and perhaps gotten to the point where you have your product and have users or even have customers, and you’re ready to raise half a million dollars or more, that’s when you can start going to early stage venture capital funds. This is what is known as your Series A round of funding.

As you go into your second round or third round of funding, your Series B, and you need between $5 and $25 million (known as growth stage venture capital), then mezzanine debt opens up to you.

Once are five or six years in to your growth, you have built out your product and generated more than $20 or $30 million in revenue, and you’re looking for more than $25 million, going to late stage venture capital funds and private equity shops is often possible.

If you ever end up needing more than $50 million, which will only happen if you’re trying to do something very technologically complex or if you’re a large publicly traded company, then you can go to large private equity funds or public markets like NASDAQ and the New York Stock Exchange and sell shares to the public in exchange for investment in your company. You can do a private investment in a public entity or a pipe through an investment bank or you can issue corporate bonds, which are interest-bearing notes from large companies, through an investment bank.

Regardless of where you seek capital, a rule of thumb that I think is an important one for most companies to follow is: do your best to avoid raising too much money. Where I draw the line, when possible, is: don’t raise more than your current annualized revenue.

Of course, that may not be possible before you have a product. You might need $100,000 or $200,000 before you can actually get to the point where you have any revenue—maybe even a little bit more. But once you have some revenue, then I wouldn’t raise too much more money until you have gotten your revenue increased.

What We Did at iContact

At iContact, we followed the advice I’ve been sharing here. We bootstrapped for the first three years. Then in 2005, when we had $1 million in revenue, we raised $500,000 from IDEA Fund Partners in Durham, North Carolina. In 2006, a year later, we had grown our revenues from $1 million to a little over $5 million and we used that initial capital to ramp up our online advertising and really build out our executive team. Then we went out and raised $5.3 million from Updata Partners in our Series A. So we had our seed round from IDEA Fund Partners and then our Series A from Updata Partners and we still had followed the rule about raising less than 1x our annualized revenue.

In 2010, when our revenues were just over $40 million, we raised a $40 million round of funding from JMI Equity. Some of that round went to early shareholders and investors, and most of that round went to the company itself. All together, along the way, we raised a total of about $53 million. In 2012, when we sold the company to Vocus, we were at about $48 million or $49 million in revenue.

By following this rule of raising no more than 1x our current annualized revenue as we grew, we ensured that we maintained control of the company. This allowed us to have leverage and negotiating power as we structured and negotiated each of our term sheets with the three or four investors that we had.

Your Negotiating Power

Your negotiating power is based on a number of factors, such as your level of need for the money; your previous business experience and success; the people around you and their experience; the quality of your advisors; the product and technology; the market; the competition; and particularly the competition for your funding (if you are considering multiple term sheets, oftentimes you can greatly increase the valuation and greatly improve the quality of those terms).

Whereas it might be fashionable to go out and raise a $10 million round of funding before you even get started, and it might even be attractive if you could raise that $10 million on a $10 million valuation and only give up half of your company in order to get to the point where you can have all that money in the bank and be able to start generating a number of jobs and employees, I often advise people to wait in the first couple of years. Get your product to market, get user feedback, improve it through rapid prototyping, and get to a minimal viable product first. Too often I see companies raise $10, $20, $30 million before they even have revenue or before they even have millions of users. I encourage you to avoid that if you want to control your company and control your own destiny.

Term Sheets

When you receive an investment proposal from a venture capital fund, you get what’s called a term sheet. A term sheet is a summary of their desire to invest in your company and the terms at which they want to invest. The most important terms on the term sheet include: valuation, option pool size, liquidation preferences, founder revesting, veto rights, the type of preferred stock (whether it’s straight preferred or participating preferred), and the number of board seats. I’ll explain each of these terms below.

Many entrepreneurs think that valuation is the most important term and that the highest valuation is the best valuation. What I have learned, in my experience as an entrepreneur, is that while valuation is an important term, it is only one of many important terms. You shouldn’t simply take the term sheet with the highest valuation on it. There are often other terms that end up affecting the true return of the investors and the true cost of capital for your firm. And you need to factor in things like firm reputation, firm access to IPO markets, and firm experience in addition to the terms in the term sheet.

Terms in a Typical Term Sheet

Let’s briefly go through each of the key terms you’ll find in a typical term sheet.

Valuation is simply the price at which a firm is going to invest in your company. If they’re investing $5 million at a $10 million valuation, they’ll end up owning approximately one-third of the stock because they invested $5 million in a company that’s now worth $15 million.

Option pool size is the amount of additional stock that the venture fund requires you to create in order to provide incentive structures for future employees that come into the company. For an early stage company in their early stage investment, a venture fund might require an option pool as high as 15 or 25%. In later stage investments, particularly once you have revenue and you’re going after your Series B or Series C, the option pool requirements are more typically in the 1-5% range.

Liquidation preferences simply means that in the case of company liquidity (in other words, if the company goes bankrupt and the remaining assets are turned into cash), who gets those assets first? Often, liquidation preferences are for dealing with the downside scenario. In a capitalization table (or capitalization chart), which is simply a chart of accounts for who has put money, in the form of equity and debt, into a company and who owns shares in that company, often the debt providers are senior to the equity providers. What that means is that in the case of bankruptcy, the people who provided debt (the creditors) get their money out before the people that provided equity. For most investors, it’s important to be as high in the cap chart as possible. So they may want to make their investments “preferred investments,” which are senior in the cap table to common investors who have have common stock, typically the employees of the company. It’s important to pay attention to this question of who gets their money out first as you negotiate your term sheet.

Founder revesting of shares is also an important term. When you, as a founder, work at a firm for a number of years, you often earn your equity over time. When you provide options and stock to employees and to founders, often you’ll provide it over the course of four years. For example, if you were to be earning 40% of a company’s stock over four years, you’d probably get 10% every year, on a monthly or quarterly basis. But sometimes, investors will restart the clock on your vesting of shares and force you to revest. In many cases, I find that to be unfair to the founders who have already earned part of their shares.

Veto rights are another important topic to look at and negotiate carefully. Veto rights are simply what an investor can say no to and what they can stop you from doing. It’s common for investors to have a veto right on something like the sale of the company or the issuance of a lot of new debt. But you pay careful attention to what they can block, particularly if there is a block on a merger or acquisition. You don’t want a minority investor or shareholder to be able to block a deal that’s beneficial to the large majority of your shareholders.

Type of preferred stock is another term you should pay attention to. There is “straight preferred” and there’s something called “participating preferred.” There’s a world of difference between these two in terms of how much return your investors get and how much your capital costs. Make sure you read up on what “participating preferred” means and try to avoid it. Stick with “straight preferred” as much as possible.

Number of board seats is the final term you need to be aware of. Board seats are critical in terms of control of the company. If you have a five-person board of directors and you, your co-founder, and someone you know and trust have three of those five seats, then effectively you control the company, particularly if you, as the majority owner of common stock, can appoint those seats.

When you start raising investment, however, investors may want one or more board seats depending on the amount of money they’re putting in. You need to be careful because if you give up the majority of the board seats or, more importantly, the majority of the rights to appoint the board seats, you will end up being at risk of other people besides yourself being able to make decisions in your company, and even let you go as CEO. Particularly if you’re a first-time CEO, be very careful about giving up board seats. The last thing you want to do is put years into building your baby and then allow some investors who don’t see eye to eye with you to let you go from your own company.

Factors Outside of the Term Sheet

There are some other factors, besides on what’s the term sheet, that you should consider when selecting investors.

Partner Chemistry. One of the most important factors to consider is simply your ability to get along with the venture partner—you chemistry, so to speak. The partner, in this case, is the person who’s going to be joining your board of directors, and who is going to serve as your chief mentor during this process. Raise money from smart people you really like because, ultimately, you’re going to be more or less married to them in a business sense for the next three to ten years, until they get their money back or you go bankrupt.

Partner’s Operational Experience. You also want to look at the partner’s operational experience. In most venture capital funds, the partners tend not to have operating experience. What that means is that they haven’t run a business or even been part of C-level team. They’ve simply been investors, financiers. And while investors do gain valuable experience through being on the boards of many different companies, if they haven’t run a company they can’t understand what it’s like to be an entrepreneur and therefore they won’t understand the nuance of the important components needed to mentor a new entrepreneur.

I’d encourage you to only take money from partners who have operational experience. Or, if you’re taking money from a fund that has some partners who have operational experience and others who don’t, make sure that the partner joining your board has operational experience, at least the one who’s going to be serving as your primary mentor.

Portfolio Alignment. You also need to consider your alignment with the fund’s other investments, known as their portfolio. Are there firms in their portfolio that you could partner with or potentially sell to someday?

Successful Exits. Pay attention to the history of successful exits from the firm and specifically from the partner that’s going to join your board of directors. How many exits north of $100 million has that partner personally been part of? How many exits north of $100 million has that firm been part of? If you’re looking at raising capital from a fund that’s had fewer than ten investments turn into exits north of $100 million, then that firm is either very new or they simply are not a good firm.

Network. Look at the venture capital firm’s network. Building your team is the lifeblood of your likelihood of success. So it’s important to work with funds and firms that have a network of operational executives at the CFO level, the COO level, or even the CEO level who they can bring in to help your company grow.

Negotiating Your Valuation

Let’s talk about valuation guidelines for a pre-revenue company. A valuation can range all over the map, depending on many factors. At a tech company, a software company, or a life sciences company—the kind of company that has huge potential in the future—a pre-revenue (that is, before you get any users, customers, or revenue) valuation might be between $1 million at the low end and as much as $25 million at the high end, depending on factors like the CEO’s past exits and results, the team experience, the size of the current user base, the number of engineers in the company, and the location of the company.

When it comes to valuations, the old adage “location, location, location” is all too true. If you’re in Silicon Valley, between San Jose and San Francisco, valuations are often double what they are in other parts of the world. Location is not just a matter of what’s trendy. Being in the right location is critically important because it enables you to attract better employees and executives and offers you better access to IPO and M&A markets. In areas like Silicon Valley, firms densely congregate in a way that enables you to have a much greater chance of eventually exiting the company.

Here are a few a sample valuations.

  1. Our first company is a business-to-consumer type of company run by a first time entrepreneur with one engineer. Their pre-money valuation is going to be pretty low, between $1 and $2 million. That doesn’t necessarily mean that company is worth $1 to $2 million, that simply means that some people may be willing to invest at that valuation in order to take a chance that their company would be worth much more in the future.
  2. Our next example is a company run by first-time entrepreneurs, but these founders have been through a good incubator like Y Combinator. They have a great idea and a couple of engineers. In the six months it might have taken them to go through the incubator and refine their idea and get an extra engineer, they may have more than quadrupled the value of their company. Many companies will get stuck in the first six months and end up going nowhere. Having made it through that phase, this company can raise money at a valuation of $4 to $8 million, even though they are still in the pre-revenue stage.
  3. Our next company is run by an experienced CEO who has ten years of C-level executive experience, has already had an exit north of $100 million, and has five engineers already working. Now we’re talking about a pre-money valuation in the $10 to $20 million range—not because the company is necessarily worth that much today, but because many people will take a risk that this entrepreneur will be able to build a company to be worth much more than $10 million or $20 million in the future, and therefore might invest $10 million on the $20 million valuation for a one-third ownership in the company.

Post-revenue guidelines are, of course, different than pre-revenue. Oftentimes they’re based on revenue multiples. That revenue multiple might range from 1x at the low end to 12x at the high end, depending on factors like the amount of revenue; the revenue growth rate; the number of users and customers; whether the revenue is recurring revenue, services revenue, or product revenue; the experience of the team and CEO; the market you’re playing in; and the location of your company.

Building a Pipeline of Investors

As you go about your fundraising, generally you want to create a competitive process. To do this, you need to build a pipeline of potential investors and have a number of meetings (as many as 20 or 30 meetings within a period of two to three weeks). You may need to have initial meetings six to nine months before you’re really ready to run your process and then have those meetings again when you’re ready. You want to build your funding process to ensure that within the period of a week, you will receive multiple term sheets.

Typically, when you get a term sheet, it will only be “enforceable” or valid for a few days, so you need to drive different firms toward the same timeline and create a competitive process so that you can increase your valuation and get better terms.

When you begin negotiating valuation, as you receive term sheets, you need to have comparables fresh in your head—valuations of firms that are similar to yours. Look for companies that have had similar venture capital deals, exits, and M&A deals, and that play in a similar space to yours. If you’re at the point where you have revenue, look for companies with similar revenue multiples and profit multiples. If you’re pre-revenue, look at similar venture deals that the particular fund or other funds have done in your area.

While you consider all these factors, remember that you don’t want to take a valuation that’s too high. That’s a mistake I’ve seen many entrepreneurs make. When they have a choice between raising capital on a $20 million valuation or a $40 million valuation, there’s obviously a huge temptation to raise money at the much higher valuation, because then you give up less ownership in your company and you’re diluted less. However, when you raise money at a an overly inflated valuation, what can happen is that the pressure coming from your investors to produce a return for the limited partners and general partners in their fund ends up creating a stressful environment in which you can’t be productive. So while it is good to maximize your valuation and create a competitive process and get great terms, don’t push your investors too hard to increase their valuation. Otherwise, when they get to the other side of the table, you’re suddenly going to find investors who are under a lot of pressure, and that won’t make your life easy.

Know Your Customer Unit Economics Before You Raise Institutional Money

It’s important to calculate your unit economics before you raise multiple millions of dollars of venture financing. You want to figure out how much it costs (in advertising, etc) to acquire an additional customer. If you take your total ad spend and divide that by your total number of new customers per month, that is your customer acquisition cost.

As I’ll discuss in more detail in the next section, How To Acquire Customers, when you understand how much it costs to acquire an additional customer and how much it costs to produce an additional unit of whatever you’re selling and how much revenue you earn from that customer over that customer’s lifetime, you’ll be able to be ready to raise venture capital at Series A or Series B level because at that point you’ll to know that, for example, every $10 of investment will generate $50 in revenue and it will be worthwhile use of capital.

To summarize my key advice on raising capital: Wait to raise your Series A until you have revenue that is growing predictably each month. Raise just a small seed round until you have proven mathematically that a certain amount of investor dollars will amount to a multiple in dollars back. Don’t raise money until you know how you’re going to use it and you’ll end up controlling your destiny and controlling your company and being able to be much more creative with a lot less stress in your life.

At the end of the day, equity capital, or venture capital, is the most expensive type of capital you can raise. So only raise what you need and make sure you know what you’re going to use it for before you take it on.

Video on Raising Venture Capital

Slides on Raising Venture Capital