When that first person says ‘yes’ things start to get really interesting. I remember the first time somebody said ‘I’d like to invest’ to me it actually came as something of a shock. I’d been pitching for so long and getting nowhere that I didn’t think it would ever happen — but it did.
When they say they’re interested the next few questions are very important. It’s worth being prepared and getting your head around all the investment language and jargon before you find yourself in a position where you might have to answer them. Here we’re assuming that you’re raising an equity round rather than debt or grants (we’ll talk about those another week). The basic questions are:
- How much are you raising?
- What’s the valuation?
- What are the terms?
The reason these questions are important is that ultimately they shape who will be involved in your venture and how. They also tend to dictate what happens if and when things go wrong. This is written and said many times but rarely internalised by founders: choose your investors and terms carefully — you’re going to be working with these people for 5–10 years.
Let’s take the questions in turn:
How much are you raising? Fred Wilson says that seed investment should be for, “…building a product, getting it into the market, and finding product market fit.” So the question is how much do you need to spend to do that. Don’t raise too little because you’ll end up having to ask for more but don’t aim for too much because you might struggle to close the round. Seed financing typically pays for a team of 4–7 people to work for 9–12 months on proving the venture could work.
At what valuation? The truth is that early stage companies can’t be properly valued in accounting terms so how much your venture is worth is a negotiation between what price the investor is willing to pay and at what price you’re willing to sell. Startups we’ve seen in London have raised £150,000 to £350,000 at pre-money valuations between £850,000 and £3 million (AngelList says the average for London is around £1.5 million). Generally seed investors are looking to collectively have 10–20% of the company after the deal.
On what terms? Once you’ve agreed to the amount to be invested and the valuation there’s still lots to agree on and this tends to be done by going through a term sheet. You can make your life a lot easier by using a standard term sheet such as the Seed Summit documents but still make sure you know what you’re agreeing to.
- The type of shares — for a seed deal you’d expect ordinary or ‘vanilla preferred’ shares rather than ‘participating preferred’ or anything too exotic.
- Board seats — who gets one? It’s normal for seed investors to expect one board seat between them.
- Option pool — usually this is the point when you set up a share option scheme (often 10% of the shares) for future employees.
- Vesting — most seed investors will insist that founders’ shares vest over 3–4 years, perhaps with some vesting straight away to acknowledge the time you’ve already spent on the venture.
- Legal fees — some investors pay their own fees, others insist it comes out of the money they invest (the startup pays).
There’s a trade-off between getting this done quickly or getting it done properly and finding a deal that everybody understands and is comfortable with. A good investor will educate before they negotiate — making sure you understand everything that might be in the paperwork before asking you for your opinion. Besides understanding all the terminology, you should also talk it through with someone who’s done it before and you’ll find that most founders are happy to help if you ask.
Next week we’ll look at how you go from one investor and a term sheet to closing the round, having the money in the bank and getting on with building an amazing venture.