As a venture studio, a company that builds companies, we work closely with founders looking to build category-defining companies. We expect that the companies that we build will need to raise financial capital from us and other investors. However, raising venture funding isn’t the right route for all startups, and we’ve seen many businesses successfully grow without it.
When you raise venture funding, you give up ownership in your company. In exchange you get money and strategic advice that can be instrumental in helping you scale. But venture funding also comes with risks and challenges, so it’s important to have clarity in making this decision.
Before we dive into the details, let’s first make sure you understand the different options you have when fundraising:
- Bootstrapping – using your personal savings, revenue from your business, and, in some cases, business loans to fund the growth of your company
- Friends & Family – the term used when you raise money from your friends and family
- Angel Investor – a high-net-worth individual who provides financial backing for small startups or entrepreneurs
- Venture Fund – an investment fund, led by a team of investors, who provide financial backing for startups
- Venture Studio – similar to a venture fund, but typically provides more day-to-day support to founders. A venture studio is akin to a co-founder, providing guidance such as crafting a brand and marketing strategy, developing an initial product and user experience, and contributing operational support through legal setup, accounting and HR.
While there’s no set path to building a successful startup, many startups start by bootstrapping and then raising a small Friends & Family round.
There are many famous success stories of founders bootstrapping their businesses- such as Sara Blakely, who founded Spanx in 1998 using $5,000 of her personal savings. You assume more personal financial risk if the business fails, and relying on your personal funds may restrict your business’s growth. But bootstrapping can be a powerful avenue to getting your business off the ground.
When it's time to take on initial capital, friends and family are a great source because they know you better than anyone else – and will therefore be more motivated and excited to support you than an investor who doesn’t know you. But before taking any capital from friends and family, make sure they know of the risks in investing in a startup.
Given that 90% of startups fail, you should make it clear to them that they should expect not to get their money back.
The last thing you want is for your startup to come between your relationships with your loved ones.
These initial sources of capital should get your business to a place where you’ve validated there’s a problem that needs to be solved, and you’ve demonstrated initial demand for your solution. From there, it may be time to think about raising from angel investors, venture funds and studios. But before you do, you should ask yourself these 6 questions to determine if venture funding is the right path for you:
1. Can your startup become a $100M business within a 5-10 year period? 💰
Venture capital investors assume a great deal of risk by investing in startups that are pursuing unknown business models. The vast majority of venture-backed startups fail, so venture capital investors expect that the companies that do succeed will be BIG businesses.
Another way to think about it – for every 10 companies a venture capital investor invests in, they expect about 7 to fail, 2 to break even and 1 to be successful. For the overall fund to be successful, this 1 successful business needs to return 10x of the investor’s money.
Additionally, most venture funds have a 7-10 year horizon to return yields to their limited partners (other investors who fund the venture capital firm), so they need to believe that the startups they invest in have the potential to become large, profitable businesses in the next 5-10 years.
From a founder’s standpoint, venture capital funding makes sense if you believe that your company can become a $100M+ revenue business in 5-10 years. A common analogy in venture capital circles is, “Would you rather own a whole grape or a slice of a watermelon?” when discussing the benefits of raising venture capital funding. If your startup has the potential to scale exponentially, then venture capital funding can grow your wealth despite the dilution of your equity share.
2. Can your business scale FAST? 🔥
This question is similar to the above. If you're going to hit $100M in revenue in 5-10 years, you are going to need to scale quickly. Venture investors expect that your business can grow at least 15% month-over-month. This number is ballpark only and will vary based on industry and stage.
3. Are you ready to sell or go public in 5-10 years? 🚀
As we mentioned before, venture funds typically have 7-10 years to return money to their limited partners. In order to return money, venture funds need their companies to exit through either a sale or IPO (going public).
If you want to run your business for as long as possible, maybe even until you retire, you shouldn’t seek venture funding. While there are always exceptions, most founders do not remain as CEO of the company post-sale or IPO.
4. Are you comfortable giving away control and reporting to others? ⛵
One of the joys of being an entrepreneur is having the power to make your own decisions about your business. But if you raise venture funding, you are going to give up some of that control to your investors.
When you raise venture funding, you’ll create a board who will be responsible for major decisions about the business, including whether to sell the business or change leadership positions. You will likely sit on the board, but so will your key investors. This means that even though you might be the CEO, you are now reporting to others.
Additionally, investors are going to expect that you check in with them periodically. Larger investors might ask for weekly or monthly meetings, and all investors are going to expect regular updates about the business over email at a minimum.
But don’t worry – this isn’t all bad...
5. Would you benefit from more support from strategic investors? ✨
While raising venture funding means you give up control, in exchange you hopefully gain valuable investor support.
Remember that you pick your investors, and hopefully you pick ones who are strategic and know a thing or two. Put that to use! In addition to supporting additional capital raises, investors with expertise in your industry can connect you with operating partners who can help grow your business.
At 25madison, we’ve built and run many successful businesses in the consumer and entertainment industries. When Onda, one of our incubations that sells tequila seltzer, was seeking a co-founder, we were able to connect the team to Shay Mitchell, an actress and entrepreneur who has helped the company reach a broader group of consumers.
Investors obviously want your business to succeed, so use your monthly meetings to ask your investors for help. Want an intro to partners? Looking for helping with forecasting? Need a little emotional support to get you through a crazy week? Investors can be great for all of these things, and lots more.
6. Do you have the time, energy and knowledge to fundraise? 🐢
Fundraising from venture funds is a lot of work. In the midst of raising a round of funding, it’s typical for a founder to spend 25%+ of their time on fundraising alone. You have to perfect your story, create a pitch deck, contact the right investors, and carve out time for multiple rounds of conversations.
If you’re already feeling overwhelmed with building your prototype or getting your product into market, you may want to hold off on fundraising until you have the time to commit. Just make sure you have at least 6 months of cash runway on hand (more on this in the next section...).
You also need to go in to fundraising really understanding your business, where you’re headed and what you need to get there. And you need to be comfortable with valuation terms prior to raising capital – as in, decide how much money you need, how you'll use it, and what valuation is right.
If you aren’t quite ready to fundraise, but think you will be in the future, it’s a good idea to have pre-raising conversations with venture funds. Ask to grab coffee and keep it casual, but be ready to share the specifics of what you’re working on. VCs see on average 1200 deals for every 10 investors, so there’s a good chance they’ve explored similar concepts. These conversations are therefore a great way to get feedback on where to focus and how to perfect your story.
If you’ve assessed the above questions and have decided that venture funding is the right path for you, you’re probably wondering what comes next. This topic warrants its own article, but to help guide you in the right direction, we’ve created a checklist to get you started.
- Choose the type of funding you want to go after. Angel investors, venture funds, venture studios, crowdfunding. You can go after multiple types of funding (most founders do during their initial fundraise).
- Create your investor outreach list. Do you know any investors? Are there funds you admire? You can also browse Angel List and Crunchbase. Look for investors who play in your sector or stage. A fund that mainly invests in Series B and C software companies likely won’t invest in your pre-launch Seed-stage consumer company.
- Create your pitch deck. Check out our previous article for more on this topic.
- Determine how much runway you have left. It can easily take 6 months to fundraise. If you have a lot more runway, you may want to wait a little longer so that you can further prove out your business and raise at a higher valuation. If you have less than 6 months, you should get moving or think about different means to extend your runway.
- Determine how much you want to raise. Typically, you should raise enough capital to get you through 12-18 months. We always suggest raising a little more than you think you’ll need. A little extra money is always better than not enough.
- Set your valuation. Setting the valuation of a company determines how much your equity is diluted based on the amount of capital you raise. We usually suggest that early-stage companies let the market set their valuation. You don’t want to scare investors away by picking a valuation that is too high, or undersell your company by picking a valuation that is too low. That said, you should have a sense of where you want to land.
- Make sure you understand technical terms. Cap table, valuations, round stages (seed, Series A, Series B...), priced round, equity, convertible note, and SAFE are some of the technical terms you should become familiar with prior to entering discussions with investors.
Feeling ready? You got this. 💪
With a founding group led by Michael Lynton (Chairman of Snap and Warner Music Group), Steven Price (Founder of Townsquare Media and serial entrepreneur), and Matt Fremont-Smith (COO of Goldman Sachs Bank), we came together in 2018 to build 25madison — a venture studio that incubates companies from the ground up and invests in early-stage companies from its offices in New York City, Miami, Atlanta, and Tel Aviv. For more, see www.25madison.com.