December 21, 2020

How to Raise US$1.35M pre-seed round for Your Tech Startup During a Pandemic (A Venture Finance Academy Case Study – Part 1)

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December 21, 2020
By Aery Advisors
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Welcome to the first part of the case study of how SaaS startup SanityDesk raised US$1.35M of pre-seed funding and the sources it used to do this. It’s a classic story of doing the necessary strategic work before setting out to raise money. If you missed the introduction part about this case study, please click here to read it.

But first of all, what exactly is venture finance? Well, it shouldn’t be confused with venture capital. In fact, venture capital is just one element of venture finance – and a relatively small part, too. For every 1,000 companies in USA, only 3 raise venture capital that is just 0.3% of all companies actually receive venture capital.

The term venture finance conflates a number of different types and sources of capital. It’s like if a tapas bar specialized in serving venture finance, it would have a number of different options on the menu and you’d choose what was best to help you launch, finance and grow your venture. It could be one dish or a combination.

A spicy crowdfunding dish? A salad of angel or superangel? A side order of government grants? A barbecue corporate VC?

In the case of Sam Cook, co-founder and CEO of SaaS startup SanityDesk, he chose several different types and sources to raise his $1.35M (and counting) pre-seed round. In Lesson 1 of this case study, we will explore the 12 most common forms of venture finance, and explain why and where and when they are most likely accessed.

We will also illustrate how Sam fared when he focused on raising venture finance from different types and sources of capital, first in Ukraine, then in the UK and finally in the USA. Soup to nuts, this is how it works in real life.

If you prefer to digest the case study PART 1 in video format, please click on the picture below:

If you prefer to digest the case study in written form, please continue reading below:

Samuel Cook

Welcome to the first lesson about raising money. I want to just go quickly through the sources of capital. I've got a list of all of them here. If you just talk through them – you don't need to say a lot about each one, but just a couple sentences on each one. And then what we'll do is I'm actually going to go through how I actually applied these principles. We have some funny stories about trying some of these different ones and settling on the right route, which turned out to be the more traditional one anyway. 

But there are a lot of different sources of capital out there. And a lot of people could potentially go down the wrong road if they don't look at all of them. Let's go through that and dive in. 

Brad Furber:

First of all, I don't want to say that this is an exclusive list. What we teach in the masterclass is about 10 or 12 different common sources of capital. The first one is friends, family and fools. 

Actually, I had someone get offended by that. Like, why are you insulting people? The concept of friends and families is pretty obvious. You want to start a business and it's going to take some money. Maybe you don't have enough personal savings. And so you turn to the people that essentially either love you or like you, and those might be the people who initially say, “Don't do this! Don't quit your job. I mean, seriously, this is crazy.” But once they decide, “Okay, you got to give it a go; we're going to support you,” the friends and family will usually give you capital on better terms. But actually, ironically, sometimes they give you capital on worse terms.

Samuel Cook

Because they don't know the game as well as they should.

Brad Furber:

And it’s problematic for future investors. The fools are basically people that aren't real angel investors. Maybe it’s their first time. Maybe it’s their first time trying to get into the game. You've talked them into it. I had a few of those. It's a little bit of a disrespectful term, but it's basically somebody who's not necessarily your friend or family who decides nevertheless to place this very risky bet on an unproven company. So that's one source. And frankly, in terms of where people get their initial capital, that's by far the largest source. Or self-generated. 

In the last 10 years or so, accelerators have proliferated. There's thousands of them. And the traditional accelerator, like Y Combinator, is the most famous. But there's a bunch of them. 500 startups in Europe. I was involved with one called Startupbootcamp, which has these things all over, but there's a bunch of them. Before Covid-19, you would apply and they would pick maybe 10, maybe 20 or 50 cases.

Everybody then had to come together in a physical location and you go through a defined program of maybe 12 weeks. The accelerator usually gives you a little bit of money. Then at the end there's a demo day where theoretically they're going to invite all these mentors and networks and investors. Some are better at it than others. And hopefully at that point you would be able to close a round. That's the idea. 

Now incubators are a little different because they might be like a coworking space. I've heard some people say the difference in incubators is like a little baby incubating, whereas the accelerator's like a rocket ship, which is kind of cute. But I would say the difference is really that the incubators don't necessarily have a beginning or an end. They have maybe access to shared services, mentors, and that kind of stuff. Legal accounting – all kinds of stuff. But there's no necessary beginning or end. 

And incubators typically don't take equity. I mean, some of them do, but they typically don't. And a lot of these incubators are supported by governments. So the governments will subsidize. It’s very common in Europe, actually. 

Now one other thing that you don't see as much in the States, but you do see here in Europe, is basically free money. 

Samuel Cook

There's a lot of grants. What I've noticed living here for seven plus years is that they're very insecure as a continent about their lack of big success in tech compared to the Americans and now the Chinese coming up with TikTok and other stuff. Europeans know they're behind on the big tech arms race. And the governments are throwing a lot of money down to try and bridge that gap. But they're still struggling at this early stage and it's free. It's literally free money. You got to fill a lot of paperwork and there's all kinds of people making money, helping you out.

Brad Furber:

The other thing I've noticed up in the Nordics is that Finland had an incredibly generous program. This is right after Nokia sort of imploded or whatever – sold their business to Microsoft. There was a ton of money to support Finnish entrepreneurs and they would get about 400,000 or 500,000 euros. That's actually a pretty nice little seed round. This was eight years ago. 

So you ramp up your team and your overhead and you just run out of money. That's scary, right? So you've got to be careful about that. Switzerland has amazing programs with increments of say €150,000 to, say, €750,000. The USA also has some and they're called SBI grants. That's through the small business administration. So that's another way you can get your company off the ground. 

We’ve covered friends, family, accelerators, incubators and grants. At some point, you might decide to pitch to angels. Angels are a little different than friends and family in that they actually have some experience. They're professionals. And so they've mentally said, “Look, I want to be a business angel.” And some of them might say, “Look, I have a strategy and I'm going to do 10 angel investments.” Usually, angels have some other business. So why do angels like to do it? They're intellectually curious. They like to work with entrepreneurs and be like the casino.

And they've said, “Look, this is an asset class that I'm willing to devote maybe five or 10% of my net worth to” and they will frequently band together with other people who they like or respect. And maybe they'll place 10 bets. And as a portfolio, they're hoping that at least one or two or three are going to give them a 10X or more. That's a strategy. 

Then you have the super angel. So what's the difference between a super angel and an angel? Well, beauty's in the eye of the beholder. But I would say, objectively speaking, a super angel is somebody that just has access to more capital and bigger checks. Bigger capital. And is also somebody that can essentially act as a lead. Super angels can pull in other people. It’s like, “If so-and-so's in, they're smart money. I know they do the due diligence. They're writing the check. We're going to be the sheep to that shepherd.” And so a super angel is like a shepherd. 

Then the next step up the food chain would be micro VCs. Micro VCs are something that have popped up in the last 10 years or so. I would say a micro VC is structured like a venture capital firm. That’s to say, it's an entity. They have limited partners. They have some kind of a management fee and carry that's negotiable. But the size of their fund is say 50 million, maybe a hundred million. In the US, I would say anything less than a hundred would be micro. Maybe here in Europe, anything less than 50 would be a micro.

If you look at just the economics of the venture business, operating a venture firm under any traditional venture, you have to be pretty lean, right? But those micro VCs would play an important role because they can basically top up the angels and kind of get you through the pre-seed/seed rounds. That's kind of where they play. They might even play in the round, but probably not. 

So today's seed round is kind of like the old A round because all the angels, super angels and micro VCs have taken up the pre-seed/seed. Now, the traditional venture funds, which can be anywhere from say a hundred million to several billion or more in assets, are looking at the A round and also the metrics.

What do you have to do in order to get the seed or the A? To get an A round, it's kind of like what it used to be to do a B round. I mean, you’d better have a proven business model and the money is going to be used to scale. Whereas in the old days, maybe an A round was more like a seed round. That's traditional VCs. 

Next is corporate venture capital. What is it and what isn't it? So if a corporation, for example, invests in a traditional VC firm, that's not corporate VC. Corporate VC is when they take capital off their own balance sheet and invest directly in a company. Like Google.If Google Ventures is corporate venture capital, they actually created a separate entity. That entity has an investment thesis and they make investments like a VC fund, but its limited partner is Google Ventures or Intel capital. 

Corporate innovation is different in the sense that it may not even be an investment. And so a lot of corporations, for good reason, are scared – as they should be – that somebody somewhere is sitting in a garage and they're going to come up with something completely disruptive. And so a way for them to keep a finger on the pulse. You could even call it corporate espionage. They will, for example, sponsor corporate innovation challenges. Which is great. Entrepreneurs who might need access to, for example, distribution. It could be an inventor, who's got the next best thing to slice bread.

Do they really need to create a company, capitalize it and try to build a startup? Or can they, for example, work with the company together as kind of like an R&D venture and maybe help that company innovate? Those sorts of things can be pretty interesting. Sometimes they'll just sponsor an accelerator. 

Down in Australia, Telstra, which is the big telco, sponsors an accelerator and they basically just create this co-working space and put their imprimatur on it. It's an accelerator sponsored by the corporation. And in a way it's good for the community. But you know, is it really strategic? And the big banks down in Australia all have their corporate venture capital deal. 

Samuel Cook

And then you have venture leasing and venture debt. How's that different?

Brad Furber:

So venture leasing has been around for a while – venture lease and venture debt. That's where usually a startup doesn't qualify for traditional bank lending. But maybe it's a startup that is going to need to acquire equipment, even furniture. You can go to these specialized lenders who will say, “Okay, I will give you some debt and they usually get an equity kicker. That's venture leasing. It's a way to essentially extend your runway a little bit.

Samuel Cook

And that also leads into revenue-backed notes.

Brad Furber

Yeah, revenue-backed notes. This is becoming a bigger deal, especially with the SaaS companies. If you have a predictable revenue stream, there are sources of capital that will say, “Look, you don't need to sell equity.”  It's not factoring, where you sell the receivable. They’re basically saying, “We will give you access to capital based on this steady stream of revenue.”

Samuel Cook

That's why subscriptions are so powerful and they're almost considered an asset class now.

Brad Furber

Oh yeah. It's a steady stream. It's a predictable stream. So that's actually a pretty good way to extend your runway. 

In fact, I missed the whole crowdfunding thing earlier because, you know, that was part of your story. You know, people have been hoping that we can democratize angel investing and so all around the world, there has been this clamoring for crowdfunding. And when you think of crowdfunding, you can think of it really in four buckets. 

One is just a pre-sale on a product. Sort of the Kickstarter thing. One is really almost sort of a philanthropy thing like a GoFundMe campaign. Then you've got actual crowdfunding equity. And then lastly, you've got crowdfunding debt. So within those four different kinds, the equity crowdfunding thing is one that, honestly, I've been a bit of a skeptic about, because I'm worried about how many shareholders you want. But we can talk about that because that's part of your story. 

Samuel Cook

And finally, we have ICO/STO. Then we'll go into my journey through these with you.

Brad Furber

When I first moved to Switzerland in 2017, this whole ICO boom was happening. People were asking me as a securities lawyer about initial coin offering and I was like, God, “I don't know.” Basically there was a lot of hype and I think about $20 billion was raised, frequently not in compliance with securities laws. But the idea is a great idea: the initial coin offering. It's just that the coin gives you some utility usually and these are blockchain. They were really being marketed as investment contracts.

Because of that, in many jurisdictions, especially the United States they didn't comply with all regulations. Security token offerings are different in that they're usually backed by a real asset and everybody accepts that as a security, as the name would suggest. In fact, it's a security. The ICO was kind of like a form of crowdfunding if you really think about it. 

I think this is actually a really interesting area. I'm bullish on it long term. But the market kind of got ahead of itself and needed some more regulation. And that's the other thing that's been really interesting. I've been a speaker and attended a lot of these blockchain and crypto events all over the world. A lot of the jurisdictions are thinking, “Oh, hey, how can we get ahead of the game? How can we become the crypto nation or the crypto valley or whatever.” And the United States is kind of slow. So there are certain jurisdictions that have jumped ahead, Switzerland being one. Liechtenstein. Malta. 

Samuel Cook

The US is also slow on the crowdfunding compared to Europe and the UK. So true. So the securities exchange commission in America is very conservative compared to other parts of the world, but ironically America still has the best environment for raising money. But just because it's got such a deep angel network/super angel/micro VC.

Brad Furber

Yeah. The US just amended its definition of an accredited investor. So an accredited investor historically has been somebody who has a net worth, excluding their home, of a million dollars – or a net income for the last two years. And, this year, exceeding $200,000 or together with your spouse $300,000. So what that really did is: it, it kind of discriminated against people that didn't have that. You either didn't have the net worth, or you didn't have the income, but you still want to be involved with startups. 

And so now they’ve basically said, “Okay, even if you don't meet those conditions, you're a sophisticated person and you know what you're getting into. You can qualify as a credit investor. Why is the US so concerned about this? You've got to go all the way back to 1933. There was the Great Crash of 1929, where a lot of people were wiped out and people were investing in all kinds of crazy stuff. And so the SEC said, “Look, our mandate when they drafted the ‘33 and ‘34 act is to protect investors from making stupid decisions.”

Samuel Cook

Protect investors from themselves. 

Brad Furber

Getting back to the high failure rate for startups: it’s that people who can't afford to lose the entire investment shouldn't be playing in this game. And so it's, it's kind of a nanny state thing. But the government is basically trying to protect you from doing something crazy. 

Samuel Cook

They also want to protect the market from having too much capital, maybe misallocated towards something and creating a bubble type environment, too. That also protects,

Brad Furber

I think that's it. I think it really is a nanny state thing. People who are sophisticated know that, because of the high failure rate, people can't afford to lose a hundred percent. If, let's say, your net worth is a hundred thousand and you invest 50,000 , and your chance of it going to zero is 80% – I mean, as a father, if my son said, “Well, that's what I'm going to do,” I would say, “That's probably not a good idea.” I mean, you do it if you want to, but I think the SECs mantra is investor protection. It's not about helping entrepreneurs necessarily raise capital. 

Samuel Cook

The theory and all the different sources is great. And I just wanted to share with you some of my learnings from this. 

I actually came to you May of 2019 and said, “Hey, I just had a really interesting offer from a guy who said he would take a percentage of my revenues in order to promote me.” And I felt like, Wow, this sounds like a great deal. And I came to you and we organized a call. And this is when I hired you to become my advisor. And I thought, “Ah, this is, this is great.” It's just going to take a little cut of my revenue: 10% or whatever it is. And we got on one call. And I remember when we got off that call, you basically said, “Run for the Hills! If you take this money, no one else will ever invest in your company.” And I remember I felt like an idiot because I didn't know any better. I thought it was a good deal. This is why I was so glad I hired you.

Samuel Cook

Well, that was a crazy deal. He wanted 10% of your revenue from now to forever. I'm like, who's ever going to finance that company, seriously?

Samuel Cook

What he did have was he was able to put people on stage. His business model was to pump a bunch of business their way and always take a cut. But what I found fascinating was how quickly you just said, “Hey, just get the heck out of there.” And, you went to lighter capital, which is a reputable revenue-backed financing that has a cap on the amount of money they take. And we were going in there very serious. We had something put together and he was just like, “No, this is the way I do it.” And we cut that off pretty quick. Yeah.

Brad Furber

That was a frolic and detour. We took the call and he just said that it was pretty much what I expected.

Samuel Cook

That right there was worth the price of admission. It just saved me from basically becoming unfundable, aside from a captive. I was living at the time in Ukraine with my company, James Cook Media, where we were self-funding. I think the first 600,000 of our product was built internally from the media agency.

So I had a meeting with a traditional VC. They said, “Hey, we liked the fact that you have a product and you have revenue, but we could care less about your revenue. You are a media company; you're not a tech company.” So I started to get this idea, which we'll get into in part two: house in order.

So then you said, “Well, let's start fishing where the fish are.” I went to look into the UK market because I'm half English. I have a British passport. I'm also half American. And I went to crowdfunding. In the United Kingdom, there's a very sophisticated and well-developed crowdfunding network. And it looked really promising. But when we started to dig into it, the crowdfunding team actually said to us, “Well, yeah, you're going to get your round filled, but you need to bring in half of the round yourself.”

Okay. You need to pre-sell the deal. And I thought, “Well, isn't that what you're for as a crowdfunding?” And they said no. Well, these are momentum plays. What happens is: you bring in money and then all the sheep follow what they think is smart money and you know, crowd. So I realized that while crowdfunding looks great on paper, I just realized I had to go looking for angels. A lot of work.

Brad Furber

It's a lot of work. At that time you were thinking of 600,000 and you were going to have to come up with 300,000 pre-sold and it was a lot of work. It's like, “I think you should keep going less, young, man.”

Samuel Cook

So then it went to, “Okay, let's go to the angel route and because I'm an American we actually looked into it harder. Even though London's closer and an easier flight from Ukraine, I had the advantage that I was a military officer in America. And you said, “Hey, you know, that's actually good on your resume in America when you're trying to raise money.”

 And we'll talk about that a lot more in point number three, about creating a compelling offer and going to market. I was going where the fish are as you'd like to say. So I tried a couple of different routes and the thing that was so powerful about working with you on this, Brad, was: I had a little frolics out there and to revenue-backed financing and crowdfunding, but very quickly you just said, “Hey, come back. You need to go to the States and fish over there because you're from there. You've got deep connections there from your military background.

Brad Furber

And the new business model. You were willing to separate the tech startup part. That's the ‘house in order’ part. It's a different deal. So at that point you had mentally said, “I'm willing to make that division.” You hadn't done it yet, but you were willing to do it.

Samuel Cook

Yeah. And next I found an angel who wanted to be an incubator, but ended up not being. He gave a lot of advice as a lot of angels do. I didn't really meet the incubator business model so he ended up just becoming an angel. And then I had some friends and family and fools And then a couple of people for whom I was their first angel investment. Pretty smart guys who definitely knew the potential and the product. But first-time angel investors. 

Brad Furber

The key about those guys is they were investing in you and they trust you.

Samuel Cook

And the compelling offer I sold them. We'll go into that. It wasn't really that compelling to sophisticated angels.

Brad Furber

Right. They didn't know whether the deal was any good, but they trusted you.

Samuel Cook

And they liked the product. They had some knowledge about marketing and they said, “This product looks good. I like you.” But they were not sophisticated. They didn't understand the offer. We'll go into creating a compelling offer a lot more in part three. Just recently we got into the super angel territory and even just got a micro VC. But you pretty much called it the whole way. 

Samuel Cook

Yeah I was curious. So it was this crowdfunding thing. I am curious, and it is real. There are people that know. There are a lot of people.

Samuel Cook

You just reined me in like a horse. “Go run in that direction.” I did. And that really made all the difference because you can really get lost. I could've seen myself without coaching, really getting lost down the revenue-backed financing note, or definitely into the crowdfunding. And as soon as we determined, “Hey, American angel network – go,” I went.

Brad Furber

The other thing is it's hard to unring the bell. The goal is to avoid making mistakes that you're going to have a tough time erasing. And I see that a lot. People make mistakes and honestly they're hard to fix.

Samuel Cook

That was really it. So this really wraps up the first principle and we're going to get into the second one. 

If you've found this helpful, just hearing Brad go through these different sources of capital and hearing my experience on it, I just can't emphasize enough the value of the Venture Finance Academy with Brad. You can't, you can't raise money without help. If you've never done this before, you're going to really lose your shirt if you don't get the help that you need. Investors may not have the right intentions or the right alignment with you. Or you're, you're just going to not make the right connections or make the right moves.

We played around with the strategic environment for about three months: where to raise money, Europe or United States, and all these different sources of capital. And that really made all the difference in our journey for raising money.

If you'd like to get more information on how to work with Brad, all you need to do is click on the link below the video, answer a few questions, and he'll tell you all about the Venture Finance Academy and how you can apply to join it – because it is an elite group that I'm happy to be a part of and really would love to see some more quality people come in there.

It's a really good smart group. And the other thing about it is: it's not just one to one. It's many to many. The side conversations you actually get in these groups are sometimes, even more powerful than the direct learning – especially, as the group grows. That's why we pay for fancy degrees at schools: the network that we get out of it. No different than venture finance. 

So we're going to move on to the second principle: house in order. 

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