What I Learned Interviewing 40 Founders Who Raised Capital
I began my journey in the startup ecosystem in 2012 while still studying law. My first attempt at building a business was a community-owned renewable energy project. Needless to say, it didn’t succeed. Shortly after I hammered the last nail into the coffin of that idea, in late 2013, an opportunity arose to co-found of an accelerator program at Bond University. In late 2015, I became the Program Coordinator at the University of Queensland’s ilab accelerator. During my time in the startup ecosystem I’ve been heavily involved in mentored at Startup Weekends and appeared on several lean startup judging competitions. In all, I would have seen about 200 startups, several hundred founders, several hundred ideas and most of the mistakes that can be made.
In 2015, StartupAUS wrote the Crossroads 2015 report in which it highlighted 8 key challenges that needed focus to bolster the Australian startup ecosystem. One challenge, in particular, stood out; “Action 6 – Increase availability of early stage capital to startups.” Using the lean startup methodology I developed a hypothesis;
“I believe founders that are trying to raise capital find it difficult because it’s a time consuming and costly process.”
I developed a marketing tactic to reach out to the specific customer segment “founders that have raised capital in Australia” to understand what their pain points were and what benefits they were trying to achieve when raising capital.
A few things need to be clarified before continuing. The purpose of this process, customer development, is to take an objective approach to gathering data leaving as many of my own biases and assumptions aside. There is a specific way you conduct customer development but the topic is too large to include here. I will write a detailed article about customer development in the coming weeks. Secondly, The information below does not represent any one particular person, but rather, a sentiment of the significant majority. Thirdly, I did interview several investors and will provide some insight however I have not interviewed enough to make an informed, evidence based conclusion regarding any of the interviews with investors. Lastly, while I’ve heard several of these stories, several times, from several different sources over the last few years, the information below doesn’t necessarily represent my personal opinions or beliefs.
Crossroads 2015 report
Page 59, action 6, paragraph 2 of the Crossroads 2015 report is probably the most important but it must also be taken into consideration that, since the release of the report, there has been significant federal and state support for startups and innovation. This is important because it’s what I based my initial hypothesis on.
“A lack of early stage capital for startups in Australia is one of the clearest market failures in the Australian startup ecosystem. As a nation, Australia is significantly below many other developed countries in terms of deployment of early stage capital, despite having the world’s fourth largest pool of superannuation funds under management at just over $2 trillion.”
Person X has been in an industry for a while, is disgruntled with how the technology or industry is currently operating and comes up with an amazing idea that no one else is doing and thinks they can do it better, quicker, or cheaper. So, they put on their shiny red boots, don a cape and start wearing their underwear on the outside. They dig into their savings account, make everyone sign a non-disclosure agreement, set out trying to find a) a co-founder and b) a developer, go into stealth mode for months on end to build an enterprise solution that’s going to change the world only to find they are going to need to raise capital to finish the build and get it to market. They try to raise capital, find out it’s a lot more difficult than it looks in the movies, run out of money and fail. Or, find out they need to raise capital, having no clue how to raise capital, having to learn how to raise capital, go through a painful 6 – 9 month process of pitching, meetings, documentation, knocking on countless doors, countless rejections before eventually getting investment.
Lessons Learned Entrepreneurs
There was a time when entrepreneurs wrote 30, 40, 50-page business plans with 3 to 5-year financial forecasts. In combination, they wrote marketing plans, strategic documents, built fully functional products, established supply chains and purchased inventory without ever having spoken to a customer. Those days are gone and a new paradigm of building a business exists. The methodology now used, borrowed from scientific rigour, is the lean startup process (I will write many, many more articles about this topic). The lean startup process is an objective way of testing and measuring your idea as quickly and efficiently as possible to see if you are actually solving a problem for a specific customer segment that will pay you money for your solution.
There was a time when entrepreneurs were seen as “shoot from the hip” types, rainmakers, risk takers, superhuman, tycoons. They are often put on a pedestal by the media as being an ultra-focused, whizz-kid, high-flying hustlers continually raising millions after millions. Entrepreneurship and building businesses have moved on from these paradigms also. There is a significant body of academic literature, effectuation, that shows very clearly defined entrepreneurial traits, that can be learned to increase the probability of success in a new venture. Effectuation is a logic of thinking, discovered through scientific research, used by expert entrepreneurs to build successful ventures (I will write an in depth blog post about effectuation and effectual reasoning in the coming months). With that said, there are behavioural traits that are required to undertake the career path of entrepreneurship that cannot be taught e.g. fortitude, temperance, grit, how to stomach risk and loss, etc.
Along with these shifts in methodology and practice comes the reframing of entrepreneurship as a career. The Australian federal government along with the state and territory governments are advocating and strongly incentivizing students to participate in the Science, Technology, Engineering and Math (S.T.E.M.) disciplines. There is discussion around modifying the acronym to S.T.E.E.M, the additional ‘E’ standing for entrepreneurship as being an established, well understood and acceptable career choice.
When speaking to founders that have raised capital, their insight into business and entrepreneurship was starkly different from the status quo, mentioned above, that I see day in and day out. Several of the interviewed founders stated that choosing to be an entrepreneur doesn’t make you a superhero. Founders aren’t entitled to capital just because you call yourself a startup and an entrepreneur. In reality, entrepreneurship is nothing more or less than a career choice, much like law, accounting or being a tradie. When choosing to build a business, you are taking a calculated risk that you can build something in 5 – 10 years that will provide a higher rate of return than you can achieve by working a 9 – 5 job. If all goes well, you’d sell for a profit and move on to the next venture. What did surprise me during the interviews were how many founders used almost exactly the same phrase when discussing this topic. They stated that “building a business, is nothing more than following a process.” Keep this in mind as it’s important.
When interviewing the founders that have raised capital, many stated they started off with little to no idea a) what the words capital raising actually meant b) they would need to raise capital and c) how to raise capital when they did realise. A few also stated they had a very immature approach to capital raising. Their first port of call was either their lawyer, accountant or the internet. Many of the founder’s first capital raise came from their direct network of friends, family and founders and sometimes done in unsophisticated ways.
Looking back over their capital raising experience they stated that there is a lack of professionalism and education in the capital raising sector. Few people understand the basics, like what a cap table is or how it works, they don’t understand how to create a slide deck or understand what investors are actually looking for. There appears to be an air of self entitlement that suggests that just because you’re a startup you are entitled to capital. There was a consistent sentiment that the startup ecosystem needed to mature and treat their actions like legitimate business transactions. Further to this point, founders operate from a belief that they are not going to part with percentages of their company because “it’s their baby” but still expect to raise significant tranches of capital. The adage “10% of something is better than 100% of nothing” rings true here and founders need to educate themselves about how the capital raising process works.
I need to reiterate that the information below represents a sentiment of the significant majority and not necessarily represent my personal opinions or beliefs. Additionally, and strangely, some of this information has come from within the investment community.
The general sentiment around angel investors is that it’s typically old money, they are very slow to move, don’t invest unless it’s dug up from the ground or something they are very familiar with which is typically not tech. Further, founders have stated that investors say they understand tech but in reality, they don’t. This is made evident when the founders compared the level of investor technical knowledge in Australia to the investor technical knowledge overseas.
Founders stated that in Australia there was a constant need to educate investor after investor and constant dismissal of ideas because investors simply didn’t get it. While in the US and EU it was a simple conversation to which the response was “yep, we get it” therefore easier to get funding and significantly higher pre-valuation rounds. Some founders stated that the risk profiles of Australian investors were simply too high and the term sheets too onerous so founders head overseas and raise capital there. To put these founders and the word “tech” in context within this paragraph while still maintaining the anonymity of the interviewees, I need to say that the founders are probably the smartest people I’ve ever met and tech is legitimately game-changing, solving a massive pain point, IP protected, in an enormous and expanding market.
What was interesting from several of these conversations was that founders looked to High Net Worth individuals, corporates, and even their direct competitors for alternative sources of funding. It was universally stated, from founders that have raised small rounds to the last stage Private Equity funds, that the money is only about 50% of the value of the capital raise. It is critical that a founder finds the right investor, with the right network and experience.
The Story of Two Networks
Based on the above information you’d assume I had validated my initial hypothesis of “I believe founders that are trying to raise capital find it difficult because it’s a time consuming and costly process” however this is not the case. Upon digging deeper into the data, I saw two very distinct patterns in types of founders and how they raise money, or more accurately, who they raised money from.
The story of a large majority of founders that have raised capital is very similar. They realise they need to raise capital, they have no knowledge or experience in this area and begin educating themselves. At times they engage with a broker which costs about $40k and 5% – 6% of the capital raise. Typically, the process takes anywhere between 4 – 18 months and involves a staggering amount of paperwork, money, about 40 – 100s of meetings and knockbacks. Founders often asked the same questions:
- where do I start or how do I get a foot in the door?
- who do I know in my network that can introduce me to an investor?
- who do you contact?
- what was acceptable?
- how do I value my company?
- what should I expect when I walk into a meeting to raise capital?
Some founders used social media to reach out to investors and attended startup ecosystem events. While people were happy to connect and meet, founders discovered the quality of the network difficult to judge and also, again, it was an incredibly time-consuming task. It appears the most difficult route to capital raising is the one most often taken which is friends, family, founders, then angel investors and then VC. Typically, it starts out less complicated, at times even with a handshake agreement, however, there is another way.
Several founders shared surprisingly similar stories which aligned with information gathered from two late stage VC firms I interviewed. The founders that were able to raise between $100k – $300k in a matter of days were able to do so because they had established connections with HNWs. It was typically an old school friend, a family friend, a co-founder, a warm introduction through a close business associate, or a serendipitous connection. What appears to be a significantly easier and mutually more beneficial route to raising capital is to build a relationship with a HNW and tick all their capital raising requirements. But, having said that, unless you know where to look, finding a HNW can be a challenging task in and of itself.
What Actually Needs to Happen
During the interview process, I asked founders “if I had a magic wand to solve all the problems you faced when capital raising, what would the technical solution look like?” This is what most stated:
- Needs to be a huge overhaul of angel scene in Australia through education. There needs to be an electronic angels ecosystem somewhere between angel and seed where all major stakeholders can be brought together in a single place and ideas funded
- Make the documentation easier and standardised including an information memorandum, due diligence, pitch deck, financial models, cap tables, etc
- There should also be a standardised process from A to Z of what to actually do to get investor ready
- Some mechanism that qualifies and validates startups on behalf of investors based on the investor’s criteria; a startup/investor matchmaking service
- A fast pre-screening process so the right startup could get in front of the right investor at the right time with the right information
- An Australian focused solution as opposed to F6S, Angellist, Gust, and Crunshbase which are US-centric
- A tool that allows startups to build dossiers on investors
Further to these technical suggestions, I refer back to Audrey’s article, which suggests a Startup manifesto change the underlying paradigms of the Australian startup ecosystem. While I’m not sure what that would look like or if this has been shown to succeed in other parts of the world, it is a compelling proposition in which to unify and move the ecosystem.
Part of the reason you conduct customer development is to uncover insights that few people know about so you can mitigate risk and/or build a better product that more accurately meets the needs of your customer. During this interview process, it became clear that there were two similar but distinct things occurring. There is the Australian startup ecosystem, nascent and full of noise with everyone drinking the same kool aid. Generally speaking, founders appear to lack a certain level of maturity, knowledge, education and professionalism needed to undertake the process of capital raising.
Then, there are those who are on the fringes, just on the outside looking in who have a completely different mentality in the way they operate and approach business. Most of these founders don’t appear to have started in or have been distracted by the startup ecosystem. They have taken a different approach to building businesses and raising capital.
The challenge lies in the fact that the knowledge and experience that is needed within the startup ecosystem often lies outside the ecosystem. The knowledge and experience are in the form of professional business people who have built and sold one or a number companies. These types of people are extremely rare and typically too busy building their own businesses to bother or be distracted by what’s going on with startups. It’s their way of thinking and their level of professionalism that needs to be adopted by the startup ecosystem.
The Crossroads 2015 report acknowledges this issue, Audrey, in her article, suggests an interesting solution of a national Visiting Entrepreneur’s Program. While I can absolutely confirm the problem exists and is significant, I’ve not spent enough time contemplating the problem in enough detail to provide any valuable insight as to how best to address it.
At the beginning of this article, I mentioned that my aim as to in/validate my hypothesis; “I believe founders that are trying to raise capital find it difficult because it’s a time consuming and costly process.” I can confidently state, based on qualitative evidence that:
- Yes, capital raising is a major pain point
- When undertaken, is in the top three pain points of a founder’s day on a daily basis
- Yes, they look for alternatives that are not suitable and
- Are actively looking for and will pay for alternative solutions
With that said, the reason I developed that hypothesis “A lack of early stage capital for startups in Australia is one of the clearest market failures in the Australian startup ecosystem” no longer seems to be valid. As mentioned, there is significant incentivisation from the Australian federal and state government to foster innovation. Additionally, there is a significant pool of wealth if you know where to look. So, the focus now becomes less about access to early stage capital but rather how do we design a solution that facilitates the building of better founders, that build better teams, that fix problems worth solving. If done, the problem of access to early stage capital becomes a moot point as these types of businesses, by their very nature, will attract investment if needed.