You have a great product that you think it's going to change the market, and now is the right time to find some investors. Unless you have already raised capital or have been in the VC ecosystem before, you probably have no real personal or professional connection to any investor.
There are many investors out there, and the first instinct of any first-time founder is to start pitching as many investors as they can. In reality however, that's not the best approach when it comes to fundraising.
I know that you may be short on capital and/or are in a rush to complete your product or launch it to the public, and really, really need some capital, but from personal experience, I can tell you that over-approaching the investors will delay your fundraising if it doesn't kill it.
Why you should not approach every single investor
Every time you approach an investor, you need to send a pitch deck, an introduction, an elevator pitch, or some stats about the cap table or current financial status.
In order to approach a large number of investors, you either need to reuse your generic materials or use AI to generate some content for you. The bad news is that neither will work. Investors are constantly being approached by founders, and they can differentiate between a tailored and targeted pitch vs. a generic or even worse, an AI-generated pitch.
A generic or AI-generated pitch gives two important signals to the investor:
- You can't sell your product and need to use AI to generate something for you, or reuse a few talking points every time
- You are desperate and are approaching investors in bulk.
Here is the greatest paradox of fundraising: investors do not invest in startups that NEED the funding. They want startups that either don't want the capital or already have plenty of options.
Attracting investors is somewhat like dating! If nobody else wants you, people think there must be something wrong with you; otherwise, others would've wanted you.
Filtering investors by using binary criteria
Not every investor is going to invest in your startup, even if you have the next OpenAI or Google.
There are two broad ways that you should filter the investors. The first, which we address in this section, are somewhat binary. Either an investor fits your startup or doesn't and reaching to answer is not that difficult. The second, which we address in the next section, are not that clear cut and you need to dig deeper in the investor profile.
Here are the clear-cut criteria you should use to filter the investors in the first step:
Geography
When you kick off a startup, you would be tied to your jurisdiction (country, state, city, etc.) regardless of the nature of the product and the type of your operation.
First, you are subjected to the legal frameworks of your jurisdiction. The legal, operational, and financial compliance of any two countries (or even two states of the same country) are significantly different. An investment in a startup is a legal process which involves contracts, agreements, lawyers, notaries, financial transactions, etc. So, an investor would be, rightfully so, hesitant to invest in a company in a different region with which they have no familiarity or experience.
Second, your home country is usually the first market you should be able to enter and expand, unless you truly have a global product. An investor, with no tangible knowledge of your local market, would have a hard time evaluating the problem you're trying to solve or assessing the viability of your product.
Third, every startup needs to raise multiple rounds of investments before its exit or financial independence. Your investor would want to know if they can help you raise the next rounds, or if they have no real connection to the local capital ecosystem. If you cannot raise further rounds, their investment will also vanish.
Every investor, even if they claim to be investing globally, will support certain countries and won't invest in others.
There are two ways to find out whether an investor is active in your region or not. First and most obvious is when they say it openly, which makes everything simple. If an investor is vague about the countries they support (which is very common), you should have a look at their offices and recent portfolio. If they have an office or have recently invested in a startup in your region, that's usually a positive sign.
Sometimes, you will find investors who emphasise a different region but are "open to opportunities" in your region. Based on my personal experience, unless you have a very hot startup or a warm introduction to these investors, you'd be better off spending your time and energy on other investors.
Stage
The budget, experiences, network, and preferences of an investor dictates the stage at which they are most likely to invest.
If you're in the early stages, you should look for investors who are active in these stages:
- PreSeed, if you are still developing your product or have launched the earliest version to the public. You may or may not have traction or paying customers. Needless to say, the higher the traction, the more likely you're going to get funded.
- Seed, if you have a working product with growing traction and a user base. Unless you're working on a product that requires a large amount of capital and a long development cycle, you should be able to answer questions about your performance with actual numbers.
- Series A, if you have a stable product with a growing user base and a good product-market fit, looking to grow and expand.
Most investors will be upfront and public about the stages in which they invest. If they are vague (which again, is not uncommon), look at their portfolio and the stages they entered the deal. There are very few investment firms that have access to such large network and capital that they would invest in all stages, but they are more like an exception than a rule.
VCs and individual investors rarely go outside of their target stage. They have a pool of capital, a target number of investments per year, and a runway. Each investment requires weeks of due diligence, research, legal paperwork, and coordination. So, if you're too early, the investment size (and the window of return) does not match their operation, and if you're too late, they probably wouldn't want to park a large chunk of their fund in a single investment.
Vertical/Industry
Every VC or individual investor is familiar with a series of industries or verticals. This familiarity or expertise allows them to know the market, laws and constraints, competitors, and potential partners and customers.
So, every VC will have a list of preferred industries and, in some cases, a list of industries they will avoid. There are investors who claim to be industry agnostic, but they often gravitate toward a handful of industries.
Investors are often very loud about the industries on which they focus, but if they are vague, you can look at their recent portfolio.
Determining your startup's vertical is not as clear-cut as geography or stage. In many cases, the product of a startup overlap multiple verticals. For example, an energy startup that focuses on transforming the energy consumption of the mining industry will fall under the "Energy", "Sustainability", "Industrial", and even "Climate" verticals.
Also, there are umbrella verticals that can be combined with any other vertical. The most prominent example is AI, which, based on our directory data, is currently the most popular vertical. However, most of the time, VCs look for AI companies in certain industries. One VC may look for AI startups in Fintech and Health, another might look for companies providing data and developer tools for AI. If you're an AI startup, we have an article about the state of the AI investments by the way.
If you have any reason to believe an investor would not invest in your vertical combo, there is very little chance they can change their approach just for you.
Ticket size
Once you have investors filtered based on region and stage, you need to find the ones offering a ticket size matching your target. Ticket size basically means how much they are going to invest in your startup.
Here is something that new founders often get wrong. You cannot get the entire funding round from a single investor. In most cases, there are more than 5 (sometimes even up to 15) parties involved in a preseed/seed round. So, the investor's ticket size should be, at most, about 20% of your target, with the lead investors often going a bit higher.
If you are raising, for example, $1M, you need angels with ticket sizes starting from 5-digit investments and VCs and angels who invest up to $200-350k. An investor with a minimum ticket size of $800k is not going to invest 80% of a round.
One mistake that early-stage founders often make is changing their funding target based on the ticket size of the investor. While approaching one investor, they are raising $1M, and while approaching another, they are raising $2M, not because their needs or plans have changed, but solely because the second investor has a higher ticket size.
The VC and angel communities are more intertwined than you think, and your pitch deck is seen by multiple people before an investment is finalized. Having multiple funding targets in the same round with no structure or logic is a very negative signal.
Other quantifiable filters
There are many other filters you need to use. Here is a non-exhaustive list:
- MRR: Some investors require a certain amount of MRR (usually $5-10k) before they consider an investment. These investors consider the MRR the ultimate sign of validation, as people are actually paying for the product. Other investors are more flexible about your current MRR and sometimes invest in pre-revenue products. Those who do consider pre-revenue startups are often vocal about it while those who have a minimum MRR in mind are often quite.
- Number of founders: If you're a single founder, keep in mind that some investors tend to invest in startups with at least 2 co-founders. This criteria is almost never publicly stated.
- Valuation: Similar and very related to the ticket size, most investors look for startups with certain range of post-money valuation.
I am lumping these requirements in one bucket, as they are often mentioned in between the lines or are not publicly stated at all, and are only revealed when you approach them.
Filtering investors by using subjective criteria
In the previous secion, we focused on quantifiable and somewhat binary criteria which could put an investor in a clear "yes" or "no" bucket.
In this section, we look for filters that are more subjective and are very tailored to your product and circumstances.
Conflict of interest
This part is very unique to you. Before shortlisting an investor, you need to go through their portfolio and make sure they have not invested in a startup with a competing product.
How you determine whehter a startup is your competition and what your criteria should be is not something for which I can write a generic guide. However, you would need to be honest with yourself and compare your product with others from the POV of the investors, not the consumers.
An investor would definitely avoid considering your startup if they have a competing product in their portfolio, as investing in the competition would directly hurt their investment.
However, I also need to mention complementing products as well. Investors usually love to create a network effect, where one company in their portfolio becomes the partner or consumer of another portfolio company. So, if you find a complementing product, take it as a positive sign.
Cold Vs. Warm approach
Now that you have a list of potential investors, we need to talk about the way you're going to approach them. This step is more about prioritizing your list rather than completely crossing off an investor.
As an obvious rule of thumb, a warm introduction is always better than a cold outreach.
However, when you're starting out, you don't know anyone in the community and don't have any network that would introduce you to a potential investor.
You do need to try to get to know people by attending events, socializing, interacting on social media, etc. However, here we continue with the assumption that you are relying solely on the cold outreach.
All investors prefer to have a warm introduction from mutual connections and trusted partners. This is a harsh reality that every founder needs to admit. However, even though some investors work solely based on warm introductions, many are open to cold outreach. You need to set your initial focus on the ones more likely to accept and review cold applications for the short term.
Here is how I would determine if an investor is open to cold applications or works exclusively based on warm intros:
- Some of the investors are very clear about their approach. Some say openly whether they only invest within their network or are willing to work with founders through online submissions.
- If an investor has a dedicated section on their website for receiving applications, they are most likely to consider your startup. The strongest signal is the presence of an interactive form (such as Typeform) for submitting an application, followed by a dedicated email for receiving pitch decks. Do not, however, start emailing VCs using their generic emails.
- Some of the investors accept cold applications on different platforms. The number of these investors is not as much as you'd think. But if an investor uses a platform, they would most likely provide a link to it.
- If an investor has clear and structured information about their investment approach, verticals, ticket size, etc, especially in the form of FAQs, in my experience, they are more open to cold outreach.
Again, you should work toward getting to know people and networking in a way that would lead to high-quality warm introductions, but that is a long process and easier said than done.
Lead vs. co-investors
Great. You now have a list of VCs and angels whose focus matches closely with your startup. Now, we need to create a distinction between those who would lead your round and those who would co-invest. Every fundraising round requires at least one lead investor who determines the valuation, terms, and structure of the deal.
First, you need to secure a lead investor. This means only approaching the investors who have the potential to lead your round. Once you have a lead investor willing to lead the deal, you can start approaching co-investors.
Approaching co-investors without a lead, besides consuming your time and resources, might actually cause losing the co-investor entirely. A co-investor who would've reviewed and taken your pitch deck positively with a secured lead, now rejects and discards your pitch because there is no lead investor to close the round.
VCs and investors don't have a good track record of stating whether they lead or prefer to co-invest. One good source of information is the press releases of their portfolio companies where they announce a successful fundraising. In those articles, they often mention which firms have led the round.
What your shortlist should look like
In the end, you have to have two list of investors, one for the potential lead investors and one for the co-investors.
You might ask yourself "is my list enough? How many do I need?". So let's get down to numbers.
We have to treat this fundraising as a sales funnel:
- Initial approach: You have a total number of potential investors you're going to approach
- Meeting secured: A subset of them will answer you back and ask for meetings
- Funding: A subset of the meetings will result in actual investments.
Here is a breakdown of the initial approach to meeting ratio:
- More than 40%: You are doing amazing. Really! That's a wild conversion rate.
- 30-40%: You are doing good and the conversion rate is very healthy.
- 20-30%: You're ok but need to optimize your approach.
- Less than 20%: Something is seriously wrong. It can be the pitch, the presentation, the way you approach, or the hard truth none of us want to hear, the product doesn't have the required backbone.
You need to keep track of the approaches you made and analyze the feedback to optimize your pitch. But here is the problem, some of the investors take a couple of weeks to respond and by that time, you have already made many different pitches. So, you need to prioritize the investors that are more likely to answer quickly. This way, you can utitlize the feedback of the initial investors to optimize your direction.
Once you have a set of meetings, some of them will turn to actual investments. Here is a breakdown of meeting to investment ratio:
- More than 20%: You are a fundraising genius. Don't read the rest of the article, write one yourself and send me the link please.
- 10-20%: This is a realistic scenario for a successful round with a great product, team, and pitch. If you can convert 10-20% of meetings to actual investments, you're doing great.
- 5-10%: You're fine and you are actually raising capital, which is more than many founders have done, but you need to optimize your pitch. Use the previous interactions to find your weakspots.
- Less than 5%: You're not doing good. There is something seriously wrong with the product, pitch, the way the team is presented, or the financial aspect of the round. You need a serious revision of everything you've done so far.
So, as you can see, even the most successful founders have a 10% approach to cheque conversion rate. A more realistic rate is about 3 to 7%. It means that in order to have the bare minimum of 5 investors, you need to compile a list of 72 to 160 investors to approach.
Compiling a list of suitable investors of this size is a lot of work but a necessary step toward a successful fundraising.
A shameless plug for FundingBanker
The article up to this point was an honest overview of the process you need to go through and I made sure to keep it independent of any single product or tool.
Over the years, I have been involved in many fundraising rounds and have done this process manually or semi-manually a lot and finally turned this into a solution in Funding Banker.
We have a sizable directory of investors which is growing every day and we manually review every investor and compile the information necessary for a founder during a fundraising, in the same manner that I needed it during my fundraising journey.
Each investor has a lot of detail, such as their focus, supported countries, cheque sizes, whether they lead, etc. which can reduce the time you need for compiling the list down to a few days rather than weeks.
After you review each potential investor in our directory, you can mark them for your round, that if they are a good fit, not a fit, or a good fit for the future rounds.
Since we manage the directory manually, you can always request a review, suggest a correction, or request for addition of an investor we have missed.
The fundraising journey can be a very fulfilling and rewarding process if done right and I hope this article and our tools would be a help.