Paul Graham says “The future [of funding] is no fixed amount, no fixed closing date, and no lead.” In other words, the future of financing is continuous, not discrete.

This post explains how to raise a seed round with no lead, no fixed amount, and a fluid closing date. The process is called mass syndication, or a party round.

Paul proposes eliminating rounds altogether, but we’re not there yet. Mass syndication is a single continuous seed round and I think it’s the state of the art in continuous fundraising.

We originally offered this interview exclusively to AngelList applicants — now it’s available to everyone.

Another future

The future of funding is also finding the right investors for your startup, quickly. Not just picking from the investors you can get introductions to.

How? You want to get instant meetings with any investor you want. And you only want to meet investors who are genuinely interested in your startup. That’s what AngelList is for. One danger of this approach is that your round is oversubscribed.

Despite the name, you can use AngelList to request intros to any subset of investors on the list — you don’t need to send it to the whole list.

Leads aren’t going away

Fred Wilson writes “If you don’t want a lead investor, then don’t knock on my door because I don’t know any other way to be.”

This interview explains how to raise a seed round with the conservative assumption that a lead won’t step forward — but it doesn’t preclude you from changing course if a lead appears.

1. Interview

Video: Interview with chapters (for iPod, iPhone, iTunes)
Audio: Interview without chapters (MP3, works anywhere)
Transcript: Below

2. Outline

Here’s an outline and transcript:

  1. You can close an angel round with ‘mass syndication’
  2. Start with terms and valuation below market
  3. What you want in your term sheet
  4. What you don’t want in your term sheet
  5. Should you have a board seat for seed investors?
  6. This isn’t comprehensive term sheet advice
  7. Memorize the term sheet before your first meeting
  8. How do you set your valuation? Price it to move
  9. How do you bring up the terms in a meeting?
  10. Describe how the terms are investor-friendly
  11. A preferred round is a good way to set up good initial terms
  12. Does a small seed round need protective provisions? Pros and cons.
  13. Get feedback on the terms in the first meeting
  14. Drop names to build social proof
  15. Social proof works differently in a Series A round with VCs
  16. See if the “interest” includes a dollar amount, intros, and name-dropping (a.k.a. soft circled)
  17. When do you need a lead?
  18. Approach the financing as if you won’t find a lead
  19. What’s a lead investor?
  20. If they say “find a lead,” ask why
  21. How to create a deadline
  22. Raise the money when you don’t need it
  23. Send two emails to the angels
  24. Do a rolling close: the cash comes in just- in-time
  25. Mass syndication can fail if a very high social proof investor drops out
  26. Use AngelList and StartupList to get intros to angels
  27. What do angels look for?
  28. Advisors are good for getting your foot in the door, not in a pitch
  29. Get advisors by going to events or talking to entrepreneurs
  30. Before you raise a seed round, you need a product in the marketplace
  31. Use customer development and lean startup techniques to get to market with less
  32. Pitching hacks free chapter: Advice on getting investor intros
  33. If you need money to get something in the marketplace, pitch idea investors
  34. Pitch incubators or do your startup on the side
  35. What are the different types of seed stage investors?
  36. If you’re talking to a VC, make sure they really do seed stage rounds
  37. Potential concerns with pitching multi-stage and seed-stage firms
  38. Get intros to seed investors with AngelList/StartupList

3. Transcript

Music: Squarepusher

Nivi: Hi there, this is Nivi from Venture Hacks.

Naval: And Naval from Venture Hacks.

Nivi: And we’re going to talk about how to close an angel round, how to put together an angel round, or in other words, how to herd a motley crew of angel investors and turn those meetings that you’re getting into money in the bank.

I think we’re going to start off by talking about mass syndication, which is an approach that I think more entrepreneurs should be taking to close their angel rounds.

You can close an angel round with ‘mass syndication’

Nivi: I think entrepreneurs make two typical mistakes when they’re doing an angel round, and they come from what they’ve read online about how to close a VC round. So, there are two things.

One: they don’t name drop enough. They don’t mention who else is interested.

Two: and I guess more importantly, they’re looking for a lead, which you don’t necessarily need in an angel round.

When you put those two together and combine them with a term sheet that you essentially write yourself, you’ve got a new way to close an angel round which we call mass syndication, which I’ve done personally. And Naval, maybe you can talk about how often you see that happening, or if you don’t see that happening, or whatever.

Naval: It happens fairly often these days. Especially the Y Combinator companies, which are well trained by Paul Graham and crew, will exercise mass syndication a lot. So, they take the standard term sheet that they’ve been given and they go out and do a rolling close of various convertible notes. And it generally works pretty well.

The keys are that you have to set the terms and the valuation very, very reasonably. In fact, you have to probably price slightly below market, because otherwise the angels don’t trust you, then they want a lead who’s done the due diligence. You have to work with people that you have warm intros with, you have to name drop like crazy, and you have to create forcing functions to get the round to close. You can’t give people all the time in the world.

Start with terms and valuation below market

Nivi: Right. So let’s dig into all that stuff. First off, I think you want to start with a term sheet that you’ve generated yourself.

Naval: I think it’s even better to have a term sheet that comes with someone else’s authority attached. So, it could be one that Wilson Sonsini has put up. It could be one that Y Combinators put up or Founder Institute has put up or Founders Fund has put up, but it’s just better to start with a widely accepted circulated term sheet where you can point to it and say dozens of other startups have used this term sheet, it’s not new.

Nivi: Yeah. And then there are the new Series C documents from Andreessen Horowitz and Ted Wang and other investors, which we haven’t reviewed, by the way. At least, I haven’t.

Naval: Yeah, we’re not endorsing any particular set.

Nivi: Yeah, so I would look at the term sheet first, and I find that a lot of entrepreneurs that I talk to have not really studied the terms that they’re signing onto enough, and they end up using the authority of: it’s a Y Combinator series AA doc, so we’re going to use it because everybody else has used it.

What you want in your term sheet

Nivi: I think there’s some wisdom in that, but at the same time I really want to understand what I’m signing. The things that I look for, personally, in a seed-stage term sheet are: If you’re going to do convertible debt there’s going to be a cap on the conversion price. In the event of an early acquisition you’re probably going to use that same cap to give the investors a non-participating liquidation preference.

Naval: Yep.

Nivi: If the debt matures before the company is acquired or does another round, you want the debt to convert into common or preferred stock, and that’s at the company’s behest.

And I like to have a majority or supermajority of the investors able to amend the documents.

Naval: They have to approve any amendment of the documents.

Nivi: Yeah, they can approve an amendment of the document, so you don’t need everybody’s approval to make some change – to extend the maturity date, or whatever, or to increase the amount of debt you can raise. Off the top of my head, that’s kind of….

What you don’t want in your term sheet

Naval: Yeah, what’s equally interesting and what’s usually not in a seed or angels syndication round is that you don’t have a minimum raise requirement. You don’t have, usually, a board seat or board structure. You often have vesting, but because the company is still controlled by the founders, the vesting is more of a pre-nup agreement between the founders than it is anything to do with the investors. But generally you want to keep it very simple.

Nivi: No option pool, really.

Naval: There can be. Actually, I would say that there usually should be, because you don’t want the situation where an investor starts reading the documents, finds out there’s no option pool, and therefore doesn’t feel like your valuation is properly represented, because these days in the market, people are used to seeing an option pool.

Should you have a board seat for seed investors?

Nivi: OK. And yeah, with the board seat thing, I think too many seed stage companies probably have board seats, especially if there is a VC involved in the round. If you want some normative leverage on that you can go to Marc Andreessen’s blog where they write, essentially, that they don’t think most seed-stage companies should have investors on their board of directors. Right?

Naval: Yeah, and it absolutely depends on the stage the company’s at and how much money you’re raising. If you’re raising a million bucks from institutional investors, you’re actually really doing more of a mini-VC round than a seed round, so you are going to have a board seat at least, although you probably won’t give it board control.

On the other hand, if you’re raising $250,000 spread across 10 investors, then you don’t need to have a board seat, although you may want to have an external board member just to help resolve any founder issues that come up, and to get some good advice.

This isn’t comprehensive term sheet advice

Nivi: This isn’t intended to be a comprehensive discussion of term sheets for seed-stage companies, but it’s a good start.

Memorize the term sheet before your first meeting

Nivi: So I think that’s our best advice on the first step, which is generating a term sheet. And you should be able, when you go into a meeting with any of the prospective seed investors you have, to essentially rattle off the major terms in that term sheet.

How do you set your valuation? Price it to move

Nivi: I guess the only thing I would add to what Naval said earlier when he described it as maybe the price is “below market,” I sometimes describe it as “priced to move.” So you want a price where there should be no discussion around the price that you’re putting forward.

We’ve got an article, actually, that you should look up. It’s called How do we set the valuation for a seed round? Let me look it up right now.

Naval: The valuation is a very difficult topic, especially when the entrepreneur is trying to do it themselves. They invariably get it wrong, and usually it’s too high. You just want to talk to somebody who has a lot of data points in the market and can give you those data points.

Nivi: Right. So you need the market data, and then check out this article we have. It’s called How do we set the valuation for a seed round?

How do you bring up the terms in a meeting?

Nivi: OK, so at this point you’ve generated the term sheet, we’re going to assume that you’ve got some meetings lined up, and we’ll get back to this topic of how to get some meetings, but let’s assume that you’ve got some meetings lined up. You do the meeting. How do I bring up a discussion of the terms?

Naval: I think if the investor’s interested, as a final step they’re going to ask you. They’re going to ask what the terms are or who’s in the round, or they’ll ask you to give them some details about the financing. And that’s when you basically say: So-and-so is committed to invest. We have a couple of people looking at it. We’re hoping to close by such-and-such a date, or we are going to close by such-and-such a date. There are x dollars available, and it’s a convertible note and it’s capped at a valuation of x and a discount of y. So, you can just throw the terms out. You can be pretty straightforward with most angels.

If you want to be a little more subtle you can say we’re raising x, and we’re selling no more than y% of the company; but I feel that with most angels you can just be direct and say the cap is whatever it is, and just give the number.

Nivi: Yeah, if they don’t bring it up you should just have a slide that says “Financing” at the end of the presentation, [laughing] and you tell them exactly what Naval said. You drop the names, and we’ll get back into the specifics of exactly how you drop the names.

Describe how the terms are investor-friendly

And you discuss the terms, and you discuss them in a way that shows how investor friendly they are and how sane they are, and frankly, there really should be no room for discussion on them. Not that there’s no room, just that there’s no need because the valuation is priced to move and there are a lot of good investor protections – which the only ones they really care about are some kind of liquidation preference in the event of an early sale. They care about getting the same terms as the Series A investors, whenever that happens, which they’ll get through convertible debt or through one of the other types of mechanisms in a preferred financing. What kinds of mechanisms?

Naval: Essentially, if it’s convertible debt, it’ll just convert into the same security as is being sold in the next round. If, on the other hand, the convertible debt has a term sheet attached to it and has specific rights, then those rights will be negotiated, but that’s pretty unusual. With convertible debt usually you usually just get whatever security is in the next round.

Nivi: No, I meant if there’s a preferred financing in the…. I mean, here’s the question: what percentage of deals do you see being done convertible in the seed round versus preferred in the seed round these days, you personally?

Naval: It’s about half-and-half. The larger the round the closer it gets to just being a preferred round. The smaller the round the more likely it will just be debt.

A preferred round is a good way to set up good initial terms

Naval: Generally, even in the startup side, it’s probably better to do a preferred round because these are the times to set your terms very favorably for yourself, and they form a precedent for what happens when you do later rounds, whereas if you’re negotiating, if your first negotiation is with a VC you’re not going to set yourself the friendliest terms. So there’s nothing wrong with doing a preferred round, it’s just that the expense is slightly higher, but it’s not tremendously higher.

Nivi: Yeah, I guess I’m wondering if there is usually some kind of most-favored nation clause in those preferred term sheets that gets those investors the same terms that happen in the next round.

Naval: No, there almost never are except that there is one game-theory element that comes into play, which is, any subsequent round has to be approved by the current round investors. So if there is some term that the subsequent investor is getting that the current investor is not, very often they will not approve the transaction unless they get that.

Does a small seed round need protective provisions? Pros and cons.

Nivi: Yeah. Actually I haven’t looked at the Series C docs. I think they might not have that in there. My preference is that if you’re doing a small seed round, under $500K, there should really be no protective provisions like in terms of vetoing the next round, vetoing a sale of…

Naval: Well, you kind of have to have some of those because unfortunately these are minority shareholders, so you do have cases where an entrepreneur, for example, will raise money from their cousin at a low valuation, or they will sell a company to an affiliated entity. These things actually happen.

Nivi: Yeah.

Naval: And so that’s why the investors often need to assure that there aren’t linked transactions or need approval. And that’s why you’ve got to know your investors; you’ve got to trust your investors to also do the right thing. People who have a history of investing in good companies and having good exits likely aren’t the types who will block financings or block sales.

Get feedback on the terms in the first meeting

Nivi: You can ask them right at the end of the meeting, after you’ve presented the terms, what feedback they have on the terms, if any. So you could solicit some immediate feedback. My guess is if your terms are structured right you probably won’t get much, if any, but make note of any feedback they give you on the terms.

Drop names to build social proof

Nivi: Let’s talk about what kind of names you can drop at the end of the meeting.

Naval: Yeah, you definitely want to use social proof to build up momentum in closing a mass syndication round. So, every angel who signs up, you should make clear to the other angels that this angel has signed up. Now, you have to be careful about what the definition of “signed up” is. If someone says they’re interested, don’t go around representing them as committed, because angels will talk and if they find out that you’ve been exaggerating or lying it will cost you trust in the whole financing. Basically, the clear indicator is if somebody says they’re in, they negotiate an amount with you, they say they’re happy with the terms, and they shake hands on it. If you want to play it extra safe, if you don’t have a long-standing relationship with this person, then I would also suggest getting an email confirmation.

Nivi: Right. So, just going from the top of the list, if they’ve wired the money, signed the term sheet, and the money’s in your bank account, you should almost certainly use their name, unless for some reason they’ve specified that you can’t. Ok; so that’s an easy one.

Next, if you’re in the process of closing with them and you’re negotiating a term sheet, I think, again, unless they’ve said you can’t use their name, it’s extremely safe to say that you are in the process of closing with such-and-such, assuming they’re negotiating the deal with you in good faith.

Next on the list, I don’t think there’s anything wrong if the angel, at the end of the meeting after you’ve discussed the terms, has said they’re interested, for you to ask: are you interested enough for me to tell the other guys I’m talking to that you’re interested?

Naval: Yeah, that’s perfectly reasonable.

Nivi: That’s what I would do with the guys who you’re not actively negotiating the deal with. Just ask them, hey, is it OK if I use your name?

Social proof works differently in a Series A round with VCs

Naval: Social proof in a venture round works differently because in a venture round you want independent bids because you’re actively negotiating a valuation. Here, because you are setting the valuation and there’s room for multiple players, social proof is much more important than getting independent bids.

See if the “interest” includes a dollar amount, intros, and name-dropping (a.k.a. soft circled)

Nivi: Yeah, the advice for an angel round and a VC round are exactly the opposite of each other. Another way to test people’s interest or to just see how interested they are is to talk to them at the end of the meeting about a dollar amount that they would be interested in investing, and then whether they would be willing to make introductions to other angel investors.

A guy who has given you a dollar amount and is willing to make intro’s – I think that’s basically what I would call the formal definition of a soft circle in an angel round. I guess the third part of a soft circle is they’re willing to let you use their name.

So, the definition of a soft circle is:

1) There’s a dollar amount attached to it.

2) They’re willing to let you use their name with other investors.

3) They’re willing to make introductions.

If you’ve got all three, I would call that guy essentially soft circle.

When do you need a lead?

Nivi: So, we talked about mass syndicating the round, and we’re not done with that, but what are some cases where you would actually want, or let me put it another way, where the angels would actually want a lead in the round?

Naval: Angels will want a lead if they don’t know you and they don’t trust you, or if they don’t agree with the terms and they want the terms renegotiated, but their amount is too low to do it themselves; or if you have a very complex business that requires a lot of due diligence, or a very mature business that requires a lot of due diligence, so someone is going to have to go in there and investigate it; or if the price is just high enough. If you just need to raise a certain amount of money, usually beyond around $500K I would say is the upper limit, then you need an institutional investor and that person is going to be a lead.

Nivi: Do you think the majority of financings of $500K or lower are done without a lead?

Naval: They certainly can be; I wouldn’t say they are. I would say about half and half. It’s always harder to do without a lead because you’re looking for smaller angels. If you find a lead it shortcuts the whole process. You’ll close much, much more quickly, but one may not always want to find a lead, either because one doesn’t want the oversight and that institutional investor mentality that a lead generates, or one doesn’t want to negotiate the terms.

Approach the financing as if you won’t find a lead

Nivi: Yeah, and just to be clear, we’re not saying that you shouldn’t find the lead, but I think you want to approach the financing as if you’re not going to get one.

Naval: Yeah. If a lead steps forward and is willing to negotiate a term sheet and do the bulk of the round, or half the round, then yes, you should definitely entertain it. If they’re someone you like and trust they can short-circuit the whole process for you.

What’s a lead investor?

Nivi: And we’ve got a few articles, actually, on Venture Hacks you can look up, How do I find a lead investor?

What’s the definition of a lead investor? Let me throw one out: They want at least half the round, and often they want the entire thing. If they don’t want the entire round they’ll help you find the other investors. They’re essentially willing to make the decision for themselves, and in the best case they’re willing to put their money in your bank account and close the deal even if all of the money is not signed up yet.

If they say “find a lead,” ask why

Nivi: So, I would say if a sophisticated angel investor, or even an unsophisticated one, at the end of the meeting or in an email says yeah, I’m interested but I need you to find a lead, I would ask why, and why they’re not interested in participating in the mass syndications. And they may end up telling you one of the things that Naval said, for example, they like you, they like the product, it looks interesting, but they don’t know the market well enough to make the decision on their own, they don’t know enough about the terms or they don’t know enough about you to negotiate the deal with you, or they don’t care enough to negotiate the deal with you, they just want to put the money in and not worry about the deal. So just ask why. Don’t take hey, I want you to find a lead, as a great answer. It’s often a way for people to preserve the option to invest in the round, just in case Sequoia decides they want to invest in the round.

How to create a deadline

Nivi: OK, after the first meeting how do we turn all these angels interest into money in the bank?

Naval: This is a very difficult problem because you have to create a forcing function, and really there are two forcing functions that work well. There are some artificial, external ones. It could be the case that your company has some kind of a partnership coming up where you have to make a payment by a certain date or you’re going to go under, so that can create a forcing function, but that’s not necessarily the good kind because it gives people leverage over you.

There are two of the better forcing functions. One is time based where you very clearly say: We’re closing a round at such-and-such a date, the notes are all authorized to close at that date. After that date we will not be able to accept more money, we will be back to focus on our business, and if we raise less than the maximum amount that we’d authorized, that’s fine, we’ll just make do on that amount, and when we go to raise money next time it will be on different terms.

That is the lesser of the two good forcing functions, and that allows you to at least put a time limit on it. Now the problem here is you have to be credible and you have to stick to it and you have to pick good time, because if you arrive at that date with no money, or too little money, you will lose all credibility when you go back and ask for more money.

Nivi: Holidays can be good forcing functions.

Naval: That’s true. Holidays are very good that way. You can say you’re trying to get it done by Christmas or before the New Year, and so on.

Nivi: By Thanksgiving.

Naval: By Thanksgiving. You probably don’t want to use ones like: we’re trying to get it done by Boxing Day, or something like that, or more obscure. [laughs] But certainly if there are trips coming up, or if the founders have to go back to the UK for visa purposes for a month, that would be another way to do it. But the time-forcing function is the lesser of the two.

The better one is over-subscription, where you basically say: We have more people who are interested than we have room for. We like you very much, but we can’t guarantee a spot until you’re committed. Allocations will be on a first-past-the-post basis. And you basically line up more angels than you have room for.

Raise the money when you don’t need it

Nivi: And the third thing I’d add is raise the money when you don’t need it. That can be super tricky, or perhaps impossible on a seed round where you’re trying to build the product, a team, and get a little bit of traction so you can go to the angels with something other than just a product or an idea, with some traction. It’s hard to raise the cash when you don’t need it, but if it’s possible I would do it.

Naval: Absolutely.

Send two emails to the angels

Nivi: So, just very tactically, how do I get the money into my bank account? What I would do, or what I’ve done in the past is collect the names of all the people who are interested, have said yes, they’d like to participate in this round. Send an email to each one with the term sheet, with the same exact terms that you discussed previously. Tell them who else is going to be participating in this round, just as long as the guy has said that they’re interested and they’re willing to let you use their name. I would list all those people in the email. Tell them here’s the day we want to sign this term sheet by – at least put it two weeks out. Ask if they have any feedback on the terms; if not, you’re going to send them the closing documents.

Basically, do they want to invest? What’s their final decision? Do they have any feedback on the terms? If not, we’ll send you the closing docs.

Naval: It can often be a good tactic to send the closing docs through the lawyers, because the lawyers will make it very formal, and they’ll put things like: the closing date is such-and-such date, here are the wire instructions. That creates an air of authority and formality around it, which helps the closing.

Nivi: Yeah. I don’t think I would send the closing docs until they’ve agreed to the term sheet, though. Right?

Naval: Absolutely. Absolutely.

Nivi: OK. So don’t force the closing docs down their throat. See if they have any feedback on the term sheet. If not, I would just send them the final rev of the term sheet that incorporates feedback from all of the investors, as well as the closing docs and the wire instructions all in one email – so this is the second email we’re describing now – again, listing the names of all the angels who have committed to sign the term sheet now, or have seen the term sheet and have approved it.

So this is actually two emails. The first one is term sheet, and please give me feedback on it, with a list of angels who are interested in signing it. The second email is: here’s the final term sheet, the closing and wire instructions, and the final list of angels.

Again, for the first email I would set at least two weeks out for them to get back to you. Do you think two weeks is too long?

Naval: Probably. I would just give a week.

Nivi: OK. I guess I would do a week. I would expect to blow that deadline in my limited experience, though. [laughs] And you’ll have to send a few emails to these guys, just bugging them a couple of times with: hey, do you want to invest or not? kind of emails. Put it nicer than that, and also always include one sentence on something great that has happened in the meantime to the company, just so you can show momentum.

Do a rolling close: the cash comes in just- in-time

Naval: This is where the concept of a roll-in close comes in, which means that investors don’t have to put their cash in all on the same day. All of the investors don’t have to commit all at the exact same time. As they get to your email, sign the docs, get their account into the lawyer to set up the wire, the money comes in. And that money can come in over the course of, say, a week or two in practice.

And you can also set up the documents so that even when all the money’s come in, there is still room in the documents to raise another 50 or 100 or another $200K using the same, exact documents.

So you can do this first roll-in close, and then you can do a subsequent roll-in close if you find some new investors you want to bring in on these same terms.

Mass syndication can fail if a very high social proof investor drops out

Nivi: Have you ever seen this mass syndication approach blow up at the end?

Naval: Mass syndication could fail at the end. It would fail, most likely, if some very high social proof investor drops out. That’s probably the single biggest reason it could fail, but it’s pretty unlikely because here you have sort of a diffuse group, so it’s unlikely that any one person would blow up the deal.

Nivi: It’s really a question of how effectively you’ve read their interest in your round when they say they’re interested. Again, I would use those signals that we put forth before, in terms of are they a soft circle or not? Did they say you can use their name? Did they talk about a dollar amount? Did you discuss the terms with them? Are they introducing you to other investors?

Use AngelList and StartupList to get intros to angels

Nivi: OK. Let’s talk about how to get intros to angels. I’ll start off.

Naval: Angel List.

Nivi: Angel List is one thing. We’ve got a list of angel investors. It’s called Angel List. You can contact a lot of the angels directly or through referrals.

Read the free chapter from Pitching Hacks for tactical advice on getting intros

And then we’ve got something called Startup List, where you send us your pitch, and if it’s a good pitch we pass it on to the angel on Angel List.

What do angels look for?

Nivi: When we look at the applications for Startup List we look for a few things: Social proof – essentially who have you convinced to let you use their name as an advisor or investor or team member. We look for your traction.

Naval: We look at your bio – who you are, what you’ve accomplished. Plus we look at your product if it’s a web-based product. We like to see the demo or the alpha or the prototype. It’s very hard to actually send something out to Angel List without having seen some evidence of the product.

Nivi: Right. If I had to boil it down to two things, I’d say social proof and traction. And if I had to boil it down to one thing, I’d just say traction.

Naval: Yeah. I’d say in order of importance, it’s probably traction then team then social proof then product.

Advisors are good for getting your foot in the door, not in a pitch

Nivi: Right. And VCs and other folks like to make fun of people’s advisor slides that they tend to put too much emphasis on when they pitch, which I think is right, but I think advisors and social proof are a great way to get into the door. When you’re in the door I don’t think it’s important anymore, but it’s a good way to get in the door.

Get advisors by going to events or talking to entrepreneurs

Nivi: And by the way, how do you get advisors? Go to events. We recently talked about this thing called Startup Digest, which is the best events in 27 cities or so. It’s a curated email list. You can subscribe to that. It’s called Startup Digest.

Naval: You can ask other entrepreneurs.

Before you raise a seed round, you need a product in the marketplace

Nivi: And I think we already answered this question a little bit, but what do I need before I raise a seed round? I would say you need your product to have been prototyped in some way or another, and it needs to have been put into the marketplace in one way or another and have some traction.

Naval: Yeah, and obviously that differs on the product type. For a consumer web product you should probably have launched it or soft launched it. For an enterprise product or something that requires a lot of money and a big team to build, you may at least want to test the market demand.

I would define traction as quantitative evidence of market demand.

Use customer development and lean startup techniques to get to market with less

Nivi: Yeah, that’s good. And look up for customer development techniques. Also look up Eric Ries’ blog, for lean startup techniques. It’s basically how to get more traction with less work.

Pitching Hacks free chapter: Advice on getting investor intros

Nivi: For some really tactical advice on how to get meetings with angel investors, we’ve got a whole book on that topic called Pitching Hacks. Look it up. You can buy it for $9.00. I think it’s worth it. You can check out the testimonials from smart guys like Adam Smith, the founder of Xobni, or Aaron Iba, the founder of EtherPad. And the chapter on how to get introductions to investors is actually free online, so you can get the PDF of that chapter for free.

If you need money to get something in the marketplace, pitch idea investors

Nivi: If you need money just to get to the point where you can apply to Startup List or talk to angels, essentially to get to the point where you have some product, some team and some traction, my recommendations are friends and family investors. So those are your actual family or people who know you and are willing to essentially back you. So it might be a boss that you worked for for 10 years who has enough disposable income to write you a check for $5K or $10K or $25K. And finally I would say people who just see the same problem that you see, and they believe in the product and the market. Like, they’ve had that same idea themselves and they don’t have the time to pursue it themselves, but they’re willing to put a little bit of money behind the guy who does have the time to do it. I call those three groups of people idea investors.

Pitch incubators or do your startup on the side

Nivi: An alternative to raising that idea money is to apply to one of the Y Combinator style incubators, like Y Combinator, TechStars, DreamIt, there are a bunch of them now. Just do some web searches. They will back you on the basis of essentially an idea alone, but in general you need to have a team of people who can get things done. It can’t be all just business guys.

Another option is to keep your day job and do your startup on the side, which you can find lots of great posts on, online, if you just do some searches. We’ve got a post on it on Venture Hacks called Half-Assed Startup, written by Tony Wright from RescueTime.

What are the different types of seed stage investors?

Nivi: I guess the last topic is what are the different types of people who invest in seed rounds? You’ve got your independent angel investor who’s investing his own cash. You have angel investors, or let’s call it a seed-stage fund, which is investing an LP’s cash. They have other investor’s cash that they’re investing. And that seed-stage fund may be represented as a fund, like first round capital, or it may be represented as more of a person, like Naval, say.

Naval: Yeah, generally the way a seed-stage fund will differ from a pure venture fund is they’ll be investing smaller amounts, they will be willing to do convertible debt with a cap, and they also will not require board seats or require heavy oversight. They can also probably decide a lot more quickly. Most seed-stage funds, although not all, don’t have the concept of a partner’s meeting. Usually when you’re talking to one or two people, you’re talking to everyone.

Nivi: Right. So I guess another example of a seed-stage fund that presents as an individual is like Jeff Clavier. Is that right?

Naval: Yes.

Nivi: Seed-stage funds that present as firms are First Round Capital. Who else?

Naval: Founders Fund.

Nivi: Founders Fund are more multi-stage aren’t they?

Naval: Ah, fair enough. True Ventures.

Nivi: True, right. And now we’re getting into the topic of multi-stage funds, so now you have classic VC funds, or new ones like Founders Fund, that invest across a broad range from incubation all the way to Series E.

Naval: Right. Charles River Ventures has a very active seed program, all the way from 25,000 to a quick start of 250,000 to Series A and Series B.

Nivi: Yeah, and other firms that don’t have specific programs like Sequoia Capital, for example, do seed-stage investments all the time, although they don’t have a specific program for it.

Naval: Correct.

If you’re talking to a VC, make sure they really do seed stage rounds

Nivi: I think if you’re talking to any VC that does multi-stage investing, you really want to ask them: When was the last time you made a seed-stage investment? How many have you made in the last year, essentially, and more importantly, what did the company look like when you made that seed stage investment? Their definition of what the company looked like may be 5 million uniques a month coming to the website and they still call it a seed-stage investment, while you’re struggling to release your product. So you want to ask them what their definition is of a seed-stage investment.

Potential concerns with pitching multi-stage and seed-stage firms

Nivi: I want to talk about two things. One: what are the things to be concerned about when you start to bring seed-stage firms into your angel round, and multi-stage firms into your angel round? And two: a lot of these firms are acting more like angels these days, and let’s talk a little about that. But let’s talk about the concerns first.

Naval: The concerns are that you don’t want to have a process that’s a VC process, so you don’t want to go through too many rounds of meetings and due diligence and so forth. You don’t want to have governance that’s VC governance, so you don’t want to give up board control; you don’t want to have regular board meetings; you don’t want to have to concentrate too much on financials at this stage. And finally, you want to be careful about firms that may have negative signaling value – so, people who often do invest in subsequent rounds and sometimes don’t – because if one of those people invest in your financing and then does not follow on in the next round, it can be a signal of death, a death knell to the other prospective investors.

Nivi: Right, so the ones to worry about most on the signaling value are the multi-stage firms who are investing in seed rounds mostly to have the option to invest in the next round, and maybe a little bit about the seed-stage firms that present as firms.

Naval: Seed-stage firms generally don’t lead or invest in following rounds, so it’s less of an issue.

Nivi: Not even for pro rata? I’m talking about a First Round.

Naval: Yeah, it depends on the firm, but yes, for example First Round probably normally does pro rata so that signal is important. But someone who is investing and doesn’t seem to care about the valuation at this time, but wants a contractual option to invest in the next round, there you’d really have to worry.

Nivi: And they don’t even need a contractual option. It doesn’t matter.

Naval: Yeah, it’s just an even stronger signal with the contractual option if they don’t exercise it.

Nivi: Yeah. I guess the other thing to worry about if it’s a multi-stage firm, is if they don’t own enough in the seed-stage round.

Naval: Yes, because then they’re going to want to invest maybe more than their pro rata in the next round, and that can create strange dynamics where they’re trying to bid your valuation down.

Nivi: Yeah, and the bottom line is if they’re trying to increase their percentage ownership in a subsequent round of financing, they have an incentive to drive down your valuation in the next round. You might ask if they don’t always have that incentive. No. If you want to do your pro rata or decrease your percentage ownership in the next round, you’d no longer have that incentive. If you want to just do your pro rata, you’re indifferent on the valuation of the next round, and if you want to decrease your ownership you actually want to increase the valuation in the next round as much as possible.

What do you see when these seed-stage and multi-stage firms participate in terms of leaving room for angels, taking half the round, just participating as like 25% of the round like another angel?

Naval: The good ones will leave room, and it’s up to the entrepreneur to dictate. Probably one of the biggest mistakes you can make in doing a syndicate is where you don’t leave enough room for individual investors, and you give everything up to one or two lead investors. The amount of help you get out of a person is relatively fixed. There might be slight variations around the edges, but you’re passing up most of the advisory benefit of having angels if you don’t do a mass syndication to a large group.

Nivi: Another bit of advice I would give is if you’re going to raise money from a fund in a seed round that has signaling power in the next round, don’t raise money from just one, get a couple in there.

Naval: Yeah, it helps to diffuse that signal.

Get intros to seed investors with AngelList/StartupList

Nivi: OK, thanks for listening. Nivi and Naval are signing off.

A last plug for our products is Angel List, which is our curated list of angel investors and what they’re looking for and how to get in touch with them, and Startup List, which is where you apply to us, we look at your pitch, if we like it we pass it on to whatever angels you want us to pass it on to, or we’ll pass it on to all the angels on Angel List if you like.

The metrics on that, to date, are pretty good. The whole idea is about five weeks old. We’ve had about 25 investors ask for intros. The other cool thing about it that I like is the investors come to you and ask for an intro, but great investors like Jeff Clavier, and Ann from Mike Maples’ fund, and guys like Matt Mullenweg, and Jon Callahan from True – just a great bunch of guys – are asking for intros. About 15 startups have gotten intros and we’ve even gotten one startup funded so far, and probably more coming online pretty soon.

Naval: One that we can talk about right now.

Nivi: One that we can talk about, yeah, where Matt Mullenweg, the founder of WordPress, invested, and we hope to announce some more success stories about Startup List soon.

Thanks for listening! Bye, bye.

Topics Angels · Interview

10 comments · Show

  • Chris McCann

    Very relevant article to us right now and many founders I know are going a similar situation..

    PS – StartupDigest now covers 45 cities and 3 Universities 🙂

  • Kevin Dewalt

    Another excellent article guys. Bravo.

    I’d only like to add one nitpicky comment that positioning the Lean Startup and Customer Development strategies in the “before you have resources” context may reinforce the common confusion that Lean Startup = Cheap Startup, although I realize this isn’t at all what you’re proposing.

    Whether you’re a part-timer with $500 in the bank or General Electric, every exercise in innovation needs to innovate faster with less waste.

    Eric, Steve, and the other advocates of the movement they’ve launched are educating a new era of innovators who will make a profession out of perfecting this process.

  • Jefrey Bulla

    thanks for the presentation, very useful. My recomendation is to do it with video to see you guys, it makes it more dinamic.

  • Phil Hill

    Where can i find some examples of great investor decks i.e. the 10-15 slides. i already have the elevator pitch etc covered. thks

  • Chris Werner

    Great insights, thank you.
    You stress that family and friends are the first target for fund raising which is of course mainly because there is a level of trust and relationship that is hard to replicate with outside parties.
    This is, however, reinforcing that the art of communicating about what you do, how it benefits potential investors, why they can trust you + finding the right channels and the right tone are what differentiates firms that succeed from those (with equally good ideas) that don’t when fund raising from outside parties! It is essential for start-ups where family and friends cannot provide the funds needed, that they learn how to properly communicate: The recipe is actually simple. Be authentic, honest, open and proactively provide information.

  • Anonymous

    In your statement:

    “We’re hoping to close by such-and-such a date, or we are going to close by such-and-such a date. There are x dollars available, and it’s a convertible note and it’s capped at a valuation of x and a discount of y.”

    What do you mean by “a discount of y?”



  • @maconic

    Convertible promissory notes are such that they convert to equity in a future financing round at an X percent discount of the that round. Angels use this strategy when they don’t want to pick a valuation (“I’ll invest $50k for 10% of the company stock”) . Instead the angel is saying , “I’ll invest $50k for a 20% discount off the stock price the next round of investors get.” If in the Series A round the investors buy the stock at, say, $10 per share, the angel would get it at $8 per share (assuming a 20% discount). This discount is basically the “conversion price” of the convertible note.

    Yokum talks about this a bit here:

    Here is a sample convertible promissory note:

  • Ralph L. McNeal

    After spending over 20 years as a V.C. and small business advocate…never heard so much “malarky” in my life. My organization reviewed over 150 deals a year and our goal was to do four. We analyzed the business plan (which is a selling document), applied our due diligence, research, etc. and produced a “Letter of Agreement.” That letter of agreement was then passed on to the participants lawyers, closing documents came forth to be signed, sealed and delivered. We acted as lead investors, and syndicated where necessary. Worked in concert with Governments, Economic Development folks, Corporations and others that could bring “Added Value” to the deal. Our goal was to bring the “Added Value” based on experience with other new ventures and industries, contacts, networking, campaigning, board representation, etc.

  • David

    In the vid, they mentioned that if you raised 1 million from “institutional investors” its like a mini VC round.

    How or why would an institution
    (JP Morgan, UBS, Blackrock, citi) even be interested?

    The DD alone would kill the deal, like going to the bank and trying to get a $100 loan, you may be good for it, but the bank wont make any money, its easier for them to do a loan for 10k.

    Next, why would a lead or whatever you want to call it, the first outsider to invest want to invest a dime without a timed close or even without a firm raise amount?

    Remember from school, the time value of money?

    So you are saying you close investor A in Q1 and investor B in Q3 at the same terms? Why wouldn’t investor A wait around where is his immediacy?

    All of this “hacking” is just that a hack for hacks.

    One last thing, if your friends/family are accredited investors, pitch them if not don’t. Why blow out all of your kin and friends over a business thing if it doesn’t work. Leave the risk to professional investors. Period.