Let’s talk about Tikhon Bernstam.
Not only has he invested in over 80 startups (including Reddit, Optimizely, WayUp, ZenPayroll, DocSend, Headspace, and many more) – he also founded Scribd, the world’s largest document sharing site – and Parse, which was acquired by Facebook for $85m. You can read more about Tikhon on his Wikipedia page.
Tikhon hasn’t only seen a lot over the years, he’s also known for brutally honest, founder-friendly advice. AND he’s agreed to pass this knowledge on directly to the Dreamers // Doers community.
Without further delay, below is no BS fundraising advice, by Tikhon, based on some of YOUR most burning questions.
Amount we’re raising: We’ve told most potential investors that we’re raising a round of $500k, but realistically would need $750,000 – $1,000,000. How do we handle the conversation of needing more than we originally thought? Is that a red flag for investors?
Standard answer is $1.5M these days. Realistically I’d hope to raise more than that. I would not say a number lower than $1M. I would never count on raising a second seed round — investors are often leery of that because you should be able to get to a series A off the first seed round or folks might think something is wrong.
I prefer rolling caps as outlined in this piece by Paul Graham — this is the fastest way to raise. Seed money is the best money you can raise — you can use quick 1 or 2 pager convertible notes or preferably SAFEs. In equity priced rounds with VCs you usually have to give up a ton of rights, control, board seat (often), protective provisions… it’s long, expensive, time-consuming, distracting, involves lawyers. YC SAFEs can be done online quickly and easily with clerky.com or ironclad.
Seed money is fast and cheap and the best money you can raise. Use YC SAFEs only and fire any lawyer who disagrees. Don’t do a priced round in your seed round. You can go from a pitch to money in the bank in 24 hours, and the pressure of the rolling cap going up as in the link above is the greatest motivator to force sheepish investors to make quick decisions. Use FOMO to your advantage. IIRC, Zenefits raised the first money at 5M cap, then 9M, then 12M, then 15M, then uncapped. And no one is complaining from any cap in that seed round.
You can go from a pitch to money in the bank in 24 hours...use FOMO to your advantage. - @tikhon Click To Tweet***
Also how does a pre-seed round affect the next raise? Should we go for a $500k pre-seed and then raise again in 6 months? If one investor is pre-seed and another typical funds seed rounds, does it still count as a pre-seed?
You should always have a minimum of 6-9 months runway in the bank. The CEO’s #1 job is to make sure the company doesn’t run out of money. Equity rounds can take a long time from fundraising to term sheet to definitive docs to money wired. 3 months is not atypical. I would want to raise at least 2-4 years in my seed round.
Read pitching hacks. Use the deck template from pitching hacks. Seriously. Do not make a deck without reading pitching hacks and Paul Graham’s how to raise money.
Angellist works too, if you have a good person leading a syndicate for your deal.
How much should we pay ourselves? Lots of talk on this in some female founders groups we’re in. We’ve heard large ranges from 50k – 100k and are hovering around $75,000 year for the two main founders and $100k for our CTO.
Recently I’ve seen more pre Series A companies paying the founders, but it used to be rare. I prefer the company pay in pre-tax dollars for all items possible, from phone bills to any business related expense (e.g. a car if you aren’t in nyc). I’d have the company cover your major expenses this way when you can do so legally and then a nominal salary if you must.
Beg for forgiveness, don’t ask for permission. Most startups don’t make it anyway, so odds are it will never be an issue anyway, and if it becomes one, you’ll have tons of cash to make it go away. In the example given above, 75k a year for 2 founders and 100k for the CTO is already 250k a year which is half of what you’re talking about raising? One good engineer will cost a lot more than 100k a year too.
Will investors give us crazy eyes for going too high? 😳
Yes. Don’t even talk about it. Investors rarely ask, and you should not preemptively bring this up. Rookie mistake. No matter what you decide to do. This does not belong in the fundraising conversation. Or any conversation before the A.
Valuation + equity: We’ve got big picture Qs around a valuation – like, how the hell do you figure it out this early? ;)
Rolling caps solve this problem of matching supply and demand to keep a fair market price. If your first guess is wrong, adjust the cap until the demand is there. If it’s too low, raise it! (+read Paul Graham advocating for rolling caps)
And as far as equity goes, we’ve currently split 50/50 between two primary founders. How do we decide our CTO’s equity split?
One way to decide is to find the market price of the company (the last valuation of the company, example money was raised at $10M), and paying them, say, $1-2M worth of stock over 4 years. Don’t forget they’re going to get diluted in future equity financings. After a Series A that 10% will look more like 6%. VC rounds are very expensive in terms of control and ownership. Don’t get me started on the games around options pools either. Minimize the size of them.
Startup equity is not a zero sum game. Over four years of full-time work by the CTO, would that person make the company worth 10% more than it is today because of their contribution? 20%? Then be generous. If the hire doesn’t work out or is not contributing, you can always part ways during the first year cliff period. But the truth is you’ll know in the first week if things are working. The first day, actually.
I wrote about how employees are already getting the short end of the stick. Treat people well, and they’ll fight for your company ’til death. Treat them badly, and they might cause its death. There are so many ways to screw up a startup — why risk another one for a relatively small amount of ownership?
Dropbox and Airbnb both raised Series A rounds between 3 and 6M post-money valuations. And from angel investors at even lower valuations. And trust me, they’re doing just fine.
B2C outcomes are binary. When you win, you win really, really big. More often, you get nothing. No one will ask you what your valuations were or your percentage ownership down the road. All you’ll care about is whether you were successful or not. Do you recall Facebook’s valuations? Google’s Series A valuation? Twitter? I doubt it.
Optimize to win, not for ownership percentage, but for terms and control. If you win you’ll make so much money it won’t matter.
Be very generous with equity and especially with titles. Cash is your scarcest resource until you can show enough traction for a VC round. Pay folks in inflated titles and equity when you can. This has the bonus effect of aligning all your incentives.
Call everyone early a founder (e.g. “Founding CTO”). In fact, get rid of the entire founder/employee distinction. It’s ridiculous today when the risk to start a company is comparable to the risk of foregone market salary as an early employee.