Why is it so hard to raise early-stage capital?

Many founders and investors will think they already know the answer to this question. I know I did. Then I asked ten people, all of whom have been been both serious startup investors and founders. I was fascinated to receive such a wide array of answers.

As an investor, I've heard endless excuses from founders who are struggling to raise:

It's harder for me because I'm a [insert noun].

Much of the time these ideas are misguided. People simply underestimate how hard it is to raise money.

For most founders though, the ability to unlock capital is a necessity. It's just something very few people have ever had to do. Most people suck at it.

Asking other people for money doesn't always come naturally. When you're not experienced in something, you're rarely confident; and when you're not confident, it's hard to be fully committed. This is especially true when, simultaneously, you're running and growing a business.

Don't be fooled by all the funding announcements you see, either. That's survivor bias. You're not reading about people like you, who are struggling to raise, because those people aren't posting anything. There are, however, thousands of them. Yes, there's more money available for startups than ever before, but there are also more companies competing for it.

In the words of Daniel Callaghan, founder of Veremark: raising money is hard... because it just is!

He's not wrong.

Take heart though. There are ways you can improve your chances of raising money dramatically. In the points you're about to read you'll find a wealth of tips. There are suggestions for how to go about raising money, but also there are insights into what not to do. Knowing what to avoid is perhaps the most important skill of all.

In no particular order, here's why raising early-stage funding is so tough:

1 - Growing too slowly

Professional investors are not looking to place bets. Venture capital may sound glamorous - a band of daring, wealthy ex-entrepreneurs bravely investing in an as-yet-unknown future. In fact, it's much drier than that. VCs do not seek risk. They are looking for no-brainers.

Often, it's not their own money they're investing, either. VCs need to be able to justify the choices they make. That means your wholehearted belief in your idea is irrelevant. They don't want (only) to be blown away by your vision of the future, they want proof. Data. Don't tell, show.

One of my favourite anecdotes about venture capital is that being a VC is 99% making up polite excuses for not investing (polite because VCs usually want the option to invest later, if things get more exciting!), and 1% begging founders to take their money.

If your business is a rocket ship, which is growing at 10% or more per week, the money will find you. If it isn't, raising is probably going to be tough.

2 - Targeting the wrong investors

This is a big one. Founders often assume that because a) their business is great and b) an investor has money, it should be a done deal. Wrong. Funds come in all shapes and sizes, they follow different cycles, work at their own pace, write different sized cheques, have their own investment theses and processes, and are guided by unique mandates. Mapping the investor landscape can be an arduous process, but it's time well spent. Don't waste time pursuing investors who can never invest in you.

"Sorry, it's not a fit, but I wish it was!"

With the world in such a state of flux, this has never been more relevant than today. Many funds were created when industries were fairly static and easy to define. Ecommerce. Social. Crypto. Healthcare, etc. But now, especially since the pandemic, startups are focusing less on industry and more on behaviour. That's potentially a big problem, for startups and investors alike. Who do you pitch to if you straddle venture, web3, metaverse, music, gaming, and social?

3 - Bad pitching

Raising money can be a full-time job. Yes, it's a problem that the founder is spending so much time away from the core business, but it's also a fact that you can rarely outsource it. Investors know you need to be able to raise money; if not now, then in a subsequent round. Are you someone who can raise emergency funding when the chips are down? Can you close that first customer? Can you sign that distributor? Can you secure a loan when business is so good that you run out of cash? If you can't get people excited enough to invest now, you probably won't be able to do it later either. That makes you a serious risk.

4 - Unrealistic valuations

As a business that helps senior professionals to launch companies, this is an issue we've come across ourselves at DQventures. Investors, by and large, are not fixated by your valuation. What they do care about, however, is the multiple they can make on their investment, and how long that's going to take.

If you find yourself in the midst of a red-hot market, which investors agree is capable of producing multiple billion-dollar companies, you may discover that your valuation isn't an issue. On the other hand, if you believe your highly specialised company is worth tens of millions of dollars because it's taken 5 years of your life, and you've spent $1m of your own money, you may be in for a rude awakening.

How much you've invested in your idea is not a determinant of its value. What matters is whether people believe that you can increase today's valuation by 10-100x within 3-to-5 years.

5 - It's not you, it's me (i.e. it's you)

At some point you've probably read that the founder is the most important factor in any startup. Whether or not it's the number one factor, it is definitely up there. If investors don't like you, they won't invest.

Committing capital to a private company is just the start of the VC process. How much help are you going to need? Do you have the ability to take the current offering and scale it into a 25-100X return? If so, what resources - both financial and non-financial - will you need?

It's probably going to be 7-to-10 years before investors see a return from their investment in you (assuming there is one, of course). That's 7-to-10 years of meetings and calls, receiving your updates, questioning your decisions, perhaps sitting on your board, and listening to your BS. You need to be someone your investors enjoy working with. Do you listen? Are you coachable? Are you an awkward bugger?

You don't need only to fly the plane, you need to be someone your fellow pilot can sit next to for 9 hours!

6 - Lack of relationships

Although it may feel time consuming, it is never too early to reach out to investors. Don't wait until you need the money.

For VCs, investing is all about risk mitigation. They can reduce their risk in several ways. They can, and regularly do, join rounds that other investors are leading. They can invest in founders they've backed before. They can take warm introductions from people they know and trust. As an investor, it's much easier to back someone you know and trust than someone who's come to you out of the blue.

If you're a founder, you should think about how you reduce an investor's risk. Do you have any mutual connections who can introduce or vouch for you? Do you have investors from a previous business? Would they write a reference, and are they backing you again?

The very least you should try to do is to build a relationship before you ask for money. That means reaching out and maybe having a conversation before you're ready for funding. This has three major benefits: firstly, you're establishing a rapport. This can help reduce the perceived risk; secondly, when the time comes, you can pretty much guarantee an audience to pitch to; and thirdly, when you first meet, you can ask the investor what their triggers are. What will you need to show them, when you come back, that will convince them to invest?

Build relationships with the right investors early on and it will pay back manifold.

7 - Lack of FOMO

There's no doubt that the fear of missing out (FOMO) plays a big part in early-stage investing. Most investors have missed a big deal - it's not a good feeling! They will not want that to happen again. If you can't build excitement about your business, you're facing an uphill climb. You need to take investors on a journey - perhaps the same journey that's made you so excited yourself. Can you create enough intrigue to get investors interested in the first place? Can you turn them into passionate believers like you? Remember, most investors don't know you or understand your idea. It's up to you to convert them from a position of ignorance into having a clear understanding of your vision, as quickly as possible.

8 - The wrong business model

There is undoubtedly some herd mentality at play in the VC world. Look at the Buy Now, Pay Later trend of the last few years, and the booming interest in Web3.0 today. If you're not operating in the area where investors wish to place capital, your chances are slim.

Even worse, you may be operating in the right space, but have the wrong business model. Are you burning too much cash? Do you lack a clear path to commercialisation? Have you tested your assumptions about buyers? Is the market too small for your chosen approach? Is there no obvious exit in sight?

"Your burn cannot be more than the VC's enthusiasm for your business model and space." Joseph Thia

Clearly some of these issues are easier to tackle than others.

9 - The wrong go-to-market strategy

A great product is wasted if nobody uses it, and most great startup ideas are worthless without investment. In both cases, it's about getting the GTM strategy right. Raising money is the ultimate form of selling. You need to define your audience, get their attention, work out how you describe and position your product and, above all, convince people to get involved.

When fundraising, the best way to get someone's attention is a warm introduction. Isn't it better that someone else says how great you are than you do it yourself? But before you ask for introductions, you need to convince the introducer. By recommending you, they're putting their own reputation at stake. Is this deserved? Alternatively you could join a reputable startup programme or accelerator, where investors will seek you out, rather than the other way around.

Be sure that your story is easy for the investor to understand, too. They should be able to repeat it. They may need to sell the investment to colleagues, friends, and the investment committee.

Equally importantly, be attractive. Make sure you provide proof that this is a no-brainer. How can you demonstrate unfair advantage, traction, momentum, and success, so others can spread the word on your behalf?

10 - Solutions looking for problems

Last but not least, in many cases, founders simply don’t understand what is required of them and their business in order to raise capital. Far too many early-stage startups are solutions looking for a problem, with little (or no) validation of the idea. This is what people mean by "product market fit". There is no point in creating an elegant product or solution if nobody is prepared to use it. And persuading people to use something is harder than many first-time founders think.

What is the "hair-on-fire" problem that is being solved? Are you tackling something "Urgent, Unworkable, Unavoidable, Underserved"? If you are, you may be surprised how forgiving your customers can be, provided you're solving their problem. If not, you'll be amazed by how hard it can be.

With so many startups launching each year, an investor has the option to pass on those they don’t feel are 100% right for them. Founders who can prove, repeatedly, that someone is willing to pay for their creation, have a huge advantage over those who simply have an idea.

Clearly there are many different reasons why founders struggle to raise early-stage funding, but take heart from the fact that you're not alone. Some of the world's most successful startups struggled in exactly the same way as you. If you're building something that can scale, and you're creating proof that it satisfies a real need, then the chances are that somewhere out there is an investor who believes in you.

With good planning in advance, it's possible to avoid a huge amount of wasted effort. Avoid constant rejection and demoralising setbacks by taking the time to identify the right investors, then build a relationship with them long before you ask for money.

Credits

Thanks to the following for your ideas and input. It was fascinating to hear such a diverse mix of answers from people who have been both founders and investors: Antonia Burridge, Chris Howard, Daniel Callaghan, Indy Sangha, John Tan, Joseph Thia, Dr Les Buckley, Mikael Krogh, and my partners Arjun Singh and Oliver Palmer.