Field Guide

Field Guide

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Introduction

Fundraising

It can seem daunting to raise capital for your startup, but with a clear understanding of the milestones Seed and Series A investors expect to see, you can set the right goals and successfully raise from top investors. 


This chapter will uncover what investors are specifically looking for, how to create excitement for your company with a strategic pitch, and how to run a bulletproof fundraising process to raise from the best VC’s.

Chapter Authors

Haley Daiber
Haley Daiber
John Vrionis
John Vrionis
Rachel Star

What You'll Get

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This chapter will cover

When Are You Pitch-Ready?
Haley Daiber
Start module

When Are You Pitch-Ready?: Consumer Social

For founders raising their next round, one of the hardest things about the “black box” of venture capital is understanding what investors are looking for. When I started my consumer networking app Forget-Me-Not in 2016, I was so confused about what I needed to accomplish before I was ready to pitch institutional investors. I knew I had to bootstrap my way to some traction, but had no idea what “traction” really meant. I knew I wasn’t there yet, but wondered how I would get there when I didn’t even know where the goal posts were. You always hear stories of people successfully pitching an idea on the back of a napkin, but in what circumstances did that really apply? Even more confusing, every investor’s website lists the same generic, vague qualities that they seek in investments they make — “incredible team” + “innovative solution to a hard problem” + “market opportunity.” Many investors claim that “no idea is too early,” but startups are often turned down when they don’t have enough proof points.

Now as an investor myself, and learning from consumer investors like Unusual partner Andy Johns, I have a much clearer sense of the goal posts. To help make this clearer for others, I’ve outlined below the goal posts I wish someone had told me back when I was preparing to pitch. The truth is that ultimately, the answer is often “it depends,” but a good place to start is the business model and four key considerations: team, product, traction, and market. How much investors weigh each of those four aspects can vary between firms and individuals, but there are some ballpark figures that might help you prepare to pitch.

It’s worth restating that, of course, there are no hard and fast rules, so please take these guidelines with a grain of salt. In our experience at Unusual, we’ve seen consumer companies raise $25M+ Series A rounds with $500K in ARR, and on the flip side, companies struggle to raise a $5M Series A, with $3–5M ARR. Another exception might be if you have remarkable founder-market fit or have previously demonstrated that you are an exceptional builder. Of course, every investor is looking for the “perfect” deal that hits on all four key dimensions.

In reality, there is no such thing as a “perfect” startup or deal — even if the company hits all squarely on all four dimensions, the deal dynamics may be complicated or less than ideal (i.e. super high valuations and competition). There isn’t a “correct” answer when it comes to investing, especially at the early stages — it’s subjective judgement. So as a founder, reading investor’s minds is pretty much impossible, BUT there can certainly be elements that are more important than others to an individual investor or a firm. For example, some firms and individual investors look for an amazing market first and foremost (often “theme” and “thesis” driven firms) and are willing to bet on a great market even if they aren’t blown away by the founder(s), the traction is good but not great, or the product is lacking a bit.

Meanwhile, another firm or investor may skew more heavily towards the qualifications of the team under the belief that it may be impossible to accurately predict future exciting markets (i.e. trying to evaluate Uber based on the size of the taxi industry), and that great people can make magic happen and pivot to find unexpected new markets. Case in point would be the Slack’s pivot from a game into an enterprise messaging app.

All that being said, we think there should be more transparency and less guesswork when it comes to what investors are generally looking for when founders pitch, so we’re sharing how we generally think about Consumer Social investment opportunities at Unusual, based on those four key areas:

Green means you should feel confident to pitch. Yellow is maybe, there’s some potential, but it’s not a slam dunk. Red is going to be a non-starter for most institutional investors. (In venture, institutional investors fundraise from limited partners to professionally invest on their behalf.)

Evaluating a Seed-Stage Consumer Social App:

Andy will now explain what each of those four aspects mean, expanding on the “ideal” scenario on what is most important to him as a consumer investor:

Team

Builder Capabilities

Consumer startups are hard. Consumer social startups are even more difficult. Not only do you have to figure out a method of communication that tens or hundreds of millions of people will want to use regularly, but you need to do so in a very short period of time (12–18 months max). From my experience, arriving at the “aha!” feature requires lots of iteration. That said, the pace of product development is often a great indicator of a startup’s higher likelihood of success (relative to all other peers).

Specifically within social, that means iterating on the product based on observations of user behavior within the early adopter base of a few thousand users. I was an early user and employee at Quora and observed firsthand how the product evolved during its first few years. Although the user base was not large by some standards (in the low tens of thousands by the time it was 2–3 years old), the pace of product improvement was world-class. The pace allowed Quora to dial-in on the set of features that led to people sharing high quality knowledge that can’t be found elsewhere, which drove the breakout moment for the company.

If the founding team hasn’t shown the ability to turn over new beta versions of the app at a fast pace, the probability of figuring out a unique insight is quite low.

Vision

For teams building Consumer Social, I look for what I call “communication philosophers,” which means that when they’re building a social product, they’re talking about the theory of human communication. There’s a depth of thought there, where they’ve observed in real life how people naturally want to share and communicate with each other. They have a nuanced and often philosophical perspective how software can accentuate the natural communication habits of people.

Evan Spiegel from Snap is a great example of a communication philosopher. Many people misunderstand and think disappearing messages are just for sending illicit pictures. Some users certainly do that, but it’s the edge case of user behavior that is being interpreted as the primary use case. However, when you talk to Evan you learn that the value of disappearing messages (ephemerality, as he often calls it) is in what the disappearing message does to the cognitive load of sharing. Specifically, ephemeral messaging removes cognitive load, leading to an accelerated rate of sharing. We can unpack this concept via a counter example.

Imagine you’re about to post something on Facebook. You create a draft and, just as you’re about to post a message, you pause and reconsider whether or not it is worth posting the message. That’s because you’ve become familiar with the downside of posting a message in a public-by-default setting. Remember the last time you posted on your account about the upcoming election and the waterfall of comments and notifications you received in return? And how irritating it is for you to read and respond to all of the comments? That’s called cognitive friction to sharing. You don’t want to share because you don’t want to deal with the backlash. The next time you go to post something publicly (which is the effective default on Facebook and Twitter), you hesitate and that slows down the pace of sharing, which consequently weakens the network effect of the product.

In real life, people communicate in a much more intimate, one-on-one basis. Because the vast majority of conversations are intimate, they are also ephemeral. When I’m talking with my brother or a good friend, no one is writing down our conversation or listening to it, which means it’s only remembered by us as the sender and the receiver. Furthermore, because the conversation is intimate it also tends to be more fun (hence the role of lenses to accentuate the “fun” part of it). Evan’s thesis on ephemeral communication makes its way through all the nuanced aspects of the product. For example, if you send a snap to 20 people, none of them know how many other people received it as well and there isn’t a public thread of responses. Those features (or the lack thereof) further reduces cognitive friction to sharing, leading to a very high rate of sharing amongst Snap users.

Hearing a founder talk about and observe how people interact in real life and then being able to communicate in a clear way how software can accentuate that, and translating that into their product is a series of events that is super rare. Often, we will see a consumer social pitch with the opposite approach where the founders are creating a new communication method that they want the world to adapt. That’s a dead end street in most cases.

Product

In a Consumer Social product, I look for direct alignment between the product features and the founder’s communication philosophy. Using Snap as an example again, the product is designed around a non-traditional UI decision and opens up in camera-mode. That unconventional product design directly aligns with Evan’s theory of ephemeral messaging and one-on-one communication.

Whenever I dissect a product relative to the other products in the market, I ask what’s going to compel users to do more of a desired behavior, whether that’s write more or listen more on that particular app compared to other mediums. So first and foremost, there has to be simplicity of design and the app clearly pointing in a single direction. Similarly, this alignment continues through to the platform of choice — having all platforms (Apple, Android, Web, Watch, Tablet, etc.) isn’t necessary, but instead having a succinct vision as to which one or few are needed to best align the product with the founder’s big vision.

This obsession with a single feature is sometimes referenced as “come for the tool, stay for the network.” Users flocked to Instagram because of its filters and stayed for the newsfeed. Similar dynamics drove the adoption and retention with Twitter, YikYak, Snap, and several other social products. When you find an app that’s singularly focused on a single function that users find compelling, that’s usually a great starting point.

Traction

For traction in a Consumer Social startup, it’s all about the rate of growth and quality of engagement. Generally speaking, you’re going to want to start with a highly engaged base of 1,000–10,000, which isn’t very large, yet their level of engagement is exceptionally high. As a high-level benchmark, I look for around at least 30% of users using it weekly or daily to demonstrate some type of durable behavior.

If you don’t have a high level of engagement in the first one to 10,000 users, it’s highly unlikely you’re going to establish a high level of engagement after that. A common mistake that’s made amongst consumer social startups is to focus too much on top of funnel. You try and drive a million sign-ups or installs before establishing a white hot coal of high engagement within a small base of users. You must resist the urge to scale top of funnel first.

So in that small audience, if your app is not really resonating, don’t try to solve the problem by pouring more water into the top of a leaky bucket. Start by iterating quickly on the user experience to figure out if there is an “aha!” feature that users will find immensely compelling. Engagement is the ultimate sign of product market fit for a social product. For those first few thousand users, we ask, “What are the DAU and WAU ratios?” or if there is another form of engagement that can be observed that we can react to and determine if it is high or not.

Second to that is the rate of growth. Scaling to 5x — 10x as many users in a year organically is a positive sign of traction. The best-in-class Consumer Social apps often grow much faster than that.

Market

Social products are designed for humanity-scale adoption (i.e. hundreds of millions of users) so the market size questions are typically answered by default. Rather, the key question to ask is “what is the beachhead?” For example, at Quora, our first 10,000 users were almost exclusively in tech and Quora became known early on as the best place to find information about the tech industry, by a wide margin. People were predicting that Quora would die because it would never become anything other than Silicon Valley Q&A. But the team had a playbook and knew they had a plan for vertical expansion into questions and answers within other topics (finance, sports, etc). Quora focused on expanding into more topics, without lowering the quality bar on content, and then moved onto geographic expansion more than 5 years after launch.

However, sometimes that expansion happens entirely on its own. You see a spark of organic engagement on a specific topic or specific geography and then the product spontaneously expands into that open space. This happened with Quora in a few countries that had a strong English-speaking + technology-centric population, such as certain parts of India.

For us at Unusual, market is really about how a team can carve out some small wedge with those first 10,000 users. Are they being very intentional around that and do they have reasonable hypothesis how they are going to open it up from here? For instance, the team of one of our Consumer Social companies has hand-picked every single one of the early adopter beta users. The company plans on maintaining its hand curation of new users even after public launch to ensure that quality engagement isn’t sacrificed with strong top of funnel growth.

Creating that wedge and the ability to expand often means having a conscious focus on preserving a bar for quality of experience. Especially now that social media is a known industry, you have no chance of creating a successful product if there’s poor behavior on the platform. People have been conditioned to not use those platforms, and that’s why so many apps fail. So Consumer Social teams have to be more conscious of these learned behaviors and model that expected behavior through the product features and how moderation is applied on the platform. If you get the first 10,000 demonstrating what the right behaviors are, then the next person can come in, see what the expected behavior is, and conform to it to maintain healthy behavior on the platform. Or, at a minimum, slow down the rate at which poor behavior creeps in.

How Forget-Me-Not would have Stacked Up

Andy laid out above the guidelines of how Unusual thinks about Consumer Social. To illustrate what those guidelines mean in practice, I’ll now give an example using my past startup, Forget-Me-Not and how it would have stacked up if I were pitching Andy:

One last thing to note that I wasn’t aware of when I was starting Forget-Me-Not is the importance of alignment in desired exit outcomes. With Forget-Me-Not, the outcome I was aiming for when we started (I was a CPA in Austin, new to the world of startups) was for LinkedIn to acquire us for a few million dollars. It almost seems silly to say, given what I know now, but it’s important to remember that this knowledge isn’t widespread. Practically, it made sense for me to think that someone would want to invest $100K in us and maybe get $5M in return — that’s a 50x deal. In reality, most institutional firms’ business models depend on the ability to see a $1B+ outcome, or “imagining the S-1 filing” in every single investment. Being upfront about goals surrounding an exit outcome is hugely important for both sides to be aligned.

Closing Thoughts

Raising money from institutional VCs shouldn’t be an opaque activity where only insiders know the unspoken rules of the game. We hope the guide above helps dispel some of the mystery surrounding fundraising and gives a better idea of what investors might be looking for when founders come to pitch us.

When it comes to evaluating startups, there are four main areas that investors tend to look at: Team, Product, Traction, and Market, with different considerations depending on the business model. At Unusual, for consumer social companies, we gravitate toward teams with “communication philosophers” and demonstrated builders, products that point users in a certain direction that’s aligned with the founders’ theory of communication, 10,000 highly engaged first users, and a wedge into a humanity-scale market.

While that’s how we think about Consumer Social pitches at Unusual, there are several ways different firms and investors weigh those four aspects. The tricky part is understanding how important each qualification is to the investors you pitch. While some investment firms might consider the attributes of the founding team as the most important factor because of the ability to create optionality or recruit, there are some firms that are heavier on product, such as really unique tech advantages. Still others might weigh traction and market more heavily. It all depends on their investing philosophy and where they are willing to take on more risk.

All that being said, just because your startup isn’t green across the board doesn’t mean that you’re not ready to fundraise at all. It just might mean that you may be better suited seeking angels, micro VCs, accelerator programs, or others who believe in your vision and team and can help you get to those metrics and milestones.

Raising a Seed or Series A Round
Start module

The Unusual Guide for Raising Seed and Series A Capital

Introduction

As a founder, you’ve embraced the life-changing decision to set out and tackle the difficult obstacles on the way to building a valuable, enduring company. At Unusual, we decode the lessons of the masters and make them available to tomorrow’s founders to increase their likelihood of success. 

In this module, we’ve broken down our early-stage fundraising guide into two basic parts: Part I. Milestones and Valuations for Seed and Series A, and Part II. Approaching Investors, The Pitch, and Closing the Deal. This guide is tailored to Founders of Enterprise Software companies. (We will cover Consumer milestones in a separate post, but there may still be relevant learnings for Consumer Founders.)

Part I. Milestones and Valuations for Seed & Series A


As an entrepreneur, thinking about all that needs to happen to succeed can be overwhelming. Many successful founders joke, “If I knew how hard starting a company would be, I’m not sure I would have taken the leap!” At Unusual Ventures, through our time spent with hundreds of successful entrepreneurs, we’ve learned that the vast majority break the larger journey into smaller, more manageable phases—each with specific goals. It may be a management secret, or possibly just a coping mechanism, but either way, it works. Conveniently, the phases are typically bookended by fundraising events. The simple formula is:

Company raises money → Company delivers A, B, & C → Company raises more money → 

In the early years of a startup, we believe there are three distinct phases for founders to successfully navigate: the Idea Phase, the Seed Phase, and the Series A Phase. Each phase has distinct goals along three dimensions: Team, Product, and Traction. 

The Idea Phase

This is the period when a founder is seriously contemplating taking the leap to start a new company.

The milestones in this phase are consistently: 

A) Team - recruiting a co-founder 

B) Product - creating a detailed description of the solution to build

C) Traction - talking with enough customer prospect types to confirm the “founding insight” that there is a true market pain and now is the time to solve it

Oftentimes, founders quit their current job to focus on accomplishing these milestones, but that is not always the case. It is true that sometimes founders do A, B, and C before quitting their job and/or incorporating a new company. Both can work. The key point: Order of operations is not critical at the Idea Phase!

If these milestones are achieved, and the business is a fit for venture capital, it is at this point that the company would seek to raise Seed capital.

A note on “founding insight”: This is your bedrock intuition that you are building your company on. Ideally, you’ve had first-hand experience living the pain that drives your belief that now is the time to build a new solution. Critically important in the Idea Phase is validating this belief through at least 20-30 customer prospect conversations. (See more specific tactics in our Outreach Playbook). 

The Seed Phase

Note: We interchange “Seed” and “Pre-Seed” to mean the first invested capital in a startup. Raising seed investment is for Idea Stage companies that are Pre-Product Market Fit.

As Benchmark Capital founder and Stanford Business school professor Andy Rachleff teaches in our Unusual Academy, achieving Product Market Fit (PMF) means that a startup has proven it understands which features to build, for a specific audience that cares desperately, with a business model that drives customer purchases. The primary goal of the Seed Phase is to find and demonstrate Product Market Fit.

The milestones to accomplish in the Seed Phase are:

A) Team - hiring the core team

B) Product - delivering 1.0 of the product

C) Traction - reaching a traction level where the business has 10+ customers and $1M of ARR 

10+ customers and $1M of ARR are not exact figures, but approximately what Series A investors look for in 2020. Note that traction is not 10 customers or $1M. Typically, you’re not looking for a single large elephant or two. Having a mix of a few six-figure customers and small-mid size customers in the $50K ARR range demonstrates repeatability and flexibility of your early go-to-market strategy. 

If these milestones are achieved, it is at this point that the company would seek to raise Series A capital.

The Series A Phase

This is the period when the startup scales its go-to-market efforts to accelerate revenue based on demonstrated Product Market Fit.

The milestones to accomplish in the period after raising a Series A are: 

A) Team - primarily increasing sales and marketing headcount

B) Product - building 2.0 of the product based on vision and market feedback, while removing early technical debt

C) Traction - reaching 50 customers and ~$10M of ARR

 

Valuations and The Startup Step Function

Startup valuations increase as a step function.

For private companies, valuation increases occur at the time of fundraising. It’s essential that founders understand the following facts:

  • Startups do NOT increase in value in a linear function, but rather as a “step” function. 
  • The valuation of a private startup is imprecise, and only significant changes occur at the time of financing events.
  • A new stock price is assigned at the time of each financing based on the agreed upon valuation of the company. 
  • The “steps” in valuation for a startup are tied directly to the company achieving critical milestones and investor perception that the overall likelihood of success for the business is increasing. (Said differently, valuation is inversely correlated with risk).
  • Reduction in risk at each phase is tied directly to the startup accomplishing the necessary milestones for that particular segment of its lifecycle.

Understanding that startups increase in value once key milestones are achieved enables founders to focus on creating a specific set of goals at each stage of the company’s journey. This way of thinking is one of the foundational pillars of the Unusual Method

Founders should appreciate that there is no “partial credit” in the startup journey. Achieve the milestones and de-risk the business such that more capital can be raised—or fail. Or, as we like to say at Unusual,

“Getting 80% of the way to the moon doesn’t count for anything.”

For Seed and Series A enterprise companies, the good news for founders is that the line for what milestones need to be achieved at each stage is clear.

Once the right goals have been set, what’s left is the fundraising process itself. This process can be broken down into five basic questions: 

  1. How do you approach investors? 
  2. What goes into a great pitch? 
  3. How do you manage a fundraising process? 
  4. What terms should you pay most attention to? 
  5. How do you ultimately make the right decision?

Consumer Subscription Evaluation Rubric

Cohort Analysis Primer

Outline Series A Deck

Outline Seed Deck

Consumer Social Evaluation Rubric

Tools in this chapter

Fundraising

Let’s get going

But before you dive in to prep your pitch deck and line up investors, review your progress and find out if you’re really pitch-ready, starting with Consumer Social.