Startup Fundraisers: What do they do? Why do you need one? What is a good one?
The great mystery of fundraisers…
There are thousands of events, now online since Covid 19, that bring entrepreneurs and investors together, or discuss investment readiness or how to pitch investors. Interestingly enough there are virtually no events where professional fundraisers who raise investment for clients speak about their profession, and very little is written about this. Virtually nothing can be found on the internet either. This is even odder when you know that the second reason why startups fail is because of the lack of investment.
The great mystery of fundraisers
There are thousands of events, now online since Covid 19, that bring entrepreneurs and investors together, or discuss investment readiness or how to pitch investors. Interestingly enough there are virtually no events where professional fundraisers who raise investment for clients speak about their profession, and very little is written about this. Virtually nothing can be found on the internet either. This is even odder when you know that the second reason why startups fail is because of the lack of investment.
If you are a property owner and looking to sell or rent a property, it is very likely that you are going to use an agent. This agent will connect you to buyers. If you are an actor you will rely on an agent to find you new acting roles. This agent will connect you to studios or movie makers. If you are an advertiser you will also work with an agency to create your message and place your ads on the relevant media channels. This agency will connect you to media buyers. The role of agent varies but overall it is well known.
Strangely the role of connecting businesses to investors is not called an agent - these professionals are called fundraisers and compared to agents very little is known about what they really do. As a result it is often assumed they do very little apart from taking a commission on the money raised. This lack of knowledge greatly explains why businesses that are looking for investors have such a poor understanding about what is a good fundraiser and about how to partner with them. As a result, businesses are more likely to make a bad choice, and in turn have a bad experience through their collaboration with fundraisers. The image of fundraising as a business consequently greatly suffers from those bad experiences.
Of course like everywhere, especially with all intermediary roles, there are plenty of incompetent fundraisers. However, two things need to be said here. 1) It is not because there might be a lot of bad fundraisers that a business should not use a good one to raise money. There are also a lot of bad lawyers or accountants, still businesses understand they need a good one to grow. 2) The only way to improve the overall quality among fundraisers is precisely to make sure that entrepreneurs are discerning when it comes to choosing them, which they are clearly not at the moment. Not differentiating the good from the bad is the guarantee to lead an industry to low quality standards. Good fundraisers need to be given the chance to distinguish themselves from the bad ones and thrive.
Success fee versus upfront fee: the mess of the commission only structure
This perplexity of entrepreneurs toward fundraisers lead them to push for the transfer of all financial risks to the fundraiser and make the transaction based on success fee only, i.e. they want that the fundraiser only gets paid once the investor has transferred the money to their account. This is called the “commission only” or success fee structure. This system allows entrepreneurs to take virtually no risk, so if the fundraiser does not raise any money it costs the entrepreneurs nothing. This way, entrepreneurs who have no knowledge about how to choose a good fundraiser, believe they are making a smart decision. As it costs them nothing, they even engage several fundraisers to multiply the odds. Whilst this seems to make sense, unwittingly by doing that they contribute to make the fundraising industry totally inefficient and prevent good fundraisers to make the difference from bad ones.
In order to survive in this very competitive and financially risky environment, fundraisers on the commission structure have indeed no other choice to do exactly the same, which is to say yes to a maximum of clients hoping that with the number one proposition will eventually get the attention of some investors. As a result those fundraisers become like a repository inbox of investor decks that are quickly and massively distributed without real strategy.
On the receiving side, the result is that investors are submerged with torrents of propositions to the point they can no longer look at them all. They also end up receiving 3, 4 or even 5 times the proposition from different people. The whole commission structure system consequently totally degrades the value chain of the whole fundraising ecosystem.
All stakeholders suffer from this mess. Entrepreneurs struggle to get the attention of investors, with the consequence that less than 1% of startups get funded. Investors miss on good opportunities. Fundraisers as a result do not get paid and deliver volume based- low quality work.
Again oddly whilst this is relatively well known, there is little written about it, there are no real events to try to address the issue, and the ecosystem continues to underdeliver with no real perspective for improvement.
This trend has been accentuated by COVID 19 as up to half of investors are currently not investing, which mean the other half is twice more solicited. Meanwhile, people working now from home or having lost their job are taking the opportunity to create their own startup, adding to the existing flow of propositions circulating.
The reintroduction of retainers
As a result of this intense and unsustainable noise there is a fast growing need for gatekeepers, and as always when there is a gatekeeper there is a fee. In this context the fee is often called a retainer or upfront fee, which is adopted by many fundraisers who also play that gatekeeper role. Retainer fees vary tremendously from one fundraiser to the next, depending on their network.
Given the situation explained above it is expected that retainers will increasingly become more common. This is already the case in the US, and the UK and Europe are rather an oddity to rely so much on the commission structure system. Moreover, the fast emergence of Family Offices, who are much more difficult to find and approach than VCs or even angels, also reinforce the gatekeeper role and therefore the justification for an upfront fee.
Whilst there are definitely some unscrupulous fundraisers around who take upfront fees and do not deliver meaningful connections, unfortunately there are also many fundraisers who do not get their commission once they have raised for their clients, as those fail to honour their part of the contract. Even when they get paid at the end, fundraisers might have to work for 6 months or even 9 months before their client convinces an investor to invest after many introductions. This is obviously a huge pressure on fundraisers’ cash flow as they need to invest time and effort well before being paid.
Entrepreneurs’ lack of experience in the process lead to mistakes which cost them to lose the confidence of the investor who pulls out of the deal before the money is transferred. These are the reasons why not all the risks can be transferred to the fundraiser as it is the case with the commission only structure. Fundraisers need to be paid a minimum upfront to cover their own costs and to be able to mitigate the risks that entrepreneurs’ mistakes generate in the fundraising process.
Fundraisers' treatment should be similar to salespeople who work for new businesses that have no sales. When salespeople start to work for a very established company with a strong customer base, they should not mind that most of their payment derives from commission and should accept a low fixed income. If the company is new and has no customer base they will want a higher fixed income as they have to work hard to convince clients to buy products from a company that has no presence on the market yet.
Fundraising with startups, especially early stage ones, precisely means working with companies that have no traction and no track records. Therefore a part of the fee given to the fundraiser should be independent from the success of the fundraise. Paradoxically, this is exactly the opposite that happens in reality. Early stage startups most often refuse to pay a retainer to fundraisers when series A+ startups are often more willing to pay a retainer, as they take a part of the previous fundraise to cover that fee.
This comes from another common misconception: Young entrepreneurs go to fundraisers with virtually no budget, thinking that the commission on the money raised will do the trick. The bad news is that to raise money from angels, family offices startups founders need to have some funds in place not only to create their MVP (Minimum Viable Product) and to create the minimum legal structure but also to build and promote their proposition to pitch investors. Investors expect that founders will use their own network to recruit the talents they need to build the MVP using sweat equity and to raise money with family and friends to pay for all the rest. Too often founders have no budget and expect to raise money with their MVP (or not even that) and a deck they put together with unequal expertise.
In today’s highly competitive environment where there are probably 1,000 startups for one investor, this approach is poised to be very time consuming and set to fail. One can decide to learn about accountancy or law in order to avoid paying an accountant or a lawyer, or realise it makes more sense to use time in a better fashion to build the business and pay a professional for accountancy and legal matters. The same applies to fundraising, there is a cost to be investment ready and to access investor networks quickly and this needs to be budgeted and integrated in the family and friends round. While founders include in their financial projection marketing costs to grow their customer base, oddly they never include any marketing costs to connect with investors, and many expect to raise money with virtually no budget. This needs to change.
What does a good fundraiser do?
To better understand what we are talking about when we use the term fundraiser we need to understand the several roles that can come under the fundraising activity:
Brokers engage in the business of effecting transactions in securities for the account of others.
Dealers engage in the business of buying and selling securities for their own account, through a broker or otherwise
Both must be FCA regulated in the United Kingdom.
Introducers or finders connect businesses that need funding with investors in their network. They can also be regulated (in the US they have to) but contrary to the brokers and dealers they do not deal with securities and are not allowed to advise on investments if they are not regulated.
Investment readiness consultants help businesses to get their proposition ready for investment, they can help build the business model and create the documents necessary to engage with investors, such as the investor deck or teasers and help define the investment strategy.
It is not uncommon that fundraisers offer both the activities of investment readiness and of finder as by improving the proposition they increase the chance to get their clients financed and therefore to receive a commission on the money raised.
For the purpose of this paper we will only focus here on the finder and investment readiness consultant activities as they are the most relevant for startups.
So what makes good fundraisers?
A simple and possibly simplistic answer to this question of what makes a good fundraiser is: fundraisers who successfully raise money for their clients. Obviously bringing the right investors is also essential.
To achieve that goal fundraisers need to have obviously great connections with who they maintain close relationships. That is so obvious that this is often the only focus of founders when they decide to engage with a fundraiser. They want to know how many investors are in the fundraiser’s network, this is the equivalent of the reach of the fundraiser.
Conversion, conversion, conversion
Let’s say that (great) connections are a given - although it is unfortunately true that many fundraisers boast connections that they do not really have, and include distant LinkedIn connections.
As all digital marketers know: reach is one thing, but conversions are what really matter.
If the finders make 100 introductions to investors and none convert into investment there is definitely a problem. It can be that the investors connected are not a fit for the proposition, which might be too early or too late for them, or the wrong area for them.
The issue might also come with the personality or attitude of founders that clash with investors. Or there is clearly no value at all in the proposition and there is no way that anyone with reason would invest a penny in it.
However, when the matchmaking and all the above are well executed, the lack of conversion comes from obstacles perceived by investors even if the proposition has legs. As investors are literally submerged with avalanches of propositions, they have virtually no time to assess if the perceived obstacles are serious or not really a concern. Most investors who have a doubt about something in a proposition tend to pass, as so many others in their inbox tick all the boxes.
So how can founders can increase conversions and how fundraisers whose fees rely on the money raised can assist them?
Building a trusted relationship with the fundraiser
First, the founder needs to create a trusted relationship with the fundraiser which will allow the founder to rely on the fundraiser to assess if the proposition is investment ready or not.
If not and if the fundraiser also offers good investment readiness service this is a good area to start the collaboration. Usually the investment readiness service should be covered by a consultancy fee, independent from the commission on the fundraise. The reason for this is that it is the interest of the founder to keep all opportunities open when it comes to the fundraise itself. If the consultancy fee is included in the commission on the money raised, then it is natural that fundraisers will want total exclusivity on the fundraise. Without exclusivity fundraisers take the risk of not being paid at all for their consultancy work if the founder raises money outside of the fundraiser network. With a few exceptions, giving full exclusivity to a fundraiser can be counterproductive, and therefore including the consultancy fee from investment readiness in the commission on money raised - which is often asked by founders - is usually a false good idea, especially at early stage investments.
Fundraisers who are only finders and do not work on propositions should be able to point out trusted partners who are experts in investment readiness. In this case the close relationship between the finders and the consultants in investment readiness is key during the whole fundraise process as often discussions with investors lead to feedback that will lead to alter the ask or information in the deck. The more finders trust the work of the consultants and the more they will feel comfortable to push the proposition to their investor network.
During the fundraise
As the proposition is investment ready and the fundraiser is happy with it, the fundraise can start in the best conditions.
The fundraiser should send a finder’s fee agreement, whose main focus is to confirm the fees i.e. the retainer fee if applicable (see section above on commission only versus retainer) and the commission rate that will be charged on the money raised. Usually rates vary between 3% to 10%, depending on the size of the raise, with 5% to 6% being the most common especially for early stage raises that are not only more difficult but also less lucrative due to the smaller amounts raised. Most often finder’s fee agreements show rates that decline as the amount raised increases. For example the commission might be 6% for the first £500k, 5% between £500k and £1.5m and 4% for anything above. So if a founder raises let’s say £3m, then the total commission will be £145k (£500k*6%+ £1.5m*5%+£1m*4%).
Investment follow up commissions
Fundraisers will also often ask to still receive commission if one of their investors reinvest either in the same round or in the next one. One reason for that is that investors often start with a small ticket, possibly £10k to £50k before investing fully in a startup. So if an investor introduced by the fundraiser invests £1m but starts with a £50k ticket, the fundraiser ends up with only £3k (based on 6% commission) instead of £55k that would correspond to a £1m raise. The other reason for a follow up commission is that investors that follow up on their investment are the most precious for founders. Not only does this mean that founders have to spend less time to find new investors, get to know them, get legal work done, but also it sends the best signal to all new investors who are looking at the proposition. So it is quite natural that if fundraisers are paid on a success fee, partially or totally, they should also be associated with the success of a fundraise when the investors they bring reinvest in the proposition. What is usually fair is that the fundraiser agrees on a follow up commission rate lower than the initial introduction commission. So for example if the initial introduction triggers a 6% commission, the fundraiser gets 3% or 4% if the investor reinvest.
From connecting to coaching
Good fundraisers do not only connect founders to their investor network, especially if they are paid a retainer or management fee, but they make sure that both founders and investors engage constructively in a way that will increase the chance of the investment to happen. This seems obvious but as said before many founders and fundraisers only focus on connections rather than conversions.
As mentioned before the first step for this is for the fundraiser to check the proposition is investment ready, many fundraisers on the commission structure only do not have the time to do that, with the result of creating irritation from investors whose time is wasted.
Then fundraisers need to make sure that founders are apt to defend their proposition in front of investors and answer questions correctly. If this is not the case some fundraisers can offer pitch coaching sessions that can be included in the retainer. Note that many founders overestimate their pitching abilities, and it is often after a few disappointing calls that pitching deficiencies are finally admitted by founders. One question wrongly answered by a founder is usually enough to put off an investor or several if it is in a collective pitching session. So this can be costly and make the difference between a funded and a not funded and therefore a dead startup. One often only gets one only chance to pitch a certain investor.
Calls are often followed by additional questions from investors who also if they are interested will require access to additional documents such as the full financials, business plan, cap table.
Answering questions properly is key and there again the fundraisers’ experience is key to understanding investors;’ concerns and giving concise answers. For that purpose some fundraisers also include in the retainer to help founders create an investor FAQ sheet. This is an efficient way to go back to investors. It also shows that founders are proactive in the way they engage with the investment community, which is a good sign for investors.
Conclusion
Fundraisers activity is often much more than connecting a business to investors. The choice of who is going to support the fundraising if external need is required, which is often the case, is possibly more important for a startup than choosing a good lawyer or a good accountant, it is a companion and a coach that can help businesses sail through the perilous journey of fundraising up through the exit . The choice of the fundraiser will influence the first valuation to the last and can make the all difference between success and failure. Despite this being nearly trivial, no one talks about how to choose good fundraisers, what to expect from them and how to work with them. Entrepreneurs on the journey of fundraising need to look for a good fundraiser from the start rather than improvising and wasting energy, resources and contacts. They need to work with their fundraiser closely rather than just ask access to their network, and that also means accepting to partly paying upfront for their time as they would do with any other professionals.