Raising Venture Capital: What Startups Need Before Fundraising

Startups often approach raising venture capital (VC) prematurely by attempting to talk to investors about their idea.  They think they have the next billion-dollar startup idea, but they have nothing to show for it because it’s just an idea. There are so many startups that try to get funding before they’re ready to get it and wind up feeling disappointed and waste their time.

However, except for pre-seed investments, that’s seldom the case. And even then, there has to be something else besides the idea that makes the startup and its idea attractive.

Therefore, in this post, we’re discussing what startups need to have with their product/service before raising venture capital. Moreover, this post will help startups like you avoid the mistakes that waste time and money when going after funding prematurely.

At the end of this post, you’ll have learned what’s needed to get to the point of where you can confidently know that you’re ready to start the process of seeking and raising investment.

And, we’ll have a follow-up post that shares the process of how to actually raise venture capital.

We’ll go over:

  • The nature of the venture capital industry
  • What startups need before they fundraise
  • Traction, how it’s measured, and how to show it to investors
  • The success and failure of venture capital funded startups
  • What raising venture capital actually does for a startup besides getting money
  • Methods of getting traction before raising venture capital
    • Idea Validation
    • MVPs
    • Product-market fit
    • The intangibles of startup growth
  • Conclusion

The Nature of the Venture Capital Industry

The best way for me to tell you what is important to have before raising capital to is to first explain the nature of venture capital itself so you can understand a venture capitalist’s perspective. This also helps us better understand the venture capital investment process.

Venture capitalists generally manage venture funds which consist of a combination of other people’s money and their own that was raised by the VC firm. Sometimes they don’t have any of their own money in it. However, the fund is usually used for specific types of investments in startups by industry.

The fund’s success is their success and naturally, they want to get a return on their investment. Venture capitalists want to see a big ROI.

We’re not talking a 2x or 3x return on investment. We’re talking of between 5x and 15x ROI via a private buyout of shares or an IPO (initial public offering) on the stock market.

Moreover, it’s important to understand that venture capitalists want to make a lot of money, so they don’t place investments in startups that cater to a small market.

Investors also want to invest in startups whose total addressable market (TAM) is in the hundreds of millions, to billions of dollars.

So if you don’t have a large enough market, then traction isn’t going to do anything for you in landing venture capital.

What Startups Need Before They Fundraise

Little do new startups know that the venture capitalists either won’t respond back to them. Or, they get a response telling them to get traction before they’ll consider investing in their startup. I experience this over ten years ago myself.

Traction is one of the first things investors look for in startups and it’s a sign that your target customers actually want your product or service. Traction is also a sign that your startup idea has merit.

Doesn’t it make sense that investors would want to see startups have consistent traction in their market before they take the risk to invest?

It’s important to make sure your idea has merit, and if you don’t know if it does, check out our guides how to start a startup and how to validate a startup idea so that you can learn how.

In the next section, we’ll talk about measuring traction and how you can show its validity to investors.

 

What is Traction and How is it Measured?

Traction is the attainment of users, whether paid or not (paid is better), to show proof of your concept. Traction is the validation of your idea through the acquisition of users and sales.

This means you need some sort of product or service, whether it’s a minimum viable product or a minimum valuable viable validating product, as Guy Kawasaki suggests, which is even better.

However, there’s no industry bar or standard of what traction looks like for each startup. But you can point to percentage increases in week over week (WoW) and/or month over month (MoM) growth as some very important key performance indicators to measure growth.

Using percentage increases are a far better gauge for KPI effectiveness than telling you that yourself that you need 500 or 6000 users or whatever to say you have traction. However, large numbers of users is also important in gauging traction.

30-50% month over month (MoM) growth is quite good. 20% MoM growth is solid too.

What’s more, setting and reaching the milestones you set for your startup will also be helpful for you so you can reverse engineer your goals. This allows you to create your plan of how you’re going to reach them.

You’re going to want to show venture capitalists how you’ve created your traction and the data to support it.

The Success and Failure of Venture Capital Funded Startups

Did you know that between 10-30% of startups who raise venture capital investment are actually successful?

This means that most of the startups they invest in are failing and the firm will often never see any ROI to replenish the fund’s coffers unless there’s a small buyout or liquidation.

Think about it — they are taking a big risk by investing in any startup because there are so many unknowns.

Markets change, teams change, and plans don’t always work out like expected.

Timelines often get expanded due to unforeseen delays, personal life crises occur, and more.

Startups are volatile.

VCs need to hedge the risks of investing and make sure they’re making a smart investment because once the deal is done, it’s done and there’s no going back. It’s not like stocks which you can buy and sell at a moment’s notice while trading is open.

Now that we understand the point of view of the VC investor, we’re then able to see why they generally won’t invest in some unproven idea.

This is true for a lot of pre-seed firms, as well. While they will invest in some ideas before a product, they’re taking huge risks by doing it and they will want to at least see a great team behind the idea.

Makes sense, right?

 

What Does Venture Capital Actually Do for a Startup?

Let’s start with analogies.

Your startup’s product or service is like an engine. Marketing, which includes sales, is like fuel. Venture capital investment is like nitrous oxide or a turbocharger.

Fuel cannot work if there’s isn’t an engine. So if you don’t have a product or service, then marketing won’t work unless you’re doing a pre-launch waiting-list.

And VC investment isn’t really going to do any good anyway because it’s meant to speed up real traction with a real product or service.

Venture capital investment only works when you have a functioning startup behind it that’s marketing. If your startup isn’t marketing, then rocket fuel won’t help.

 

Methods of Getting Traction Before Raising Venture Capital

From the very beginning of your startup, validating or invalidating your idea will give you a good understanding of how well it gains traction because, in order to validate your idea, you’ll have to contact your target customers.

When you do that, you’re able to start building a relationship with them and if they like what you’re telling them, then they’ll probably become your earliest customers and evangelists, as long as they’re willing to pay for it.

 

Idea Validation

So via the following article I wrote, learn how to validate your idea.

You and I both know that you don’t want to screw up your startup, so your options are to either validate or invalidate it.

If the idea doesn’t hold up, then think of a different way to go about it and ask the same people for feedback again and ask some new people, too.

Or, just continue living life normally until you find a better idea or join a team of people that have something great.

Please don’t throw your life away for an idea if nobody cares about it.

 

Building a Minimum Viable Product

What’s more, you’ll continue to work on building traction after you’ve built your minimum viable product (MVP).

In the following article, I show you how to build a minimum viable product and you can also refer to Guy Kawasaki’s advice on improving an MVP to become an MVVVP here.

With your MVP, you can start marketing it more, especially on social media. StartupDevKit has loads of great startup and marketing content to help you with growth so you can keep building traction.

 

Product-Market Fit

As you work to build traction, you’ll be simultaneously working to reach product-market fit (PMF).

From this article I wrote, you can find out what product-market fit is, why you need it, and how to get it.

Working towards PMF is a constant exercise of building traction and achieving greater growth. So if you want to raise venture capital investment or just have a successful startup, then achieving product-market fit should be a priority.

 

The Intangibles of Startup Growth

Every startup has its own different and unique challenges in its efforts to gain traction.

It often takes a lot of experimentation before you find out what works really well for you.

That’s why when you perform at least four constantly running experiments per month, you’ll have a much greater chance of finding out what works and what doesn’t. One experiment per month just isn’t enough.

Find what works and what doesn’t so you can concentrate on what works and concentrate on startup growth and get the traction needed for raising venture capital.

 

Conclusion

The moral of this story is, you guessed it: startup should be getting traction before raising venture capital investment – especially seed-stage capital.

Trying to do it the other way around is just going to waste time and credibility. Save time and energy for better things, like gaining traction.

However, the methodologies you use to gain traction is up to you.

Was this informative for you?  Have you had an experience where VCs have told you to talk to them again after you get traction and is that why you’ve read this post? Share your thoughts and experiences in the comments below!

Get more helpful startup and marketing content like this delivered to your inbox.

Share Your Thoughts!

Your email address will not be published. Required fields are marked *

scroll to top