In the last couple years, it's become popular to say that you can launch a startup from anywhere. But building a startup is a lot more than just launching -- in particular, you need to land financing for the startup. I argue that the only logical place for founders to raise money is in Silicon Valley, particularly if you want the money with founder-friendly terms. In the past few years I've visited many of the new startup hubs around the world like Austin, London, Miami, Paris, and Sydney -- and many are growing quickly, but simply don't have enough scale within the investor community to guarantee that fundraising will completely successfully.
Let me make my argument with the concept of "the Term Sheet Funnel."
Fundraising for a startup is often treated like sales, and for good reason. Just like sales, founders will start a spreadsheet and track their pipeline of prospective investors. They'll include names, contact information, and build a stateful funnel that describes where they are in the investing process. And just like sales, fundraising is a bit of a numbers game.
The Term Sheet Funnel works like this: At the end of your fundraising process you need at least two but even better three term sheets. The reason is that if you only have one, you are a position where you have to accept the offer. There's just no leverage to negotiate. if you have two or three term sheets on the other hand, then you're in a situation where you can pick your favorite investor, and ask them to match the various terms in the other offers. This is the ideal.
Million dollar question becomes, if you need three term sheets at the bottom of your funnel, how many "All Partner Monday Pitches" do you need to attend? The data that I've seen is that you usually need to pitch at two Monday morning meetings in order to get one term sheet. Thus you need at least six pitches.
How many first pitches do you need to get these six final partner meetings? And how many intros do you need to get the first pitches? Or how many emails do you need to send to get investors' attention? When you quickly do the math, you realize that in order to get two term sheets, you probably need to pitch at least 15 to 20 VC firms that can lead around in order to guarantee that the Term Sheet Funnel will work.
How many cities in the world have enough investors that can lead around, that you can talk to 15 to 20 in the span of a few weeks? Not many.
The other concept I wanted to introduce is: Time to First Term Sheet (TFTS). this is an important concept, because startup fundraising often resembles a snowball. It starts out slow, accumulating momentum, but eventually picks up enough velocity to go where it wants to go. Founders often see the same dynamics when their initial meetings with a half dozen firms go slowly, with few diligence questions and follow ups. However, once one firm is leans in and starts scheduling second and third meetings, then founders pick up the leverage to push everybody else along. Then they have the ability to tell all the investors in their funnel that there's momentum, which is often a positive signal.
You might think it's silly that investors react to "heat" in a financing. Here's why it makes sense though: Every investor knows that they are not the last check into a company. This is particularly true at the early stages where the first couple million dollars will likely need to be followed up by tens of million dollars and eventually hundreds of millions of dollars in a success case. Fundraising is a skill. As a company gains heat, that reflects well both on the founder in terms of their fundraising skill set, as well as the momentum of the company. It means there's another thing that is de-risked a little bit. As some folks say, the best way to predict future heat is current heat. And the ability for a founder to run a type process might be annoying at first, since an investor might feel hurried, but they benefit from the skill in all future fundraises.
This emergent behavior drives the criticism that investors "act like sheep" and all want to invest in the same things. Sometimes this is true, but I argue it's for good reason.
Going back to my point, the Time to First Term Sheet becomes an important concept because it's a measurement for how quickly a start up pick up heat, and ultimately predicts how long it'll take for the round to close. ideally the TFTS is 2-3 weeks at most. Any longer than this, and a startup is often viewed as "stale" or "low momentum" or that they "whiffed." These are all bad, because they are negative indicators of a founders ability to fundraise. The best way to predict a lack of heat is a current lack of heat.
It's for this reason that the San Francisco Bay area is the best place to raise startup capital in the world. Not only are there a huge number of investors that are willing to price and lead a round of millions of dollars, they will do so quickly. After years, and sometimes decades of highly competitive rounds, the investors are also trained to offer founder friendly terms quickly in order to win opportunities, where they want to be involved. As a result, not only will good startups get more first meetings here, they'll also get more term sheets. And those term sheets will be more founder friendly as a default, and investors are often willing to negotiate them further.
This is part of why startups raising in the Bay Area end up with the highest valuations in the world, and why the so-called "the European Discount" is a real thing. That is, startups that raise VC in Europe end up with lower valuations and more investor-friendly terms. But by the way, this isn't just Europe, it's also most of the US including the East Coast. The European Discount is actually a "Non-SF Discount" that exists everywhere around the world.
So in other words, the top of funnel is bigger, the conversion rate is bigger, and the Term Sheets that result at the bottom of the funnel are better by default. What's not to love?
The main downside to all of this, is that the market is very efficient and can be brutal. In a smaller market, perhaps some investors can be less sophisticated as they haven't been pitched the same idea 10 times in the last year. in Silicon Valley, the market is larger and more efficient, which means that people have a better sense of which ideas are being over-invested. They might have a more discerning eye for the best teams, and might prefer to pile into the outliers, rather than investing in a diamond in the rough.
The other challenge is that founders from outside the region often find it hard to break in. This might be because they don't know enough investors and as a result, the wider top of funnel does not help them. It might be because they don't understand the kabuki dance of running a tight process, when to share information and when to hold back, and how to push investors at the right moments to move a process forward. When these protocols aren't known, then the conversion rates might be worse not better.
Ultimately the best way to take advantage of the ample fundraising resources in the Bay Area is to create a plan towards building a network that can feed the top of funnel, learning how to run a tight process, and finally driving towards a few offers with good partners. For the first step, I find that founders often refuse to spend real time in San Francisco even when it would benefit them -- if you're going to be raising money, expect to spend 6 months in the region. They also tend to gravitate towards meeting the most famous VCs at the most famous firms, who will never introduce them to other investors, rather than other founders, who are usually much more generous with their time and effort. It's also for this reason that joining an accelerator can be very helpful as a way to supercharge a startup and investor network. The goal is to ultimately be able to build a tracker spreadsheet with 20-30 investors in it, before kicking off a fundraise. Usually that just takes one super helpful friend or an angel investor who's connected.
For learning the protocols around fundraising, nothing works better than calling in some favors, and having someone who successfully fund raised before coach you on the day-to-day details. I often serve this role with startups that I work with, and have frequent stand-ups with founders while a fundraising process is active. I find myself often commenting on weird questions that were asked. Or parsing confusing feedback. Or rehearsing tricky answers that folks are sure to ask (about a departed cofounder, or a weak set of metrics). This is also a great reason to have a small set of advisors or angel investors who have been there and done that-- they can help navigate what is otherwise an opaque process. Not surprisingly, the best folks who can do this are often based in the Bay Area as well.
The Term Sheet Funnel is hard to navigate. And people have different experiences. Some folks talk to a few investors and get offers from each one. Otherwise take over a year and need to go through many dozens of investors to get to a term sheet. The logical thing is to plan for the median experience -- it'll take 6 months, you'll need to pitch 20 firms, and at the end you'll be lucky to have 1-2 offers. And if you're planning for the median, the best place to focus in the Bay Area -- it's been the best place to do this over the past decades for good reason!
