Background
Raising money in crypto is easily one of the most confusing, mind bending things you can do given the lack of standardised play book and structures. What makes it even worse is that as the market conditions change so does the strategy and options you have. This is something that wasn’t clear to me when attempting my first raise many years ago. I wanted to write this piece as a somewhat timeless piece that can offer context and insight to future entrepreneurs depending on where they are with their journey. This is the article I wish I had when I was raising.
First up, your raise strategy is extremely important - especially in the early stages. The decisions you make early on are irreversible and any bad ones you’ll have to live with. This is hard to conceptualise because when you start you’re just another scrappy startup with a dream to do whatever you’re setting out to achieve.
To offer context about my journey so far: over my years in crypto I’ve directly raised over $8m+ from angels, community, DAOs, venture capital firms and hedge funds. As a part of this process I’ve also been an angel in numerous deals and an active market participant (long term time holder mainly) to help me keep a pulse on what’s going on. I hope that this article can provide context that can usually only be found through on the ground conversations.
Before You Raise
Raising money is one of the most glorified activities that founders look up to. You’ve literally been primed your entire life seeing massive TechCrunch heads lines of “Hot startup XYX raised $XXXm at a $Y billion dollars. The most important thing you have to realise at your core is capital is just a tool and not a measure of success in any way, especially in crypto. More money is always more problems and you want to make sure you can balance your money and your problems. For first time crypto founders the biggest risk you run into is the fact you don’t truly understand the market unless you’ve been through one bull/bear market cycle. This can be dangerous given your product roadmap and priorities will be skewed. Therefore you can de-risk yourself in two ways:
Build slowly and learn what the market wants/needs. Some of Ethereum’s biggest success stories start off as side projects the founders built slowly.
Spend a few months on the idea and iterate through it by having as many conversations as possible with people to better understand the problem space
General point here is that knowing the nuances of the market is crucial to understand who you are building for and where you see your project going. Anyways, let’s assume that you have your idea and you’ve done your research. The next part is figuring out legal structures and entities. I don’t want to comment too deeply here but my high level recommendation is to be as crypto native as you possibly can. The more ties you make into meatspace the slower you’ll move and spend time on problems that aren’t crucial to your product and customers.
The Landscape
Okay so you have your idea, a pitch deck and maybe a team. Your next step is understanding the kinds of investors out there and their motivations. Let’s break them down:
Angel investors. These are often individuals in the space who have been around and don’t mind writing small checks. In my opinion getting the right angel checks is probably one of the highest return things you can do depending on the person. Investing is more so an excuse to work with the people you look up to and understands your problem space the best. Make sure you do your research on everyone and then work hard to get the right introductions to your dream list. Typical check sizes range from $5k-$25k and are usually low fuss. The key thing to optimise around angel investors is the connection you form given it’s a personal one. Truly ask yourself, “is this someone I would get beers with”? If the answer is no then you probably shouldn’t take that money given you won’t be able to build an effective relationship. Your first meeting/call will probably determine this. The only downside with angels is depending on how busy they are milage will vary. While they may be able to help you with specific things it’s really up to your relationship building skills to get the most out of them. The more busy they are the less you should expect in terms of their time.
Venture capital/hedge funds. Typically these two are separate however in crypto both of them kinda merge. For those of you that don’t know the difference, venture capitalists raise a fund from their limited partners (LPs) which dictates they need to spend that fund within 2-3 years and generate 10x returns within a 5-10 year timescale. They’re playing the ultra long term game and not touching their holdings. Hedge funds are basically the opposite, they manage liquid books and will happily trade in and out of whatever they want, when they want. The reason why I’ve merged both of these into one is because venture capitalists in crypto have their liquid fund and hedge funds have their venture funds. It’s a long way of saying everyone does everything. Usually your pot of money will be determined by your investment amount and lockups. Small checks for hot rounds might be done from a liquid fund whereas a muli-million early stage financing deal will be done from a venture fund given the period of illiquidity. When going for a professional investor, if there’s one thing I’d emphasise is that the partner at the firm matters just as much as the firm itself. In my experience the only reason I took money from certain VCs is because I really vibed with the partner. The others not so much. That being said you might take on a VC for their brand, just make sure you don’t get *too* many brand names for the sake of it. Also ask them what their LPs let them do with the money (can they yield farm) and will they provide liquidity for your network? Those that do are much more value add since they’ll use your product and risk large sums of capital in your network.
Community. This is basically raising money directly from the internet via some sort of public fundraise. Typically these are great for ensuring a wide distribution of your tokens and can be effective to tap into wide sources of capital. For first time raises, I’d typically advise against them given you need the right legal infrastructure setup and can create a high pressure environment to get everything right. It’s not impossible to do your first raise as a community one but it may not be the most appropriate option for your first financing round. Later stage rounds probably make more sense here. If you can cultivate a high quality community, they will be your biggest cheerleaders and probably the most useful investors. Don’t sleep on them or discount them!
DAOs. I’m still on the fence here about DAOs. Typically they’re just on-chain syndicates although with the complexities around the legals + tokens they basically can be thought of loose affiliation networking exercises. If you’re new to town then taking money from them can be a good way to get intros to the right people. However if you’ve been around for a while apart from basic networking the value add isn’t particularly high for a hard skillset. This isn’t to say they’re bad but just recognising they’re another class of investor and the appropriate way to think about them in the context of things
Assessing Investors
There’s a saying in startup raising, “either you have a round, or you don’t”. As in either you’ll have people banging on your door to invest or it’ll be empty. This is pretty much true for most investor classes across most periods of time. Even the most “sophisticated” ones. The key thing you need to figure out as an entrepreneur is how much do their words add up to their actions. There’s two ways you can figure out the role this investor will play
First encounter questions. Most people ask “how can you help”. To which the basic ones will respond “network, hiring, raising” which translates to “not much”. Instead you want to ask more detailed questions such as: “what’s the most work you’ve done for an early stage portfolio company”, “given what we’re doing, what are the primary challenges you see and how can we think about them better”, “what sort of hiring pipelines have you built up to help portfolio companies”, “in which specific ways do you help the networks you fund”. All of these are much more pointed questions and should hopefully yield better answers. Asking how they get their money, what they’ve promised their investors and what their objectives are are important. Not all money is created equal and you want to know what kind you’re dealing with.
Building relationships. To avoid on the spot interviewing, I typically suggest building relationships with the people you want to raise money from well in advance you want to raise money. This helps you figure out if there’s a good fit for both parties and you’ll be able to get a better idea of how helpful an investor can be. It also builds trust and respect on both sides which is particularly helpful in an industry where more things than you can imagine are done on handshake deals.
Reference checks. You’d be amazed by how far these go. Find the things that this investor has invested in then reach out to the founders to get your opinion on how helpful they were. No founder will ever tell you who has been “very unhelpful” although you’ll get a very good pulse on which ones are helpful. Any sort of neutral or meh kinda enthusiasm is usually a strong sign that the entrepreneur wasn’t too impressed or happy with the firm. That being said check size matters here and it’s hard to figure out if they weren’t helpful because they only wrote a small check or they are genuinely not very helpful. Building up your circle of founder friends is something any entrepreneur should do, just make sure they’re roughly at the same stage so you can provide useful advice to each other.
Round Construction
So you’ve done your research on everyone and had a few conversations, how do you determine how to put together a round? Well first of all you need to figure out what sort of business you have and what are the primary needs of it. A general template that provides you the basics would probably be something along the lines of:
Two to three cornerstone professional investors with a good brand name. Each of these will take $250k-$750k allocations.
Five to ten angel investors who are well connected in the vertical you’re playing in
One DAO for broad networking exposure
The reason why I recommend this as a “starter template” is because it provides a healthy balance between all investor interests and diversifies your network off the bat. Do not skew too heavily on any of these investor classes otherwise you’ll create weird effects. For example:
Too many professional investors and now you only have 2-3 allies in your corner and a large portion of your network is owned by 2-3 investors. Remember, the earlier the round the easier to acquire large percentage ownership stakes relative to later rounds.
Too many angel investors and now you have a wide network but no one with enough buy in to really stand by you when times get tough since you’re just another bet. Speaking from experience on this one.
Too many DAOs and now you have a bunch of people you’re connected to but they have very little incentive to help you given they’re only loosely affiliated with you in some way
Now the challenge you’re going to run into is figuring out who you want in the round. Remember, the most important rule is managing expectations. Never make commitments on the spot until you have a better understanding of all the parties and who brings what to the table. One of the quickest ways of burning social capital is cutting people out of rounds or going back on your word. Remember, you’re playing a long term game and there will always be a future raise/deal/round. Don’t optimise for the short term!
Who should you have in your round? Well, assuming you’ve:
Asked the right questions to understand what each party brings to the table
Built relationships or had a meeting or two to understand their vibe and see if it checks out
Done reference checks with other founders to rate investors
Then you’ll already know who you want onboard. If your answer is you want everyone because everyone seems great then you probably haven’t asked the right questions and only collected surface level data. Remember each investor should bring something unique to the table that can compliment whatever you’re doing. A few examples:
A venture firm that has auditors, product people and engineers to help build dashboards and other useful utilities
A hedge fund that has a $50m+ on-chain fund that can provide liquidity to the network
An angel investor who is well connected and has good Twitter clout and not afraid to use it
A professional investor who has good Twitter clout and publicly backs the companies they go in
An angel investor who has hard skillsets such as engineering or experience doing whatever you’re into
A human who is a founder/operator who can be a friend and show empathy when things get tough aka someone you trust and can get comfort from when you need it
Terms
This is probably one of the hardest things to think about and the one place where probably 90% of founders lose it, especially in bull markets. Valuations, lockups and structures. Friendly reminder: valuations are not an expression of your self-worth and are instead a benchmark of future expectation setting.
To founders initially, valuations come from a place of zero sum thinking where you get into the mindset of wanting to give up as little as possible of your precious baby for the maximum amount of money to keep dilution at bay. That’s the wrong way to think about it (at least in my mind). Instead you want to think about valuations as a function of risk to return on behalf of an investor and being honest with yourself to avoid future pain.
Let’s say you’re building some sort of DEX and you optimise around getting the highest valuation possible for each round and focusing on pumpa-mentals rather than optimising for the right people and relationships. Here’s some possibilities you could run into:
The market is extremely hot and investors are willing to shove more money than you can handle. You decide to set a valuation of $50m for your seed round because you can. You don’t have a product and the execution risk is very high.
Three months later you’re about to launch and you decide to do one final round before going to the public, given the last round was $50m your previous investors want at least a 2x markup. The new valuation is set at $100m and your previous investors are happy but the current round turned out to be harder to pull off given the steepness of the valuation. Furthermore, any intelligent value add investor will probably not invest given the froth. So who’s left? Generally unhelpful investors who are just deploying capital for the sake of it. Oh and because your valuation is super high, this round of investors is going to demand a certain portion to be unlocked at launch. You agree to get the round done.
Your token now launches and given the last private valuation was $100m, you need to get enough fire ammo to send the valuation north of $200m+ and convince your community you’re worth that much. You spend money on hype marketing and other means because you’re locked into a certain frame of mind. Furthermore your community are the final bag holders and are buying 5x from your initial investors in ~3 months. Not a very healthy dynamic to build upon. If anything you want private investors buying from your community at higher prices!
Everything is good until the market decides to come crashing down and we enter the next bull market. Now suddenly, the true value of your product and network is exposed. All bull market reasoning goes out the window and things are reduced to their core elements. Now depending on the gap between the valuation you aimed for and the true valuation of your product, you’ll start to see some pretty adversarial effects given everyone who has ever purchased from you could be underwater. When people see red they aren’t very happy and that makes your life as a founder harder.
To summarise what happened through this entire lifecycle:
The seed round was super hot and the easiest to sell given the prospects of the future. This created a high starting valuation that meant that each subsequent round had a very high valuation once even a 2x multiple was applied on it.
Because the next round(s) had high valuations, the difficulty in raising increases and so does the quality of backers go down since smart money assesses risk and reward closely.
By the time community got involved, they were buying the peak. It doesn’t matter how good you are, if your community members get utterly rekt from private investors dumping you’re going to create a very sour taste. This is the real danger with private money that you need to be acutely aware of.
Okay so what’s a healthier dynamic you may ask? I don’t have any perfect answers but instead principally you want to raise in tandem with your fundamentals and give yourself and your team time to build alongside your valuation in a healthy way. A counter example that takes longer but sets you up for better long term success:
You set your valuation to $15m and raise $2m to only give up 13% of the network in the first round. While this does sting initially it also means that you can literally construct your round with whoever you want and can maximise your chances for long term success since you have the right partners by your side.
You spend the next few months building out your product and de-risking at least one part of your business proposition. Now that you’ve done this successfully you can go back to your investors and justify the increase in your valuation through the hard work you’ve put in from building. You’re now comfortable raising at a $50m valuation because you know the key metrics are lining up and you can rely on them for future rounds rather than hoping the market does its thing.
You distribute tokens to your community via liquidity mining or a sale pre-token launch to allow them to get in at better prices before launching the token. Now that the token has launched and there’s real usage/traction backing it speculators ape in and push the price higher. What makes this case better than the other one is that now your inner community is actually part of the upside rather than being the very last bag holders. Random apes and speculators should pay the highest prices, not those who have contributed and invested their time with you.
The easiest way to distill this is that you want your valuation to be a step function drawn out over time rather than an exponential graph compressed into 6 months with a catastrophic crash. On the topic of lockups and vesting, basically the higher your valuation the shorter your lockups/vesting periods will need to be. This is the key clause that changes how investors think about investing. If you price your round at $100m with a 50% unlock on launch then the case to buy and dump because clearly easy. If you price the round at a $100m with a strict 12 month lockup then they’re assessing whether your project will be worth $100m in that timeframe. Depending on where you are in the cycle, something to think about. The longer term you want your investors to stick around, the lower the valuation to compensate for the illiquidity.
Team Vesting
I’ll add a short section here. If you’re a team raising with a vesting schedule less than 4 years (3 years on the shorter side), expect to be passed by high quality investors. I’m maybe a bit more old school here but if you’re not going to be sticking around for a bear and bull market you’re a highly risk investment. The gains in crypto come from sticking in the game and teams that don’t demonstrate that aren’t gonna make it. Also as a founder your lockup determines the tone for your investors and team. At ARCx, every core team member (including myself) is on a 4 year vesting with no liquidity for the first year. I will almost always pass on investments where I see signs where the core team is looking for quick exit liquidity or doesn’t show long term thinking. 10% unlocks at launch are also suspicious.
Closing
When it comes to actually closing a round, make sure that before you begin you a/b test your legal docs with a few friendlies so that you can find fair terms that everyone will agree on. Don’t make special exceptions for any investors. I’ve had requests such as being requested to sign personal side letters putting personal liability on myself. Especially avoid such things. Everyone should invest on the same terms for the same round. No special exceptions. Once you have this nailed, communicate clear deadlines and keep everyone moving through the funnel. “hey so and so, we’ve received a lot of interest and would need a response within the next x hours whether you’re in to secure your allocation in the round” are basically the kinds of messages you’ll be sending for the next few weeks. Say goodbye to sleep as you accomodate for the world’s craziest timezones as well!
Raising has long term implications and each round you should think about your future self trying to raise money and the changed dynamics. The market, users and technology all change up within a 6 months so keeping this in mind is key to surviving and then thriving when you’ve done the hard work. Whatever you do design flexibility into your structure, think long term and optimise around surviving and giving yourself as many shots as possible.
That being said, I’m always excited to meet fellow bright entrepreneurs and would be happy to invest/be a part of whatever your building! I’m available to reach via Twitter DMs (twitter.com/kermankohli).
Special thanks to Sid from Maple for reviewing and providing feedback! Give him a follow at: https://twitter.com/sidbpowell
Brilliant article. Looking forward to building with you
Shouldn't this be "...bear market..." in "Everything is good until the market decides to come crashing down and we enter the next bull market."