Image: Murat Abdrakhmanov
Business angel Murat Abdrakhmanov gives an insight into how to develop an effective investment strategy as an early-stage start-up.
The global venture capital market is in decline, with last year’s investments down 35pc compared to 2022 and at the lowest level in five years.
Attracting funding is difficult these days, especially for start-ups at the pre-seed stage, which is the riskiest stage for investors.
When choosing a fundraising strategy, a founder should consider several factors: how much potential investors value the start-up, the amount of funding they offer and the additional benefits they can provide beyond money.
It’s also crucial to recognise the right time to begin seeking funds. The process typically takes at least three months with angel investors and 4-6 months with venture funds. If a start-up runs out of money, it risks entering a precarious situation, potentially facing unfavourable terms from investors.
To help aspiring start-ups choose the right investment strategy, here are some key things to consider.
Offer more than an idea
At the idea stage, founders don’t have anything tangible to evaluate. Experienced investors, including myself, rarely invest in mere hypotheses. We need at least an MVP (minimum viable product) and some initial sales to gauge interest in the product. Sometimes, entrepreneurs approach me with their ‘brilliant’ ideas. I jokingly suggest they sell their car, and if their hypothesis proves correct, they can come back for my investment.
However, that’s only half a joke. At the idea stage, founders don’t have many ways to obtain funding. In some countries, start-ups can get grants from the government or from private companies. But the two most common fundraising strategies are the 3Fs (friends, family, fools), ie, raising money from people you know, and bootstrapping, where founders develop a start-up with their own funds. Let’s talk about the latter.
Bootstrapping
This strategy is typically chosen by founders with prior business experience. They have confidence in their idea and expertise and are ready to invest their own savings. Another group includes inexperienced founders who have a strong belief in their project and are willing to go to great lengths to make it succeed.
Bootstrapping offers some pros in the form of independence – founders don’t face demands or requests for repayment from anyone, which in turn leaves them more time to dedicate to their business idea.
However, it also comes with downsides. A founder with no external obligations might struggle to turn their idea into a tangible product. Conversely, they could spend too much time perfecting the product while competitors gain market share. Additionally, a founder who isn’t engaged with the industry misses out on valuable networking opportunities and expert feedback.
Sometimes, a founder might be reluctant to dilute their equity and chooses to continue self-financing the project through seed and later stages. While this approach is understandable, it’s important to remember that start-ups are inherently risky and can fail at any stage. Investing all your savings into a start-up is high stakes. It’s often better to accept equity dilution and gain support from experienced professionals, which can significantly increase the chances of success, rather than spend years working on a project and end up with nothing.
Time for valuation
Once a start-up has an MVP and initial sales from testing its hypotheses, it’s time to discuss funding. Since investing involves buying a stake in the project, the investment amount will depend on the start-up’s valuation. A common pitfall at this stage is accepting a low valuation. I advise founders who are confident in their product to avoid settling for low valuations and seek out investors who recognise their potential.
There are several methods for evaluating a pre-seed start-up. One approach is benchmarking, where I compare the start-up’s financial performance against similar projects in other markets. This is particularly useful for assessing SaaS services, for example.
I focus primarily on growth dynamics. For example, a month-over-month growth rate of at least 20pc indicates that the start-up has likely achieved product-market fit (PMF).
Think about funding types
The pre-seed stage, also known as the angel stage, is when founders typically seek out business angels – investors who use their own funds rather than venture capital.
At this stage, angels generally take no more than 10pc of a start-up’s equity to ensure that the founder remains motivated. Given that angels are investing their personal money, their investments are usually smaller. That is why pre-seed rounds are often closed with contributions from multiple angels or through an angel syndicate.
In a syndicate, there is usually a lead investor – an influential market figure trusted by their peers. The lead investor negotiates the terms of the round, conducts due diligence and often takes on up to 50pc of the round.
The MA7 angel club, which I launched this year in Kazakhstan, operates on a syndicate model. I personally select projects for the club and handle negotiations with founders. Alongside other members, we can invest up to $1m in projects at seed or later stages. We aim to channel up to $10m through the club annually. We’ve been able to close rounds quickly, having already completed three deals totalling $1.6m. Our club is open to considering projects from various countries, but you need to be prepared for a thorough review.
Angel investing
Angel investors are often seasoned entrepreneurs who can identify a project’s weaknesses and help founders avoid potential pitfalls. Their expertise and guidance help start-ups conserve valuable resources.
Angels can also connect start-ups with key industry contacts, providing invaluable networking opportunities. These connections can benefit founders in the future by expanding their network and creating opportunities for mutual support.
However, it’s important to remember that start-ups face the risk of encountering toxic investors at this stage. These individuals, aware of the difficulty in securing funding, may impose unfavourable terms on the start-up. Examples include demanding repayment of the invested funds if the start-up fails or securing the right to buy out the project at the initial price, even if the start-up has grown significantly.
Toxic investors should be avoided as their presence on the cap table can deter other investors from participating in future funding rounds. For me, this is a red flag. If a start-up has no other options, it is crucial to negotiate the most favourable terms possible.
Accelerators
At the pre-seed stage, start-ups can join an accelerator program designed to boost growth. Notable companies including Dropbox, Airbnb, and Reddit have participated in such accelerators. These programs provide teams with mentorship over several months, helping them develop a high-quality product and an effective customer acquisition strategy.
There are many pros to joining an accelerator. Good accelerators kickstart start-ups by helping them achieve product-market fit and refining their customer acquisition strategies. These programs also facilitate rapid networking, allowing start-ups to connect with potential investors. Graduates from top-tier accelerators such as Y Combinator often find themselves with a line of investors eager to invest.
With more than 7,500 accelerators globally, some of them fall short in quality. Joining a subpar accelerator can waste valuable time and hinder growth. Gaining entry into a top accelerator is highly competitive, as they accept only about 1-3pc of applications annually. Therefore, it’s crucial to carefully choose an accelerator program, ideally by consulting with those who have previously participated in one and have positive experiences to share.
Another drawback of accelerators is their often low valuation of start-ups. My advice is to negotiate the valuation, even when dealing with well-known accelerators.
Venture capital funds
At the pre-seed stage, start-ups can also secure funding from venture capital funds such as Beta Boom, Forum Ventures and 2048 Ventures based in the US.
There are many pros to securing venture capital funding. A venture capital fund can provide a start-up with a larger investment compared to angels, and support from a reputable fund signals industry recognition, which helps the start-up gain the trust of other investors and market participants, allowing the founder to quickly build a strong network.
However, different venture funds are involved in start-ups to varying degrees. Some funds, unlike angels, provide minimal attention to the projects, which can lead start-ups to spend additional resources on consultants. Conversely, other funds may place their representatives directly on the start-up’s board of directors. Founders should clarify all conditions before finalising a deal and determine the extent to which they are willing to allow the fund to influence operational activities.
Crowdfunding
Crowdfunding is a way to raise funds through contributions from individuals. Popular platforms for crowdfunding include Kickstarter, Indiegogo and GoFundMe. This approach is particularly effective for hardware projects in their early stages. A notable example is Oculus Rift, a virtual reality headset company that raised over $2.4m on Kickstarter in 2012 and was acquired by Facebook for $2bn in 2014.
In terms of pros for using this option, crowdfunding can often be the only option for securing funds to launch the first batch of a hardware product. Also, investors are more inclined to fund start-ups that already demonstrate demand for their future product. If users have pre-paid, it indicates that the product is both useful and in high demand. I had a hardware project in my portfolio that successfully raised money for its initial production this way. When the founders presented a report showing that they had sold thousands of devices based solely on the idea, I was quick to invest.
It is important to remember that to run a successful crowdfunding campaign, investing in marketing is essential. This requires spending your own money, and there are no guarantees of success. Furthermore, if the project raises the desired amount but fails to deliver the final product, backers may file a class action lawsuit to reclaim their funds.
It’s also important to remember that crowdfunding is just the first step. It won’t eliminate the need for additional funding from investors later on.
No matter what strategies you employ to raise funds in the early stages, know that securing funding is a process that can’t be delegated. The founder must manage it personally, and it will be a time-consuming process, so allow for that in your business development plans.
Murat Abdrakhmanov is a serial entrepreneur from Kazakhstan with 10 years of experience in venture investments. He has provided funding to 52 startups across the US, European and Asian markets.
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