The market for Mexican venture capital is limited as you may have read in my previous post. Now that you know the investors in Mexico, it is time for me to share how I got the seed round for our investors and why I feel “dating” your investors is very important, especially in the Mexican venture capital market. To repeat what you might already have read, the amount of venture capital funds in Mexico is very limited: 43 in total and only 12 active under $1 million USD investments. So your best chance to grow your business is by bootstrapping it. There are two main reasons to put the effort into finding Mexican venture capital. The first is traction. If you want to conquer a large market fast, having a good amount of traction in your startup that later needs follow-on capital is a good reason to look for capital. The second reason is simply because this is a capital intensive business. In our case, we focus more on medium size businesses, and closing a deal can take several weeks. The capital needed to pay for the acquisition of each client can be cash-flow intensive so you need enough to carry you through the lean times. Then getting cash to grow makes also sense. So, in my opinion, there are two reasons to get capital from a Mexican VC and these are:
- To have traction, to grow the team to conquer a market quickly
- To have a proven business model that is capital intensive in order to grow
Image source: Profit Guide
Your first round of financing should come from your own pocket. As cofounder in my company, I put in a good amount of cash together with my co-founder to pay for the first two years of our development. In addition, we did not take any salary for a long time to make sure we got a product market fit. We failed many times using our own money before finding an interesting model that required venture capital. After you’ve exhausted all your savings and max’d out your credit card, it is time to consider either:
- Reaching out to friends, family and fools (FFF) for money or
- Locating a “seed round.”
What is a “Seed Round” in Mexico?
“Seed rounds” are financial injections into your business based on the potential of the team and the product. Most of the capital is based on the background and achievements of the team in the past years. The product might change (called pivots and iterations), but the team is the core investment of capital of the “seed round.” A seed round from venture capitalists in Mexico starts at $10,000 USD and goes up to $500,000 USD. Expect to have valuations as low as $100,000 USD to $1.5 million USD (I recommend that you buy the book Venture Deals if you don’t know what valuations are). This will cost you anywhere from 5% to 25% for VC’s who care about the founders of the company. In my opinion, any VC who wants to take more stock is greedy, and you should only allow this to happen in return for significant benefits. For example, a small but famous incubator program, like “500 Startups,” will invest up to $25,000 USD in your company, taking approximately 5% (that is on a valuation of $500,000 USD), but you will most likely have to pay the incubator program, leaving you with little cash to actually spend. Startup founders have told me that even Wayra ‘invests’ in your startup, by giving you half the cash amount and claiming that their services and network is worth the other half. It’s true that the Wayra network is large and that it can be very helpful, but you should verify if their previous batch of founders in Mexico were actually able to jump to a profitable business or to a series A follow up round. I don’t think that has happened yet.
Make your seed round count in Mexico. It should get you to product/market fit with enough revenue to be cashflow positive before the seed round runs out. The reason for this is that the follow up capital is harder to get and only will be available for the best of the startups. Most likely, you will have to make it on your own, so plan for this by quickly finding a commercial model for your business. ‘Alta Ventures Mexico’ invested in our company and added a convertible note later to be able to bridge to a series A, but don’t expect every investor to be so generous in Mexico without having to make serious traction. I highly recommend that you follow the problem/solution interviews as setup by Ash Maury in Running Lean and the “Nail It” chapter of NISI-book by Paul Alhstrom. Find the revenue as fast as you can. There are very few Instagrams in the world where user growth is incredible and monetization will come later. That just doesn’t happen with Mexican startups; we are not in the US. Here you survive by making sure that revenue is higher than your cost (cash-flow positive) until you find your hit.
When Are You Ready for Mexican Venture Capital?
So your startup is a wonderful idea on the back of a napkin, or it’s a continuation of your almost successful Startup Weekend project, cooked up by multiple acquaintances who all helped the first few weeks but who soon returned to their regular and safe jobs. Congratulations! you just landed in intellectual property (IP) HELL! Setting up a company after you got some traction is perfectly fine, but please don’t go shopping for capital if you don’t have a wonderful 8-page waiver of IP from all the people involved or have contracts that clearly specify who owns the code you now use. Do the same with your previous employers, or don’t be surprised if coding up some project with colleagues actually ends up being the property of your previous employer.
Source image: Startup Weekend Cancun
Setting up the correct legal structure is important. It won’t kill your chances for investments, but it will make everyone’s life easier if you have a Mexican Sapi or US Delaware C-corp set up by a real lawyer. No, your brother-in-law’s divorce lawyer does not count. Great – you have your Delaware corporation set up, you have contracts with past employers and contractors signed, the code is yours, and now you go for the next step. Whow, hold on a second. Are you using some sort of GPL licensed code you found online?, ehh. Wrong again. Use MIT- or Apache-only material when you start, and you won’t have to re-write it all again. The reason for this is that investors usually need an exit within 5-8 years (depending on the fund) so you will need to sell this company. Unless you sell to another open-source company, your application -full of LGPL or GPL code- just became a really unattractive acquisition target for a company who cares about keeping the code to themselves. Forget about re-writing all code or trying to figure out where you got that snippet of code. Try to avoid over-use of these licenses, make sure you document their use very very well, so that when the time comes, your team won’t need to spend weekends re-writing those sections.
Forget all I just wrote!
IF….. you have traction and awesome growth (talking 50%-100% month after month, for 6 months), IF…. you are paying clients in hundreds and a run-rate (12x last month) of $300,000 USD, you will get seed funding, and your VC will probably help you fix all things broken. Traction: double digit growth in paying clients or a huge growth in active users and some monetization on active users is wonderful to hear for Mexican VC’s in the seed stage. When we got funded in December 2011, I wondered how much competition I actually had from startups since we had little paying clients, had small growth but a great team, had a fully working product and huge market potential. So, in all honesty, this will not work in 2013. Every batch of startups delivered in Silicon Valley is making $25,000 a month or more. Less than that is just not good enough anymore. In a way, you might be lucky here in Mexico where the startups and VC’s are in earlier stages, but trust me, in 2014 this game is over. Make money before you leave your incubator or before your friends at Mastercard/VISA come for the final bill.
Find a Good Dating Site
Here we find again some similarities with your love life. When you’re happy, you are more attractive. The same goes for dating your VC’s. Just build an awesome company and keep talking to investors along the way. Network when you don’t need any money; help others along the way; make sure you understand the needs of investors; and help them out with introductions to other, more advanced startups. Networking is currently the best approach in Mexico, since you just won’t get access to investors any other way. The online presence of VC’s is very limited, and it is not uncommon for VC’s to find your email in a long lost email box. Here in Mexico, introductions go a long way. Even with a name like ‘Alta Ventures’ as a backer, I’m still waiting for some angel groups to get back to us after two webform submissions and after contacting three of the partners on LinkedIn. So it seems that, with limited funds and limited startups, the entire quality of the eco-system has not reached the valleys, again either an advantage or a disadvantage, depending on your perspective. Two months ago, I made a list of all Mexican VC’s and since then, there are only two new funds – Jaguar Ventures and InventMX – now open for business (see comments in the original posts). There is just not much capital available in the market for startups, and the selection will only become more difficult, so be prepared, and be exceptional. Since we have no real dating site for VC’s, I suggest that you monitor mine, and I will update it regularly with new VC’s, accelerators, and incubators. I can be your Match.com for now. Network events are another good way to meet your future partner, flirting when you don’t need money. Getting to know the analysts, partners and staff is not difficult. Make sure you help them; ask their advice and make them partners in your growth. There are a good number of events like 7×7, FuckUp Nights, TNW, Startup Weekends, BarCamp, StartupDrinks, iTuesday, INCmty and more, that you can use as your platform to meet other entrepreneurs and investors. The last three years have been amazing for Mexico. Many entrepreneurs, technology evangelists and investors have done an amazing job growing the eco-system.
A Mexican father-in-law is not easily convinced to let his princess go. But, if you have a brother-in-law on your side, this entire exercise will be a lot easier. Consider the investors’ analyst your new best friend to help you understand the funds’ partners. Your first few meetings with the investors are most likely to be with their analyst. The analyst is the person who finds deals, who goes to a Startup Weekend, who analyzes the market. and who does the due diligence of your company. They verify the deal that is generated before it is presented to the partners. They also can help you prepare your pitch if you can be open and try to find out where the investors have their focus. Get to know the players in the Mexican market by reading my previous post and take the time to find out if you have a good fit with the investors’ goals. Get to know the partners and analysts during events. Most events here in Mexico happen in the biggest cities, but you can find travelling partners and analysts at many events. Build an informal network of contacts years before you will ever need it and make sure you are involved in events that build your local eco-system. Seeing others fail and succeed .. and how they get things done is super helpful. Being known in the technology and startup circles eliminates the problem of becoming known to the investors at the moment you actually need to raise money. I did not do this very well, and I’m sure our investors’ analysts had a hard time doing a background check on “the Dutch” and “the Romanian.”
Determine your company’s value yourself and be done with it. For a seed round, there are no real calculations, only emotion. The benefit of using emotion for valuation is that it basically eliminates the argument. Here is a valuation range for Mexico:
- Idea Phase and average founders: valuation $0 USD
- Idea Phase and amazing founders all from Google: valuation $500,000 USD
- Prototype and average founders: valuation $0 USD
- Prototype and amazing founders all from Google: valuation $500,000 USD
- Product live, first 10 paying clients and average founders: $1,000,000 USD
- Product live, first 10 paying clients and amazing founders all from Google: valuation $2,500,000
Read more here http://venturehacks.com/articles/seed-valuation
I read the first chapters of Venture Deals before pitching, and I soon learned that it saved me a lot of money to know the difference between pre- and post value of an investment. Let me help you with a quick example. If your valuation is $1 million USD based on pure emotion, and your investors ask: “is your valuation for the $250,000 USD investment pre or post valuation?”, you say:
- “Pre“: $1,000,000 + $250,000 investment (money) = $1,250,000 Post. Investors own $250,000/$1,250,000 = 20%
- “Post“: $1,000,000 – $250,000 investment (money) = $750,000 Pre. Investors own $250,000/$750,000 = 33%
So when you want to give away a maximum 20% of your company, and you had $1,000,000 USD as the valuation, please say that is a “pre money” and save 13% of your company.
In the US you might be able to pitch 100 investors in your fundraising period, but here in Mexico you get 3-4 pitch opportunities and then you are done, no more opportunities. Unless you are willing to move to the US, or build your startup in Argentina of Chile, it is unlikely that you will get investments from any fund if you have only average traction. Remember that validation is the key for national funding, and mind blowing traction will get you money from anywhere. Prepare, practice your pitch 100x until it is flawless and take a look at these following guys: Guy Kawasaki, David Rose and Dave McClure. These three are just a few examples I used to help prepare my own pitch. Make sure you understand the investors. Figure out who is in the room, how they think and what is their investment philosophy. Most Mexican VC’s either write a book, give presentations or have (have to admit pretty crappy) websites with material. Read it all.
You will fail. Yes, and you have failed! Sorry. Most likely there are lots of failures in your history, there is no point in hiding them. Use them as part of your pitch, to show you never made the same mistake twice; it can never hurt. Show that you can hustle and that “no” is just a starting point for you. Funding can never be the end point. Your strong character and your amazing team are assets. But avoid being stubborn. I’m stubborn as hell, ask my investors, but that is not always an asset. So when your investor starts taking over in the middle of your pitch, don’t continue talking. You won him over, shut up and let him sell your idea. Even if you hear them take it in a direction that was not the intention, there is always time to correct that later. So don’t be too stubborn at pitch-time. Other partners in that room trust the colleague who just took your story and made it his. Congratulations, you found your board member.
So… are you going to wear your wedding suit with a tie? To suit up or not? I wore a blue two piece suit (without tie) to my first pitch to our fund, but I’m not going formal again. I’m more and more influenced by startups and founders who follow their own path. So for me, it will just be casual for my next investor meeting. Diego Bañuelos and Josue Gio are both founders of Mexican software businesses who raised a seed round from angel investors and who now help other startups in the eco-system, and both agree: casual is the way to go in Mexico. But “casual” here does not mean Dave McClure casual: flip flops, jeans and t-shirt. Mexican “casual” involves dress-pants or nice jeans, a nice shirt (no t-shirt) and a jacket. You don’t have to bring your whole team to a pitch. Most of the time the first presentation can be done by one founder only. Since you should expect a lot of rejections, it might be best to save as much time as you can. One founder, the most articulate, should go. Follow-up presentations can include another member of your team, but try not to put too many people in one room. If you do well, there will be at least one meeting a week after that with an analyst to see if you two can figure out things like the valuation and some other basic terms. So suddenly you are informally working on the term sheet.
Big ideas in small markets can be done bootstrapped, but big ideas in big markets need capital. So this term sheet is the moment where you should be absolutely sure what you are getting yourself into. You just got 10x the pressure to actually make 10x the investment back for your investor. So bootstrapping mode is over, your money saving time is over. You need to put the money to work. Are you ready to be an example to other startups in Mexico? Ideally, you get multiple term-sheets from investors to have better negotiation power, but as soon as you sign the term-sheet, you are in a serious relationship. Mexico is different here. When I got the first investor, it took four weeks to get even the term sheet up to a level where I would sign-it. The reason not to sign too fast is that most term-sheets mean an exclusive dating relationship. They just locked you in for a good period of time in this semi-long-term relationship that prevents you talking to other investors. So no more flirting. Make sure there is a max. time you take to negotiate and keep an end time in mind for this term-sheet so that you can walk away if they are just stalling you, snooping in the kitchen or actually flirting with the competition. Did I tell you this looks a lot like a telenovela? You need to know what vesting is, about employee stock option pool. Figure out why your investor is pushing for a large pool. Focus on keeping it large enough to fit its purpose but small enough not to be giving extra percentages of stock to your investors. But for these and things like vetoes and board seats, I’d like to refer you to the first half of the book Venture Deals. That was how I prepared for the time after the pitch. Read it twice before starting to pitch, three times if you get a term sheet, and another four times when negotiating the final deal.
Last notes, the loose ends that can still break the deal
You Are Almost Engaged to be Married, Ready for the big step?
The final stage of your single life as an entrepreneur has arrived. You should be happy, you possibly found the partner who helps you grow, personally and as a company. Here are some small details that you should be aware of, my personal tips from my own experience after getting a new partner in the company December 2011.
- Lawyers Yep, they are expensive. They cost between $20,000 and $40,000 on an equity round and about $10,000 on a convertible note round that is simple. So if you raise $250,000, you will be losing 10%-15% within the first 30 days. You will be able to find lawyers who take about that much on the actual close. You can save money if both the investor and you use the same lawyer, particularly since the investor usually expects you to pick up their lawyer’s bill as well as your own. Sorry no “going Dutch dating” in the investor world.
- Tranches It’s not unconditional love, my friend. Your new partner is protecting his interest so expect your investor to place tranches on your funding. These are payments in stages of the investment based on your performance and milestones. It’s hard to get away from these, they’re a pain and feel very paternalistic, but as a founder, you also need a beating every once in a while. Tranches are there to do that in an grown-up way.
- The Board Your new board on a seed round can be kept simple. Three members should be enough to monitor the activities and advise. You might be getting away with keeping two founders on the board, but most likely this will become one founder/CEO, one independent board member, and one partner of the VC fund. The board is a new and very important part of your company and has important powers. Lose control of the board, and you lose control of your company’s future.
- Due Diligence Forgot to submit taxes on time?, have an open tax bill?, forgot to tell about that partner who joined and left the first month of the company’s formation? Or funny things like, napkins with written promises to split the billions you would make that you gave the bartender who gave you the idea that drunken night? or that old employer who supplied you with stable income as a developer while hacking on your startup coding? Yes, all will get you in trouble in this phase. Do your due diligence, it’s time to clean house.
Compare an unmentioned $115k tax bill as deadly to your term sheet to a stripper on the bachelor night. Easy to avoid but a killer for your wedding day
Without sarcasm, I’ll share what happened to me, on the topic of stupid details that can break a VC deal. We had forgotten to file taxes in California in 2010 and after the summer holiday, I got my first notice. No worries I thought, I’m in Delaware, I’ll deal with this later, a small detail. Around the same time that we got the first draft of our term sheet, I got another present: a tax bill of $115,000 USD from the state. Their estimate of taxes owed. Uh-Oh. This was not a pleasant surprise, and luckily it only took the accountant (CPA) weeks to make that surprise go away and get our 2010 taxes in order. Guess who delayed the term-sheet and due diligence negotiations long enough to deliver the tax files with only $500 of taxes showing to the investor?
Bring the bride into the bedroom, pop the champagne and get to work
A hard lesson for a bootstrapper like myself is that money in the bank is money not at work. I wish I had doubled down faster on an idea and not followed several iterations of our product. I wanted to do a “lean startup,” to perfect in the hope that this path would lead to a magical product. But part of the magic has to come from the visions of the founders, not from a lean startup. So I’m still looking for that balance of “lean-vision,” where obvious lean strategies combine a strong vision and a gut feeling of the market.
Now you got funded, congrats!
The day you check the bank account and the first trance is in, is magical. Really it is, you give your life’s partner a big hug, call your parents and you feel like sending out a press release. Do everything but the last. Do enjoy this moment. The negotiations have been stressful, and every bootstrapper who ever closed a round will tell you that funding is not the final goal of a startup. I know it is not, but after knocking on doors for months sharing your vision and passion to people who can help you reach the next stage, after negotiating terms that you never heard before, after struggling to understand last minute details that could ruin the deal… all is a lot of stress and you deserve a gift. Yes, I have no problem that you buy yourself a new computer with your VC’s money since yours is crappy. Consider that your gift to yourself for closing the deal. But don’t announce to the world that you closed a deal. Be proud, get a hug, a shoulder pat, some extra sleep that weekend, since it’s the last sweet, quiet night you will have in months to come. But there is nothing to share yet, since you have no awesome product…….. yet.
149 Days Before Money Runs Out
Welcome to your office, boss. On Monday you start to work on your newly funded company. The first thing you now need to do is to make a webpage with a timer, one that connects your cash in the bank to the costs you have, while calculating the days left before you are broke.
Find some peers to talk to, because dealing with investors and a new board is all new to you. Try and find some other founders who got funding from either angels or VC’s and have them on Whatsapp or Facebook Messenger. Share your frustrations and challenges, but overall, enjoy the ride. You did something that was very hard to do. You found a partner who believed in you, who bought your vision with stock, and who gave you the ability to make something awesome. Congratulations! It’s not an easy ride as entrepreneur, and you should be proud of passing this phase. It’s not the beginning.. or the end; you are just in the middle of your marathon.
Thank you Vicky Lyall for proofreading