No matter how you hack the cost side, raising money is usually an inevitable route startup founders take. Raising money is hard. Usually, it takes longer than expected, is harder than expected, and more often than not, leaves battle scars. It involves repeated pitching, continuous recrafting of the story, calling in favors, and kissing many frogs. It also includes rejection and requires parking your ego at the door.
For most startups, there is no way to get around the need to raise money to develop the technology or the business idea, and to build the product or service and get it to market. It is not, however, the only way. This chapter considers the dynamics of fundraising: it kicks off with a discussion about the necessary mindset in Do or Do Not, There Is No Try (Yoda), and continues through fundraising basics, including the timing of raising funds and the effects of the economic environment and the venture itself in The Micro/Macro Angle. Insights on the different stages and their particular needs and requirements follows in Set the Stage, and the diversity of investors and alternatives to VC such as government programs and the optionality of bootstrapping are covered in VC Is Not the Only Way. The chapter continues with discussion around investor psychology and alignment of interests in the local ecosystem in The Lighter Side of the Dark Side. Finally, economic considerations are considered in VC Economics. The chapter concludes by assessing what founders need to consider when going out to raise funds in De-risking Opportunities for Investors, and closes with Eyal Gura’s Musings on Fundraising.
I have heard many entrepreneurs say, “We are trying to raise between X and Y million/hundred thousand dollars.” The reality is that conditional psychology doesn't really lend itself to success. Raising funds is an ‘all in’ endeavor.
Ziv Aviram of Mobileye131 and Orcam132 is known to say that the best time to raise money is any time you can.133 For early-stage startups, the timing is usually a function of needing money to complete a POC or MVP; to expand sales and engage in paid marketing; or to pay salaries to developers, other outsourced personnel, or even the founders. Often, it's any combination of the above. In the Zell experience, some ventures have started fundraising in the course of the program, though for a host of reasons, that is a rather difficult task. For the most part, it’s because investors are looking for fully committed entrepreneurs, and students by definition are not.134 We have had some exceptions, and quite a few companies raise at the tail end of the program or right at its end.135
The decision to go out to fundraise is not trivial. It means a full-time endeavor for at least the CEO, which will invariably come at the expense of the development of the startup. It will take longer and be more painful than expected, and when it's done, it's really just the beginning.
The reality of fundraising is that economic conditions can have a big impact on an entrepreneur’s ability to raise money, which is typically a function of macroeconomics (i.e. lower interest rates make startup investing more attractive; economic downturns make risky illiquid investments less attractive), and microeconomics (team, idea, traction, etc., which will be discussed in the context of investor psychology below).
There is also the matter of location and location bias. Investors in Silicon Valley generally prefer to invest in their backyard because this ensures better access to meet face-to-face and keep tabs (though COVID-19 may be impacting that),136 but there are other biases that relate to fields and stages. For example, Israel is known for investing early in cyber, but less so in B2C.
In both the YesChef and RealFace case studies, the founders note that the fact that they were raising for consumer-focused businesses was a serious limitation in fundraising in Israel. YesChef is a venture offering high-end chef tutorials direct-to-consumers. The venture is media (of which there are not many local investors),137 and also relies on a distribution strategy that needs to reach home cooks directly, one by one. [See the YesChef Case Study]
For RealFace, the difficulty of raising funds for a consumer venture using deep tech facial recognition to improve digital self portraits, or selfies, was met with challenges, despite the tech angle. In fact, it was one of the driving forces behind the team’s decision to regroup and pivot to a B2B offering. [See the RealFace Case Study]
Despite the location bias against consumer-facing ventures, for many Zell Program ventures, consumer focus provides an easier start.138 It may be a scratching of an itch, or just generally a market that is more easily understood, but for many ventures that eventually continued beyond the program, inevitably there was a shift from B2C to B2B, and only part of it was because of product-market fit. As was the case in RealFace, fundraising ability can also serve as a big impetus to pivot. But VC funding is not the only way. [See the RealFace Case Study]
Location refers to geography, but industry is also a differentiator. Different industries have different benchmarks for funding. Coupled with location (and availability of capital/appetite for risk), industry impacts pricing as well. In addition, the macroeconomic environment impacts funding for different stages and deal terms. Currently, the investment environment globally and in Israel is awash with cash as a result of zero interest-rate policies and pandemic relief funding. Although there was a decrease of new startups in 2019-20, that has reversed drastically in 2021. To date, there are more investors in Israel, and more money and startups.139
Here is a general framework for stages of funding in Israeli startups:
For Eyal Gura, from his experience as a founder of PicApp, PicScout, and Zebra Medical, an angel investor in Israeli rocket ships such as Appsflyer and his family’s startups Missbeez, The Gifts Project, and Empathy, and a venture investor with Pitango, including in Zell Alumni ventures FormLabs and Ubimo, he has collected some thoughts about what those stages mean for the life of a startup through the lens of the fundraising history of Zebra Medical. [See more in the Zebra Medical Case Study]
Self-funding is not common for first-time entrepreneurs. It is usually more prevalent amongst second-time or serial entrepreneurs, and at least at the time of Zebra Medical’s founding, it seemed to indicate a trend.140 For Eyal, it made no sense to raise money and build a team before he was able to secure the data he needed to start building the algorithm. After several successful ventures and consequent exits, he was able to take his time.141
After three years of self-funding, Zebra Medical raised a noteworthy Seed round of $8 million dollars led by Khosla Ventures and joined by Deep Fork Capital, Marc Benioff, and OurCrowd, all investor relations which Eyal had curated along his entrepreneurial and venture investor career.142 Notably, Khosla Ventures was the leading (and almost only) top-tier investor in the digital health space at the time. OurCrowd rounded up a Series A at an additional $4.9 million dollars six months later. According to Eyal, the key consideration in Seed to Series A is finding investors that can help connect you to the next round of investment. For first-time entrepreneurs, there is also a need for some operating experience, but second-timers and beyond should strive for angel investors or early-stage funds with lots of connections in the space in which the venture operates. “The more relevant connections, the better the investor,” as Eyal sees it.
He also notes that today, Pre-seed and Seed have replaced Series A in a sense. “Today’s Seed is Yesterday's Series A” he notes. If in the past, Pre-seed and Seed rounds were characterized by funding in exchange for ordinary shares, today, these rounds are often for Preferred Shares143 from the get-go. The pricing for these earlier rounds has also grown. The investment round with the first institutional money is pivotal for the company, according to Eyal, as it is usually the round after which a professional board of directors is established and the company’s organs begin to take a more mature form.
In May of 2016, Zebra Medical secured a meaningful strategic investment from Intermountain Healthcare, with Dolby Ventures, Nvidia, and existing investors joining.144 Adding a strategic investor was critical for Zebra Medical, although it had a wealth of data from Clalit, Israel's leading healthcare maintenance organization (HMO) and health insurance provider, getting data from a U.S. source increased the diversity and breadth of data, and importantly, the ability to run trials at Intermountain hospitals was a meaningful step in the validation process. In highly-regulated spaces, a minimum viable product is not very minimal, and is only viable if an industry player is willing to commit. Series B is a classic time for a venture to introduce a strategic partner.
In June of 2018, two years later and now with FDA-approved algorithms and some traction, Zebra Medical raised $30 million dollars led by aMoon Fund,145 a leading science technology fund in Israel, with participation from additional investors including Johnson & Johnson, Nvidia, and additional individual and existing investors.
All in, Zebra Medical raised $57.4 million dollars over an arguably long and winding road to product-market fit in an industry that is both heavily-regulated and highly-competitive. Zebra Medical was out there almost on its own when it started, and as a result, it needed to build out many of the underlying tools it would need, which required a large investment of capital. Now, the company is most certainly not alone and needs the money to grow its client base.
From self-funding, through the big name and well-connected industry leader Khosla, to a strategic partnership to help actualize pilots, the Zebra route holds some key takeaways for many startups on the fundraising path.
However, though it represents one way to make the journey, it's not the only way.
Getting a business going requires capital. It can be borrowed (though for technology startups that are high-risk, bank loans and the collateral they require do not make that a viable option). Or, it can be achieved through grants (there are a few European innovation grant initiatives relevant for Israeli startups and many Israel Innovation Authority grants)146 that provide capital with no equity required, and are often non-recourse or only some form of revenue share.147
Some founders invest their own money, usually to be able to get to MVP, as in the case of Liat Mordechay Hertanu (Zell 1 – 2002) in 24me [see the 24me Case Study], or even for the first few years as in the case of Eyal Gura (Zell 2 – 2003) of Zebra Medical. In some cases, that initial capital is the only capital raised, as was the case for Noa Issler Segev (Zell 9 – 2010) of 1Item [see the 1Item Case Study] and Yoni Elbaz (Zell 11 – 2012) of Loox [see the Loox Case Study]
In the case of 1Item, having sold out of all of their inventory upon launch, the revenue stream and need for additional cash beyond the revenues was mitigated. For Yoni at Loox, he had started out his venture bootstrapping, seeking to bring his product to market, and had initially thought, as most founders do, that to achieve scale he would need venture capital. After raising $50,000 dollars from the ZEP Fund and speaking to several VC firms, Yoni realized he was better off building from the ground up. Though it took 15 months and both he and his co-founder did not take salaries during this time, they became profitable and never raised an additional dollar. Instead, they are paying dividends to the ZEP Fund!
As detailed in the last chapter, there are innovative ways to gain traction without investment capital (i.e. OnO Apps’ ProBoNo program). As the Magical fundraising showed, community can be the bait for investment capital.
Tommy Barav of Magical first built a community, and then was able to capitalize on that community to get his first investment.148 He started with a workshop, grew a base of supporters that were early evangelists for his blog, morphed the workshop into a product, and was able to harness those supporters to represent traction and product-market fit. Magical raised $50,000 dollars from the ZEP Fund along with other investors, including investors from Silicon Valley, for a total of $3.3 million dollars.149 This shows not only a ‘bottom-up’ fundraising approach, but also a hack to location bias. [See the Magical Case Study]
Bootstrapping and bottom-up fundraising does not work for most founders beyond the initial MVP stage. We created the ZEP Fund to help bridge that space between the end of the program and the maturity needed to raise angel or venture capital funding. The ZEP Fund invests in 5 startups every year, with a priority for ventures of recent graduates that just finished the program. The remainder of the investment amounts are available to any company with an alumnus founder holding over 15% of the company's equity.
Traditionally, Zell Ventures right out of the program succeeded more with angel investors at the outset, but over the years, the trend has shifted and there are now more early-stage venture capital funds in Israel with an appetite for pre-revenue startups.
Having spent a few years in venture capital as a partner at Marker LLC, a Herzliya-NYC fund focused on Series B investments in Israeli founders (usually just as they expand their reach to the U.S.), I came away with some interesting insights. I had always been part of the VC ecosystem (or so I thought), and knew many investors, however, spending time on the ‘dark side’ was eye opening.150 It wasn’t so much that it was truly dark, but more that it highlighted the somewhat different perspective a venture capitalist needs to take to service its constituency of limited partners (LPs) that invested in that VC fund for outsized returns, not for hand-holding of young entrepreneurs.
However, most of the investors in the local ecosystem that I have had the privilege to work with in one way or another (and the list is exhaustive), whether through Zell, Marker LLC, the many advisory roles I have had, or the Kauffman Fellows151 have at the forefront of their objectives the goal to help entrepreneurs realize their potential for the mutual benefit of the fund and the entrepreneur. However the interests don’t always align, but it’s a small market here and every investor understands that their ability to get the next deal is very much connected to the references from the founders in which they have already invested. Or as Sam Zell often says, when closing a deal, winning is important, but there also “needs to be something left on the table.” The world is round, and in Israel, very small.
Despite all the good intentions, the propensity for misaligned interests is real. Any entrepreneur that goes out to raise funds should have a basic understanding of fund structure and investor math. A VC fund, unlike an angel investor, has for each fund an amount to invest that should ideally reap a 2-3X return. For a $100 million dollar fund, that means roughly:
6-7 investments – No returns (equals 0)
6-7 investments – 1X returns or a third of the fund (meaning if the cumulative investment amount was about 30% of the fund or $30 million dollars, then $30 million dollars was returned (i.e. each investment and follow-on was about $5 million dollars and each returned its invested amount).
1 Home Run – Return of the entire amount of the fund (i.e. a $100 million dollar fund with a 10% holding in a portfolio company requires a $1 billion dollar exit).
What’s left? Usually what’s left are about 5 investments that yield meaningful exits. These are not quite home runs, but accumulated can reach the full fund amount of $100 million dollars. This means about $20-30 million dollars of returned capital each (again, assuming a 10% holding at exit and no other liquidation preference, meaning that each exit was $200-$300 million dollars).
This means that fund size matters, as well as the timing of the fund (i.e. whether it just raised, or has little dry powder).152
Assuming the investor is upstanding in the investor-founder community, has a fund with dry powder to invest, and can demonstrate synergy between the fund objectives and the founder, ‘getting to yes’ still requires work. Specifically, it's about de-risking the risk of the investment. Investors are in this for achieving outsized returns. When they assess an investment, they need to calculate risk-reward. Since for early-stage the numbers are not quite evident, in my experience, this focuses on a set of risk considerations. Taking into account that different investors have different appetite for risk in absolute terms, and relative to each of the below dimensions, this can still be loosely set out in the following framework:
Asked to summarize some thoughts on early-stage venturing and tips for young entrepreneurs, Eyal Gura shared the following:
For Yotam (Zell 11 – 2012) of Daisy, as a second-time founder, there is the privilege of choosing your investors.“When choosing an investor, the trust between the entrepreneur and investor is a priority,” advised Yotam. For him, an investor needs to trust the process and be aware that the entrepreneur does not have all of the answers upfront, as it’s a learning process for him or her as well. “A potential investor from NYC wanted to join the round and called my investor, asking a lot of questions. Our investor told him, ‘I don't know what they will do about it, but I trust them. They understand what they’re doing and they’re learning fast, so they will figure it out,’” said Yotam. [See the Daisy Case Study]
