Jim Davidson of JGD Ventures, On How Startup Funding Works

Everything you need to know about funding

Jim Davidson

Jim Davidson

Jim Davidson is an entrepreneur, early-stage investor and advisor with more than 20 years of Internet technology experience. He is now focused on early-stage impact investing, providing capital and serving as an advisor for companies that leverage technology to further their social benefit and sustainability missions.

Jim is going to visit Bangladesh for the first time this month. On the eve of his visit we spoke to Jim via email about his experience with funding, the funding culture in the US, what startups should do before raising funds and more.

As we’re running ‘startup funding’ as our theme for this month we believe Jim’s insight will give you food for thought and give perspective to get it straight. Fund should not be a problem for startups unless you make it one and as Jim says: “It’s important for entrepreneurs to understand they are providing an opportunity for investors, not asking for investment. Build something that matters”. Enjoy. ~Ruhul

How does the funding culture work in the US? What are the ingredients that help to foster this funding culture?

The funding culture of the US is famously vibrant and tolerant of risk and failure. You see this in hundreds of angel investment groups, acceleration/incubation programs, and young entrepreneurs jumping into the space everyday.

Having said that, fund raising is still very hard and failure rate of startup companies is very high. A particular problem is that less than 10% of eligible investors ever make a single early-stage investment and half of those never make a second. This is a problem for two reasons: 1) Without a portfolio (perhaps 20+ early-stage investments), an investor has a low probability of achieving a risk-adjusted return and 2) Not enough capital is available for worthy businesses.

Addressing the reasons eligible investors are not engaged is an opportunity to improve the funding culture and results for investors and entrepreneurs.

Fund raising is still very hard and failure rate of startup companies is very high. A particular problem is that less than 10% of eligible investors ever make a single early-stage investment and half of those never make a second.

How does startup funding work?

From my experience, there are three distinct ways I’ve observed fundraising.

First, there is the serial entrepreneur who starts by reaching out to past investors. This sort of entrepreneur quickly circles the seed investment and then engages with other investors through accelerator or angel group channels with a high level of confidence and a clean narrative.

The next category is the first time entrepreneur. If the product idea is compelling, they may get into an acceleration program (e.g., TechStars, Hub Ventures, etc.). There, they learn that their business model and plans are generally way too light to attract investment – the need to get much more crisp on the future revenue prospects, unit economics, and capital plan with clear use of funds. Either through an accelerator or an active mentor, they quickly come to a much more fundable status and then circle funds through angel groups and possibly an early stage venture fund.

Finally, there could be the entrepreneur who is working on their startup part-time, funding it slowly or through clever use of Kickstarter or similar crowd-sourcing means. These startups seem to build slowly and are powered by a super passionate founder who can maintain support himself or herself with some other income stream or a spouse. They may eventually stumble on a mentor / investor who helps focus them and make the leap to investment and full-time effort.

What do you look for when you fund a startup?

I invest in “social ventures”, also called “impact investments” so I look for:

  • A business whose activities generate a clear environmental and/or social justice goal
  • A business model with a “plausible narrative for future revenues”
  • A capital plan with a clear use of funds, i.e., a plan with a specific amount that will go to a specific list of objectives which predicts a specific list of outcomes, all of which lead to a next logical step in the business
  • A founder who is passionate and coachable
  • A team who works well together and is smart

When is the right time for a startup to raise funds?

The right time is consistent with a previous question, i.e., when they have a clear plan to use new capital for a clear and plausible result. It’s important for entrepreneurs to understand they are providing an opportunity for investors, not asking for investment. This means when they have a clear plan and they truly believe they can turn that investment capital into a 5-10x return in 5-7 years, then the time is right.

Now, in practice, acceleration programs and general expectations lead startups in the United States to generally converge on the $500k seed investment ahead of the $1-2m Series-A. I think this is an ok guidepost but it’s still important to be clear on what the specific business needs.

It’s important for entrepreneurs to understand they are providing an opportunity for investors, not asking for investment. This means when they have a clear plan and they truly believe they can turn that investment capital into a 5-10x return in 5-7 years, then the time is right.

Why do you fund startups and early stage companies when the startup failure rate is so high?

First, I have been fortunate to have worked at a high-growth company which generated sufficient wealth forme to allow me to invest without risking my ability to provide for my family. And, while I believe we may over emphasize the role of the startup and under emphasize the role of policy makers in solving big problems, I generally believe business can be channeled to good benefit. In addition, I have done my homework enough to understand the critical need to have a portfolio of many early stage investments to mitigate the risk and enhance to probability of success. So, I’m comfortable making investments in risky ventures because I make so many of them my returns to date have been acceptable.

How can we build a funding culture here in Bangladesh?

This I cannot answer right now as this will be my first visit to Bangladesh! However, from a US investor’s perspective, I can say that issues of strong and stable governance are certainly critical in attracting foreign investment.

What advice do you have for startups who are planning to raise funds?

First, startups need to have a compelling idea. It needs to solve a clear and present problem and the plan to generate revenues needs to be believable. When pitching investors, founders need to be aware investors will generally understand the product concept very quickly and then look for evidence the team can execute. So, a clear capital plan that shows realistic steps to execution is critical.

Also, startups should explore how to bootstrap without direct investors. Can they crowd-fund via pre-purchase (e.g., Kickstarter campaigns)? Can they seek non-dilutive grant capital? Debt financing? How can they get revenues quickly, build through retained earnings? While those sources of capital may be insufficient, it’s important to have explored such options before looking for equity.

Startups need to have a compelling idea. It needs to solve a clear and present problem and the plan to generate revenues needs to be believable. When pitching investors, founders need to be aware investors will generally understand the product concept very quickly and then look for evidence the team can execute. So, a clear capital plan that shows realistic steps to execution is critical.

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