I recently gave a presentation at the SVASE University, a forum for Silicon Valley engineers, entrepreneurs and those involved with startups, on the topic of the challenges and strategies for raising a first round of capital in this difficult environment. I thought I’d share that with you here.

As a former entrepreneur (I guess I still consider myself one having started Nueva Ventures to take on some of the structural problems with the VC industry) I’ve had to raise capital for extreme startups and often in challenging times.

My first venture at Adesemi Communications was to launch wireless telecom ventures in Africa, “the last frontier”, requiring large amounts of capital to buy equipment and get these networks going. We started this back in 1993, when the whole idea of investing in emerging markets was not even on most VCs radars and it was a stretch to even get an east coast VC to invest in the west coast, let alone Europe or Africa!

My co-founder, Monique Maddy, started out by bootstrapping it with corporate money – Motorola, Sprint, Hughes and a few others provided consulting money just to scope out the market to see if there might be opportunities for them to deploy equipment and services in certain markets in Africa. With that first $100K or so of essentially no strings attached capital, we were able to make progress in lining up operating partners and securing licenses.

Next we found a couple of key angel investors who understood emerging markets, the telecom sector and had invested before in very early ventures. I often use the advice “rifle target your angels”. It can be a real stretch to convince someone to invest at the earliest stage where you might have just an idea and some smart people chasing it, let alone the complexities of the technology, sales cycle and in our case country specific risks like riots, coups, out of control inflation and the likes. If they get your space, at least they can get comfortable with a big part of the risk equation. We were able to raise $250K from a couple of such angels, which made a huge difference in our advancing the plan.

The angel round was certainly not enough to draw a significant paycheck and I had to adjust my lifestyle to cope – cutting way back on expenses and living out of a suitcase for over a year given the demands of travel to our target markets. Since I just came out of business school, I was not used to much of an income anyway. Stretching my student loans was a challenge (!) but I had an understanding lender (my folks). I also found it necessary to make the occasional payroll with my credit cards, something I doubt I’d do again (and certainly not without my spouse knowing all the details) but at the time seemed like the only way. I got very good at moving balances around to take advantage of zero interest financing offers.

As we progressed, we went through another angel round but this time with seasoned VCs from the space (again who “got” our space) who invested personally after they were unable to get all the partners of their firm on the same page. We also leaned on our equipment suppliers to extend us credit and leases. We were opening up new markets for them and spun a good story that, although not without much selling effort, got us some very attractive terms.

The institutional venture rounds that followed were the result of an intense global search for capital, much of it not exactly the traditional VC path – one large fund of funds private equity investor with a side venture fund for direct investments (the founders had traveled extensively to Africa and believed in the opportunities), two European project financiers who were used to doing project finance in Africa, and a strategic partner, a carrier in the cellular space. We eventually found our investors but it wasn’t without a wide search, everything from traveling to Korea and meeting with KT for funding, meeting venture capital firms in South Africa who ended up being gun shy about doing anything outside of their backyard, and a long list of US VCs who invested in telecom but could not get comfortable with the emerging market risk.

This was a venture that required a long term investing horizon and therefore investors that needed to be aligned with that expectation. Case in point, our largest operation, Westel Ghana, which we started in 1996, was sold in 2007 in a transaction valuing the business at $175M to CelTel/Zain. A total of around $25M had been invested in it.

On to a different case study, my last startup, CDR, which did VoIP telecom to markets in Africa, was a completely bootstrapped venture. We started this in 2000 right after the dot-com bubble had burst, probably one of the worst times to start an Internet and Telecom company all in one! We decided right from the start that we’d structure it in such a way as to avoid having to raise much capital. We started the business up with one international route to Africa which needed a single Cisco AS5300 switch, which we bought on eBay for half price. I made a few brief phone calls to friends and family, asking for just $10-20K each and a quick decision – telling them in no uncertain terms that this was highly risky and they should only put in what they could afford to lose entirely. It was heartening to them that I was putting in some of my own money. Our $50K of initial fundraising was over in a half hour.

Most importantly, we structured a key revenue sharing deal with a traffic wholesaler to source and terminate traffic for us while they provided us with all the equipment and technical support we needed to expand. This meant that we no longer needed to build a big operation, could focus on our core skills -structuring carrier deals in Africa – and keep our burn way down. My CTO partner built our network management system himself from open source software, all for under $5K. We each had a monitoring server in a closet at home. It paid off handsomly as the venture became cash flow positive within a couple of months of turning on the route and grew to over $10M/year in revenues in its second year. With a tax efficient LLC structure, we provided a great return to our investors.

So what are the lessons here?

1) Think of your business structure – are there different ways to run the business that would enable you to need less capital than you think, or are you simply going to have to raise a large venture round because of the nature of your business model? In the case of CDR, structuring the revenue share deal with a key corporate partner was what made it possible to keep capital needs way down. While we had thought it would need far more equipment to build a robust, redundant and reliable network, getting up and running on just one switch got us up quickly and to cash flow and the service, while more prone to interruptions, was still far more reliable than anything else currently running in the market. We followed the mantra I often preach- release early and release often. Get something out there and going, get market feedback and adjust quickly to improve it.

2) What is the appropriate type of financing you need for the stage you are at:

- Bootstrap: The bootstrap scenario is where you have to make serious tradeoffs between using your savings and what resources you can harness at low cost. Be prepared for economic hardship and maybe load up on credit cards or a HELOC. You might think of supplementing your income by doing some non-core activities like consulting in the mean time to keep some income going.

- Friends and Family: They know and trust you so will probably be willing to write a relatively modest check to keep you going pursuing your dream. It won’t matter to them that you have no revenues or product yet, just that they are encouraging you and you will put your heart into it. Treat them generously and fairly in the terms you give (e.g., give them the equivalent of founders stock rather than a convertible note, but watch there are no weird terms that would scare away a VC later…see an earlier post I did on structuring terms). Be sure that you and they won’t feel bad if you lose their money and they understand the risks from the get go. I would say the upside here is that it feels really great to deliver a nice return to your friends and family and you can directly see the impact if things work out. I’ve seen F&F rounds of $50K-$500K.

- Angels: Rifle targeting…means finding individual investors who get your space and can add value. While some organized angel groups can be worth the effort (and I do think it is a lot of effort, be prepared) in raising some larger round sizes, I believe that finding investors in your space who bring relevant expertise and contacts to be the most valuable. I call them “power angels”. They usually make faster decisions. You might add one or two to your Board or at least make them formal advisors with some stock incentive to keep them engaged. I rarely added an advisor who did not invest his or her own capital. I’ve seen angels personally do anywhere from $10k-$1M, with typical investment sizes of $50-100k.

- Micro-cap VC: usually target round sizes of $1M as the first “institutional” capital in, done as a Series A or Series Seed round. We look for entrepreneurs who want to prove out the business model with less capital before raising larger venture capital to ramp. The advantage is less dilution at what would otherwise be a highly dilutive phase, exit flexibility – being able to sell the company if an attractive offer comes in that would not otherwise move the needle on a large VC fund, and enhancing your chances of success by maintaining a low burn while iterating the business model until the right approach is found. We often co-invest with others like us and the community is fairly small that we know most of them. A microcap venture firm should always be reserving capital for follow on needs, be sure to ask about that.

- Standard VC: plenty of talk but usually won’t be interested unless you need >$5M, have launched the product, significant ramping revenues, well rounded team and sales cycle all figured out. It’s not to say that no VCs are out there that would do a <$5M round and bend on these issues, but their incentives are tied more to capital deployment. If you are going after standard VCs, try to do some homework on the kinds of sectors they focus on and understand if they have recently raised a fund. If they raised a fund more recently than 1-2 years, it’s likely they still have plenty of dry powder to invest in new ventures versus allocating capital to existing portfolio. Traditionally the path was Angels to Standard VC, but now Micro-cap exists between them.

- Strategic Partners: I’ve had good success with securing capital from companies that are natural customers and could be acquirers. There is always a tradeoff in disclosing your state and possibly losing a key customer because they don’t think you are capitalized well enough, or even worse having your IP stolen. You have to make the call about whether there is a risk versus the possibility of funding. In cases where I did structure strategic finance, we did equipment loans on very attractive terms and in one case structured a large direct investment into a convertible note. In the latter case, we opted for a note because the company wanted to figure out if they really wanted to buy our company, yet we wanted the flexibility to pay them off if a competitor wanted us instead. That structure turned out to be very effective when the competitor bought our company. Other forms of strategic investment are NRE (non recurring engineering – a flat out payment for development work) or consulting as we did when starting Adesemi. NRE is good because it allows you to show progress in securing a paying customer.

3) What are the milestones you are going to have to meet to get past each step of the way. In the case of Adesemi, we knew that we’d have to stay in bootstrap mode until we were able to secure our first license. After that we were able to get angel funding and then progressed up the chain with our first revenues starting. Keep in mind that fundraising is time consuming – taking 2-4 months typically, perhaps longer in this environment – so you have to add time beyond when you will achieve your milestone to ensure sufficient time to raise the next round. I always like to see at least a year of funding between rounds, ideally 18 months.

4) I can’t stress enough the importance of networking in fundraising. At all steps of the way, getting referred in, ideally through more than one path, is the way to rise up above the noise and get attention. Your referral will also be able to check on status and get feedback if, as is often the case, you just don’t get a straight answer about interest or not. Find a way to get to the person you need to reach and get them to say something good about you to open the door.

5) Traction & momentum: Also at every step of the way, it’s about traction – charts showing adoption, customer testimonials, pipelines, usage metrics – what gets investors excited is knowing that something is taking off and if they don’t move on it, they will be left out. The more you can convey this excitement and progress, the better. It’s also about periodic updates…if you are targeting to raise funding from a VC later on but are not quite there yet, find a way to send a periodic update to the partner, or have an informal lunch/coffee to get their reaction on where you are at. When getting ready to close a round, it’s often a forcing function to set a date and get the documents going.

And I do believe a lot of it is luck…my best wishes as you embark on the journey. Be sure to pause once in a while and enjoy it.