Startup studios, venture builders continue to rise.
And we are close to taking our approach mainstream! One bottleneck we still need to push ourselves through is studio fundraising. Studios are incredibly effective in building early-stage startups. But the capital needed to get up to speed is high and investor pockets open too slowly.
When we set up our first studio fund in 2017, we already built a dozen low-cost startup experiments. That was from our own capital. We already had a solid name recognition in our ecosystem, and all the local investors knew about us. And we wanted to include external inventors to build our next batch. From the first pitch to closing deals, we needed about 9 months. As a result, we found five co-investors and started Studio1. It is a holding company that we used to finance new companies. Now, five years later we’ve already spent our capital. We started 10 new projects. Five are still active somewhere between seed and Series A stages. Among them one nearing an early stage acquisition.
So we are getting closer to the point when we are preparing to raise our next round of capital. And I also get recent questions on how we pitched our studio to investors. In the Startup Studio Playbook I described the whole framework for building and scaling studios. But I felt that the fundraising part deserves some more attention. Considering all these, I wanted to take this time to share some of our learnings, so you can use it for your own benefit.
Success of startup studio fundraising is built on strong foundations:
- You have to prove a timely and coherent vision;
- Viable strategy
- Capable Leadership
- Winning Core Team
- Portfolio traction
- An optimal financial-organizational structure.
Let’s start to build this up…
Raising capital for the startups itself is a different story. So is bootstrapping. And corporate studios. And venture studios that build cash-cow companies instead of traditional startups. And transforming a service agency into a venture studio. To keep it simple, in this article let’s focus on raising capital for the studio itself to build a new batch of startups.
Preparation will be our best friend. We need to have crystal clear answers to some difficult and high-impact questions. Including:
- Do you want to raise the capital into your studio or establish a separate fund?
- Will the studio act as the GP? Will this be an official fund or a holding company?
- Will the Studio be shareholder of the Fund/Holding or the other way around?
- How to cover the studio’s operational costs? For a management fee and carry? Or charge the startups? Or bet everything on the long-term returns of the studio’s equity?
- How will you manage conflicts of interest between the Studio the Fund and the Startups?
- How will you ensure successful exits of your portfolio and thus ensure a high fund ROI?
In the Startup Studio Playbook, you can find a lightweight framework for creating studios. It’s important to have some draft plans in place before building your fundraising strategy. To start, have some thoughts on your studio’s main vision. Consider how you will organize your venture building process? How big a team will you need to succeed?
Then let’s continue with the three most common questions:
- How much money to raise?
- Which kind of investor to approach?
- How to build the fundraising deck?
Economy of scale has a high initial price tag
Startup studios are extremely efficient in producing many startups in parallel. With a large enough core team, you start to see economies of scale. You can build products and businesses with less risk and impact of failure. And faster build times, which means quicker market entry. All which costs a lot of money.
How much capital should we raise? The simple answer is: As much as you need to create a batch of startups and have enough runway as a studio until the next liquidity event. This is when you can realize the returns from one or more of your startups. Or when you get a new round of capital for your studio.
Much of this is estimations and forecasting. And these are important tasks. Because potential investors will also want to know the logic behind your numbers. The amount depends on:
- Average cost of one startup: people, infrastructure, services;
- Cash flow between Startups and the Studio and the Fund;
- Batch size and scheduling of batches, work phases;
- Time from zero to independence for startups;
- Time until the studio gets first returns.
There is an exciting question here. What will happen to your portfolio companies after they become independent? And what will happen to the studio’s equity part. Follow-on investors will want to dilute you. First to make sure that leaders of the startup have enough equity to stay motivated. Second because in the later-stage startups the studio’s role is less significant. But if you as a studio have enough capital to take part in later funding rounds of your ventures, you can solve this. This of course means that you need to think ahead of what to do a few years from now
A) Raise a new fund for a new batch of companies;
B) Raise money so you can participate in the next funding rounds of your batch one startups;
C) Or both?
There is a fine line where “thinking big” and “being realistic” meet. We just need to find your line.
Let’s assume that you want to raise $10 million to create a 10 year long fund. The goal is to test and evaluate about 100 ideas and eventually end up investing into 10 ventures. Yes, this is a simplified example. And there are dozens of variables that we could fine tune based on your vision and preferences. We could go into detail about:
- How to structure this if you have an agency that you are converting;
- How to make a clean start;
- Whether to raise money directly into the Studio or set up a new fund;
- Whether it should be an official fund or a holding company.
- How to value existing studio assets
- What options you have to create an evergreen fund…
All these are variables that we need to synchronize.
For now, let’s go with the simple example. Let’s assume that the Studio has a strong Core Team, and capital flows into a new Fund. This entity will make the investment decisions about building new startups.
Now we need to find the right kind of investors to approach.
How to find the best money for a newly emerging asset class?
Different types of investors need different approaches. Getting capital from traditional VC-s for a studio fund is a big challenge. Mainly because they used to do single-venture deals. And in our current example we want the money to build an entire batch. Getting buy-in from angels, Fund-of-Funds or a Family Office might be easier. These investors are more open to engage in innovative investment structures like studios.
We could also look at this from another perspective:
- Inside out: We assess your internal assets and preferences. For example what is your main desire and vision with the studio, what kind of investor and/or corporate relations you have right now that you want to utilize, in which markets do you feel comfortable and see high potential…? After this assessment we identify what kind of structure and investors would be ideal for you.
- Outside in: We look at what is the norm in your region, which VC or fund or other potential investor has investable money, what are the hot markets and sectors… And we shape the studio’s strategy to meet these expectations.
The best is to blend these two approaches, gradually. Make sure that the end result is what you want to achieve and that is also aligned with the current economic realities.
No matter the structure, investing into studios brings a lot of potential benefits to investors:
+ Insight into a whole batch of new companies right from the start;
+ faster progress from zero to one, from ideation to market entry;
+ higher ownership at a lower cost and less impact of failure on the entire portfolio;
+ with higher ownership in startups comes higher commitment to achieve joint success;
+ Potential preferential follow-on investing rights.
From a traditional investor attitude, one of the most important questions is how you will exit your companies. Some studios are good at building companies with stable positive cash-flow. And they are building up their portfolio of companies, ever growing their cash reserves. But there seems to be tension. A tension between building cash-flow positive companies vs building high growth potential startups. When raising funds from investors, it might be better to focus on markets and startup projects with high growth potential.
And you need to make sure that the investors you talk to meet certain criteria:
- They understand the studio approach and are willing to trust you with managing the fund;
- Their track record fits with the type of companies you want to create;
- They have available cash to invest;
Besides raising your studio capital, it’s also beneficial to building up relationships with traditional VCs. This way, you can better support the follow-on fundraising of the portfolio companies.
And now for the hardest part. What to show and tell investors? How to convince them that you are the right leader of the right venture builder? What makes you able to build an entire portfolio and turn it into strong returns?
Show personal credibility and power to execute and exit
You need a comprehensive investor deck to open investor pockets. And it all starts with building up trust and credibility. In particular:
- Show that you are able to build up a strong venture portfolio. Either from internal ideation process and/or partnering with existing startups;
- Prove the worth of your venture building system. That it can take concepts from inception towards growth and exit.
First, introduce a comprehensive investment thesis that makes sense. Within the first few slides, tell the story that goes like this:
- We believe in [market/technology/trend/opportunity]
- Our studio wants to achieve [mission statement]
- Therefore we will produce startups that [startup profile]
- We are raising [amount] into [investment structure]
- This money is to finance [cash flow structure]
- This investment will [benefit for investors and returns]
- Ultimately we will [long-term vision for the studio]
Use the rest of your deck to expand on the narrative.
Highlight your Leadership Team’s achievements, personal strengths, network. And also show the Core Team behind your venture production system. Build up and show an advisory board that covers all the competencies relevant to your studio.
Spend a few slides on explaining the market sector you are targeting. Why that market? What are the future trends? Where are the pain points and the opportunities? And tie it together with your team: what makes you the best builders in this area?
Be clear and transparent on your metrics. The amount raised, expected returns, studio funnel. Be prepared for a challenging due diligence. This won’t happen in the first few meetings, but it’s good to be prepared for everything.
Show the investors the startup progression from zero to independence and all the way to exit. Highlight why it will be beneficial to entrepreneurs and startups to work with you. Why is it better to take your smart capital instead of other pre-seed or seed programs?
And since we live in 2021, at least spend one slide on how you handle covid? There is a lot of change in how we can live and do business. To a large extent this is trouble, we all feel it. And you need to show investors why and how your team is able to perform in such circumstances. All this trouble of our “lockdown economy” can also be translated into opportunities. There is change in our shopping behavior, in the way we learn, we do work. Show momentum and initiative.
Once you put your fundraising strategy in a deck, the real challenge begins. Finding the right investor leads. Approaching them and making the first pitch. Going into the deep negotiation process, finalizing the paperwork. Along the way you will be challenged:
- What are the weaknesses and holes in your plan and how you fix them;
- Doing an extensive reality check of your thesis, your market, your processes;
- Showing momentum while the negotiations are still in progress;
- Building up your Core Team and Entrepreneurs before the money is in;
- Prove your business economics and make the investment decisions;
- How you can make progress even before securing the first money in;
Yeah, you feel it right: Raising money has a high price tag on its own. And you pay this price with putting effort into preparation.
Reading about real-life case studies and keeping up with studio newshelps. So is finding studios that are the best possible benchmarks for you. The Startup Studio Playbook gives you nine case studies. All about different studios and implementations. And we are fortunate to have communities like Studio Hub, where you can build up your personal connections and ask around.
If you need help, in refining your investment strategy, in assessing the viability of your studio concept, in preparing for the tough investor Q&A, reach out and I’ll help you. A little fundraising coaching can go a long way. Especially if this is your first time raising studio capital. And if you already had some not so successful investor meetings. Let’s debug where it went wrong, and how you can turn the tables.
And keep in mind that “startup studio” is an approach and a framework. You need to align it with your preferences and circumstances. The most successful studios are custom-built for the vision and preferences of their leaders.
ABOUT THE AUTHOR
Attila Szigeti is an internationally recognized startup studio expert who started his leadership career at Fortune 500 companies and was COO of the fast-growing startup studio in the CEE area. He is also: CEO of Studio1 Pre-Seed Investment PLC, Author of the Startup Studio Playbook, Advisor to Startup Studios. https://www.attilaszigeti.com/