February 23, 2023
Raising funding for a startup studio is no easy endeavor. From an emerging studio just starting out to experienced studios, great networks, relevant experience, and even successful studio track record, the challenge of fundraising cuts across all studios.
Why is it so difficult?
Startup studios break several common patterns for investors. The approach is unfamiliar. The structures and terms used often differ greatly from the standard 2% management fee and 20% carry of the VC fund model. The operations costs and how they are handled look like hidden fees. The economics seem too favorable to the studio rather than the investor. The studio team has not run a successful studio before.
For an investor to dedicate enough time to study the studio model, your legal structure, evaluate your team, and review the returns model requires a substantial time commitment on their part. The same amount of time it would take them to perform due diligence on many standard VC funds.
So why would they take the time? The biggest reason – they know the studio founders personally.
When it comes to raising from investors, your network is your net worth. In a small survey of startup studios that had raised their first fund conducted by GSSN, they reported that less than half of the funding they received came from investors that they did not have a prior relationship with. One third of those surveyed said less than 25% of their initial funding came from new investors.
So the question is, can you raise between 50% and 75% of your target from your existing network?
If you can, congratulations! You can consider starting your studio by raising funding.
If you can’t, looking at alternative options to launch your startup studio may be the wisest course of action.
Raising for a startup studio is harder than raising for a VC fund. Studios are much more operationally complex than venture funds, often structure their raise outside of the typical 2% management fee and 20% carry of a typical VC fund, and break many of the accepted patterns of VC fund investing which often makes a decision to invest much harder.
New VC Funds (called emerging funds) take on average 18 months to raise. That’s focused on raising full time for 18 months. Emerging VC funds over 18 months can demonstrate deal flow by packaging investable opportunities as SPVs (Special Purpose Vehicles) and asking potential fund investors to invest in these one-off deals with no obligation to invest in their fund.
Studios have an incredibly hard time taking a similar approach. Bringing a qualified and validated opportunity matched with a founder to investors and then playing the role of founder while finding more portfolio company opportunities to individually fund. Impossible, no. Just find the money to support the team doing the work before the investment and bandwidth to deliver after.
So how can a studio raise funding without building a series of companies along the way? One option is to make the abstract notion of creating companies real. Show investors the kinds of opportunities and founders you will be partnering with. Do the initial validation of opportunities. Verify the founders are a fit for the role, and ideally bring several matched sets of validated opportunities with founders attached. This makes both the investment real in the minds of investors, demonstrates the capabilities of the studio, and begins to create a little FOMO.
How to raise? Specifics will vary based on where you are, but broadly speaking you have two options. Raise funds the traditional way, in private getting in front of investors at events, through referrals, introductions, and cold outreach, or you can raise publicly, adding the ability to speak publicly across any channel legally allowed. Being able to speak publicly about raising can greatly increase the speed of a raise, but often comes with significant administrative and legal hurdles. Regardless of which path you choose, you must be aware of the legalities of raising and especially accepting investment. This is not an area to head in blindly. A simple mistake here can prevent you from being involved in raising funds permanently.
Startup studios are a unique investment. They are generally similar to early stage VC funds in that they invest capital in companies before product market kit and build a portfolio of investments. Studios take a large position concentrated in a small number of investments rather than the typical pre-seed VC fund approach of a large number of investments with small ownership stakes. The studio approach may reduce the risk, but on the whole startup studio investments are high risk, high return investments, just like any venture fund. This nature limits the potential investor pool greatly.
So who are the investors in startup studios today? Which ones are ideal? And how can you get them on your captable?
Institutional Investors $10M+
Interest is limited but growing from institutional investors today. These investors rarely invest less than $10M and often require a fund size of $50M or greater. Studios need a strong relationship with them and a track record that makes it easy for them to justify investing. Rarely will they invest in the first fund, generally they will target the 3rd fund or later once a track record has been firmly established.
Family Offices $500k+
There is growing interest in studio investments from one of the most patient sources of capital around. Studio knowledge is often hit or miss, as is interest in early entrepreneurial investments. Family offices are willing to invest as early as fund 1, with relationship being a driving factor. These investors think quarters, years, and decades, not weeks to months. Family offices can and have fully funded studios becoming the sole LP of the fund.
Wealthy experienced individuals tend to be fast and shrewd investors that can quickly evaluate the team and studio model. Their networks and hands on support can be invaluable in raising and in studio operations.
When industry or technologies align, corporations can make solid early investors or build partners with studios. With the right partner track record and network, corporates and corporate venture capital consider investing as early as fund 1 in studios. Corporates have fully funded studios, becoming the sole LP of the fund. Hint – executive leadership team relationship or board level access is the fast track.
Operator Angels $25k+
Experienced startup and executives that want to be more hands-on bring capital, their network, and hands on support. Generally quicker to grow interest and an understanding in the studio model.
Friends & Family $5K+
They invest because they know you and trust you. Often smaller checks, but with limited need to fully understand the studio model since they are investing in people they know. Their investment may be restricted depending on the raise structure and applicable regulations.
Tapping into a community with aligned interests to address a common cause is a powerful option, especially for impact focused studios. Impact and aligned interests lessen the need for deep understanding of the studio model, making raising easier. Community investment often requires specific regulatory approaches.
Fundamentally investors invest in startup studios based on a strong relationship. Most often this with the founding team, but not always. Studios formed by or in partnership with universities have instant credibility and strong relationships with the alumni network, often a strong source of funding.
Without the right network and connections, other ways to get the startup studio off the ground should be considered. There are more than a few options, some align very well with the activity of the studio and help establish proof points that will make raising a fund in the future easier.
Raising for a studio is massively more difficult than raising for an early-stage startup. Investors are familiar with direct startup investments and they can invest quickly. Even better, the validation on an opportunity that a studio can deliver plus the team a studio brings to the table should stand head and shoulders above other opportunities.
Angel investors and pre-seed VC funds are potential investors to consider for this approach. One challenge to navigate is structuring the investment so that it can be used as an example of a studio portfolio company in the future. Enabling direct investment with a convertible note or SAFE will be more straight forward and throw up fewer red flags, but an SPV that establishes similar deal terms and ownership as what the studio will use in the future will make raising easier.
Sometimes getting off the ground requires more than what you can bring to the table alone. Partnering with corporations, studios or other groups can be a strong option to consider. They can bring funding to the studio directly, either through small investment or revenue.
Startup studios have great entrepreneurial and SME talent at their center. Talent that is organized and geared for action. Leveraging that talent to build revenue streams to cover studio operations and even initial investments is one of the most common approaches. Depending on the specific path taken to generate revenue, it can be very distracting and even consume the studio.
Non-dilutive funding that can be used to directly fund studio operations, build portfolio companies, or create revenue streams to cover studio operations is a powerful option for those positioned to leverage it. The funding available will vary widely based on the location of the studio, but most locations can tap into some non-dilutive funding options. Unfortunately, grants take lots of time and effort to apply for and they are rarely granted quickly. This option is best when combined with other studio funding options.
Your studio team will heavily influence the right funding path for your studio. Regardless of the right path today, until startup studios become a common asset class, building a network with potential future investors is critical to make fundraising easier next time.