05 Feb Raise Before You Raise
Fundraising is something all of us as entrepreneurs think about constantly and discuss almost every time we meet. The lore of the Valley is full of stories of going to pitch meeting after pitch meeting… cold pitching to 50 VCs before getting that first round of funding. I completely disagree this approach.
Raise Long Before You Raise
Fundraising starts years ahead of actually going out to raise money. At Accompany, we set record a record for fastest close for a first round. We then broke that record for our second and third round. Sure, the mechanics of getting each round closed extremely fast, but it was the result of years of continuous networking combined with targeted efforts on partners we thought would be good board members for our company. Remember, it is ultimately a person you will be working with, not a firm. Always focus on the person over the firm when selecting an investor.
First, get yourself out there and help people in your network. Get into a give, give, get mindset where you get in the habit of helping without ever having an ask. It will always be a positive ROI over the long-run. At some point, you may have an ask and that person might be the best point for a warm intro.
Find a way to get a warm intro early. This isn’t about a blind LinkedIn ping to someone you met at a conference, it’s about finding people who know you and the partner you want to meet. Your initial investors will be with you for the whole ride. Pick wisely. Tap into your network and do your homework to see who is interested in your space, who is insightful on the issues you will likely face, who is good to work with in good & bad times.
Figure out why you might be a compelling fit. Look at their portfolio companies, background, etc, to find the hook that makes sense for connecting. Remember, the math for wanting to do the deal is multiplicative, not additive. It is team x product x market – if any are zero, the entire equation goes to zero.
Deal math is multiplicative, not additive. It's team x product x market - if any are zero, the entire equation goes to zero.
Actual Process: Targeting the Right Firms
Understand the Investment Thesis: Look at the current portfolio, see what partners are interested in which space. Looking for the multiplicative aspect. The things we do feel unique, but there is almost always an analogous or adjacent space we can use as a proxy to see if you’d be a good potential fit. Our initial virtual chief of staff need was well understood by people from an enterprise sales background that valued human connection. That helped with focusing on the potential partners who would be interested.
See if They Actively Investing: Time is limited. Remember, you are not the only one in the equation who is fundraising – often times so is your potential investor. VCs need to convince their existing limit partners to invest in the next fund or need to find new investors themselves. Look to see if they have raised a fund recently or whether they have made any new deals in the last 3-4 months. The last think you want is to just be interesting deal flow for the firm when they have no capacity to invest.
Marriage, not a Transaction: Your lead investor will want a board seat. They will be with you for the whole ride. The length of the average US marriage that ends in divorce is eight years. In some cases, your board members might be with you longer than even that. Do your own diligence when it comes time to close. Get a list of all the portfolio CEOs and reach out Make sure to hear cases where the company has been a success, a failure or just gone sideways. You’ll want to know what your board member is like in those situations.
Who Are you Targeting & What Kind of Terms: Priced Round vs Convertible Note; Angels or VCs. There are dozens of great posts these types of deal mechanics, so not looking to recreate the wheel here.
Our Pitch – 7 Slides + Interactive Demo
- Team knew how to scale
- Founding team
- Problem trying to solve & the addressable market
- Early validation from customer interviews
- Use of funds
+ Interactive demo of what we were going to build.
Back pocket, need to have good initial answers on how are you going to make money. VCs will want unit economics, how are you going to monetize. How are you going to use, sell money, think through different pricing tiers, etc.
In Parallel, Find the Right Lawyer: Legal is another partnership, if done properly. You can be a big book of business with future raises, cap tables, exit, etc. For Accompany, our CEO sourced and interviewed a half dozen lawyers to see who would be the right fit. Again, this is about finding partners that will work with you throughout the years. Just as importantly, a good lawyer can do a lot of the back channel work, push on a few hard points so that it is not just on you.
Giving an Out: Investors have to present the terms of the deal to their partnership and get consensus. As part of keeping a good relationship with that investor, you’ll want to give them an out if it is not going to be a good fit before they’ve made that meeting happen. A VC’s job is to out hunt other VCs – they are people who take great pride in win. You don’t want to have someone unnecessarily have egg on their face if they go to bat in front of their colleagues, only to later go back to say they lost the deal. Before any term sheet is written, see if they will give you an outline of what they are willing before a term sheet is written. Maybe you’ll be the one that got away and they will help fund the next company.
You Can (sometimes) Buck Convention: If you have good leverage, you can ask for non-standard terms or limit items, e.g., pro-rata, information rights, observation rights, etc.
Option Pool as the Quiet Dilutor: There is a fundamental tension between you and the future investor when it comes to the option pool. That money comes out of your ownership BEFORE the money comes in. Of course they will want this as high as possible. The remainder goes away during an acquisition and keeping a well funded pool keeps the investor from being diluted down the road by reducing the likelihood of needing to refresh down the road. This will be the first of many times you and your investor will have different motivations.
Investors Can Back Out: They have a no shop clause for you, but I have seen friends almost go under when the VC backs out. Ask for initial commitment so you can sleep well at night while they make a capital call to their LPs. Push for a quick close. I would much rather pay legal overtime vs. pay that out over weeks anyway in a slow process.
CHECK THE MATH: A junior associate will be doing your docs. We had a case where the associate did ownership calcs on the pre-money value, not post. BIG difference. Ended up getting caught early, but re-enforced the importance of triple checking the numbers.
Understand the Fund Age: What age of the fund making the actual investment? If it’s at the end of the cycle, you might have more pressure to exit to return to LPs before you are ready. After all, VCs need cash returned to their investors.
Graciously Close Down Other Discussions: Once the deal is signed, you will need to close down other discussions. Follow up with those you passed; send wine, something meaningful. Who knows, they might come into your next round or fund your next company.
The Fundamental Tension with Investors
Lastly, you and your investors are roughly aligned, but not exactly. Over time, as you raise capital, each investor will have different points that will make them happy on an exit. You’ll see these dynamics play out in the board room through the advice given. Investors want EACH investment to have the potential to return the fund, but what that means will differ greatly by investor. Also, you are one of a portfolio of options for the VC. VCs know that a vast majority of companies will go under. They are in the homeruns business vs. a single chance for something life changing for you. This is your baby.
Final thought: Think carefully about your first round. If you can bootstrap to get a better outcome later while fundraising, it can have huge returns. Your first funding round will likely be the most dilutive ever, so make sure you are raising enough to have the runway you need. You are you funding the option pool for the first time, giving away a big chunk of the company. Maybe you and your co-founder started out as 50/50 owners. After closing docs, it could quickly be 25-30% for each of you after the first round depending on option pool, valuation, etc.
- Raise Long Before You Raise: Give/Give/Get mindset. Careers are long so invest in your network. Do your homework to target specific partners that appear interested in your space & get a warm intro from the network you’ve hopefully be cultivating for a long time.
- Target the Right Firms: Do you match their investment thesis. Is the team actively investing or are they fundraising, too. Reach out to portfolio CEOs so you enter the “marriage” knowing what this future board member is like in good/bad/ugly
- Find the Right Lawyer: This is another partnership, if done right. Pick a lead partner at the firm that you can work with from incorporating through exit.
- Negotiating: Give the investor an out by holding off on getting a term sheet, if possible. No one wants to be embarrassed in front of their partnership. Option pool as the quiet dilutor. Be deliberate on the sizing.
- Close: It is not finished until money is in the bank. Triple check the associate’s math. Be gracious on closing down other discussions.