As the founder or CEO of a venture-stage startup, you’ve taken a good, maybe even fantastic, idea, invested your blood, sweat, and tears, and have a business that’s ready to burst onto the market. Now it’s time to fundraise.
If you are new to the process, you’re probably asking yourself: How do I approach a round of VC fundraising? How do I find the right partner? How do I negotiate a deal? How do I protect my ownership?
It can be overwhelming.
Having worked with many founders and CEOs and having been one myself, I understand that venture capital fundraising is an entirely new challenge. The majority of founders are entrepreneurs. They’re operators and visionaries. They’re focused on making their great idea into a viable business. Very few have actually had the experience raising large amounts of money, and it can be daunting.
On top of that, there are not many firms that exclusively focus on helping earlier-stage companies fundraise. Unfamiliar with their options, many founders turn to large institutions like investment banks. But generally speaking, investment banks aren’t equipped to work with smaller companies. The return on investment simply isn’t great enough in their eyes, and more importantly, they do not have the expertise.
It’s essential to find a partner that truly understands the process and the key players when it comes to venture-stage fundraising. According to a survey conducted by the Harvard Business Review, “More than 30% of deals come from leads from VCs’ former colleagues or work acquaintances. Other contacts also play a role: 20% of deals come from referrals by other investors, and 8% from referrals by existing portfolio companies. Only 10% result from cold email pitches by company management.” There’s art and subtlety in how to proceed down this path, and in this competitive environment, having a trusted resource with an established network on your side can make all of the difference.
The Propeller Transaction Advisory team leverages our collective experience in investment banking, venture investing, investor relations, and as former business operators, to give founders an insider’s perspective. My team and I have partnered with hundreds of venture-stage startups and helped them successfully find the best partner, negotiate the right deals, and run an efficient process.
We’ve learned a lot along the way about what to do and what not to do. Here's my version of the seven deadly sins - mistakes you'll want to avoid - of venture capital fundraising.
1. Raising from a position of desperation (not strength)
This may seem like a no-brainer, but whenever entering a fundraise, it’s critical to negotiate from a position of strength. Some owners feel like, "Things are going well. I don't want to give up ownership of my company now."
When things are going well, but you know that you will need capital sooner than later, that's a great time to raise money. You are entering a transaction with positive momentum and milestones to share that will only help your valuation.
Rudina Seseri pointed out in a recent Entrepreneur article: “Equally important to articulating your vision is being able to execute on that and demonstrating traction, real results. Investors are looking for founders who can point to having attained what they said they would achieve (and then some).” Make sure your balance sheet (read cash balance) affords you runway, your sales are strong, and you are meeting strategic objectives. That’s when you will attract the most interest. Conversely, if you go to fundraise with a short cash runway, investors will look at your balance sheet and think, “They need our money.” They will feel like they are in a position of power. Naturally, they will try to get the best deal for themselves. By negotiating from a position of strength, your company presents itself as an attractive business worth investing in.
2. Getting greedy too early
While founders want to negotiate the best possible deal and minimize dilution today, it’s important to consider the capital needs over the next 12-18 months. You want to make sure you raise enough money to allow you to execute various initiatives and drive value over the long term. It's vital to make sure you're raising the right amount of money. Once again, many owners think, "I don't want to give up a lot of my company." That is a valid point, and no one wants to give up too much too early. At the same time, it's better to have a smaller piece of a big pie than a big piece of nothing. Take a step back and be honest with yourself, and don't get too greedy too early.
3. Having misalignment within your team
Early-stage startups are partnerships. It’s crucial that your team is aligned. Be sure that your ownership team agrees on long-term goals, risk tolerance, and exit strategy. Any significant disagreement can impede the process or put a deal at risk. Ultimately, you need a board vote, and if voting board members aren’t in agreement, then you can’t make decisions swiftly, which is critical for fast-paced startups.
Team alignment goes far deeper than just the ownership team. Remember, in the early stages, people are investing in the team - your people. As this Harvard Business Review survey revealed, while the management team and the business model are both important, “ultimately they deem the founding management team to be more critical...founders were cited the most frequently—by 95% of VC firms—as an important factor in decisions to pursue deals.” If that team isn’t aligned, it can cast doubt about the viability of the business.
I recently interviewed Propeller Transaction Advisory client Bill Deacon, CEO of Eastern Standard Provisions, at the Food Edge conference (watch the full interview here), and he put it this way: “Identify those on your team that are all-in versus those who aren’t a good fit. Realize who your core people are and move on from all the others. This includes staff, vendors, and investors.” It’s crucial that your investment partners are aligned with your vision, which is a perfect segue into our next point.
4. Picking a partner for the money alone
Don't pick a partner for the money alone - choose a strategic partner. Make sure your investor is someone who can add value to the company. When you are looking for an investor, you are not just looking for the highest valuation. You are looking for a partner who has strategic connections, relevant experience in your space, and someone who can guide you across marketing, sales, operations, etc. You don't just want money; you want smart money.
When looking at venture funding or private equity, you need to make sure the people at the fund understand how to actually operate a company, have relevant experience and connections, and understand what you're doing. You want to be able to bounce ideas off of them and ask, "Hey, does this make sense? If you were in my shoes, what would you do?" In short, make sure their experience can add value and help you grow your business.
5. Being close-minded
Throughout the process, be open to all of your different options. I’m an unabashed fan of the Bachelor/ette franchise. There’s always the front-runner, “the one” that seems like the perfect match at the outset. But they often do not end up being the winner. Some founders are starstruck by certain funds and their portfolios, which is all fine and well, but you need to be “open to the process,” as the host/hostess would say. Be open to different opinions and to the fact that maybe who you thought was the right partner at one point is no longer the ideal match. Things evolve and you need to evolve with them. And when in doubt, remember point 4.
6. Having unpolished financials
If you're going out to raise five to ten million dollars, you need to have your act together. Things need to be buttoned up, and you need polished financials. It’s probably a corollary to the first point, but you can't just rush in to raise money. You need to make sure you have the last few years of financials in really good shape. You also need to have a strong, defensible, and thoughtful forward-looking model. Your model will be scrutinized and pressure tested by multiple savvy investors, and you will need to be able to defend your assumptions and answer questions intelligibly. People might not agree with everything you've done, but that’s ok as long as you have a thoughtful explanation as to why you did what you did.
When I work with clients preparing to fundraise, I look at their model as an investor would and give them candid feedback regarding the things that don't make sense, and offer suggestions about things they may want to reconsider. I ask pointed questions about their sales strategy, marketing strategy, who they will hire to support their growth, etc. It's almost like an audition, or a test run, for when you go out to raise money so that when founders get on calls with interested investors, they’re not blindsided.
7. Being dishonest
Don’t blatantly promise things that you know you can’t deliver, and do not lie. As much as you want to sell your business, it is imperative during a capital fundraise that you put out numbers and milestones that are achievable. One of the worst things startups do, and where deals fall apart all the time, is when negotiating a deal (which typically takes three to six months) and companies start missing their numbers throughout the fundraising process. They lose credibility with their potential investors in their ability to project their business and their ability to meet future numbers. As you go out into the later years, you can be more aggressive since everyone understands it is hard to predict a few months down the road, let alone a few years. The most important thing for you is to develop a repertoire with your future investors, and as in all relationships, trust is key.
Fundraising can be daunting, especially for the uninitiated. However, it’s part of the road map for high-growth startups. The good news? You don’t have to traverse this path alone. Propeller’s Transaction Advisory services team can partner with you for a successful round of fundraising.
Let’s start a conversation today.