At least a few times a week, I get asked “are we too early to be raising money” by an entrepreneur. This might be in the context of a company trying to raise their seed round, or a company that is further along that I’m giving feedback to about a series A, B, or C round. Another related question I often get is “what do I need to accomplish to raise money from investor X?”
There are some rubrics that arise from time to time about what it takes to be “ready” to raise a round. For example, there is sort of a magic number for SaaS businesses to achieve $100K MRR, which is usually a good benchmark for being able to raise a decent VC-led series A or B. But overall, I think that this is a question that is very difficult to answer. No matter where you draw the line in the sand, there are cases of companies that have raised capital way earlier with way less meat on the bones. And at the same time, there will be companies that had way more meat on the bones, but struggled to raise.
Here’s my framework for how I (and I think many investors) think about how ready a company is to be funded. Think of this as sort of a sequel to my seed VC decision tree:
So, here’s what’s going on. As an investor, I am thinking about every opportunity in terms of my conviction around the team, product approach, and market opportunity. The final factor is usually deal terms and pricing, but usually, that gets figured out last. I’m smashing that all into some measure of “conviction” on the vertical axis.
At the same time, for any given company, there is a “burden of proof” that is required to get an investor to the point that they will want to invest. These are all the proof points that the business is working, and can range from actual financial metrics to even subjective things like how industry experts and potential customers are perceiving the idea.
The kinks in the curve show the major milestones for most business. The first kink is going from product-discovery to real product/market fit. The reason it’s a sharp kink is that when you clear that threshold of “proof”, the conviction needed for investors to get interested drops significantly. The same happens when you go from product/market fit to having an established, repeatable, business model and growth machine. This is the second kink in the curve.
This over-simplifies things of course, but generally speaking, seed rounds happen before product/market fit, series A’s (and some B’s) happen between PMF and figuring out the business/growth machine, and C’s and later happen after the machine is built.
The sad faces are any place under the curve, which basically represents when investors will say “no”. A “no” happens because the burden of proof for the company is too high given the investor’s conviction. You will notice that between the kinks, the curve is relatively flat. This illustrates the reality that when investors lack conviction, the “proof” they need to eventually say “yes” is usually unreasonable. To put it another way, an investor that has just a little less conviction than one who would be willing to say “yes” has a much higher burden of proof.
This is why sometimes entrepreneurs feel like “keeping investors up to date” just results in the goal posts being moved back more and more each time. This is also why entrepreneurs are almost always kind of puzzled and disappointed when they ask an investor “what would we need to accomplish to get you interested”?
VC’s pretty much live in the unhappy area under the curve. We consider thousands of potential investments each year, and the conclusion almost all the time is that our conviction around the opportunity relative to the proof don’t jive. Even for companies that are far along, the valuation is the great equalizer. An investor may love the team, product, and market, and be impressed by the proof points, but think that it’s just not a reasonable risk/return at a particular price.
If you assume that the startup market is approaching efficiency (which is increasingly less debatable) then the pricing of a deal should get bid up to a point that is essentially too expensive except for the investor with the most conviction. Another way to think about this is from a quote from Mark Zuckerberg at the time when Facebook was approached by Yahoo to be acquired for $1B. When discussing board conversation about turning down the offer, Peter Thiel described Zuckerberg’s argument in this way:
“[Yahoo] had no definitive idea about the future. They did not properly value things that did not yet exist so they were therefore undervaluing the business.”
In a way, VC’s that actually pull the trigger on an investment are thinking in this way almost every time they do a deal. They are committing to a future that is undefined, at a stage that most others think is too early, at a price that most others think is too high. This is also why we always remind founders that fundraising is about “searching for true believers, not convincing skeptics.” Skeptics are further down the conviction axis, and because of the slope of the curve, the burden of proof to get them over the hump is just impractical.
Note: This is not true for what some VC’s call “proprietary deals”. The idea here is that some entrepreneurs will work with a VC at a price that many VC’s would love to invest, but because of a pre-existing relationship, that VC gets to win the deal at below market price. This does happen, but realistically, I think is less than 20% of deals that are done.
A friend of mine just completed a very successful fundraise for an institutionally led seed-round of capital. Increasingly, these seem to be the most common ways that venture-funded companies get started.
What’s interesting is that this entrepreneur has raised $30M+ in venture capital before and knows the VC process intimately, but remarked to me midway through “this process is completely different from every other fundraise I’ve been a part of.”
It’s different across a few dimensions, but it comes down to the fact that most seed rounds are multi-party optimization exercises. In a given $1.5M round, there are often 2, 3, or more “funds” that are investing between $200K – $700K. Also included in the round are typically 2 sorts of high-quality angels – those that really know the founders and are let into the round because of relationship, and those that are more value-added in nature, usually because of the brand credibility they bring or deep domain knowledge. As an entrepreneur, you’d be willing to spend a bit extra time getting those angels across the finish line, even if their $’s aren’t that big. In some cases, these rounds come together very quickly and easily, but in most, it takes a bit of time, and feels a bit like this:
No fundraise is completely predictable. Actually, most are very unpredictable. But at the risk of being too formulaic, here is one possible roadmap I’d recommend for raising this sort of a round.
- This assumes that you are “ready” for the round to happen. Figuring that out is the subject of another blog post. This also assumes that you have a reasonable “ask” in terms of dollars, valuation expectation, etc
- Overall, I believe in very limited staging of a process. As Paul Graham as written, it’s a “breadth first” process, then you triage your list in a probability weighted way. So, even though I’m proposing a sequence of steps, the reality is that it should feel a lot more like a big parallel process
OK, so, here is a broad process:
- Line up support. Know who people are going to call as a reference – your prior bosses, obvious people in the ecosystem that would have a strong POV on you or your idea, etc. Pre-wire them so that when the calls come, they are ready and/or you are least know what they are likely to think.
- Get commitments from those who know you. These are the angels that are your closest mentors/references or individuals that you want to have affiliated with the company. The idea is to get a small but solid commitment from these people, so that when you have your first conversation with a lead, it doesn’t feel like you are starting from scratch, and there is built in credibility.
- The way to mechanically do this is to just get these individuals to feel comfortable with at least an investment of x ($25K or something) and then remind them “only say yes if you are willing to have people ask you about it. There is nothing more damaging that having a VC call an angel and have them say “actually, I’m not really committed”.
- You can give people the option to back out. Make it clear the commitment is “assuming reasonable terms and a round at least X” so they don’t fear that they are investing on potential dumb terms or an underfunded round. This is kind of the equivalent of “I’m in as long as you have a lead” but sounds a lot better. You want to be able to say “they are in, assuming reasonable terms. Feel free to call them”
- Find a lead investor: These are funds that are willing to stick their neck out and be the first “yes” and issue a term sheet. There are ways to do this without a lead, but I’ll ignore that for now. Some thoughts
- There are tons of seed funds, but way fewer than you would think actually lead.
- Leads tend to do fewer than 6 investments/year/partner (and I’d argue, ideally, much less than this). If they are higher velocity, I’d question whether they’d be able/willing to lead. There are some exception, however.
- This takes longer than you think, unfortunately. Leads usually do work, real due diligence and reference calls, but that’s because they are going to lead. But a good lead shows forward progress pretty transparently and can do their work in a couple weeks. If someone isn’t showing that kind of interest, de-prioritize.
- Be willing to travel a little. I think it’s helpful to get some feedback in fundraising, so it’s worthwhile to hit a few markets like BOS, NYC, and SF. It’s less likely to find a lead outside your core geography, but it does happen, and it ends up being pretty unpredictable who really does get excited or doesn’t. I also think that getting some market feedback is helpful from investors that have a different vantage point than you.
- Triage appropriately. As my partner Lee often says, fundraising is about searching for true believers, not convincing skeptics. This is particularly true at the earliest stages. It’s easy to spend too much time focusing on skeptics.
- Slightly behind lead conversations is value-added non-lead investors. Think of these as additional arrows in your quiver. These groups can augment the network of your lead, provide additional support capital if you need an extension, and hopefully be helpful. Prioritize these groups for value add, but keep in mind, these groups tend to be more clubby and care more about who else is in and social proof.
- Have good news to share along the course of the fundraise, if possible. Even small pieces of data like small-scale tests, new hires/advisors, etc. Unfortunately, fundraising is much easier when there is a sense of momentum behind you, so do what you can to create some momentum. Investors tend to exhibit lemming-like behavior. You can’t really change that, so accept it and try to make it work for you.
- When you get a term sheet, you can do some work to optimize the deal. Expect this to take a bit longer than you think. In my opinion, the goal at the seed round is to get a fair deal done quickly with the right partners, not to maximize valuation or terms. If you have a term sheet or two, you have a finite window to convert it to a deal – so do it pretty quickly. Time kills all deals.
I didn’t want to be too prescriptive here, so happy to get into more details in the comments if folks have specific questions.
Fundraising tends to move slow until it moves fast. What you’ll find is that in the middle of the process, it might seem frustrating as some investors pass, some investors feign interest but don’t really dig in, or it just takes a while to get meetings with the key decision-makers. But push through it! Once a lead or two start to take serious interest, the chorus will change. The challenge with seed rounds is that multiple parties can invest, even without being the first “yes”. So unfortunately, it potentially rewards investors that hang around the hoop and then try to sneak in at the end (as lame as that seems). But once there is some demand for the round, the group of potential investors will swarm pretty quickly, because ultimately, many of these rounds end up way over-subscribed. Just keep plugging away, and remember it moves fast until it moves slow.
This might seem laborious, and it kind of is. Funny enough, raising a seed round might end up being as time consuming as raising a larger round because of the multi-party nature of the process. But if you manage it properly, you can go from start to a term sheet within 3-5 weeks, and to a close a few weeks after that. Sometimes it can take longer, but beware of being in the market too long because a lot of seed investors are pretty chatty and word gets around fast about a company’s struggles to raise capital. Some investors are independently minded and can see past that, but most investors tend to get hot and bothered about momentum and perceived traction. I’ll talk about seed stage “traction” in another post.
A lot of things are evolving in the startup and VC world. Many of them for the better, as there has been a great surge in great talent going after big ideas and greater access to capital at the early stages. It’s an exciting time to be an entrepreneur and investor in this ecosystem.
But I find myself lamenting some things that seem to be changing. Or at least, things that used to be very rare, that are becoming less so. I’m pretty new to VC in the grand scheme of things, but I do think that are some old school idea that are being lost or forgotten that I tend to agree with. Here are three old-school ideas in particular I’ve been thinking about.
1. Knowing your investors.
This seems like common sense. In the early stages, entrepreneurs have historically known who all their investors are. Entrepreneurs will certainly know the VC’s that led their round, and they certainly know the friends and family that invested in their companies. Often early rounds included angel investors, and these usually fell into two categories. The first were people who know the founder really well, and believe in them. They wrote a check because they believed in the talents of the founder and wanted to support him or her. The second were people who know the space or opportunity, and either sought out the company because they saw the promise, or were sought out by the entrepreneur for the value they would bring by validating the business or helping the entrepreneur navigate the future. Almost all the founders we back have seed and series A syndicates that look like this. These syndicates have a manageable number of people on the cap table, and each person there is known and is there for a reason.
But this is slowly changing. Angelist syndicates and some other developments mean that there will increasingly be participants in seed rounds that are unfamiliar to the founder, or in some cases, completely unknown. I suppose it’s good because that means that there is more capital in the market, but it just doesn’t seem great to me. I think the best entrepreneurs tend to raise money in the way described above, so I wonder if these other capital sources are really funnelling their money into the best opportunities. And as a founder, I wonder if you really want to have someone as a shareholder in your company and life’s work that you don’t know, trust, and think could be valuable. Maybe it’s an old school idea, but I think it’s good to know who your investors are.
2. Investors that Lead, not Follow
The best investors tend to be very independent in the way they make decisions. They don’t particular care “who else is in” and they are a bit contrarian. As a VC, leading also means working with an entrepreneur to invest a meaningful portion of a round, negotiating terms, taking a board seat, and other activities that show that you have built substantial conviction around an opportunity.
Similarly, the best angels lead in their investing activity in a different sort of way. As described above, the best angels are either ones who know the founders exceptionally well, or know the space exceptionally well (or both). They will commit, and often commit early. They don’t typically say “come back to me when you have a lead and the terms are set”. They are more likely to say “I’m in for X amount assuming a reasonable deal is in place.”
But this behavior is changing, and I notice it most in seed rounds with smaller funds, especially groups that are more like angels that are institutionalizing. Once they are managing other people’s money, or once they are writing bigger checks, there seems to be more at stake. Also, because seed rounds are creeping up larger, you see rounds that are made up of a number of different groups, which makes it easier for an investor to hang back and try to squeeze in when a round has “heat”. More often, I’m hearing about funds that say “we don’t lead, come back when you have a lead.” Or “who else is interested?” Or you see the same investors banding together in the same deals over and over, rather than seeking independent, contrarian thought. As a result, you see many “seed funds”, but shockingly few that actually lead. I thought it was interesting to see a tweet from Shai Goldman a few weeks ago:
“@shaig: who is actively leading seed rounds in NYC? @ffvc @MetamorphicVC @firstround @trueventures @homebrew @NextViewVC @ResoluteVC are, others?“
There are certainly a few more he is missing, but even an all-inclusive list is tiny when you think of the morass of seed investors and “super angels” in the city. I think most of the best investors act like leads, even when the market might allow them to hang back and chase heat once syndicates form.
3. One Company at a Time
Sometimes called “portfolio entrepreneurship”, I notice a bit of a trend towards more founders that have their hands in a number of different projects simultaneously. This can look like a lot of things, like founders that launch multiple companies at once, different forms of incubators, founders launching side-project companies while running another one, etc.
I can see why this is attractive, and I can also see how a bit of a creative outlet can be helpful for an entrepreneur’s core endeavor. But I wonder if it’s really net-positive for the vast majority of founders. My old colleague Bijan at Spark wrote a post on this 5 years ago that still rings true. I won’t rehash it, but here’s the money paragraph:
“Ultimately in early stage investing we are backing people. I think founders that don’t want to commit 100% aren’t helping these companies reach their fullest potential. The companies don’t get enough time/focus, employees get mixed signals, end users suffer (and you know how important they are). Plus, every early stage company goes through its ups and downs. If not every day then every week it seems. If the founder isn’t 100% committed then it’s hard to deal with those ups & downs properly.”
There are some entrepreneurs that seem to have been able to do this reasonably well. Jack Dorsey working with both Square and Twitter, Elon Musk working on both Tesla and SpaceX. John Borthwick has done a nice job with Betaworks, launching multiple companies simultaneously. But there aren’t that many examples where this has worked out well.
Maybe these are old school ideas, but I tend to think that building great companies takes incredible focus and dedication, and the odds typically are not in your favor. So I think going old school isn’t such a bad idea for most people most of the time.
Today is an exciting day at NextView. Earlier this morning, we announced our investment in Change Collective (our first investment of 2014). Just as exciting, I am also pleased to announce that we are looking to add to our team for the first time since NextView was founded several years ago.
The venture capital industry is one that is experiencing unprecedented change. New funds are emerging with better strategies that are more in tune with the needs of founders. Additionally, firms are thinking more and more about how to add real value to their portfolio companies, and create more leverage all around for members of the team.
This is why I’m pleased to announce that we are looking to hire a Director of Platform and Community to join Dave, Lee, and I at NextView. Specifically, we are looking for someone who brings to the table four things:
- Deep, authentic commitment to the entrepreneurial community in Boston
- Ability to juggle lots of initiatives quickly and flawlessly in an unstructured environment
- Creativity and marketing acumen to help raise the visibility of our portfolio companies and help the portfolio WIN
- Hunger to work with us to build something great
At NextView, we think of our jobs as “Source, Select, and Win”. We find the best entrepreneurs and teams to work with, try to select the best opportunities that fit with our POV of the future, and work really hard to help those companies WIN. This role is all about Winning, and working with the investment team to propel our firm and entrepreneurs we support further.
More detail on the role and instructions on how to apply can be found at Dave’s blog post here.
My old colleague Michael Dearing (who is an outstanding seed investor in SV btw) shared this tweet recently:
“mcgd: The difference between companies who practice OKRs or equiv and those that do not is stark. n = hundreds”
I’ve definitely found this to be true in my experience so far. For those of you who are unfamiliar with this, OKR stands for “Objectives and Key Results”. OKRs are used in some form by many companies to focus teams around specific goals, track progress, and instill accountability throughout an organization.
There is surprisingly not that much written about OKR’s on the web in much depth. The best collection of info is probably on Quora or this terrific article by Angus Davis at our portfolio company Swipely.
From my observation, it’s a lot easier to manage by OKRs when a company is post-launch and there is some semblance of product market fit. Or maybe, I’d put it differently. When a company is pre-launch and pre-product-market fit, it’s easy to be much looser about OKRs since there is much less continuous feedback from users or customers and goals could potentially change dramatically in a short period of time.
I think that as a founder and CEO, it’s important to set a tone and culture for measurement and accountability from day 1. That’s why I am a fan of setting up a board even as an early stage company. I’m NOT a fan of laborious board meetings and extensive prep.
But it’s easy for early stage board meetings to be just an “update” meeting. “Here are the things we accomplished since last time.” That’s fine and informative, but more or less rudderless.
Instead, I’d recommend using board meetings as a cadence for setting OKRs. Early on, I’m a fan of meeting every 4-6 weeks. Your OKRs should span 1-2 periods max. But then use the time to review progress towards your objectives, and set goals for the next period. This is then an anchor for the OKRs for the rest of the team.
Of course, if things are going sideways, you should feel free to blow up the goals and priorities mid-stream. That’s the nature of companies at such an early stage. But establish this discipline early and take it seriously.
Since I wrote my draft of this post last week, it sounds like there are a few efforts in SF, NYC, and Boston to host some workshops around this, which I think is great. I’ll be working on one as well – stay tuned!