How startups should approach venture capital and avoid crushing terms
“Capital invested in a project in which there is a substantial element of risk, typically a new or expanding business” (Google Search definition of Venture Capital)
Surely Google can’t have it wrong?
Yet after many conversations, stories from fellow founders and approaches for help from people starting out in the industry, it somehow seems “substantial element of risk” has been erased from not only the definition of Venture Capital but the mindset of those driving this component of our local market.
There is no doubt venture community interest in early stage investment continues to grow momentum, however, the ability to fund ventures without “a substantial element of risk” certainly does not. So where does this leave us?
Over the last ten years, since finishing my cricket career and landing into the world of startups, I have been lucky enough to be involved in many ventures predominantly in Australia but also across the USA, UK and South East Asia.
As a result of various founder, executive, board or lead advisory roles I’ve been responsible for raising over $50 million of early stage capital (Seed, Series A or Series B rounds) to a variety of investors, from family and friends’ rounds to high net wealth, venture capital and private equity investors.
The last few years has seen a dramatic change across the industry, especially in my home market of Australia.
Despite the profile and interest in the ecosystem exploding, the rate of capital available to founders and early stage businesses continues to be stifled by lack of risk appetite and unreasonable terms from the investment community.
It helps explain why the likelihood of our ecosystem producing another Atlassian shares similar odds to winning Tattslotto.
When asked to provide an opinion on the Venture Capital market from a founder’s perspective, I hesitated, not wanting it to impact chances of raising investment. But the reality is the only way our ecosystem will thrive is via rigorous debate and working through how we create more balance between downside protection for investors and providing startups with the right capital to grow globally successful companies.
Here are a couple of my tips for founders when raising early stage capital in Australia:
#1: Do your research and significantly shorten the capital raising cycle
Raising capital is a necessary evil for nearly all entrepreneurs who are not able to self-fund their business.
As a result, it is essential to raise funds as efficiently as possible to ensure focus remains on running and growing the business, not just funding it.
Most investors have a clear mandate of what they invest in; from level of risk, stage of business and quantum of investment. Seek to understand these key areas before approaching a potential investor to ensure better alignment.
I have heard far more times than I wish to remember, “it’s a bit early for us”.
This will mean one of a few things: (a) they don’t like your business and they’re being polite or (b) you haven’t done your research and they have other mandates and investment criteria and you were never a chance or (c) they actually don’t have any money left in their fund (or they are a ‘club’ model which means they access deal flow and leverage that to try and access capital to raise their own investment fund)
#2: It’s not just about the money
Think long and hard about who can help your business. Some of my best investors have only invested small parcels but have added immense value.
No one likes a big share register (It can take time away from the business,) but if you are strategic about who you involve and why it can mean you have access to a broader team of experience, business development talent, brains and ways to solve challenging problems.
As long as alignment is around focus on growing a great business and not arduous reporting (over reporting is usually as a result of an inherent fear of the ‘substantial risk’ and the investors fear of losing their dollars), your chances of success will improve dramatically.
Be wary of investors with veto rights, (a lot of VCs have them) as effectively you’re handing over the keys to your business, for them to make all the important strategic decisions.
#3: Stay in control, it’s your business
Like any business transaction, investors are wired to extract the best deal. Use of terms, valuation negotiation and classes of shares are all levers and mechanics for investors to try and obtain the best chance of success and volume of return, especially VCs.
Remember, as a fund manager it’s their responsibility to drive the best possible return for their investors, so ensure you’re aware of the business’ true value (remove founder bias here) and can see your downside risk as this will determine how hard you can negotiate or — in some cases — simply walk away.
Try to secure 30 per cent or more oversubscription on any round in an early stage business to ensure you have choice and flexibility to select the most strategic and aligned investment group.
This will also help take back control of the terms, and “decide” who you work with. When fear of missing investment opportunities in great businesses and teams becomes real, it is amazing how the arduous terms we’re used to seeing here in Australia, quickly become founder-friendly.
This article first appeared in The Australian Financial Review http://www.afr.com/technology/how-startups-should-approach-venture-capital-and-avoid-crushing-terms-20160623-gpqc2y#ixzz4D4VY2eMd