StartUp Camp #2: The Errors Everyone Keeps Making (And How To Avoid Them)
In any area of life it is relatively easy to find good reasons to do the wrong thing. Mistakes are inevitable — but early stage mistakes, like the kind associated with capitalization, can cost you dearly down the line. And they’re almost impossible to reverse. Here are five classic mistakes tech entrepreneurs make with their funding.
1.Picking The Wrong Angels
Entrepreneurs need to select Angels who will add value to their company—by facilitating introductions, recruiting talent, building the product, or getting customer wins. When you take money from someone who does little else but cut a check, it comes at the expense of someone who might have actually helped your startup grow.
Lets say you’re doing a $10M raise and have four different VCs in at $2M each and five different angels on board for the balance. Feels good right? So many new resources to tap? Lots of impressive logos on the management presentation? Nope. When no investor is in the lead, no one assumes a leadership role, because everyone presumes that someone else is doing it. No one in this scenario has enough skin in the game to come to the rescue, financially speaking, if things hit the skids. VCs will have other fires to put out, where they have far more money on the line — but everyone will still will find a way to disagree and fight when important or tough business decisions have to be taken. Instead of the Jedi Council, you get the United Nations.
3.Not Understanding Liquidation Preference Mechanics
Investors often misinterpret the effects of dilution and liquidation preferences — and fail to see the financial consequences to themselves until years down the line. I put together a really helpful and easy to understand illustration of how these concepts work. It’s possible for you and other investors to be completely wiped out in a liquidity event, even if you hold a substantial amount of equity (and it happens more often than you’d think). http://mergertech.com/wp-content/uploads/2015/02/Dilution-LP-Ash-Sethi.pdf
4.Selling The Company Too Late
If a startup is not profitable (and that’s many of them), then it has a certain amount of time left before money runs out. When you raise too little, there won’t be enough runway ahead to get airborne. But what really kills a business is failing to make a decision regarding M&A a good 6–9 months before its cash is projected to run out. Money always goes faster and M&A conversations will go slower than a founder plans — so one needs to be brutally honest regarding potential for future fundraising. If things aren’t running the way they should be, start planning an M&A process. Or else you’ll get bullied into accepting tough deal terms just to keep the lights on or get the investors some money back.
5.Your Honor, I’ll Be Representing Myself
Entrepreneurs often make the mistake of trying to negotiate VC termsheets or corporate LOI’s without fully understanding them. LOI’s and purchase agreements are complex and terse documents that hide a horrible minefield of unknown consequences particularly for first-time entrepreneurs. So hire yourself a good deal attorney if you already have a termsheet in hand.