Horses, rabbits and poker

How to raise money from venture capitalists

When seeking to raise venture capital, a well constructed approach can help improve the outcome. There is not, however, one technique that is the right fit for every company. In my experience, I've identified three separate approaches that I affectionately refer to has The Horse Race, The Rabbit and Heads Up.

The Horse Race. The Horse Race is the traditional approach to fundraising. Select between 6 to 8 targeted firms that you would like to fund your company. Get introductions to said firms all teed up and ready to go, and then, BOOM, like horses being let out of the starting gate, release the introductions at the same time.

The goal of this approach is to keep of all the prospective firms on the same pace so that the firms remain at a similar stage in their process as your process progresses. The objective is to have more than one firm making an offer at the same time so that you have the negotiating leverage brought on by having more than one option. Without a second firm in the running, if an offer from one firm arises, your choice at that moment is between raising money or not (or at least starting the entire process over again) so it is vital to keep the horses moving down the track at the same pace. This is a somewhat unnatural act for most entrepreneurs who instinctually try to move things along as quickly as possible. Fight your natural tendency! If you have an offer from one firm and are just in introductory meetings with the other firms, you have no real leverage. You might as well just be talking to one firm! Don’t let one firm get way ahead of the others.

It’s not possible to keep things entirely in sync and the last thing in the world you want to do is tell a firm that you are intentionally delaying them so that others can catch up. Use your wiles to coordinate the process as much as possible.

The horse race is the traditional approach and I suggest it for most companies looking to raise money. There are, however, two different tactics that can be deployed if the circumstances warrant.

The Rabbit. The Rabbit is a variant of the horse race, but instead of releasing all the horses at once, it’s like a dog track where a (mechanical) rabbit starts down the track and the dogs are released shortly thereafter. In this technique, the little furry fellow is a venture capitalist whom you meet with a week or so before you begin the horse race process outlined above. The benefit of the Rabbit technique is that it helps move the VCs along a bit more quickly. If you call many VCs for an introductory meeting, they are likely to offer you a meeting somewhere between two and thirty weeks from now. That conversation, however, might change if the response is “I’d love to meet you in 8 weeks, but I have a second partner meeting at another firm next week, so I’m concerned that things might have progressed by that time.” All of the sudden a time slot will magically open up on the calendar in the near term and that is the true benefit of the Rabbit.

The Rabbit will it only work if you have a VC with whom you have a pre-existing relationship or who has otherwise shown interest in your company. Also you have to pick a VC with whom you would want to work as your Rabbit. The reason for both of these caveats is that the Rabbit must be an effective negotiating alternative. If it’s just a random firm that might or might not take the first meeting or a firm that is interested but that you are not excited about taking money from, then it becomes nothing more than an elaborate bluff and that’s not really going to improve your negotiation position.

Heads Up. The final technique I call “heads up” after the poker term for having only two players left in a hand after all the other players have folded. In this variant, you go to a single VC and say “I am going to go out and raise money. I really like you and want you to invest. If you make me a great offer, I will take it.” In the more aggressive version of this conversation, the VC will reply “tell me what you think is a good offer” to which you should reply “[I]f I am dumb enough to do that, you should not invest in my company. I’m not going to negotiate against myself.”

The goal of this approach is to make the VC negotiate against him/herself with the tantalizing knowledge that there will be no other bidders. This approach really requires a strong pre-existing relationship with a VC. The advantage of this method is that it can save time (and information leakage) of the regular Sand Hill Road song and dance. It is also possible that from a game theory perspective you will get a better price. In a typical auction format (like the horse race) you will rarely elicit a high bid early since most investors believe that there will be multiple opportunities to raise their bid. Heads Up turns that assumption on its head, but only if you make it crystal clear that there will be no second bid. This is a delicate balance so I only recommend Heads Up for the experienced entrepreneur.

While I have described these three techniques as separate and distinct, in fact they truly represent a continuum of approaches. For example, a soft version of Heads Up where you encourage the VC to bid early is pretty close to the Rabbit and the Rabbit can morph into the Horse Race as timing lines up.

These methods represent negotiation tactics designed to help you get the best deals that you can get. My own view, however, is that the objective of most funding rounds is not to get the highest possible price, but rather to find the right partner. Outcomes for start up companies tend to be somewhat binary and I’d suggest optimizing for the investors you believe will be most likely to make your company successful. With that goal in mind, however, you should still get the best deal possible with your investor of choice and hopefully the Horse Race, the Rabbit or Heads Up will help you to get there.