Decisive fundraising: how to run a tight process that ends with multiple termsheets

One of history’s most successful fundraising exercises

Venture capitalists play a lot of roles on behalf of their portfolio companies. At the end of the day, though, the most important role has to do with funding: successful VCs help their start-ups raise funds.

No fundraising connections or process can replace the importance of good business fundamentals: a start-up that is struggling with the product or the business will also struggle to raise funds. However, all things being equal, the fundraising approach makes a big difference in valuation and eventual outcomes.

This blog post is an excerpt from our Operating Manual chapter (which is available to our portfolio companies).

What to do (all discussed in greater detail below):

• Take the time to agree on strategy, storyline, preferred investors and process with key executives, investors, and other stakeholders
• Build the deck
• Create ancillary materials (Blurb, one-pager, dataroom)
• Create master target investor list tracker. Aim for at least 30 “quality connections”
• Launch a bulk process, in 2–3 waves
• Structure the round thoughtfully and decisively

Signs of badness:

• Drip, drip, drip: no “bulk process”… lots of one-off discussions with random investors. This approach either leads to a term sheet from an investor who may not have been high priority (and then have pressure to accept… see the next item below)
• Too narrow of a focus: engaging only with 5–10 investors, and then quickly only having 1–2 solid leads (which can easily become zero leads OR lead to only one sub-optimal termsheet, which you then have pressure to accept quickly)
• Under-leveraging of current investors/ advisors: this is where the investors should be earning their place on the cap table; entrepreneurs have an obligation to know how to effectively use them
• Lack of homework: not knowing what investors prefer in terms of stage, vertical, geography, etc. Also, not knowing what investors are invested in directly competitive companies
• Not understanding what is confidential, and what is not confidential: it is not good to be overly cagy with investors. Most information about your round should be shared with investors (ie, it is confidential, but not “secret”). Assume that most of your information will be passed around to other investors, and gain acceptance of that fact (you can put some control in place by using DocSend for most information transfer, including your data room)

The goal is to operate with speed and determination. Take the time up-front to prepare the round. Once the process is underway, lean in hard to move investors towards termsheets.

Details

Round definitions

Foothill Ventures focuses on the seed stage, with occasional forays into Series A and pre-seed.

Understanding each of these rounds is crucial to understanding what the funding pitch should include (and — more importantly — what milestones should be achieved for each round).

According to Pitchbook data, a typical startup will see a new round raised every 12–18 months, with each subsequent round occurring at a roughly 2–3x rise in valuation. There is an internal logic to the process: companies should not constantly be in fundraising mode, and the milestones usually required to achieve a major valuation step up can generally be broken down into 12–18 month chunks.

Our round definitions are as follows:

Pre-seed definition:

anything from “two guys and a powerpoint” to a company that already has an early product. The hallmarks of pre-seed are usually:

• Product is in a highly nascent form — either pre-launch or in an alpha version
• Customers: No customer traction or very early discussions
• Team is usually just the founders

Pre-seed financing

• Story focuses on the market need and the innovation that will fill this need. Funding success almost wholly depends on the strength of the founding team
• Round dynamics: usually angel investors, friends and family, and (occasionally) 1–2 pre-seed funds. $1–3M on a $3–10M valuation (where the valuation is highly dependent on the team strength)

Seed:

normally a company that already has an early product in market. The hallmarks of seed rounds are usually:

• Product has usually launched in at least beta version
• Customers: Early customer traction, usually in the form of POCs; early signs of customer satisfaction, but pre-product/market fit (“PMF”)
• Team: average 5–10 people, largely focused on product/ engineering (in a team of 10, we would expect ~7 to be directly working on product development)

Seed financing

• Story focuses on the market need and the innovation that will fill this need. Customer experiences become important (ie., how is the product solving their problems? What is the value of the product to them). Go to market strategy has to be well-articulated, even if it’s not yet implemented
• Round dynamics: usually seed VC firms (often one lead will take ~75% of the round). Many seed firms have ownership requirements (often 10–20%). $3–7M on a $7–15M valuation (where the valuation is highly dependent on the team strength)

Series A:

normally a company that has achieved $1MM+ ARR, and has proven both PMF (at least for a niche) and an effective sales motion that can be scaled

• Product is in “general availability”, and has a well-defined mid-term roadmap.There is normally a dedicated PM (not just the CEO), and an engineering team that has achieved scale (eg., 10+ engineers for every 1–2 PMs)
• Customers: Significant customer traction and clear indication that there is a customer niche that finds value in the product. Willingness to pay is well-understood. Classic revenue benchmark for Series A is $1MM ARR with high (3x) projected y-o-y growth and “software margins” (~80% gross margin)
• Team: average 10–30 people. Still product/ engineering focused, but with a dedicated GTM function (sales, customer success, partnerships, etc)

Series A financing

• Story shifts from the market need and the innovation that will fill this need (although this is still important) to monetization and customer traction. Story needs to clearly demonstrate that
• Round dynamics: Series A and seed firms have a fairly high degree of overlap (many seed focused firms will look at Series A and vice versa). The classic Series A is a $10–15M raise on a $30–40M pre-money valuation. In recent years, Series As have gotten very large, so the “classic” is becoming a bit dated. Series A firms can be very “sharp-elbowed, and often will have a lead that will take substantially all of the round (after insiders get their pro-rata allocations)

Round extensions

In addition to the traditional pre-seed, seed, and Series A progression, there are occasionally half-step funding rounds. These occur most commonly when a major milestone is within reach, but has not been clearly achieved. As a result, a smaller step-up from the previous round may be warranted. Some investors view round extensions negatively — a sign that the company is not executing smoothly. However, it is still a very common practice. It is not unusual for insiders to lead this round.

A second scenario where a round extension is common is where a seed round is vastly over-subscribed, and the target company will offer a chance for investors to enter a stepped-up round (ie., the seed may close at $20M post, and then may take an additional $4M at $25M pre).

The deck

The ideal fundraising deck is well-matched to the round definition (ie., a Series A deck should clearly show that PMF has been achieved for a valuable market segment, while a seed deck will spend more time on the product story and the very early customer experiences).

There are a lot of resources online about the ideal deck contents (like this Sequoia article by (the great) Aaref Hilaly…now at Bain Capital)… we will not rehash these thoughts here.

The process

Pre-raise: take investor meetings or not? We are big fans of founders who regularly update investors that they met during previous fundraising discussions through a quarterly mailing list. There is not a need to accept 1:1 meetings with investors during a period when you are not raising funds, though: these are a drain on time, and any good investor will understand the response: “sorry, but we are heads down in execution mode, and are not taking any investor meetings at this time”.

Only take investor meetings once the raise process is kicked off.

Timing:

The timing for kicking off the process is constrained by 2–3 factors: months of burn left vs. milestones achieved (sometimes market conditions will also fall into consideration).

• Months of burn: companies should want at least 4 months of burn when commencing the raise (ideally as much as 6 months)
• Milestones achieved: as noted above, the classic milestone for a Series A raise is $1M ARR. However, there are many other milestones that can trigger a raise (a particularly large customer win; a giant growth spurt, etc)

Other considerations:

• VC cycle: US venture activity slows considerably between Thanksgiving and New Years day, while Chinese venture activity slows between New Years and Chinese New Year (usually in February). US venture activity is also somewhat slower during summer holidays.
• Market conditions: there are many macro conditions that may lead to an accelerated funding cycle. Fear of a coming recession; enthusiasm about a particular sector; stock market booms or busts, etc

Pulling the trigger

Practice and refine the pitch

In our experience, a well-run kick-off starts with executive management agreeing on the timing with their board, and then scheduling a few sessions to review the deck and build the target list.

It is good to run at least one “murderboard” session with the board playing the part of potential investors (and even recording the session — the entrepreneur will learn a lot from watching themselves present).

For Series A and beyond, it is worth it to hire a professional design firm for assistance in both polish and story-telling. This will cost between $2–9k, depending on the firm and how much work is involved. Even $9k is generally worth the expense.

Build the list and supplementary materials

The entrepreneurs and investors/ advisors together should build the target list of next round investors. The goal should be to get to 30 quality leads that can be engaged with. The ideal round will have at least 3 credible investors bidding for the rights to lead the round. In our experience, processes that start with a smaller number of investors (eg., 10) have a danger of ending up with just 1 committed investor by the end. This is a very dangerous situation

The goal should be to get to 30 quality leads that can be engaged with. The ideal round will have at least 3 credible investors bidding for the rights to lead the round

How to build the list of 30 investors?

First, some basic research has to be conducted:

• Who are the top investors for the vertical and stage of the company? In particular, are there individuals who have shown a fondness for this sort of investment?
• Who are the direct competitors that would likely block an investor from taking part? (should be identified by executive management)
• Are there any special categories of investors that should/ should not be considered (ie., are there CFIUS concerns (which would prevent the company from raising from foreign sources)? Are Corporate Venture Capital firms (“CVCs”) desirable?

Ideally, these are all warm introductions among the entrepreneurs and current investors. If that number of investors cannot be achieved through current contacts, then the entire group has an obligation to actively network to find warm contacts that are potential investors. Completely cold outreach is extremely unlikely to be effective.

All of the targets should be arranged on a tracking sheet that also includes the list of investors that are likely precluded due to conflict (because otherwise their names will keep coming up: “have we talked to Sequoia yet?”).

They should be divided into 2–3 waves, separated by ~2 weeks). We have generally done the following:

• Wave 1: closest relationships: these are contacts that the entrepreneur/ investors will be sure to get direct and honest feedback. They may or may not be the top investor targets — at the first wave, information and feedback are most important
• Wave 2: non-Wave 1 top investor targets. Ideally, several Wave 1 investors are already leaning in, so Wave 2 will have some time pressure
• Wave 3: opportunistic/ non-core investors. These investors are still excellent and desirable, but the entrepreneur would likely not choose any of them over any Wave 1–2 investor. At the same time, they may be credible candidates to join a round. And, if Wave 1–2 is not yielding closure, they can further amp up the pressure.

The “failure mode” here is to under-leverage existing investors/ advisors.

The entrepreneur will often (at best) run a series of 1–1s with existing investors to solicit help. This is fine, but it is our experience that investors and advisors feed off of each other. Getting all of them on the same call results in them strategizing about approaches and contacts that they may not have originally thought of. In addition, it establishes a “war room” cadence/ mentality that will be helpful to maintain throughout the process. This is where your investors should be really earning their equity — hold their feet to the fire!

Supplemental materials

In additional to building the pitch deck and the investor target list, several other items are recommended:

Introductory blurb (drafted by executive management): Introduction to the company that can be sent by investors to their contacts. It may also include other attachments/ links/ videos

One page teaser: pdf (sent via DocSend). Should outline the key points of the company (including team, market, product, traction, and raise)

Video demo (can be done through loom.com): not strictly necessary, but very effective when done well

Data room: should have this prepared and shared with either DocSend or DropBox. It should include:

• Articles of incorporation
• Team roster and employment contracts
• Financial projections and detailed analysis
• Commercial contracts
• Patents

The outreach/ meetings

Each person responsible for an investor on the outreach list should reach out to their personal contacts, and update the list as they go. The different individuals should start with the same standard blurb, but should obviously feel free to adjust for their personal outreach.

There used to be some controversy about whether or not to use DocSend (it is somewhat annoying to investors, who would prefer to have a deck). At this point, the advantages of using DocSend are fairly clear: Version control and more intelligence on who sees the presentation (and where they are spending time). Use DocSend, but make it as friction-free as possible (ie., do not use a password, allow anyone to access by entering their email, etc). Investors have become accustomed to DocSend, and almost all know how to download a DocSend file if they really want to.

Initial meetings should be scheduled for 45 minutes. If the meeting is proving to be a waste of time (ie., if the investor quickly indicates that there isn’t a fit, but still took the meeting just to meet the entrepreneur), then the session can be ended in 30 minutes without being rude. Far more often, the meeting is useful, and the time will stretch to a full hour. No one ever schedules over the “stub” 15 minute slot. A 30 minute meeting is just too short, and ends up feeling transactional.

95% of the meeting should be spent helping the investor to understand the business. The entrepreneur can save their “what value do you add” questions until after it’s clear that there are multiple investors bidding for the right to invest. The only items that are critical for the entrepreneur to ask are:

• What is your typical process (ie., how do you make decisions)?
• What are your typical investment parameters (ie., check size, lead vs. follow, ownership requirements, etc)?

We have written another blog post on this subject here.

Negotiations and closing

If the process has been well run, assuming the business is tracking to the expected milestones, there should be multiple parties that are looking to invest.

The focus has to be to get a lead termsheet in hand as soon as possible. Once one termsheet has been issued, there is a very short window to receive other offers. If you have run an efficient process, most investors understand if you delay the process slightly. If the process has already dragged on, there will be less goodwill.

The termsheets should be as “clean” as possible — no super pro-rata, no special voting rights, etc. Allowing early investors any unusual rights will complicate the closing of the full round, and will inevitably cascade to new problems down the road.

Once the entrepreneur has multiple termsheets in hand, then the entrepreneur, along with key board members, should talk to the bidding parties and decide what offer to take. A key consideration will be how the lead views the round dynamic: whom else they would like to have in the round, and how they will work with them.

My personal view is that “sharp elbowed” investors that want to take virtually the entire round for themselves at Series A are less preferred. The positioning indicates a certain level of arrogance. Building start-ups is a tough job, and the entrepreneur should have access to as many good investors (within reason) that can marginally help.

We like to look for incrementality. Many Silicon Valley based investors have overlapping skills and networks. When the entrepreneur needs connections (for fundraising) or advice, they will not add much to each other. It is far better to have a firm from a completely different network (eg., Hillhouse Capital, which has a strong China background, is non-overlapped with Menlo Ventures. Each firm can bring their full strength to the table).

Summary

Like everything else in building a start-up, the process and the content are both important. An entrepreneur has a lot more control over process than over content (ie., the ARR of the business is a function of many things; but a well-organized data room can be achieved by anyone).

Running a solid process also conveys a good impression to the potential investor, so it creates value beyond just the advantage of efficiency.

Finally, the entrepreneur is so busy running the company that the the worst thing is to get bogged down in endless financing discussions. It is worth it to take the time up front to get the deck, the story and “the list” right, and then run the process decisively.

As always, we love feedback. Any additional advice? Any stories you’d like to share? Send to eric.rosenblum@foothill.ventures

Huge thanks to Alvin Zou for helping with much of this research!