The most common pitfalls I’ve seen among founders seeking investors for their companies, plus some advice on how to avoid them
I recently did a webinar helping two dozen CEOs with the wide range of challenges facing them as they grow their business, and about half the questions that came in beforehand were about just one topic: fundraising. At first sight, that may seem bizarre. Are these guys obsessed with money? What about their product? Their team? Their customers? Or the half-dozen other areas on the agenda, where startup founders can improve their chances if they up their game?
Reflecting further, I realised that if you think of a startup as a machine, then all these things are important engineering issues to make the machine run faster or more smoothly. But fundraising is different: money is fuel. And we all know that drivers fill up the tank much more often than they take their car in for a service. So it’s not surprising how much fundraising looms in the minds of startup CEOs.
Fundraising is different: money is fuel
I’ve seen startup fundraising from different perspectives. As a founder, raising five private rounds from angels, VCs and growth investors before an IPO. As an investor, writing over fifty cheques between $25m (when acting as a VC), and $10,000 (when I’ve wanted to send a founder the message that even though the company may be out of scope, and even though I think it’ll probably fail, I just want them to know that I admire them and support them). I’ve seen it as a director, sitting on the boards of nineteen companies and getting updates from the management on how the fundraising is going. And I’ve seen it from the intimate perspective of a coach, where I hear CEOs talking in private about their fears, about what they’re really doing and how the process is really going, and about the help (or lack of it) they get from their investors and their boards. Ten of the CEOs I coach have gone to investors for more money so far this year. And even though it’s summer right now, the process hasn’t stopped.
Reflecting on what I’ve seen, I think there are a number of fundraising mistakes that CEOs often make. Here’s a list of the top four; as ever, it’s a work in progress. If you have other thoughts, please let me know directly or by writing a comment.
Mistake #1: Making the wrong decision about intermediaries
Here’s an email that I’ve sent, in various forms, about twenty times this year:
“Dear John, Here’s the thing. At the early stage where we invest, it’s all about the founders. And founders have a big advantage if they’re good at researching who to approach, building compelling slide decks and plans, and making a persuasive pitch to investors. We’ve recently done some analysis on which companies that reached out to us for funding were most likely to be the ones we invested in, and we found that the companies whose founders couldn’t fundraise by themselves and needed advisers or boutique investment banks like yours to do it for them were in the bottom slice. So for now, we’ve decided to just not look at anything that comes in via a paid intermediary. Sorry! — Tim. PS: Please take us off your mailing list.”
Reading this, you might think it’s not worth using professional intermediaries when you’re raising money. But here’s another example. Two days ago, I took a walk in the park with an investment banker who took on as a client a fast-growing tech company that had had great difficulty raising its previous round. When the job came in, the banker had his junior people do the necessary work to put together a private placement memorandum (PPM) and a slide deck, and to ensure the company had all the information needed for due diligence in an online data room. He then made six phone calls to potential investors he knew had history investing in the geography, stage and sector. Three weeks later, the company had commitments for a raise of between $50-100m. The valuation at which the money came in, after a few auction rounds, was more than twice the highest initial offer.
“Easiest $2m I ever made,” the banker told me
The banker’s delight at how effortlessly he earned his fee might tempt you into thinking that this means the company should have raised by themselves. But in fact, it’s the opposite. As a CEO, you need to assess whether an intermediary can help you raise money more easily and quickly, since effort and delay take you away from the job of running and building your business. Then you need to assess what the cost of using the intermediary will be — or indeed whether there will be a cost at all, since in this case the valuation that the banker achieved by triggering competition between the investors was so much higher than what it would have obtained by itself that the effective fee was heavily negative.
So this is the first question you need to ask before you start fundraising: does it make sense to use an intermediary? Let’s make the criteria more precise. If you’re early stage, or if the decision is qualitative rather than quantitative, or if the targets aren’t used to dealing with bankers, or if you can readily name a number of potential investors, the answer will probably be no. Otherwise, you should use an intermediary and save yourself a bundle of work and grief. You also can stop reading here, since the bankers will do the rest for you.
Mistake #2: Loading the funnel with too few potential investors
For all their reputation as evil geniuses, many venture capitalists allow weirdly subjective factors to influence their investment decisions, some of which they’re aware of but many of which they’re not. Did they like the shirt you were wearing? What colour was your slide deck? Is your product aimed at people like them or their kids? How successful was their firm’s last deal? How happy or depressed are they feeling today? How well are they getting on with their partners or their spouse? What did they have for breakfast, and how long ago? What was their most recent (as opposed to their most important) mistake?
In your personal life, if you want to find a good partner and protect yourself from randomness, it’s a good idea to go on lots of dates. When running a startup, it’s a good idea to reach out to lots of investors.
The banker’s crisply curated list of six I described above is a dream scenario. A better approach is to think of your fundraising as like selling B2B SAAS: you need to think about the successive stage that a successful ‘customer’ will need to pass through in order to sign the deal and send the money, then make a guess at the conversion rate from each stage to the next. Multiply the percentages together, and you’ll get a number showing what percentage of the people you reach out to will send you a term sheet.
For instance, suppose your five stages are: 1. send them an email, 2. have a phone call, 3. meet in person, 4. they visit your office, 5. you pitch to their partners.If you expect half of the prospects to drop out at each stage, then your overall conversion rate will be 50% x 50% x 50% x 50% x 50%, which is 0.5⁵, which is just over 3%. This means that you’ll need to talk to more than 30 people to get a term sheet. So if you want to have three term sheets, that would mean reaching out to 90 potential investors.
And note: that doesn’t mean spamming 90 random VC firms you found on some publicly shared Google sheet. It means doing the research to find 90 investors who are visibly interested in your stage, geography and sector, and who don’t have stakes in your competitors, and then reaching out to them with a personal, not visibly canned, approach.
Mistake #3: Failing to qualify prospects
Many investors think the best response to an approach from a company they’re not interested in investing in is to do nothing — simply to ignore the approach. That’s dispiriting for startup founders, and especially dispiriting for first-time founders, especially those raising outside money for the first time who also make basic mistakes in their initial approach to investors which means they get a low hit rate. The result is that founders are often so grateful, so pathetically grateful, to get a response from anyone that when an investor emails them back, they’ll immediately drop everything and cross town (or sometimes even hop on a plane) to go to and see this exciting potential source of cash.
Whoa. Not so fast. Before you invest significant time and emotional energy in the relationship, it makes sense to verify that there’s a reasonable prospect of closing a deal. In B2B sales, a common checklist is BANT: does the potential buyer have the budget to buy your product, do they have the authority to make a decision, do they recognise they need it, and is their timeline right?
I’ve written an article proposing a special investor checklist that startup founders can use when fundraising, whose purpose is to help you screen out VCs, family offices, strategic investors and angels who aren’t likely to close. It goes by the acronym FACKWITS.
Mistake #4: Misunderstanding how serious investors are
Your best friend calls you to say they went on an amazing date. They had a delightful evening. Maybe they kissed, maybe not; nice people don’t tell. But at some point in the evening the other person looked into your friend’s eyes and said, “I really like you.” Surely, your friend asks, it’s time to book the venue for the wedding?
If you’re a good person, you’d probably let your friend down gently. But you’d try to persuade them that one date, however enthralling, doesn’t often indicate that the couple are destined to have a blissful sixty-year marriage with four lovely children. There are lots of steps and obstacles to go through before the wedding can take place, let alone their lives afterwards.
As with life, so with venture funding. VCs have a process for making investments. Some, like us, have mapped it out in explicit stages in a CRM, with consciously chosen conversion criteria at each stage of the funnel that I described in #2 above. For others, the process may be much more impressionistic and intuitive. But what professionals have in common is that they have limited resource for looking at potential investments, and they try to focus those resources on the deals that are most likely to come to fruition. That’s the reason for term sheets; no point spending $25,000 on a full set of legal documents only to discover that there’s fundamental disagreement on one of the basic terms.
What this means is that talking to VCs about funding is incremental, and you need to be realistic about this. The degree of enthusiasm that a given investor shows for your business is likely to be more related to their temperament and personality than to how likely they are to invest. Many VC firms employ junior people whose job is to ‘map the ecosystem’, going to lots of conferences and events and following up with company founders to learn what you do, what progress you’re making and what your plans are. A positive half-hour phone call with an enthusiastic analyst may therefore indicate nothing more than that they’re a friendly person and they’re on track to hit their target to gather five key data points about six companies and get them into the CRM by Friday.
Things are a getting serious when you start talking to a partner, as Suranga Chandratillake explains in this helpful deciphering of VC job titles — though funds like Andreessen Horowitz, realising that you know this, call everyone a partner (and hence you need to realise that the real partners are the ‘GPs’, the ‘general partners’ of the legal partnership where the ‘limited partners’ are the pension funds and foundations who actually put up the money that the firm invests.
Since VC firms don’t want to waste time on deals that are unlikely to happen, it’s a sign that things are more serious when they’re willing to come to your office. Now a conversation with you isn’t worth just a journey of twenty steps from their desk to their conference room but actually a journey across town, some travel time, and a $20 Uber.
And the deal is progressing further still when you’re invited to meet multiple partners. Sometimes you’ll be asked to pitch the firm’s regular partner meeting, and they’ll make a decision the same day on whether to offer you money. The most flattering thing is a combination of the two: an office visit where multiple partners come. (If the entire partnership flies in to see you, then the balance of power has flipped; they’re pitching for the privilege of giving you money, and trying to convince you that they’ll be more helpful than the other top firms they fear you’re talking to.)
Finally, there’s the term sheet. The whole point of a term sheet, as I’ve explained, is to get all the deal points clear before switching on the taximeter of lawyers’ bills. It takes half an hour or less for a VC to generate a term sheet and send it to you, but it’s a sign of concrete commitment. Although term sheets typically say explicitly that they’re subject to commercial due diligence, and they’re not binding except for the bits about confidentiality and who will pay whose fees if the deal falls apart, most US firms send a term sheet only when they’ve firmly agreed do to a deal on exactly those terms. The only thing that will derail it is if they discover your murder conviction or the fact that half the emails on your customer list are firstname.lastname@example.org. Some Europeans are more weaselly about this; one London-based VC I know has a habit of agreeing term sheets and then ‘finding’ issues in the due diligence that require a modest tweak in their favour, like a 70% cut in valuation or an option to invest the same money at the same price next year. But the difference between a term sheet and no term sheet is still vast.
What this means for you as a startup founder is that you need to block your ears to what investors are saying, and observe what they’re doing. Six people who say they ‘really like’ your business and ‘want to learn more’ is a lot better than nobody taking your calls. But two funds who’ve had second meetings, three who’ve visited, and one who’s sent you a term sheet: that’s a more concrete measure of the progress you’re making in the round.
Something important for you to do next is to map this progress against your runway, so you don’t run out of cash. But that’s another story, which I’ll write later.
I’m Tim, and these articles come from my work coaching Series A and B CEOs backed by VC firms in Europe, America and Asia. Since 2013, I’ve run a seed fund out of London that invests in SAAS, platforms, marketplaces and tools. I’ve backed 50 companies, sat on 19 boards, founded a startup, and taken it to an IPO on the NASDAQ. Before that, I worked for The Economist and the Financial Times and wrote business books.
About this publication
This is one in a series of blog posts covering nine of the most important skills I’ve seen in founders who successfully scale their companies. If you’d like to read more of them, please follow; if you’d like to review a copy of my forthcoming book, let me know in a comment or DM. And if you think you know a CEO who might find these ideas valuable, please give a few claps or share:)
Photo by Scott Rodgerson