#FundraisingFriday Tip 2— Know Your Terms

Practical tips for founders who are fundraising

Will be publishing fundraising tips every Friday for entrepreneurs who are embarking on the arduous journey of convincing VCs to give them money.

Tip #2:

VC: So how much are you raising?
Founder: Not sure yet. Maybe $1–3M? Or Maybe $3–4M if there’s enough interest?
VC: Okay…what are the terms? Equity or convertible note? Valuation or cap?
Founder: We’ll let the market decide :)

^THE WORST!

There are two reasons this happens:

1. The entrepreneur thinks they’re being clever by keeping it open ended. That way, they can raise as much as there is demand for and at a valuation that’s as high as possible.
2. The entrepreneur has no idea how much working capital their company needs and how one should value their company.

One is annoying and the other is worrying. Come in with a plan!

Regarding how much to raise, there are some pretty straightforward questions to answer:
Why are you raising this amount? Why do you project your burn to be this much monthly? How much do you plan to spend on customer acquisition? Server costs? Salaries? What milestones does this money get you to? When do revenues kick in to offset your burn?

Regarding terms, it gets a bit more nuanced depending on who you ask: Entrepreneurs typically raise a convertible note when they don’t want to peg a valuation to their company. A convertible note is debt that behaves like equity (or is pretty much equity in the case of YC SAFE agreements). A loan is made to the company and that loan converts into equity at the next equity raise at either a valuation cap or discount (to prevent investors from being diluted too much if the next round is really high). This is founder friendly because it’s quick and valuation discussions can be delayed until the company is at a stage where they can get a higher valuation.

Entrepreneurs will raise an equity round if they just want something simple without dealing with notes/debt or if they’re comfortable with the valuation they’re getting. Valuations in VC can be very unscientific but it’s usually done in three ways:

1. M&A Multiples — Who’s been acquired in this space and for how much? (it’s not always a Revenue or EBITDA multiple, certain industries have been valued off of subscriber or headcount multiple)
2. Public Comparables — P/E ratio, EV/EBITDA, EV/Sales etc.
3. Last Round Valuation — The least scientific way of doing it. e.g. their last round was a $50M post and they’ve made mild progress so let’s give them a 1.5x up round?

Regardless of how you arrived at your valuation, you should at least pitch a ballpark range and be able to justify it. At the early stages, founders often times pick their valuations based on how much dilution they’re willing to take and VCs understand that. However, it’s also important to be able to back it up!

Hope this helps and stay tuned for more #FundraisingFriday tips!