Raise Money On an Insight, Not Interest
By Ross Fubini
Brad recently warned of inflated early-stage valuations. Companies raising 10, 20 or even 40 pre. The cyclical nature of the ’99 — ’03 investing boom and subsequent bust feels somewhat imminent concerning how much capital is currently in the system.
VCs know that valuations are skyrocketing, venture rounds are increasing, and early-stage investments are nearing an all-time high. This appears both demonstrably good and bad for our business.
More entrepreneurs have access to capital to start companies in order to create more potential outcomes for investors and individuals at large. That’s a net good, but as Brad mentioned we need “to be careful.”
In this era of overly abundant access to capital, many investors are ignoring sound principles in favor of exceptional people raising money on an an interest, not an insight. Investors are rushing to deploy dollars into the “best folks they know” operating in a hot space ahead of a particular “problem to be solved.” This leads to inflated valuations and de-minimis returns.
In my opinion, it’s not enough to be fascinated by healthcare, or interested in VR. We’ve seen that the cornerstone of great companies is either a relevant insight into a specific problem or a novel way to achieve distribution.
The best entrepreneurs I’ve worked with were focused on raising the minimum amount of money they needed to get as close to their customer as possible. They were relentless in seeking out what solution they were trying to build, and decided to raise money after months (or sometimes years) of R&D. This invaluable research then manifested into their “unique entrepreneurial insight” which became the impetus for them to start a company I could ultimately fund. Not the other way around.
No matter the individual pedigree or previous operational experience of the entrepreneur or team, the insight and goalposts for each round of financing must be clearly defined.
Founders often take capital too early in order to “explore an idea” allowing all sorts of problems to ensue — not the least of which being founders spending precious time building the wrong company.
The ramifications for raising too much money too early are obvious and enormous. The irreversible pref-stack and terms often lock entrepreneurs and investors into undesirable outcomes. How do you expect to raise more money when you sold 30% in the Seed, wasted 5M bucks in 18 months and don’t have legitimate traction to help you raise an A? This is where Brad’s ominous messaging comes in.
The problem is, with the enormous amount of individual and institutional capital available for exceptional entrepreneurs at every stage how do VC’s decide?
When offered, an entrepreneur should almost always take as much money as she can get. Early stage investors on the other hand have to know whether to invest in the “individual” or their “insight” into the problem/market at hand. This can be a tricky decision.
Due to today’s market dynamics of mega funds, mega rounds and massive dollars coming into Seed, there is a new problem for VCs to combat. Namely, competition and the unprecedented reality that the best folks around are likely going to get funded with or without your help. The availability of capital and the proliferation of new investors means that if your talented, someone is going to lead your round.
VCs struggle with this phenomena since they now need to choose between locking in a relationship with an individual or team they believe is extraordinary or focusing on the fundamentals of investing which rely of clear insights, traction, customers, market and more.
Friends often ask me “What if I found the next Zuckerberg or Hoffman or Gates? Is it better for me to invest now and pray? What should VCs do?”
There is certainly some truth to the fact that in 2018, you either lose every exceptional operator/founder to the competition or pre-empt and participate in the madness at hand.
It’s a real problem and there seems to be no easy answer.
One way I’ve found some peace is to take a step back from the hype and endeavor to align on old school objectives and clear milestones/reasons for a company to raise cash. An entrepreneurial “interest” is simply not enough.
I do believe there’s more to the story than just inflated valuation, and more things VCs and entrepreneurs need to consider when raising the next round. More investing in our ecosystem is good but laissez-faire process, principles and decision making based on entrepreneurial interests as opposed to insights definitely is not.
If you’re an entrepreneur raising cash, I encourage you to focus on finding the right partner, minimizing dilution and raising the bare minimum you need to prove that what you are working on is real. Everything else is noise.
If you’re investor looking to deploy dollars, take a breath and deploy patience. Sound principles seem to prevail. Don’t let yourself, your companies, or your own interests get ahead of the material insight at hand.
Thanks for reading. You can connect me on Twitter and LinkedIn.
