RESPECTING EARLY INVESTORS
Early investors bear enormous risks, and as ventures grow, their contribution is often forgotten.
This is a topic that came up in some conversations this week. I’m not going to add to the opinions of high profile investors and the mechanisms designed to help early investors retain participation rights through financing rounds. Instead, I’m going to share my philosophy for how I think founders should maintain respect for all investors, and particularly the few who back founders early in their journey.
If there is one take away from this post, it’s that entrepreneurship is a craft. It takes multiple efforts to build great companies. And because of this multiplicity, founders are very likely to engage with the same investors time and time again.
In this context, respect is much like trust, it is based on consistency over time. Optimise for trust and respect, then no matter the venture’s outcome and there will be room to re-engage in the future.
Choose to de-prioritise these relationships, and your chances of future engagement are close to, if not, zero.
The early days
Early stage investors are the ones who believe in you as the founder. They back you when a pitch deck and traction from a product held together by duct tape is all you have.
They are family, friends and early-stage investors and they put post-tax money at risk by backing your venture. In other words, they had to earn two dollars for the one they are investing in you.
They make a conscious decision to commit that capital but to say that ‘they know what they are getting themselves into’ is generally a huge cop-out. You can say that about seasoned early stage angel or venture capital investors but not about friends and family.
In any case, before their capital is committed to the venture, founders can be assured of two, self-reinforcing factors.
First, entering into an investor/investee relationship changes the dynamic between those two parties forever. If a startup investment provides a return or at least returns capital, that is a win. However, the more likely outcome is that every dollar will be lost. Founders need to be OK with this possibility and how it will affect those relationships.
There are two things I hate in this world. The first are bullies. The second is having to tell investors that I have lost their money. As I’ve written about before (here and here), if that time comes, the only thing that stands between you and any future relationship is the respect that has been built up over time.
The second factor is the fact that the understanding of what risk actually means will vary significantly between early-stage investors.
No one wants to lose money on their investments, but seasoned investors are more aware of the real risk of losing every dollar and the potential reputation damage that comes with early-stage investments.
Family and friends hope you will pull it off.
They think you’ll be the one or they may not fully appreciate just how much risk is involved in building something from the back of an envelope.
These two factors can be managed through repeated and candid conversations. However, there is a third one that is often only recognised with hindsight.
It’s that these early-stage investors are the same people who are often forgotten as new investors with deeper pockets enter the cap table.
Being too transactional
What I’m about to say doesn’t apply to all founders, but many will be able to relate. I believe in always being in motion on business development to identify and secure new partnerships, customers, hires and investors.
When it comes to finding new investors, it can become more of a numbers game than one of acknowledging people and the risk they are taking. That’s because founders wade through a sea of ‘No’ before they arrive at the few who are willing to engage. And as fundraising fatigue and the desperation to keep their company breathing builds, the numbers, investment terms and closing the requisite number of investors becomes the main game.
There is an unintended consequence of this focus on the current financing round which often affects earlier stage investors. In a nutshell, the risk(s) that they took, in the beginning, get traded-off against the ‘value’ that founders believe incoming investors will bring to the company.
This can play out in many ways but here are the classic hits:
The Rush
Founders provide minimal communications about their venture’s progress and then deluge investors with details of an imminent financing round. The amount of context and questions that need to be asked and answered puts all parties under pressure, including existing terms like pro-rata rights, and when push comes to shove the venture’s survival is in the hands of the founder(s) and incoming investors. As a result, early-stage investors have little choice but to agree to new terms. The unintended consequences of which can be profound.
The Pivot
Like the Rush (above), founders share their thinking and plans to pivot the business model with those who they believe to be their most influential investors. Other investors discover later, often much to their surprise.
The Note
Founders introduce an unfamiliar financial instrument to people with limited startup investment experience and try to convince them of the instrument's merit because the founder isn’t willing to nominate a value for their company. This can happen at the beginning of the venture or at some point in the ventures history.
Whether it be a convertible note or a SAFE (simple agreement for future equity) note, the founder is likely to claim that this is the best option due to a lack of clarity on the companies current valuation. While these notes do have a role to play, many founders don’t fully understand the intricacies and implications that can disadvantage incoming investors, future investors and the venture itself.
The classic issue with notes, particularly convertible notes, and inexperienced investors is that they often end up with less equity than they expected after the conversion event.
Why?
Because the founder either claims they cannot provide financial advice and that the investor should seek independent financial advice (which is true) or, using the previous reason, avoid discussions about specific scenarios with the prospective investor for fear of them not being comfortable with assumptions or their resulting potential stake in the company. Either way, this can leave a bad taste in the investor's mouth.
Respecting early investors
Aside from risk, some inevitabilities come with being an early stage investor. Some of these issues can be forecast, while others fall out of regular conversations. The impact of dilution is one example which can be forecast. Even though the share price will change at each round (hopefully upwards), less experienced early-stage investors will be more concerned with dilution.
The point is that education goes a long way to short-circuiting the potential anxieties that come with uncertainty.
In this context, education comes in the form of conversations that help investors understand the current state and how the strategy is unfolding.
At the other end of the spectrum is no communication or a readily identifiable petering out of communications from the founders. This is a red flag for investors. And because this is a well-established signal that a venture may be in trouble, investors will start forming opinions in a vacuum which is often counterproductive. Especially if this issue could be solved with routine communications.
Avoid red flags with four tactics
I employ four tactics to establish and maintain respect with all, but in particular, early-stage investors:
1. Express the company’s intent - In addition to sharing the opportunity and how you plan to capture it, share how the founders (and other existing shareholders, if any) plan to engage with new investors. This might include the high-level terms (e.g. a standard shareholders agreement), the different share classes (if more than Common Shares), the pro-rata rights available to shareholders and how much capital the venture expects to raise in the next 2-3 years if everything goes to plan
2. Regular status updates via email - This is a simple monthly email update that includes six items:
- Business Update - Cash at bank, Monthly burn rate, runway (based on current burn rate) and headcount
- Our Mission - Your venture is a small part of your investors' life, broken record style reminders are important
- Key Growth Metrics - List the key growth metrics that are being tracked (including last month’s result and a rolling three-month average to help add trend-based context to the data)
- Progress - This section talks to advancements made in customer and partner acquisition, hiring and the development of key relationships
- Challenges - These are the current roadblocks. This makes for especially good reading if investors can see that the founders are leveraging existing investors and advisory board members to solve issues.
- Next Month’s Focus
3. Strategy updates and scenario planning - These are a formal presentation and Q&A sessions done in person or via Zoom with all investors. Think of them as an ‘all hands’ meeting with investors. A pre-read is issued before the meeting and questions about the material are also requested ahead of the meeting.
This provides the team time to formulate responses. Not only does this model help to effectively respond to questions, but it also helps the team galvanise their thinking on particular issues. Pro Tip: Record the session using Zoom for those who cannot make it can listen at their leisure.
4. Ad-hoc check-in calls - I really enjoy time speaking one on one with investors. It's an opportunity to learn more about each other. I make sure I call investors once a quarter. The timing will seam ad-hoc to them, but it’s carefully scheduled in my diary.
One last thing…
Respecting early investors is about developing a relationship to ensure intent and incentives remain aligned. I do not mean for founders to dedicate significant portions of their time to investor relations. I am advocating for setting up routines and rituals needed to keep investors informed.
Entrepreneurship is a craft. You will engage with the same early stage investors time and time again if you create respectful relationships that endure. The best way to achieve that is to give early-stage investors time and air cover to understand the benefits and implications for their ownership of the company.
They expect it and will thank you for it.
HOW TO PREPARE FOR INVESTOR MEETINGS
Preparing for investor meetings is all about communications. Most entrepreneurs think this means writing a pitch deck and practising its delivery. They are 50% correct. The other 50% involves planning to ensure the time with investors is extremely valuable. For the investor, you and your team.
In this post, I am going to share my method for preparing for investor meetings. However, before I do, I think it’s important for founders to stay focused on one part of our job that doesn’t get anywhere near enough air time. Most commentary about the primary role of a founder talks to the importance of hiring and keeping the business funded, either through revenue or financing.
The role that gets lost in startup hype (and I suspect de-prioritised by founders who are busy fire-fighting) is team communication.
For the most part, this is because founders assume that sitting next to each other or being constantly available on Slack means that their team (and board) are clear on what founders are thinking. What compounds this poor assumption is a founder’s belief that their cofounders should intuitively know what to say or how to act just because they have a solid relationship.
In the context of capital raising, the CEO is probably doing the groundwork to identify and set up meetings with investors. Then once an investor meeting is confirmed, the CEO rallies their co-founders around the pitch deck and they briefly discuss who will say what during the meeting.
You might consider this a 'good case' scenario for the founding team.
It's what I used to do.
However, this approach creates only a fraction of the value that could come from 30-45 minutes of planning.
The one expectation I have going into investor meetings
I will walk out with value.
That is the one expectation I have for every one of my investor meetings. I plan and enter each investor meeting with this mindset because I value time above anything else. My time is finite and valuable. So is the time of investors and so is the time of your team.
Walking out with value means one of two things. Either you walk out with a commitment to proceed to the next investment stage (e.g. a next meeting request, due diligence, term sheet negotiation or deal close). Alternatively, you walk out with new insight and knowledge. Ideally, you walk out with both.
But here’s the thing; You can’t expect to walk out of an investor meeting with value without first creating value for the investor.
When I think about creating value for investors, I think about how investors play the information arbitrage game. They are continuously gathering information about industries, business models and how founders are thinking about solving big problems to help make decisions about which ventures to back. The more knowledge and experience they have partnering with and learning from founders, the more likely they are to make well-informed investment decisions.
The bottom line is that those founders who walk out of investor meetings without investment momentum and with no new knowledge or insights have failed to plan.
My template to plan and prepare for investor meetings
There are three steps to this approach. The time investment is 30-45 minutes (excluding time to draft pitch decks and the meeting time with the investor). I also want to stress that this approach is just as crucial for solo entrepreneurs pitching for investment as it is for those of us with teams.
It’s the discipline that matters. The more I do it, the more efficient I become.
Step 1: Research
This step intends to bring co-founders and board members to a common understanding about the investor you plan to meet. This research is delivered via email with as much time as possible before the pre-meeting call (step 2).
Here are the subheadings for the email:
Context (answer these questions)
- Whom are we meeting?
- What is their title and where are they (and their firm) based?
- How are we meeting (in-person or via Zoom)?
- How did the introduction arise?
About the investor
- Copy the blurb from their website that characterises their focus and mandate. Include the investors’ website URL
- List the companies in their portfolio that are in your industry (this provides clues on the stage and types of businesses they invest in)
Meeting Intent
- Describe why the meeting is taking place. There is typically more than one reason to engage with an investor (e.g. secure investment and get access to relationships and portfolio companies)
- List the key questions you want to ask (be specific, and have at least three questions read to ask)
Roles (to discuss on pre-call)
- Outline who is going to say what and who will ask each question
- The first pass of who will be saying what should be drafted by the CEO and then discussed during Step 2 (the pre-meeting call)
Step 2: Pre-Meeting Call
After I send the research email to the team, a 15-minute call is scheduled to discuss the plan and especially who will be saying what during the investor meeting.
Step 3: Followup
Following up is non-negotiable. After every meeting, send a ‘thank you for your time’ email. Moreover, there is always an action that accompanies this email. If the investor expressed interest, then you follow up with more detailed documentation and a suggested next meeting time. If your venture is too early, then you add them to a quarterly investor only mailing list.
Don’t pay lip service to this offer. As I wrote about recently, developing relationships takes time and not following up is a missed opportunity.
Gaining value from ‘thanks, but no thanks.’
Every founder will receive many more NO’s than they will YES’s. And while it is important to plan for when the answer is ‘YES’, as I wrote about last week, I always have two questions ready to ensure we walk out of the room with value even when the answer is ‘thanks, but no thanks’.
The first question: Have you come across any ventures who are trying to capture a similar opportunity to us?
This question demonstrates curiosity, and the answer can result in additional market intelligence.
The second question is: How would you encourage us to think differently about the problem we are trying to solve?
This question demonstrates adaptability, and the answer can help shape strategy.
One last thing …
Planning prevents poor performance. I learned the value of this as a soldier, and I apply it to much of what I do as a founder.
I think about meetings with investors as potently valuable learning opportunities. Value gets generated when you show up and come well-prepared to communicate ideas and your momentum in the context of the investors are of interest.
A small amount of planning not only helps you bring the full weight of your company to the conversation, but it also helps to keep your team and board informed and engaged which they will appreciate.
PLANNING FOR WHEN THE ANSWER IS ‘YES’
The punchline is to plan the four actions you need to take when the answer is ‘YES’. Consider this training to reduce surprise and potential confusion that can come from an unexpected ‘YES’.
Planning for rejection, risk and worst-case scenarios is second nature to entrepreneurs. From the moment the first version of a business model is hatched, we are in de-risking mode. Ten steps back for each step forward. It’s a familiar tune. I love this grind and how it forces adaptation and learning.
I also love being told ‘YES’.
Doesn’t everybody?
There’s nothing better when the grind pays off. Closing a partnership deal, finalising funding rounds, securing that key hire or having a product launch work better than expected makes it all worthwhile.
Founders feel relief and the team embraces the shot of confidence.
What happens next can make a business. Or dramatically stall its momentum.
If a ’YES’ answer is the suck, then go where the suck is
Opher, my good friend and co-founder at AirShr always used to remind me to ‘go where the suck is’. The essence of this statement is to serve people who like what you do. And we followed that advice but we did so carefully.
In early-stage companies, founders invest a lot of time validating who makes up their actual target customers. In fact, most will tell you that moving from a ‘persona on paper’, or who you think your target customers are, to understanding who they really are is much harder than it sounds. But, you have to start somewhere.
When people start expressing interest by wanting to test and buy what you’re selling, there is a natural inclination to listen more to those people.
And herein lies the cautionary tale: Homogeneous customer groups are not (usually) representative of your total addressable market.
Kickstarter and LinkedIn
There are two interesting examples to illustrate this point.
First, consider Kickstarter, the world's largest funding platform for creative projects. While Kickstarter has helped facilitate pledges of more than 4B USD to projects on its platform (of which there have been more than 150,000 successfully funded projects), it is difficult to name 10 household brands that have achieved significant scale from starting on that platform. And while many companies have successfully adopted Kickstarter as their business model (by launching all of their products via Kickstarter), it is hard to scale beyond an early adopter market.
LinkedIn is the second example. As Reid Hoffman described in his Masters of Scale podcast, the early days of LinkedIn attracted a self-organising group called LinkedIn Open Networkers (or LION’s as they became known). This large and at the time growing group believed that they should be able to connect with anyone on the platform. They also believed that everyone would want to connect with them.
That was obviously not true and the LinkedIn team prevented that from happening. The point is that at the time the signal was so strong that LinkedIn could have gone where the suck was but it would have alienated other users and that would have stalled growth. A potentially terminal move.
So the moral of both of these stories and why you should plan for when the answer is ‘YES’, is that if you don’t, you could find yourself course correcting your company to a false plateau. In other words, and in the absence of other recent wins, founders pursue this win as their new strategy.
Being more circumspect about the ‘YES’
More experienced founders might chalk a ‘YES’ up to a small win and continue with the strategy that was already in place. The thing is that when you look at the strategy of most small startups (less than say 2-3 years old), there isn’t really a strategy to refer to.
And as much as first-time founders won’t want to admit it, ambition and milestones are important, but that’s not a strategy.
So whether you have a clear strategy or you’re still working on it, here’s what I do, and I hope it helps. This applies to pitching for investment, negotiating partnership agreements, hiring new talent, engaging with government or elevating public profile (and there are others):
Step 1
Whiteboard the known and (have a guess) at the unknown reasons why the other party would say ‘YES. I do this with my co-founders and board members
Step 2
Detail the items that you think need to be delivered under each scenario. For example, a prospective investor says ‘YES’. If they are now a candidate for ‘lead investor’, what type of information would they need to see in order for them to take on that role and help you close the round. Another example is when an important potential strategic partner says ‘YES’. What information should you have ready in order to accelerate that agreement from a deal into the first value-creating phase?
Step 3
Estimate how long each deliverable will take to create. This includes what tradeoffs you will need to make because you still have the same number of available resources.
Step 4
Communicate each scenario and their deliverables to your team. This is an essential step. There are enough unknowns in your business, your team doesn’t need any more unnecessary surprises as I wrote about here.
One last thing…
This might fly in the face of ‘faking it till you make it’ and ‘don’t build it until you know someone wants it’ but reframe it like this.
You don’t want to be left looking naive, shocked and bashful when a prospective investor or partner says ‘YES’. And you don’t want to appear rash and impulsive to your team or investors by changing tack whenever a user or customer group says ‘YES’.
Plan out the ‘YES’ scenarios and what would need to be made or delivered under each scenario.
Consider this training to reduce surprise that comes from the unexpected ‘YES’. This doesn’t mean you will lose the relief and euphoria that comes with landing that much-needed decision. It means you will be able to respond with a clear head and create the groundwork for more of the same.
KNOWING WHEN TO CLOSE A VENTURE
Two interconnected questions torment founders. Speaking from experience, the first is am I building a great business? The second is ‘how do I know when it’s time to close a business’?
I have been asked the second question a number of times this year. The angst that usually prompts this question is palpable, as is the fatigue and emotion of the founder.
I know that feeling.
The reality is that if you choose company building as your craft, you will face into this issue multiple times in your career.
In the spirit of dialling down the taboo around this issue, here is the framework I use to answer this question. It begins with understanding that this decision is often complicated but not complex.
Complexity & Complication
These two words are often used interchangeably, making the decision more psychologically taxing.
The punchline is that unlike starting a business, deciding to close a business is a complicated problem to solve, not a complex one.
This distinction is important because it helps the founder to realise that whilst this decision is laced with a cocktail of emotions, it is a problem that can be solved.
I like how Rick Nason explains it. Complicated problems can be hard to solve, but they are addressable with rules and recipes or with systems and processes. However, the solutions to complicated problems don’t work as well with complex problems.
Complex problems involve too many unknowns and too many interrelated factors to reduce to rules and processes. He goes onto explain that a technological disruption like blockchain is a complex problem. A competitor with an innovative business model — an Uber or an Airbnb — is a complex problem. There’s no algorithm that will tell you how to respond. And that’s why experimentation is used to pave ways through complexity to build a business.
Framing the decision to close
Armed with the knowledge that the decision to close a venture is a solvable (i.e complicated) problem, I use four principles to frame the decision.
1. It’s an internal decision
The decision to close a business is one for the Directors of the company. In most startups, the role of Director is synonymous with founders who will often also be significant shareholders. While this interplay between investors, founders and Directors can make for multiple and sometimes confronting conversations, the rule stands that Directors must act in the best interest of shareholders.
This means two things.
First, as compelling as they might be, external voices don’t make the call to close a venture. The views of customers, users, suppliers, the media and the community built around the company are inputs. This is easier said than done given the investment made to bring them along for the journey.
Second, and in the case of smaller startups where Directors and shareholders are one and the same but with unequal ownership, majority shareholders can exercise rights which can be at odds with minority shareholders. Playing by the rules established in the beginning is important.
2. People aren’t using your product or they are criticising it are not reasons to stop
For the record, these are not reasons to close a venture.
All businesses face headwinds. Iterating, learning and coping criticism is par for the course.
Healthy perspective and capital are needed for entrepreneurs to deliver on ambitious visions.
Break down these two ingredients, fatigue compromises perspective. If you are extremely tired and all you can do is think about your business, take longer than a weekend to get some rest and be with people who make you laugh.
On capital, an entrepreneur's speciality is securing resources and capital to make things happen. The question is: Has everything (and by everything I mean legal and won’t break the business) been done to secure capital to extend your time in market?
If No, then keep trying.
If Yes, entering the conversation to close the business may be needed.
3. How out of ideas are we and are they working?
I don’t often see the first incarnation of a product work well straight out of the gate. In fact, we spend a lot of time iterating and experimenting. This is fine until what you’ve built doesn’t resonate with the intended target audience and you run out of ideas (and/or money) to continue iterating.
What I think happens more often is that the founders and their teams realise, while there is still money in the bank, that their product isn’t working as expected. By definition, they have a little bit of gas left in the tank to course correct or pivot. This sounds good until they realise that their well of ideas is dry. I’ve been here before and it turned out to be a consequence of fatigue compromising perspective. In this case, bring in, if you haven’t already, mentors and investors to help ideate. It can make all the difference.
Three eventualities can arise from this situation. First, investing the remaining capital and resource into the new ideas and it works (no need to close). Second, no ideas result from ideation and the company has residual capital left over. Third, investing remaining capital and resource into new ideas that don’t work. In the latter scenarios, discussing how to close the business and return residual capital could be the next step.
4. Is your heart in it?
This is the issue people talk about least. At some point, founders can hit a threshold where a change in circumstance adjusts their perspective on the problem they set out to solve.
It can be a gradual buildup of signals they receive which leads them to this threshold. Or, they might wake up one morning and know that they’ve had enough. Importantly, the company could be performing poorly or doing quite well.
Either way, this threshold is best recognised by asking one question: Is your heart still in it?
The answer is binary. Good news if the answer is ‘Yes’.
If the answer is ‘No’ and you’re relatively well rested, the two next immediate thoughts are likely to be, ‘what will [Insert Name A, B, C ...] think?’ And ‘how will I tell them?’
Not being part of your business might be a good thing, it may complicate the business or it might mean the business needs to close. No matter how this plays out, always adhere to the founders’ cardinal rule. No surprises.
One last thing ...
In a post that I wrote called ‘The Rules To Follow When Winding Up A Venture’, I talk about how making decisions comes with the territory of being an entrepreneur.
If you make company building your craft, closing a venture won’t happen once. It’s also important to understand that your ability to start future businesses that require investment and teams to grow largely depends on how your reputation survives the closure of businesses.
When the time comes to call it a day, be radically candid having done everything to make the model work without breaking your family or the law.
Be remembered as that founder.
Live to fight another day. Because as I’ve heard time and time again, being an entrepreneur is a numbers game and all you need to do is get it right once.
FINDING FUNDING: HOW TO FUEL GROWTH
Jo Burston and I spoke in Canberra at an event called 'Finding Funding - How To Fuel Your Growth' today.
Here is the slide deck from the event as well as the blog post and podcasts I referred to during my session.
Slides - Finding Funding
Resources
- 11 Things You Don't Know About Raising Capital The First Time Around
- How Do I Raise Money For My Startup?
- How Founders Should Think About Money
- Founder To Founder Podcast
- Masters Of Scale Podcast
I hope you find them useful!
If you would like me to speak at your event, take a look here.
HOW FOUNDERS SHOULD THINK ABOUT MONEY
The punchline is that money needs to survive three tests when you’re an entrepreneur.
I raise this after troubling conversations this past month which left me thinking that most first-time founders don't know how to think about money.
While the reasons vary, I think the core of this issue lies in how people have received and valued money in their lives before taking on investment.
People Invest For Different Reasons
It's important to understand why people invest in ventures. There are three macro-level reasons.
Friends and family invest as a means of encouragement. They don’t often expect a return on their capital.
There are professional investors who make risk-adjusted commitments. They expect growth and a return.
And then there are those who invest because they like the problem and believe you’re the right person to solve it.
However, as soon as the money hits the account, regardless of investor motive, the companies commitment to its investors becomes real.
Four Post Financing Thoughts
Founders tend to have four thoughts in quick succession as soon as they close a financing round.
1. I’ve never seen that much money in an account before
Celebrate it because it was likely hard won.
2. Time to get started and I hope this capital is enough
It probably won't be. More often than not the amount raised is less than ideal. This means that compromises have been made against original estimates and now the real work begins to make each dollar stretch three times as far.
3. I’m going to keep my investors informed, I owe that to them
I want to point out that this is the wrong way to think about investors.
‘Keeping investors informed’ suggests the development of a monologue between entrepreneur and investor. In doing so, entrepreneurs cut themselves off from the non-cash value that investors bring to the table.
Notwithstanding their motive, investors engage to increase the likelihood of your venture succeeding. They expect to be informed but the best investors also want to contribute experience and expertise to help solve problems and remove roadblocks.
They can end up being a secret weapon and that’s why maintaining a dialogue with investors is vital.
4. I guess I can’t do what I like anymore
This can be a jarring realisation. The capital was committed to deliver on the plan and team subscribed to by investors. And some founders can think this means they have to strictly adhere to their plan.
The reality is that (most) investors are firm on the mission but flexible on how to achieve it. That’s why they back the entrepreneur. They expect them to have a better ‘on the ground’ perspective and an experimentation-led approach to learning as quickly as possible to drive growth and momentum.
Does this mean you can’t take gambles with product and marketing initiatives?
No, but it means you’ll need to make sure it tracks towards the mission and that the decision can be explained.
Three Money Management Tests
Investors expect their portfolio companies to carefully manage capital. This is easier said than done for entrepreneurs with limited financial management experience. And it’s for this reasons that entrepreneurs need to survive three important tests.
The Daylight Test
The first is the daylight test. This is the ‘is it appropriate to spend this money on this item’ test. When expenses see ‘daylight’ they are often being interrogated by co-founders, accountants and investors.
This can be straightforward or be confronting. And it’s often the latter because how much to spend on any item is surprisingly subjective and based on experience.
This is compounded by the unspoken expectation when founders and first hires come together that there is some intuitive, pre-existing benchmark for spending.
It’s a mistake to assume a benchmark is understood or even exists.
Serial entrepreneurs understand frugality. They have developed a habit for processing the financial trade-offs that come with battling ever shortening runways. For them, every dollar counts.
Those who join or form their first startup from a corporate or government career have different experiences and context.
The money they spend is often regulated through their procurement department. These people source the best deals with preferred suppliers that are appropriate for the business. Although this helps staff get on with their day job, these procured standards create expectations about the ‘reasonableness’ of expenses. And in some cases, it even desensitises people to the actual cost of goods because the expense isn’t hitting their pocket.
This might be ok for that business but there’s a good chance it won’t work in a startup.
Hotel accommodation seems to be the best item to help level set teams about expenses.
I’m not sure why, but setting the upper limit for accommodation (say $150 per room per night) seems to quickly align teams on the general standards for spending company cash. But it shouldn’t stop there.
While teams should develop habits for acting (and spending) like an owner, they shouldn’t be left to work it out on their own. Take the time to set expectations on can be reasonably spent and what thresholds trigger a conversation with managers or founders.
The Trade-off Test
The second is the tradeoff test. This is the more straightforward of the three tests and I use (and have for some time) engineering hours as my tradeoff value.
In other words, I think about the opportunity cost in terms of how many engineering hours I will forfeit if I invest in something else.
It is not a perfect measure and it does reinforce my belief that the ability to scale is reliant on robust products. The point is that engineering hours provides me with a useful yardstick to help me determine trade-offs.
The Core Metric Growth Test
Every venture has a core growth metric which is the linchpin for its business model. It’s not a suite of measures or a vanity metric like the number of users (or any other chart that easily climbs upwards from left to right over time).
The metric is often revenue growth.
And this test focuses on whether or not spend by the venture is focused on increasing the core metric.
A ‘fail’ for this test occurs when direct or indirect paths to revenue growth are not clear to investors.
One last thing ...
I remember seeing the balance of the company bank account after the seed round closed at our previous company. It had been an arduous effort and while we were exhausted we still marvelled at the balance.
After that we made sure our capital survived all three tests and today, we do the same at inkl.
If your venture has just raised money and never talked about how to spend it, have that conversation and go one step further, ask each team member to come up with their own trade-off test.
Finally, provide each team member with permission to ask ‘how will this increase our [insert core growth metric]?’ when the team is exploring a new initiative or assessing an existing one.
It will save a lot of time and potential angst in the future.
BE WARY OF THE 18 MONTH RUNWAY
A company’s runway is the amount of time it can survive based on the cash it has in the bank.
While the struggle is real for established cashflow businesses and investor-backed companies that are yet to prove their business model, entrepreneurs who decide to raise capital are left to answer a difficult question: How much capital should I raise from investors?
Two schools on how much to raise
The first is to raise only what you think you need.
You Google ‘budget template’. Download it. You enter your estimates for year one through to year five, add some contingency and decide that you need to raise $X to achieve specific milestones to demonstrate traction.
This is a frugal plan. It’s designed to keep the business lean and not give away too much equity in the company.
The second school of thought is to raise more than you need.
While the budget construction might be the same, I think about the final numbers as the minimum I need. And instead of raising that amount, see how much capital I can raise above it.
While investor demand will ultimately determine how much I can raise at a given point in time, I follow the second school for three reasons.
First, building a company is unpredictable. It almost always takes longer than expected. Raising more capital means you can weather storms for longer.
Second, and for a similar reason, it’s important to have the capital to pursue opportunities you can’t see coming.
Third, I focus more on value creation and less on dilution. The right investors will help a company grow into a huge business and I expect to depart with ~20% of the company at each round.
The bottom line is that businesses don’t usually grow without a capital injection at some point. I prefer to own a proportion of something huge instead of a 100% of nothing.
Why 18 months?
Investors usually expect to see traction within 18 months of capital being raised.
It’s a convention based on the experience of angel and early-stage venture capital investors.
And while 18 months may seem arbitrary, it is usually enough time to test and learn and arrive at the first base of your product/market fit.
I call it first base because contrary to popular opinion, product/market fit is not a fixed milestone that ‘gets achieved’.
It is a continual pursuit which changes each time a company attempts to scale.
This is usually because products behave differently in different markets and while technology tries to solve for it, one size rarely fits all.
When it comes to raising capital, traction rules. Companies that develop compelling traction or learning after the first 18 months will raise more capital with relative ease.
Those funds will scale product and marketing and if timing, team and luck align, the company will be on track to achieve the next stage of growth.
However if traction is lacking, the 18-month runway goes out the window. In this case, all manner of survival techniques gets deployed. And this can last for a very long time.
Always expect the latter scenario to play out, as it does in 90% of startups.
Seed is a phase, not a round
If there is one thing that entrepreneurs get worked up about it’s the ‘stage’ of their company.
The stage of a company is typically judged on how much capital has been raised and the amount of traction that capital has yielded over the companies lifetime.
And the reason this is such a touchy topic is that up until a few years ago technology investors expected entrepreneurs to follow a relatively linear path when it came to raising capital.
It would go something like raise a small amount of capital from friends and family.
Then you would raise a ‘seed’ round of capital (e.g. $250K) that was based on momentum and opportunity. After the seed round and more traction, you would then raise a ‘Series A’ investment ($2M - $10M) and then larger rounds after that.
The punchline is that investors (and entrepreneurs) are turning their attention to the fact that ’seed’ is a phase, not a round.
In other words, the last decade of startup growth has shown that traction can take longer than expected.
And as the early-stage venture investor, Hunter Walk recently wrote:
Asking founders to prematurely perfectly forecast the amount of capital they need to get to a Series A is an unnecessary constraint.
He goes on to say:
Startups are raising more total dollars, in various configurations, to get to the point where a strong Series A can occur.
This takeaway for entrepreneurs is simple.
- Your company can raise multiple seed rounds providing it continues to demonstrate traction and learning, and
- If you don’t know what to ‘call’ the round, just say your company is raising capital and let your traction tell the story.
Don’t let the 18-month runway mask the marathon
Building a company is a marathon, not a sprint. But here’s the problem. Most people have never run or trained for a marathon. All they know is how to sprint.
A marathon in company building terms is ~10 years. That’s why investors look beyond technical skill and pedigree and carefully examine the resilience and tenacity of founders.
A number of early-stage investors I know ask first-time founders point-blank where they see the company in 10 years.
Predicting where or what form a company will take in a decade’s time isn’t the point. Investors don’t know and neither do founders.
It’s about seeing if the founder flinches at the first sign of commitment because even if an exit appears within five years, it sure as hell will feel like 10 years (if not longer) by the time that deal is done.
One last thing...
The very important thing to remember when raising capital is that the current round is just the capital you need at the moment.
In the 10-year marathon to build a great company, 18-month runways are the short term chunks of time to demonstrate momentum.
Chances are it will take two or three of these chunks to begin realising the potential of your product.
The best entrepreneurs always find ways to accelerate momentum. But even the best, because they are building something new, fall prey to a shortage of capital to manage unexpected issues or capitalise on unforeseen opportunities.
Think about time. How it’s your most valuable asset.
When the company grows beyond your wildest dreams you will have learned a lot.
When the company fails you will have learned a lot.
Raise more money than you need.
Focus on creating value with extraordinary investors and worry less about dilution.
EXPLAINING GROWTH
Growth is explained as a story of metrics.
They are the bullet-point metrics that founders rattle off to anyone else who asks to provide a brief snapshot of progress.
And for the most part, it’s relatively easy for businesses who have survived the first three or so years to know which metrics make up their traction narrative.
It’s not that simple for early-stage ventures.
During the early years, founders do one of two things in relation to measurement; fixate on one or two venture-specific metrics that are tied to their original thesis, or they leave metrics for another day and rely on qualitative events that take place.
Neither of these work for an early stage venture.
Most founders will tell you that while the thesis may remain the same or similar from day one, the customers, products and distribution channels inevitability change. These changes usually make the one or two metrics the company started tracking from day one inappropriate or obsolete.
And ventures don’t survive on qualitative insight alone.
I think it's important for ventures to capture as much useful data as possible from day one. And because it can take a while to work out what is worth measuring, I look to one measure which is universally important for all ventures.
Revenue Growth Rate
The revenue growth rate is as much a mindset as it is a quantitative metric. It is the speed at which revenue increases (or decreases) each week, month, quarter or year but it also:
- Focuses founders on the importance of revenue (which can get lost in the depths of product development and marketing)
- Applies to ALL business models (including marketplaces) regardless of the age and stage of a venture
- Aligns founders on the value of time and the rate at which their business is developing
The subtle message for early-stage businesses is that revenue growth rate should be the ‘light on the hill’ metric from day one.
It is the one metric that should be front of mind as work begins on figuring out what to measure in growth experiments because revenue solves a lot of problems. And the faster revenue can be generated, the quicker the business can deliver on its vision.
My colleague Garry Visontay talked about this in a recent post.
Explaining growth
Growth usually requires investment. And when it comes to external investment, founders need to think carefully about how to approach investors.
Revenue growth rate and other key metric growth rates metrics play an important role in convincing investors to commit. This is more difficult for pre-revenue ventures trying to close a ‘friends and family’ or seed round of funding.
When grappling with how to demonstrate momentum pre-revenue founders make the mistake of presenting one or two metrics that they hope will look convincing to investors.
I’ve heard founders say ‘Facebook only uses two metrics (User Growth and Time Spent On-Platform) to describe their growth’.
The truth is that works one out of ten times.
A two-measure traction story usually only works when ventures consistently achieve product/market fit at scale.
Instead, I encourage founders to move into funding rounds with a revenue growth rate mindset and a collection of traction-related stories using these six themes to demonstrate momentum in their startup.
1. Revenue
If you have it, show it. Convincing people to pay for a product or service is one the greatest challenges for new businesses. It's also one of the strongest lead indicators of growth.
2. Customers
Obviously, customer growth is tied to revenue growth and it may be more important than revenue if the company is pursuing a massive opportunity and charging a small price.
WhatsApp charged 1 USD/user/annum prior to being acquired by Facebook February 2014. At the time they had 430M monthly active users.
3. Users
User growth and retention, insights about user behaviour and the proportion of users converting into customers are an essential part of showing off a freemium model.
4. Partnerships
Partnerships are the most efficient pathway to growth today. Ventures that operate single actor business models (i.e. you sell to one customer at a time) benefit from distribution partnerships.
Ventures that generate value through a marketplace model (e.g. inkl which creates convenience and value for news publishers and readers) benefit from both supplier and distribution partnerships.
Founders should use Memorandums of Understanding and partnership agreements as evidence of growth through partnerships.
5. Reviews
Although a more qualitative approach, reviews should not be underestimated, particularly if you sell or produce software. App store reviews and testimonials on websites can send a convincing message that there is a there, there!
6. Experiment Outcomes
This is one of my favourites and in my opinion, isn’t put on show nearly enough by founders. Hypothesis and data-driven founders often discover how to grow their businesses well in advance of those who use less structured approaches.
Presenting insights from key experiments that demonstrate not only progress but a replicable discipline to assess opportunities is very useful.
I also encourage founders to share the number of experiments currently underway when talking to investors. It often adds an additional layer of depth to the relationship and helps the founders stand out.
One more thing
Use a ‘revenue growth rate mindset’ and a collection of traction stories to explain growth. It helps investors understand the effort and holistic approach being made to find product/market fit and grow the business.
It also helps investors identify opportunities for how they can add value beyond capital (e.g. helping to accelerate the closure of a deal or helping optimise sales funnels).
The final thing on explaining growth is to know your audience.
The best investors have enough experience to know the challenges you’re facing and how likely you are to negotiate them. Don’t bullshit them with expressions they will see right through or charts that always paint your venture in the best positive light. It’s one thing to hustle. It’s quite another to develop a relationship.
Be authentic, show ambition and demonstrate you have what it takes to achieve the mission. Using a revenue growth rate mindset and a collection of traction stories to demonstrate growth has helped me many times. I hope it helps you too.
PRESS RELEASES ABOUT FINANCING ARE LIGHTNING RODS FOR STARTUPS
Press releases that announce startup financing are a future lightning rod for founders, they just don’t know it at the time.
It's easy to understand the reasons behind these announcements. Raising capital is a long and agonising road for entrepreneurs.
When you close a funding round issuing a press release to celebrate the milestone may seem like a natural conclusion before you get back to work.
And there can be pressure to follow through with this idea. It can come from team members, investors (although rarely in my experience) or from a member of the startup press who learned of the round from a third party.
The reality, however, is that founders are often too elated and exhausted having found a way to finance their company to think through the medium-term implications of the information they’re about to make public.
I have felt that elation-exhaustion mashup many times and not once have I issued a press release about a financing. Here's why and I hope these six lightning rods serve as a caution to founding teams.
1. The moment news of the financing is published, the company’s valuation is public
Press releases are like calling cards and as time passes, they become historical markers. As soon as they are published, whether you like it or not, the market quickly forms their view on expected future growth.
And the omission of a specific valuation in the press release won’t matter. Interested parties will connect the dots between presentations, blog posts, tweets and other online collateral. When you combine this information with the amount raised, stage of the business and estimates of traction from competitors and it’s straightforward to estimate the valuation.
But here’s the kicker, it’s not the current valuation that’s of interest.
Today’s valuation sets the benchmark for the next round of funding.
This means that if significant traction isn’t achieved between the current financing and the next, new investors or acquirers may be in for a bargain as the company tries to raise financing at a similar valuation or a more dilutive down-round.
2. Earnings now need to correlate to the valuation
The valuation of a new venture is often based on the ‘stages method’, a strangely accurate approach used by angel and venture capital investors.
The stages method helps ascribe a value to a company that doesn’t yet have meaningful cash flow.
At some point, this method gives way to more conventional valuations based on current and projected revenue growth rates.
Although there might be good reasons why revenue isn’t growing at a rate consistent with the valuation, the reality is that raising further finance will be difficult.
3. Pivots will require greater explanation
Pivots happen all the time but any pivot the company makes between financings will require further explanation if high-level details of the strategy are included in the press release.
4. Competitors also get the memo
Whether you care about competitors or not, they see your press releases too.
Companies also mulling market entry now become more aware of your progress. In any case, it’s a double-edged sword.
5. At best customers won’t care. At worst, they will.
I encourage founders not to lose sight of the fact that a financing, while a massive achievement, is the result of convincing a relatively small group of people that you’re worth investing in.
Customers and users probably won’t understand or care about the significance of this event. And that’s good. However, a press release may inspire a different line of questioning about the underlying sustainability of the business.
6. The public relations payoff rarely meets expectations
Instead of getting back to work and putting new capital to good use, small teams can invest time agonising over the press release’s phrasing and distribution.
Once it’s published, it’s a gamble whether a news outlet will pick it up or not. This gamble may create the right type of attention and you get swamped with new users and customers.
You might have seen this happen. I haven’t.
Closing thought
I'm not saying that all mentions of financing events should be excluded from a startup's external communications. They are an important aspect of creating confidence and should be used as part of a predictable value creation story where significant uplifts in customer growth and revenue happen soon after a financing closes.
The bottom line is communicating value creation (instead of valuations) is the best investment in public relations for new ventures.
It might mean that public momentum-related announcements are few and far between but substance matters.
In any case, I think it’s a mistake to think that press releases about financings are marketing for startups. They are the PR equivalent of vanity metrics. And rarely do good things comes from vanity alone.
THE RULES TO FOLLOW WHEN WINDING UP A VENTURE
Winding up a venture is awful.
It’s one thing to make a public announcement that things didn’t work out as planned. It’s quite another to finalise the decision.
There is an assumption amongst the uninitiated that ‘winding up’ happens in the same way that you close an online account. There are times I wished it was that simple.
A painful reality of entrepreneurship is that winding up happens multiple times during a company building career.
This month my previous venture, AirShr, will be finalised. Although I’ve been here before, it’s still a bittersweet experience.
Events like this remind me that we achieved the incredible but for all the blood, sweat and tears, we couldn’t stay in market long enough to achieve the extraordinary.
And while lessons and experience are carried forward, the reality is that people invested time, opportunity cost and hard-earned, post-tax money to pursue a vision.
Founders, team members, investors and followers of failed ventures process the outcome differently. Some act dispassionately and it’s understandable why others don’t.
Falling short of expectations and having little to show for the effort is hard, sad and disappointing even when everyone claims they understand the risk at the start.
Own it because it won’t be the last time
If you’re a maker, someone who loves finding another way and creating a new order, you will launch another venture. And the one factor that will precede that venture and everyone after that is reputation.
As I’ve written about before, reputations are built on the interactions people have over time. Reputations are easy to maintain when partnerships, product and traction is developing BUT they are made or broken in times of stress and ambiguity. Making the call to wind up a venture and face the music is one of those times.
There are two sets of rules to follow when winding up a venture
The first set of rules are well-established and take place every day. Lawyers and accountants shepherd founders through these standard rules and for the most part they are black and white.
The second set of rules aren’t as straightforward.
When shareholders come together one final time to write-off their investment, they will look forward (and expect) to close this chapter of the relationship in the same way it began, with respect, candour and courage.
Obviously.
But there was a time when I struggled with the obviousness of this statement. When I wound up my first venture I was still grieving its loss. I had played an exclusive role in its failure and I didn’t think my investors and I would cross paths again.
Hindsight proved that to be short-term thinking.
In fact, there’s an excellent chance that somewhere down the road you will interact again with co-founders, team members and investors. You won’t know how this will play out until it does but one thing is certain. It will only happen if your reputation, and by extension the relationship, is intact, no matter how big the hit was to your ego or self-confidence when you initially parted ways.
With this in mind, here are the second set of rules.
1. Fight to preserve relationships
This should be the opening gambit for anyone involved in the venture. You engaged with them in the first place for good reason. The relationship may have changed but you don’t know what the future holds. At worst, you part ways amicably. The best case scenario is you realise there’s value to be had in partnering again in the future and at some point you make it happen!
It might not be realistic to save every relationship but that’s not the point. The point is that this is a mindset as you enter a difficult situation.
2. Tell the truth, especially if it is unpalatable
The right thing to do is always the right to do. There is no point in bending the truth or embellishing even just a little. And especially not at this stage in a venture.
Just be upfront. It pays dividends.
3. Absorb disappointment but seek comfort away from the situation
Expect there to be residual frustration, disappointment or sadness at windup and for a period afterwards.
It’s human to be upset and if emotion is directed at you, it’s likely to be a byproduct of a grieving process.
4. Over communication process
Winding up a venture usually requires unanimous shareholder agreement. And while the legal and accounting processes are well established, unexpected issues can arise. So to ensure a difficult situation doesn’t deteriorate, over communicate with shareholders and provide weekly status updates as the company moves through its final stages. It will be appreciated.
5. Acknowledge the reality and stay humble
Although it may be painfully obvious during the process, remember that no one wants to wind up a company. Acknowledge the reality and remain gracious and thankful for the investments in time, money and energy that people have made. It is essential to extend these signs of respect.
Closing thought
Difficult events like winding up a venture expose people’s true colours. Results aside, this stage of the journey will reveal to investors if they did in fact back entrepreneurs with courage and integrity. Similarly, founders will soon understand if they accepted money from the right type of investor.
Whether you’re an investor or an entrepreneur, perhaps look into the future and imagine winding up a venture with people whom you’re about to engage. What are their true colours at that point?
HOW DO I RAISE MONEY FOR MY STARTUP?
Raising capital is part process, part endurance event. Like every event that requires sustained performance, preparation is key and like every process it can be optimised. But before you start thinking about capital raising as a linear experience, remember we’re talking about startups where ‘linear’ is fictitious and one-step-forward-five-steps-backward is normal.
This post is the follow-on to 11 Things You Don’t Know About Raising Capital The First Time Around.
Here are the five steps I use to approach raising capital. It’s born from experience and driven by the single most important element in company building and the currency that is always in short supply and constantly running out – time.
1. Design The Path To Yes Or No
The rate at which you can achieve a ‘Yes’ or a ‘No’ from prospective investors is the product of a well-designed process to reveal their interest. In a world where timing is everything, the best early stage investors make investment decisions quickly because they understand the opportunity cost of your time and their own. However when there is a mix of investors, all at different levels of sophistication and all with varying priorities, it’s up to founders to design a path that enables each prospective investor to make an informed decision as quickly as possible.
Think of the path as a series of events. The faster these events play out, the faster investor interest can be gauged which drives the pursuit of funding alternatives and/or (ideally) the closing of a financing round.
I break these events into two groups and track progress in a Google Sheet so that co-founders can understand progress, on-demand.
Pre-Term Sheet Events
These events include introductory and early due diligence conversations with prospective investors up to the point at which term sheets are signed. This is the phase where social currency is established (i.e. where a collective of prospective investors begin to ‘buy-in’ to the business model which propels other investors to also engage) and conversely where the majority of “No” responses are received.
Although the size and stage of investment influences the number of conversations required, this is the guide I use for seed stage investments:
- Introduction + Pitch — First Meeting
- Follow-up 1 (within 3 days of first meeting): A phone call to gauge interest, offer to provide additional insight and politely ask when you could expect a response. If interest is high, offer to send term sheet. If interest is low, see below — If the answer is “No”, get there quickly.
- Follow-up 2: Timing for this meeting is dependent on the outcome of the second meeting. If no response is received from the first follow-up attempt, try making contact six days after the first meeting.
- Follow-up 3: If no response is received from the second follow-up attempt, try making contact 10 days after the first meeting. There can be a number of reasons why a prospective investor may not respond by this point. If no response is received from the third attempt, try making contact one final time at 20 days after the first meeting.
Obviously, following up can also be done by email but a phone call often yields a more direct response. Remember, timing is everything. Email is easily lost and can be used as a convenient excuse for not responding.
Post-Term Sheet Events
These events are largely process-oriented. Incoming investors have signed a term-sheet and undertake any remaining due diligence. From this point forward, a lawyer well-versed in start-up financing (let me know if you need a referral) helps guide founders through well established processes to formalise agreement between existing and incoming investors.
The rate at which these events are finalised is based on the preparedness of the lawyer and readiness of investors to review and electronically sign legal documents.
If the answer is “No”, get there quickly.
Remember that most people’s default is avoiding confrontation or awkwardness when it comes to declining an opportunity to invest. This can be one of the biggest (and most frustrating) time sucks as you try to assess who is likely to join the investor team. So remind each prospective investor it’s OK to say ‘No’ and that it avoids wasting their time (and yours) and advances the round by helping to focus on other prospective investors.
The obvious caution here is presenting the ‘No’ option in context. I recommend using something like this during the second or third meeting: “We’d love you to join [venture] as an investor. We really appreciate the consideration you’re giving this opportunity and we’re happy to answer all questions and supply additional materials to assist with your decision. However, if you’re leaning towards not investing it would be great to discuss this as well.”
If ‘No’ is the ultimate answer, positioning the discussion in this way will precipitate the right conversation. And remember, ‘No’ only ever means ‘No’ at that point in time. The world changes too quickly to accept ‘No’ as a terminal response.
2. Be Investment Ready
This means presenting a compelling narrative about the experience you are creating and it’s underlying business model. And to be taken seriously this narrative must include traction. In support of this deck, a prospective investor should be able to access a product demo, a term sheet and the existing shareholder agreement (if a company has already been incorporated) – on request.
Expect that your deck will evolve the more you pitch but don’t make the mistake of thinking it’s OK to cobble together product demos, a term sheet (or shareholder agreement) as investors begin to express interest. Be organised to respond to investor interest, it will help accelerate the closing of your round. Alternatively be aware that if you’re not investment ready, there’s next to no chance of raising capital.
Should I write an investment memorandum? comes up from time to time. Generally, at seed stage the answer is no because it’s considered a nice-to-have or overkill. An IM is typically a 30+ page document that goes into extensive detail about a venture. We wrote one for AirShr because we wanted an added layer of depth to our narrative. Our investors have appreciated it.
3. Identify And Engage Prospective Investors
When the right investors are matched with the right investment opportunity, a deal can be reached and a financing round closed in a matter of days. In most cases however, the process of identifying prospective investors starts with desk research.
So, open a Google Sheet.
Add ‘Name’ in cell A1.
Add ‘Value They Can Bring’ in cell B1. This is the expertise and relationships (beyond capital) that an investor can bring to your venture — be as specific as you can.
Add ‘Early-Stage Investment Experience?’ in cell C1. There is a subtlety to this column that all founders should be aware of. It’s rare to find someone with early stage investment experience who, at one time or another, hasn’t lost money or had a poor experience investing in a new company. I think it’s useful to assume everyone with early stage investment experience has been burned at some point. Approaching prospective investors with this mental model has helped me ask probing questions like “Given your experience as an investor, what factors matter the most to you when deciding to invest?” and “What three pieces of advice could you offer to us, as a new venture, to make the next 18 months as successful as possible?”. The answers to these questions usually leverage their experiences (good and bad) at other ventures. The insight is typically very useful and asking these questions demonstrates an appetite for learning, an essential capability of great founders.
Add ‘Relationship’ in cell D1. This is the name of the person who can make the warm introduction to the prospective investor.
Now, spend a day with your co-founder(s) working through LinkedIn contacts (both 1st and 2nd connections), address books and emails communications. Add people to the Google Sheet who make sense to contact as prospective investors based on the strategic value they could bring (column B) and their investment experience (column C).
Context drives engagement
The wise man who once said “context is everything”, was right. Anchoring a meeting request with a prospective investor to an area of mutual interest or a mutual acquaintance (or better yet an introduction made by the mutual acquaintance) is the most productive way to creating that all important first meeting. This, combined with short and punchy detail about the value proposition, the fact you’re seeking investment of $X and a link to a product page or pitch deck, helps the recipient make a quick determination about how to respond. After all, you need to assume they know nothing about you or your product and only have 30 seconds of concentration (at best) to apply to the email when they read it.
It’s also OK to politely follow-up once each week for three consecutive weeks if you don’t hear back. The best early stage investors usually respond quickly to progress (or decline continuing) the conversation.
4. Hustle To Close
Notwithstanding the need to carefully review and execute legal documents after signed term sheets are received, establish a process and timeline to close the round with your lawyer and communicate this to each investor.
The hustle demonstrated when shepherding prospective investors from first meeting to signing a term sheet must continue to close the round. And like the speed and focus with which the company will grow, it’s up to the founders the drive this.
5. Move To One Team
On closing a financing round it’s likely that incoming investors haven’t met ‘the rest of the family’. Although time zones and schedules might not align, it’s important to formally welcome and introduce new investors to existing investors and leaders at the venture. Ideally, this is done in person but it can also be done via conference call or email if a face-to-face event isn’t practical.
This is the first step to unlocking the potent combination that comes with mixing strategic investors with entrepreneurs. And this initial communication (and regular ongoing engagement via events, monthly or quarterly email updates) sets the tone for how the team, as one force, will help grow the company.
This might seem obvious but in the cut and thrust of every day, these investments in building a team of supporters who have a vested interest can be overlooked. The events and communications that draw the best feedback from investors aren’t lavish but ones filled with insight, radical candour and, if needed, specific requests of support to investors.
Remember, if you’ve selected the right investors they will be 100% committed to your success and will be open to providing support however they can. That’s why they backed your vision and your team in the first place.
11 THINGS YOU DON'T KNOW ABOUT RAISING CAPITAL THE FIRST TIME AROUND
It takes you away from shipping product, building partnerships and hiring the best available talent. And there is no question that bootstrapping a startup is THE way to go but for at least 70% of founders the need for capital and strategic assistance to take a product to market is essential.
Raising capital is physically and emotionally intense.
It will take longer than you think and you will be told ‘No’ many more times than ‘Yes’ and until the deal is closed even a initial ‘Yes’ is usually ‘Maybe’ (at best). You will call into question why you’re putting yourself through this process and there will be times when walking away looks and feels like a very attractive option. This is part and parcel of entrepreneurship. It’s opt-in, remember that.
Although raising capital can take it’s toll the good news is that, like anything, you become better with practice. But like everything there are retrospective ‘if only I’d known’ insights that can make life a little easier.
So here are the 11 fundamentals I’ve learned based on my experience (read: from serious rookie mistakes to closing rounds and everything in between) at AirShr and other ventures, and supporting other founders in their financings.
1. Raising capital is about relationship development
When you ask people for their hard-earned money to support your vision expect that you are walking into a 10-year, one-to-many relationship. Rarely does it take less than 10 years to grow a great company and by one-to-many I mean that there will be you and your team and a collection of investors who may or may not know each other in the beginning. As you move from one milestone to the next (and endure the inevitable one step forward, three steps back approach to achieving product/market fit) the management and investor teams become one and endure the journey together.
This relationship can only be based on trust, respect, candour, and regular, authentic communication. And each investor relationship begins with an introduction that signals an opportunity for a mutual exchange. And mutual doesn’t always mean equal, after all there is a power imbalance between investors who have resources and entrepreneurs who need them. In the context of mutual exchange it means that the entrepreneur may be able to access capital and strategic value. Likewise, the investor may have the opportunity to work with visionary entrepreneurs capable of putting a dent in the universe. Although entrepreneurs and investors are both busy people, these relationships only flourish when entrepreneurs invest effort in making regular contact with prospective or current investors to check-in and provide progress updates, share insights which will be interesting to them or even to wish them happy birthday.
LinkedIn is the platform I use to keep up to date of my investor, partnership and a host of other relationships. You should too. Its power extends well beyond network and content and into relationship management (just look at the Relationship tab in any one of your first degree connections).
Developing and fostering relationships is a core capability for entrepreneurs. Get very good at it.
2. People invest in business models. Idea’s don’t cut it anymore.
Forget about walking into an investor meeting with a pitch deck that sells only a vision. Gone are the days where that’s enough. Today and in the foreseeable future demonstrating evidence that a business model is functioning well or has potential to flourish is a precondition for investment. Evidence equals traction and Ash Maurya is my go-to on this topic. He describes traction as a measure of how a business model delivers and captures monetisabe value from customers. And if you’re just starting out, traction is a reliable leading indicator of future business model growth.
In both cases, and regardless of whether you lead a direct (local cafe), multi-sided (like Facebook) or marketplace (like OneFlare) business model, traction is always based on a customer action or behaviour and the rate at which a business captures monetisabe value from its customers. Think of Facebook, they consistently report on size of their user base and monthly active users. Although there are a host of operational metrics that exist, these two measures provide all the evidence needed for Facebook to demonstrate traction and monetise the value of its users.
But beware of measures that do not contribute to capturing value (i.e. number of downloads, number of survey respondents or growth in team size). These are vanity metrics. They are always convenient measures and inevitably grow left to right. They do not demonstrate traction and can be identified a mile away.
And with all the hype about big cheques being written for great ideas in the last decade (and in some cases recently in the US), founders can be lulled into the belief that raising capital is simple and straight-forward. Unless you’re a serial entrepreneur or founding team with a seriously impressive track record, closing a large round is usually a hard-fought battle laced with trade offs and shifting timelines. This is the reality for 90% of founders which isn't often featured in popular startup media.
3. Investors live at all points of the sophistication spectrum
Most shareholder registers of early stage companies consist of parties who have a wide variety of investment experience. At one end of the spectrum there are those who are highly sophisticated which is to say they know the practical ins and outs and realties of early stage investing. These investors pride themselves on being pattern recognitionists, after all their experience has repeatedly exposed them to what works and what doesn’t in terms of identifying, backing and growing early stage ventures. Those who do this well typically provide a quick decision (one way or the other) on an investment and when the financing round is closed they will be the one’s saying: “My job now is to get out of the way and let you deliver. Call me whenever you need me”. In my experience the speed at which these investors make considered decisions is the leading indicator on how effective they will be as a member of the investor team.
At the other end of the spectrum are those who have limited experience investing in early stage companies. Generally they are enthusiastic and rely on their accountant, financial advisor or lawyer for guidance on their investments.
The degree of due diligence and relationship development required when trying to close a round can correlate to the level of investor sophistication. The higher the mix of investor sophistication, the longer it can take to bring everyone onto the same terms and close the round. Of course, in some cases the opposite it true. The point is to be aware of how different investors engage in a process. Typically this means closing a round takes longer than expected.
4. Recruit strategic investors (and avoid accepting only cash)
There are investors with cash to invest and there are investors with cash AND specific strategic knowledge to invest. Focus on recruiting the latter — strategic investors. These people bring industry, product or distribution expertise to the table or they possess a complementary expertise e.g. law or technology investment that you can lean on.
The term ‘recruit’ is used specifically in this context. Just like recruiting the best talent, it’s equally important to recruit the best investors for your company. Framing the exercise as recruiting (in contrast to just ‘finding’) helps hone in on investors or funds that are likely to be a better fit. LinkedIn is again the perfect environment for identifying and recruiting strategic investors (more on that in next week’s post).
In AirShr’s case, we had a powerful team of strategic investors who are called on from time to time for their counsel.
The filter to understand how valuable a prospective strategic investor will become to your company (beyond their experience) is based on three practical factors:
- You won’t call on them super frequently but when you do, they will call you back within 24 hours — time is always of the essence.
- When you ask for assistance to make an introduction to a potential partner or customer, they action it within 24 hours.
- At every appropriate opportunity they evangelise your company and brand.
Just ask if they are OK with meeting these expectations. It demonstrates your desire to leverage every available asset at your disposal to deliver on the vision. Importantly, it also gives you a sense if prospective investors understand the importance and value of time, it’s always in short supply.
Seed rounds also attract friends and family investors. They often invest early on to provide encouragement and help progress your vision. This is common and expected. Providing they are fully aware of the risk of investing, they too can be a trusted sounding board as you become too close to your product or business model and need a fresh perspective.
5. Focus on domestic investment
Investors often prefer to be geographically co-located with the founders leading their portfolio companies. It’s obviously easier for them to provide support if they’re nearby. There are exceptions to every rule but this is the consistent feedback I’ve received from early-stage founders who have been declined investment from overseas investors.
6. The ideal runway is 18 months
However, accept 12 months worth of funding to achieve your essential milestones and product/market fit.
7. Your idea is only new and shiny to you
When you pitch your business model be prepared for investors to respond in one of two ways; 1) They get it and then apply their own mental model to your business or 2) They don’t get it and then apply their own mental model to your business. See where I’m going with this?
Experienced investors will rely on the countless number of startups they’ve encountered and draw parallels between this experience and your business model. In both cases, whether they accept your business model or not, listen carefully to their feedback. Even if you disagree with their insight or characterisation of your business model there’s a good chance others will come to same conclusion. Consider this (and all other) feedback as clues to investigate further.
Ignore them at your own risk.
8. Your pitch deck should be compelling and 12 slides (in this order)
- Solution (Your vision is in the future, sell it early)
- Problem (Present today’s experience/use-case being solving)
- Market Size / Opportunity (Is the opportunity big enough to pursue?)
- Product (Show product/service that embodies the solution)
- Traction / Timeline to Traction (Demonstrate tangible progress)
- Business Model (How value is captured from customers)
- Marketing & Distribution (How product/service will get to customers)
- Competition (Who is/will threaten the business model)
- Business Model History (Who has tried this before?)
- Team (Who will deliver on the vision and are they qualified?)
- Competitive / Unfair Advantages (Why will the venture win?)
- The Ask (What do you want?)
Additionally:
- Use font size 44 in the body of each slide
- Consider your potential exit options and be prepared to answer related questions but don’t add a slide on it. There are many milestones and alot of luck to experience before exiting becomes an real option
- Be clear on the investment required, how the funds will be applied and 3–5 key milestones to be achieved given the runway provided by the investment
9. The other half of a pitch deck is a term sheet
When it comes to engaging with prospective investors it’s important that a well-considered term sheet is available for distribution to interested parties. This document presents the terms underwhich incoming and existing investors will engage as owners of a company. These terms will be later incorporated into a shareholder agreement.
Invest in legal advice from a lawyer who’s expertise is technology investment so you can be guided on structuring terms and determining the mechanism (i.e. priced round or convertible note) for an investment round that suits your venture’s strategy and stage of growth. If you’re investment ready and looking for a legal expert to support an capital raising, I recommend you contact Daniel Szekely. He and his team provide outstanding service to AirShr. And remember, receiving signed term sheets from prospective investors is an incredible milestone but it only takes you 60% of the way to closing the round. Your lawyer should guide you through the balance of this process.
10. No investor is going to sign an NDA before receiving your pitch deck. Be OK with that.
The reality is that your pitch deck does not (and should not) contain intellectual property. Send it to prospective investors ahead of a scheduled meeting in the spirit of advancing their knowledge and ability to make an informed response to your request for investment.
And by the way, the likelihood of a prospective investor replicating / stealing your idea is ridiculously low (at best). If you’re not convinced, speak to Robert Kawalsky at Zeetings and use their awesome product to distribute and solicit feedback on your pitch deck.
11. Prepare for your valuation to be challenged
It’s important for the founding team to set a preliminary valuation for their company. For technology ventures, arriving at a valuation using a discounted cashflow model, particularly when pre-revenue, isn’t helpful. the DCF model will be flawed due to its fictitious assumptions and the inherent lack of cash flow.
Instead, consider the ‘stages method’ of valuation. This is a commonly used and surprisingly accurate approach to determining valuation of early stage technology companies and is based on their development. Once the valuation is established, determine a range within which the founding team will accept investment. As you introduce this valuation to prospective investors prepare for it to be challenged. This is part of negotiating a deal and at this point it comes down to convincing prospective investors that the valuation is reasonable.