Tuesday, April 4, 2017

Letter To A Young Entrepreneur: On fundraising

Dear T.,

Thanks for your candid email about fundraising for your startup. It looks like you have assembled your team, your first product, and you’re getting (very early) market traction. So you feel that it is time to raise funding, in order to fuel that growth (and more honestly, because cash is running out, and you’re not likely to finish the year if you don’t raise a round of funding).

If I may, let me share you a bit of advice, that stems from being on the receiving end of a total of 18 MEUR of venture funding (as an entrepreneur, shareholder or board member), and advising countless startups through the hoops of the fundraising circus.

Think already about your next fundraising
This may sound counter-intuitive: going through a first round of funding is already such a challenging feat, that will strech your patience and nerves over a 6 months period (at least –nine months being not uncommon from start to money in the bank), why on earth should you be thinking about the next round ?
Well, let me put it this way: raising the first time…I wouldn’t say it is easy, but at least you are on a blank slate. You may project how great your startup idea is, how it will make millions on year 3, and you stand a chance to find an investor willing to buy into the dream and fund your seed round. But when you actually are in year 3,…you’d better be in good shape, to have actually delivered on your business plan.
Otherwise your next fundraising will be scorching, with only your initial funders to go to, and then it will be normal that they accept to fund you further only under drastic conditions (huge dilution, loss of control,…)
So: make sure that whatever funding you raise initially, it is sufficient to put you on safe ground for a second round that can tap into the broader investor market.

Due diligence on the investor too
Most of the time, young entrepreneurs are at a significant disadvantage when negotiating with investors : they’ve done it time and again, whereas for you it is the type of event that happens only a couple of times in an entrepreneur lifetime…
Also, I believe that entrepreneurs have a right to conduct some “due diligence” on their investor too. You should be able to ask (very politely) :
-       What other deals have you done ?
-       How will you get involved in the governance of the startup ? (every entrepreneurs aspires to “smart” money; just define the expectations behind “smart”)
-       What timing can you guarantee ? (to avoid being dragged for months in vain)
-       Can I speak to the CEO of one of your portfolio companies ?
Note that they are likely to introduce you to the “good” CEO of their portfolio ; do your research, and look into the less palatable deals…

Don’t focus too much on valuation, beware the small print
Entrepreneurs tend to focus on valuation, because that is one metric that they can readily understand: how much investment money are we getting in exchange for how many percent of the company’s equity ? (the valuation also seem to imply how much the founders’ shares are worth: beware that it’s an illusion until the company gets fully acquired, believe someone whose shares were once worth tens of millions…virtually J )
Don’t focus too much on the valuation, it is only one parameter of the equation. Pay close attention also to the small print, the clauses that are attached to the funding. For instance, the party that gets a “drag along right” can force the sale of the shares of another shareholder to a third party. An entrepreneur not having it may see the opportunity of a company exit disappear; an investor having it may be able to force the initial founders out of the company. “Liquidation preference” and “anti-dilution clauses” are also mechanisms that can have very dramatic effects on founders’ shareholdership (in some cases, it may happen that a startup is sold e.g. for $5M, and the founders receive exactly 0$...)

Don’t do it alone  
The complexity and length of a fundraising process are reasons enough to be seeking some help. You can easily find intermediaries, who will manage the fundraising process with you and for you (in exchange for a retainer and a success fee of around 5%). Unfortunately, there’s a wide variety of profiles, from charlatans to top notch corporate finance advisers, with an extensive network of investors. Again, thorough background checks are in order. In any case, I would advise in favor of using the help of a fundraiser: they will help you sharpen your presentation, solidify your business plan. And more importantly, introduce you to qualified investors. And they will chase the investors in a parallel way, whereas I see too often entrepreneurs doing it themselves in a sequential way (with lots of time lost, when one promising investor finally turns the deal down).

There are many more things that could be said about venture fundraising, but this should be enough to get you started.
All the best,


Roald Sieberath has been an entrepreneur in mobile messaging, ebooks, business software, and big data. He is now a venture partner and coach at LeanSquare.