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November 16, 2011

Fund-raising: Manage the process, don’t let the process manage you

One of the most frustrating and distracting yet critically important aspects of building a business is ensuring it has adequate capital to grow. Pretty obvious, right? Well, the process a company follows for raising capital can have a strong positive - or negative - impact on the company, its employees and its prospects. I’ve seen companies get sucked into the vortex of VC hell, bobbing in a sea called no-man’s land where there is lots of “interest” but a disturbing lack of conviction (check out Eric Paley’s excellent post on exactly what this means and how it can impact the fund-raising process). And this can drag on for months and months, pushing founders’ psyches to the brink, causing the deal to become stale and frequently resulting in financing terms far less attractive than expected (or perhaps warranted). This painful path is one that should be actively avoided at all costs, and is generally an outgrowth of not aggressively managing the fund-raising process and becoming subject to the whims, schedules and biorhythms of potential investors. Don’t let this happen to you.

Let’s say you’re an early-stage start-up and you’ve raised some seed financing. Congratulations - you’re off to the races. Let’s also assume that while your business is doing well, it is going to need a Series A round to bridge the time between commercial release of the product and when net cash burn turns positive and the business can be self-sustaining (unless the founders and the investors want to grow more rapidly, indicating that a Series B financing might be warranted). Between the seed and Series A rounds the company is often building product, working with early customers, perhaps securing early contracts and building a reputation in the marketplace. It is during this period that companies will frequently receive inbound interest from venture investors, sometimes from junior staff working on “market mapping” exercises to augment a firm’s knowledge of the competitive landscape (often annoying, unproductive and time-consuming), but sometimes from General Partners who are intrigued from their 30k foot knowledge of what they’ve heard but are eager to learn more. It is at this point when big, big mistakes are often made that can impact a company for the next 12 months - or more.

If a company is heads-down writing and shipping code, delivering product and working with customers, almost nothing is more distracting than potential financing discussions. But let’s be truthful - if a big swinging VC from [name your shiny firm here] reaches out and wants to do some diligence, it takes a lot of intestinal fortitude to say “Hey (Swinger), we are truly flattered by your interest and are happy to take a brief meeting at our offices to begin establishing the relationship, but we have a very clear execution plan and roadmap and we’re not planning on discussing fund raising for another [put your aspirational number here] months. We have a lot to do, are laser focused and will not be distracted from our holy mission.” As a VC myself, I will tell you that this response is maddening - AND TOTALLY AWESOME. A founder in control, focused on product, customers and execution yet interested in building a relationship? I think I’m in love… But too often, the response of the star-struck founder is “Swinger, we’d love to see you. Please come by and we’ll show you the time of your life.” Big, big mistake - but not for the reason you’re thinking.

Taking too much time too early with Swinger is only the beginning, because once somebody of Swinger’s status shows interest, guess what happens - other firms start to sniff around, and the founder feels “Hey, the time must be right to raise our financing earlier than expected; let’s get this done and move on.” Bottom line: not good. There is a chasm a mile wide between INTEREST and CONVICTION. If a company is doing cool stuff, almost any VC with investments in and around the space will be interested in taking a look. This says absolutely nothing about whether this interest will morph into conviction, yet the founder has made a massive bet by equating interest with conviction and jumping the gun on a financing and a timeline that made tons of sense relative to the product roadmap and execution plan. You thought one VC discussion was disruptive? Try 10. And then 5 follow-ups. And then 3 more after that. And different VCs ask for different materials, analyses and plans. And then they call everyone who has known you since you were 10. And you are so psychologically pregnant with the notion of getting a financing done that if it doesn’t get done, someone is going to lose their mind. Founder Gone Mad - the Movie. I’ve seen it and it is NOT a pretty picture.

While so much of building a successful start-up is calling audibles and adapting to rapidly changing conditions - competitive pressures, product requirements, customer response, etc. - how to do a financing subjects itself much better to planning and linear execution than other aspects of start-up life.

  • Rule #1: Have a plan. Model your costs thoughtfully and know where you stand relative to cash on hand at all times. Months until cash zero is THE vital input to financing plans. The financing plan ties closely to product plans and customer development plans, as these will be the key metrics looked at by VCs as part of the Series A diligence process. I can’t stress it enough - TAKE THE TIME TO BUILD A SOLID PLAN AND REVISE AS NEW LEARNINGS COME TO LIGHT. Without these plans you’ll be at the mercy of the VCs and will rapidly lose control of the financing process.
  • Rule #2: Don’t let yourself become overexposed. If a true Swinger with what appears to be genuine conviction comes into the picture, set a very hard time line for receiving a term sheet. If there are 1-2 other firms who have been staying close (perhaps they got to know you during the seed round financing process), you can say “We have received pre-emptive interest in our Series A from a top VC. While we are not looking to do our financing now, we might consider it if the price is right. We are giving ourselves [2 weeks] to receive terms sheets. If they don’t reach our investment and dilution targets, we’ll simply pass and move on.” And let’s assume that either no term sheet is received or one or more don’t reach the company’s goals, when the company goes to raise its Series A on its established timeline it should still be very thoughtful and targeted with respect to the firms brought into the process as well as the time allowed for due diligence and submission of term sheets. There is almost nothing worse than a deal broadly shopped around Silicon Valley and NYC. People talk. Questions are raised. The deal begins to smell bad. Very bad.
  • Rule #3: Mr. Market is always right. Nobody loves a company more than it’s founders. Every baby is beautiful in the eyes of its parents, just as every start-up is pure platinum in the eyes of its founders. However, it is important to note that investors might price a potential investment quite differently than the value perceived by the founders. This is ok; it’s called reality. Further, there are a variety of factors beyond the price of a particular round, especially an early round, that may warrant accepting a term sheet from someone other than the one offering the highest price (such as the chemistry with a particular investor, their domain experience, network of valuable relationships, skills and experience in scaling a business, etc.). Founders can let ego get in the way of doing what’s best for the company in the long-term: don’t let this happen to you.    
  • Rule #4: It’s not personal; it’s just business. There is almost nothing more personal than starting a company. You bleed for it. You dream about it. You have paranoid fantasies about it. You’ve often made gargantuan economic sacrifices to pursue your dream. That all said, it is extremely important to be cool, clinical and calm during the fund-raising process. You can’t take a “no” as an indictment of your personal worth or that of your company. You shouldn’t get visibly pissed off if you hear the same idiotic question 14 times - I can assure you, it will happen. In general, investors are smart and care and are just trying to figure out if they want to married to you for the next 3-8 years, for better or worse, in sickness and in health, as long as the company hasn’t been sold, IPO’d or shut down. In short, it’s a HUGE obligation. Just as you didn’t undertake your start-up pursuits in a cavalier way, investors aren’t going to meet you, hear your spiel, pull out their checkbook and write you a check for $5 million. It’s just not the way it works. Don’t take it personally.

All of these rules yield a simple conclusion: Manage the fund-raising process. Do NOT let it manage you. Cede control at your peril.

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