The Operations of Fundraising Part II
November 1, 2017
A few days ago, I published a post on the importance of setting up internal processes for fundraising. Part II focuses on identifying the correct potential firms, interacting with them during the process, and finally closing the deal. Let's jump in.
Raising capital, like any sales process, becomes easier when you identify the proper targets and their individual goals. However, in this case, a deal will hopefully lead to a long-term relationship with a partner or partners who want play an important role in the success of the company.When raising institutional capital, there are generally two types of prospective investors: venture (private equity) and strategic (CVC). It's important to know the traits of each category in order to craft a pitch that will resonate and understand the terms that will matter if the deal begins to materialize.Venture capitalists are primarily financially motivated. As a founder, it's important to research a firm's thesis, geo-focus (if applicable), and stage focus to find the best fit. While the chief goal for a VC is optimizing ownership, good investors are seeking a deal on fair terms that will leave the founder with enough equity as to maximize the incentive to pursue long-term value creation or seek additional capital.Corporate venture capital is a little more tricky as it pertains to motivation. Depending on the CVC, the reasons for investing can range from outsourced R&D, first-look at potential acquisitions, reduced customer acquisition costs, or synergies with upside potential.It's easy to imagine the difficulty in predicting the motivations of a CVC and the potential hazards that come with misaligned incentives. Combine these uncertainties with the typically longer deal process and it becomes clear that raising capital from a strategic requires careful consideration.
The next factors are ones we see many founders neglect to consider: understanding both how and where you fit in a VC fund.
- How: the combination of thesis (discussed earlier) and funding stage. In the slide above, we use a $100M fund as our example. Typically, a fund makes 20-25 investments and reserves for follow-on. (note: this varies by fund, but this is the typical model). Let's assume this fund reserves $60M to maintain or increase its position in the winners, leaving $40M for initial investments. This means an average first check lands somewhere in the neighborhood of $2M. If you're asking for $500K, it's unlikely (though not impossible) this fund is too large.
- Where: the age of the fund and how this will impact the VC's need for an exit. Most investments are made during years 1-5 of a 10-year fund. Depending on the stage, a startup can be great for either end of that timeframe. However, it becomes possible to be pressured into an early exit due to a mistimed investment or have a board seat change hands in a secondary sale of equity.
It's completely fair for founders to ask questions surrounding these issues. I would argue it shows maturity in both understanding the venture process and wanting to ensure that both parties are completely aligned for the entirety of the partnership.
Much too often, we see cold-emails that are clearly of the "spray and pray" variety meaning founders are emailing as many potential investors as possible with no difference in message. My advice to those startups would be to take a step back and really consider building a targeted pipeline of potential investors.Start with a wide funnel that encompasses all the investors in either the industry, technology, or geographic region in which you operate then begin to narrow by the remaining criteria plus average investment size. For example, if you are a healthcare company in Dallas you might build a funnel of all healthcare investors which have done a deal in the last 12-18 months in the US, then narrow by the ones who have made an investment in your technology (ex. software/hardware), and finally by Texas.Once you've selected the top 20% of firms that seem like potential fits, find the partners which made the investments. Generally, all will have an online presence wether it be Twitter, a blog, podcast appearances, or just quotes in press releases, find something to use in the initial outreach which explains why it's the right fit for a partnership outside of capital.
Though it varies from round to round and startup to startup, fundraising often requires thousands of interactions with hundreds of contacts. It is essential to keep up with these contacts in an organized way while delivering positive news throughout the process.For this reason, in addition to a CRM, we highly recommend finding a meaningful KPI which is unlikely to go down and sharing an update at the end of every week. The weekly update serves several purposes: it creates a trend line from dots, it shows accountability, it shows execution ability, and it keeps your startup at the top of the investor's mind.As the interactions with prospective investors increase, it becomes important to filter the noise and avoid "kissing a lot of frogs." After all, you're still running a business and time is precious. We encourage entrepreneurs to do their diligence on investors including asking service providers such as banks and lawyers for their opinions. Association with the wrong investor can be a negative signal to the investors you covet.Lastly, ALWAYS authentically respond to no's. They are an amazing chance to show humility and learn. When a founder ignores a no, it feels like a confirmation, right or wrong, I made the right decision. After sending a response, move on. Time is money.
It's often said time is the enemy of all deals. Once a VC has agreed to invest, work to close as quickly as possible. Often, it's hard to manage the process especially when it pertains to service providers but there are steps that can be controlled.The groundwork laid in the previous post really comes into play as the close nears. Thorough research on comps helps guide the valuation process and an organized data room containing the appropriate materials increases the speed of diligence by reducing the need to find materials and limiting unnecessary communication.Much like the previous post, this one was long in nature. However, I hope these tips are potentially useful and maybe introduced a few unfamiliar nuances in the fundraising process.Credit: John Tough, partner Invenergy Future Fund, for the inspiring the images used in this post. Part I can be found here.