Dos and don’ts of raising early stage venture capital

Published 10 September 2012 06:44, Updated 11 September 2012 10:03

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Dos and don’ts of raising early stage venture capital

Beware the heavyweights ... It’s hard to overstate the herd mentality of the venture community. If the top guys pass, everyone below them will be too afraid to do otherwise. Photo: James Davies

Most great businesspeople I’ve met would correctly advise an entrepreneur to avoid raising money if possible. Easy for them to say, right? But there are good reasons to bootstrap. First, you maintain control of the company. Second, maintaining control allows you to experiment and learn where the business is “naturally” going. Third, if you own the company, you can have a great exit at a low price. Fourth, if you’re able to build the company without significant outside capital that may mean your business has even more “real” legs.

But raising venture capital is sometimes a great idea. If your business has high velocity, high margins, and a huge market, venture may be a good road for you. There are some helpful resources out there on venture terms, good venture funds vs. bad ones, and questions you may want to ask a venture capitalist if you meet one.

The notes below are practical working tips on how to go about navigating venture capitalist conversations. Some of these might be surprising or seem hard to follow. But, in my experience, they’re good medicine.

1. NEVER START YOUR FUNDRAISING PROCESS BY MEETING THE TOP FUNDS FIRST

When you are ready to raise money, scratch Sequoia, Kleiner, and maybe one or two other top dogs off your preview list. It’s hard to overstate the herd mentality of the venture community. If the top guys pass, everyone below them will be too afraid to do otherwise. Get your practice reps in with easier audiences.

2. DON’T RESPOND TO INBOUND INQUIRIES FROM ANYONE BUT A PARTNER

Many entrepreneurs are excited or flattered when they hear from associates or analysts at venture funds. Don’t be. An “associate” at a venture fund is not a venture capitalist; she is an outbound prospector. Junior members of VC teams are paid to source information about companies. Their job is to make contact, extract information from you, get a PowerPoint deck, and build a profile of your business and industry. They are not qualified or authorized to do deals. If a junior member of a venture firm recommends your company to her superiors, it may actually be a negative signal inside the fund rather than a positive. Wait to connect with partners. (Depending on the firm, exceptions can be made for individuals carrying the title Vice President or Principal.)

3. IGNORE POST-DING FEEDBACK

If a fund decides to pass on your deal, discount any feedback the firm representative gives you. Her only goal in this circumstance is to avoid having you go ballistic about her on TheFunded or a comparable site. She will easily lie to accomplish this goal, and her stated reasoning for saying “no” will fall into one of a half dozen “avoid an argument” categories designed to let you down without hating her or having grounds for calling her an imbecile should your business succeed. Feedback you should heed more closely is from funds that are expressing genuinely positive interest in your company, but who are urging you to develop your business further, move in direction X, or fill gap Y in your executive team.

4. NEVER SEND YOUR PRESENTATION OR DECK BEFORE YOU MEET THE VENTURE TEAM

This is non-negotiable. Many fund representatives will tell you that they don’t meet with entrepreneurs unless they have seen a deck first. False. Every fund does. Be extremely polite and decline to send a deck in advance. Some venture guys will give you grief. Some may even make noises about not meeting you without receiving a deck in advance. Stand your ground. Even after you meet them in person, you should only ever send an electronic version of the deck after you feel very comfortable with them. Until that time, you should assume that they will a) use your deck to compile a picture of your industry, b) share your deck with their portfolio and/or their friends and your competitors (yes, many absolutely do this routinely even though they promise they won’t), and c) develop a file on your company. You should assume that you are simply fodder for trendline generation until you have a specific reason to believe otherwise. (By the way, for full disclosure, on the few occasions I’ve broken my own rule in the past, I’ve always regretted it. By contrast, I’ve never regretted following this rule.)

5. DON’T BE PSYCHED THAT YOU “GOT” A MEETING WITH A VC

VC’s livelihoods depend on deal flow. That means they pretty much must see you, assuming the summary description of your business passes a super simple sniff test.

6. DON’T MEET WITH THE THIRD PARTIES THEY WANT YOU TO MEET

A typical next step for a VC is to recommend that you get together with one of their portfolio companies or an unattached executive with whom they “work” frequently. Politely decline. There are three reasons the VC wants you to take the follow-up meetings. First, they want to extract more information about your business and you. Second, the venture capitalists want second opinions. VCs are famously cowardly decision-makers: except for the most successful handful, VCs have difficulty making up their own minds, and they seek shelter in third-party approval. Third, VCs sometimes send companies to unattached senior executives to compare notes on a commonly known entity and thereby evaluate the executive’s acumen, not the company’s prospects. Basically none of these reasons benefit you. Therefore, unless you really want to meet the third party for your own reasons, you should beg off.

7. BE CAREFUL BEFORE YOU TAKE “QUICKSTART” FUNDS OR JOIN FORMAL “INCUBATORS” WITHIN ESTABLISHED VENTURE FIRMS

A new class of “superangel” funds has appeared (Floodgate, First Round Capital, etc.) which have challenged the historical primacy of established funds in getting the “early” seed and A round deals. Early rounds are the riskiest, but they also provide the huge returns that make venture capital firms famous. Superangels have been able to snag much of the best deal flow because they have more streamlined decision processes and friendlier deal terms than established VCs. To fight back, some of the bigger funds have openly or secretly created “quickstart” or incubator seed funds that allow a subset of their partnership to authorize a convertible note-style investment of a few hundred thousand dollars. It’s a great idea, actually, and it seems to have worked in some cases. However, a tragic flaw has materialized. If you don’t get full and visible support from your incubating/quickstarting fund — to the effect that they will invest even if no one else does — the investment community is all too likely to think that the fund knows something that they don’t, and your deal may become unattractive to any potential investor.

8. KEEP THREE TO FOUR FRIENDLY ARMS-LENGTH FUNDS UP TO SPEED ON WHAT YOU’RE DOING ON A QUARTERLY OR SEMIANNUAL BASIS

Consider them your “investor council.” Give them enough information so they can give you helpful feedback. Listen for commonalities among the comments, and listen for changes over time. Test out your company narratives and solicit ideas for new ones. It’s likely enough that your eventual investor will come from this group: because they know you, they’ll be able to reach an investment decision faster, and you’re more likely to feel comfortable with them. Fair warning, though: keep the group limited to three or four funds. Any more, and you risk making your deal feel “shopped” before you have even decided you want to raise money.

However you do it — with or without venture capital — good luck building your business.

Michael Fertik is a repeat internet entrepreneur and CEO with experience in technology and law. He founded Reputation.com in 2006. You can follow him on Twitter at@michaelfertik.

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