I’ve been a bit delinquent on updating my blog with all the new podcasts we’ve shared recently on http://podcast.seecamp.com
However, below is the list for your convenience. We’ve discussed hardware startups with Marc from Winnow, PR with Bryce from Albion Drive, Entrepreneurship and investing with Suranga from Balderton, Growth Hacking with Malcolm Bell from Mailcloud, investing in the Asian markets with Tytus from Fresco and Bay from Brinc, how top tier firms Index Ventures and Greylock Ventures invest with Neil Rimer and Josh Elman respectively, Reshma and I talk about what an Acceleration fund is, Taylor wraps up his Product Roadmap series, and lastly, had the honor of sitting down with John Collison, co-founder of Stripe!
One of the most time consuming things founders have to do other than raise money is deal with all the legal paperwork pre and post termsheet that fundraising typically generates. Not only can the legal process be time consuming, but also it can be emotionally difficult depending on how many items are being discussed before finalizing.
While there is no standard process (largely due to the variability in deal types and jurisdictional issues) that can be outlined for how to deal with your unique legal situation, I’d like to propose a few tips that might help you navigate your process along the way. As such, read this post not so much as a how-to, but more-so as a list of things to consider while going through your investment documents.
0) Always be mindful that the most important thing you have at your disposal is your word. If you make promises, keep them. Create trust between everyone you deal with. Say what you mean and mean what you say, and ask questions if you’re not sure. This will help build you a good reputation that will greatly help you along your way.
1) If you aren’t incorporated yet, or if you’ve just started working on an idea with friends, have a pre-founder and advisor arrangements (relating to splits and vesting) agreed before lawyers start drafting stuff later. Lawyers often need to change docs several times to accommodate founders changing their minds or negotiations taking a different turn before the legal docs. We’ve put up a document on our Seedhack site called the Founder’s Collaboration Agreement, which you can use if you don’t have something like this. I assume that for most of you this is not a relevant point, but perhaps for some of the newer teams that haven’t incorporated yet.
2) Always check what your legal responsibilities with existing shareholders are before taking any decisions with or without them. When you have existing shareholders, involve them (including the distribution of information about the new round) as per whatever rights they may have agreed with you as part of their investment documentation. If this means you need to inform them, then inform them, if this means you need to ask them something, then ask them, but don’t leave it to the last minute. Generally speaking, they’ll try and be helpful, but depending on how busy they are, they can take a while, so don’t leave it for the last minute.
3) Don’t be annoying:
a) Lawyers cost money for both sides of the table. Do as much research as possible on your own and try and aggregate your questions as much as possible so that you use your lawyers and their lawyer’s time efficiently.
b) Make sure you have a position on items that are being discussed so that you don’t go back and forth on stuff on the phone or after decisions have been made. Nothing is more annoying than backtracking in legal processes.
c) Don’t let your lawyer get annoying or overly aggressive with your investor. The investor can always walk away if you and your lawyer are coming across as overly difficult and asking for stuff that might actually be destructive for the company in their view. Be assertive for sure, but don’t be divisive. Seek to understand the issues and always think creatively on how to solve them rather than letting the lawyers get into a stalemate or in an argument with your potential investor. Always feel free to say “let’s park this point for now and return to it after we’ve had to consider it”.
d) Don’t let paranoia of what others could do to screw you get the better of you. It is OK to be slightly paranoid (I know I am), but don’t let it be so bad that you make the legal process feel painful as you come up with bogus reasons by which to reject perfectly common clauses in an investors proposed documentation.
4) Legal documents have two parts, the commercial stuff (like valuations, percentages, etc) and legal stuff (like which jurisdiction, which filing/reporting procedures, etc). Get all or as much of the commercial points agreed between you and the investor before involving the lawyers (this is effectively what the termsheet is, but sometimes some stuff slips into the subsequent docs to keep the termsheet ‘light’) so that the lawyers are just left with representing these on your documents. If you need to have a discussion on a commercial point, do it with the investor alone and offline (even if you had to ask your lawyer or another shareholder for advice) you shouldn’t spend time on the phone with lawyers negotiating commercial points. Lawyers will help you through the technical points.
5) Always ‘red line’ any changes you make to documents. Keep track of all changes. Use track changing on Word. Google Docs may have this, but lawyers don’t use Google Docs generally.
6) Generally speaking.. and this is just a general rule… conversations are Founder <> Investors and Lawyer <> Lawyer.. meaning, you rarely speak to the counsel of the Investor directly or the Investor with your counsel directly without you guys being on the phone with them.
7) Keep CALM AT ALL TIMES. If you lose it, you will lose it.
8) Always seek solutions. There are multiple ways to skin a cat. Any issue can usually be solved via some creativity. The lawyers aren’t there to come up with stuff for you, you have to sometimes be the one (along with the investor) that can come up with solutions and then the lawyer’s articulate it legally. Although.. Don’t get too creative too, cause that can burn you.
9) Most of you are using lawyers that have been recommended and are experienced, but maybe you are struggling with your current counsel and are looking to switch. It is important that you get good counsel (read my post on this here). Don’t be cheap on this one. You’ll regret it later.
10) Do propose using standard documentation that other lawyers have frequently seen, in the USA consider using the Series Seed docs, or here in Europe, the Seedsummit docs which are based on the US Series Seed docs, or the BVCA ones, etc. there are probably a few more out there, just familiarize yourself with a few to ask them if the ones they send you are based on ‘standards’ as that will reduce everyone’s workload.
11) Managing the closing process. This is a difficult one and in the UK, with deed execution requirements can be difficult, but when there are multiple angels involved lawyers often spend a lot of time getting signatures and it increases the costs that founders don’t want to pay (I just heard of a deal that had 9 angels and the lawyer spent 20 hours managing that process for the entrepreneur, thus ended up overall 3x over budget). Sometimes, you as founder, can handle this but best case is if one of the leading angels takes charge of this process, we have seen this and it has been really good but you can’t count on having that organized person being on board, so be prepared to be ‘that guy’.
12) Do your due diligence homework. Get your IP agreements, employment agreements, etc organized to help the process go by faster and smoother for your new investor as they will likely have to review these documents.
Hope that helps, and feel free to add your suggestions in the comment section below!
Raising money for your startup is never fun. It takes time, distracts you from developing your product, is fraught with emotional ups & downs, and doesn’t have a guaranteed outcome. Frankly, many founders would rather go jump into an icy lake than take another fund raising meeting where they aren’t sure what they should say to ‘convince’ an already hesitant investor to open their purse strings and invest in their company.
So, back to the main question… how much money should I raise?
The flippantly short version of the answer is, “as much as you can”… but in some cases, more isn’t necessarily better. Although you should raise as much money as your company needs to achieve major proof-points/milestones, overfunding a company can also have its drawbacks.
Let me explain this last point before going further on the ‘how much money should I raise’ question:
Many founders are obsessed about raising as much money as possible all at once because well, if you do raise a big war chest, then that’s one less problem you need to worry about. However, with a large amount of money come several potential problems:
1) With more money usually come more investment terms and more due diligence. It is probably a fair statement to say that the more money involved, the more control provisions an investor will want as well as more diligence to make sure that their money isn’t going to be misused.
2) A high implied post-money valuation. In order to accommodate a large round, investors need to adjust your valuation accordingly. For example, if your business is objectively worth 1 million, but you are raising 2m, unless the investor plans on owning 66% of the company after investment, they need to adjust the valuation upward (I’ll abstain from giving ranges for now). Having an artificially higher valuation prematurely can put a lot of strain on a startup if things don’t go well and then later need to raise money again, as it increases the likelihood of a subsequent round being a down-round (when you take a negative hit to your valuation) or rather, other new investors passing on the deal in the future because it is ‘too expensive’.
3) A propensity to misuse ‘easy money’. You could argue this point from a psychological point of view if you wanted, but suffice it to say, I know many VCs that believe that over-funding a company leads to financial laxity, lack of focus, and overspending by the management team. Perhaps it is lingering fear over the hey-days of the late 90’s were parties were rife, and everyone got an Aeron chair, but the general fear with overfunding a company is that it will be tempted to expand faster than it can absorb employees into the culture, integrate new systems, or expand real-estate needs without substantially disrupting the efficient operations of the company.
4) A last one, which is hard to really quantify and happens only to very few startups, is the media’s reaction (positive or negative) to how much money you’ve raised relative to what you have. Think about this story, although very rare, it’s what the effect of what too much can cause.
Ok, got it, overfunding can be bad… too much money can be a bad thing, but if you said I should raise as much as I can, where do I start and what is the ‘magic’ number to ask for then?
Alright, let’s look at this question from a different point of view, as I mentioned in my previous post on how an investor evaluates your financial plan, an investor (depending on their areas of focus) may not necessarily know what the exact figures your business will need to grow to its next major milestone, but rather, the investor will rely on your ability to communicate this on your financial plan for the investor to then make a decision on whether your accurately understand your cash needs or not. Tied to this cash need is an implied understanding of your company’s milestones.
Let’s define what a milestone is before proceeding:
A milestone is a quantifiable achievement, be it in terms of product development, team expansion, or market adoption of your company’s value proposition.
Your financial plan will likely be a series of chronologically organized milestones. For example:
Month 6 – Hire UX guy to optimize app
Month 8 – Launch mobile app
Month 10 – Start charging on the mobile app
Month 11 – Hit 10,000 users
Month 12 – Launch partnership with key distributor
Month 18- Hire CMO
These are all milestones. Some more important than others, and frankly an investor will likely want to talk to you about the importance of each one of them to get a feeling for which ones are the key ones to focus on to determine if your business is going to ‘take off’.
The reason for this is simple, the best time to go fund raising, is RIGHT BEFORE or SHORTLY AFTER the successful completion of a key or series of key milestones. For example, right before a key milestone, you can woo new investors with the promise of how successful you will be at the completion of the milestone and basically you convince them that if they don’t get into your company by investing now, that they won’t have a chance after you’ve achieved the milestone because many others will also be interested and the competition will be stiff (remember, investors don’t want to lose out on potentially hot deals). Shortly after achieving a key milestone is also a good time to try and convince investors because you’ve effectively accomplished a major thing (like launching a product), which de-risks the investment for them, but they can still get in the company before it ‘takes off’. Frankly, the worst time to go fundraising is when your last major milestone has grown stale and the next one is too far away to be de-risked. So, this is why it is key to know your milestones, and when they are happening.
Parallel to this milestone timeline is the ‘cash timeline’. As in, how much money, in aggregate, you will have spent to get there. So using my examples from above:
Ignore whether this is a realistic example for your business for the time being, but I’ve assumed a 10K cash burn on this example up to the end of year 1, and then starting in Year 2, I’ve assumed 20K monthly cash burn. If you don’t know what your monthly cash burn is, you’re in trouble. Monthly Cash Burn is a KEY figure to know before meeting any investor.
As you can see, an investor could choose any of the milestones above to focus on for your cash needs. The idea is simple, fund your company through the achievement of major milestone(s) (to reduce investment risk and to see if your company has any traction before putting more money in) and then go fund-raising for more money, hopefully on a strong note, where you will have met your timelines and expected outcome (be it market traction, or successful completion of your product, or hiring of the appropriate person).
For example, an Angel investor (someone that usually invests from their own money) typically can’t invest millions, so their investments tend to be less than 300K. However, they’ll want to make sure your business is going somewhere before putting all their money in, so it’s likely they’ll want to come in early to give you enough cash to achieve something plus a little extra to help you fund-raise after, but also to see how you achieve the milestone before putting in more. So, perhaps this Angel may opt for funding you through month 10 with your requirement of 100K plus a few more for fund-raising. This would get you through your product’s launch and give you a couple of months to see how it goes in terms of market traction (all the time you will be speaking to new potential investors) so that you can have something strong to talk about for fundraising purposes.
Alternatively, an institutional investor (one that invests other people’s money as well as their own), say a VC fund, may see that your company has some real potential in what it is trying to do, sees that you have a plan that requires 100K to launch before you start trying to monetize, but with their experience of seeing your kind of business having to do a few pivots before getting the launch product 100% right, think that perhaps the best quantity to give you based on your calculations is about 500K for about a year to a year and a half. This should also give you some breathing room to work on achieving your various milestones rather than having to focus on having to be constantly in fund-raising mode.
So now you are probably asking yourself, how is it that some investors have different perceptions of how much money I need and wish to give me? Effectively, how much money does an investor ACTUALLY think I need vis-a-vis what I ask for?
Your exact calculations may have said that you needed 100K to launch your product, but an experienced investor may have seen various companies like yours and seen that there are usually mistakes done along the way that consume cash without quantifiable progress towards the agreed milestone (you may have learned something, but you may be delayed in your launch because of some screw up). Because of this, investors some times include ‘buffers’ into the number they offer you in a deal. This buffer could come from the various sensitivity analysis the investor did, such as, what if the company is delayed in launching their product by two months, or what if the company can’t find that key employee, or what if the company can’t start charging for their product for an extra few months, or what if the product needs a pivot, or what if people aren’t willing to pay what the company expected? All these things will affect the cash flow of the company and because of them, the investor may assume some or all will occur, leading to the company needing more money than was planned by the founder. Effectively, your 100K in a perfect execution timeline, may actually be 250K after some minor delays and mistakes, and with the extra cash the investor in my example above gave you, you now may have enough cash to go fund-raise without having to panic about having to get cash in ‘yesterday’ or be constantly in fund-raising mode.
Keep in mind that this larger amount an investor may be willing to give you will also affect your valuation range, too much and it ‘inflates’ the valuation range your company sits in (as per my point number 2 in the intro), so an investor won’t give you ‘excessive’ buffer so that it forces the company to be ‘overpriced’ for them and for the company’s future. Inversely, hopefully you can also see where an investor may deem a company to be ‘underfunded’ if it doesn’t have enough money to get to where it can achieve a meaningful milestone(s) upon which to go fundraising with a strong foot forward for future investors to be attracted.
In conclusion, raise as much as you can but understanding your monthly cash burn and map out your company’s important timelines and the cash you will realistically require to achieve them. Then have an engaging conversation with your potential investors as to how much they think you need based on their experience. As a rule of thumb, try and raise enough money so that you have time to go fund raising after you’ve accomplished your next key milestone(s). In a future post I’ll discuss how much time you should set aside for fundraising, but to make the rule-of-thumb complete, add AT LEAST 6 months to the amount of money you need for your next milestone to include time to go fundraising.
Hope this helps
A friend of mine emailed in and mentioned that perhaps there was a difference in how investors from different geographies look at this issue of how much they want to invest in a company up front, and yes… I would agree with that statement, but the point of my post is merely to provide the reader with a ‘framework’ by which to approach the question of how much to raise, not so much to answer the multiple varied ways that investors might look at the amount required and subsequent fundraise amount. For example, some investors may choose to just want to back the team and thus will just give them an amount that they think startups typically get for the stage the company is in, and others will give an amount of money merely to exclude the investor competition from winning the deal from them!
However, I believe the framework I’ve mentioned in this post can help a founder assess how much money they may need for a period of upcoming time no matter the risk averseness (or not) of the investors they meet with. Whereas a bolder investor may not really focus on minor milestones, but rather just focus on a larger one such as ‘grow the network’ and for that the amounts invested is done with far less due diligence and far more quickly, a more risk averse investor will probably be more specific about what you plan on accomplishing with his money.
In the end, the most important thing, is to be keenly aware of your cash needs on a month by month basis, so that if the question comes up, you know how much you plan on spending and by when. You should also focus on raising enough money in your timeline so that you also have time to accomplish your key milestone(s) before going fundraising again, and lastly you should include enough buffer in your last fund raise to help you through your next fundraising period post-milestone. If you meet an investor that wants to invest a lot quickly, great, if you meet with various investors that are more risk-averse, at least you won’t get caught not understanding your execution plan. If you want another rule of thumb, many Early-Stage VCs will look at the next 12month to 18month worth of cash needs + a buffer to estimate the cash needs of a company. Add to that 6 months of additional cash burn and you have a rough starting point for a ‘headline figure’ from which to start discussions.
In my recent post on how an early-stage investor values a startup, I talk about how market comparables were the closest guide to how early-stage investors value a startup vs. any other methodology. However, I feel like I left one question unaddressed. Namely, why are there valuation discrepancies for comparable companies across the world (more specifically at investment stage rather than exit stage)?
The answer has to do with liquidity of deals, the localized risks for investors, and the supply of investors.
As I mentioned in my last post, there are various factors that can come into how an investor values a startup, but using market comparables from deals done in the USA doesn’t always incorporate all the risks that are prevalent in the specific geography where the company and investor in question operates. Furthermore, the availability of capital in any geography will also affect how an investor gauges his own risk/reward ratio when pricing deals.
I’m going to talk about this point abstractly and without incorporating the argument of the global nature of internet-based businesses (they do have some localization risk still, but less so). So, for example, startup exits for investors in certain developing economies will happen less often than say, in Silicon Valley. This has to do not only with the number of companies coming out of the country, but the universe of potential buyers for these companies in that geography.
This affects that risk an investor takes, as he is less likely to get that 10x that I mentioned in my previous post. Therefore an investor seeks a ‘discount’ to take on a deal in order to have a portfolio of deals where there is the possibility that one will be able to exit in spite of whatever market conditions exist locally. Add to that the fact that the investor may be one of very few investors, and therefore can command this discount more forcefully than if more competition existed (once enough investors exist, market pricing becomes more stable and in parity with other larger markets).
Think of it this way… If you’ve been on tourist holidays to resorts abroad, you’ll have noticed that things that are generally cheap(er) back home are notably more expensive at the resort store. This higher cost is due not only because of the transport cost to the resort, but also the cost of holding them there in inventory without knowing if anyone traveling to the resort will buy them. If the seller doesn’t include a higher premium on these items, he will not break even considering the high scrap-age risk he must take on inventory not-bought, and if there aren’t any other stores around, the store doesn’t have to compete on price either, but can continue to seek profit under the circumstances.
So, the point of this post is only to highlight why in certain parts of the world financing can be more difficult to get, but also why it can be priced differently than equivalent deals elsewhere.