11 October

The Startup Fundraising Playbook Is Broken

Liz Zalman and Jerry Neumann, authors of Founder vs Investor

Adapted from Elizabeth Zalman and Jerry Neumann’s Founder vs Investor: The Honest Truth About Venture Capital from Startup to IPO

Icon of the founder as Little Red Riding Hood

Founder View: Premeditation Is Key

The Startup Fundraising 101 template says to email a bunch of investors and pitch them all at once. I reject this.

While you may have a narrative, you don’t know how well it will hit. You don’t know that it can’t hit better. You don’t have a sense of the first-, second-, and third-order objections that will arise. You don’t know a lot. Fundraising is like trying to figure out exactly what product people will buy. It requires tons of testing. So before you pitch the firms you really want, you best be ready, and ready means iteration.

It’s also critical to consider that in order to get term sheets to come in at the same time, they all have to be at the same stage in the process. The way to do this is by pitching in waves. Waves are designed to maximize your chance at success by pushing all of your learning up front. By the time you speak to “the best” investors, your story is airtight:

A co-founder and I developed this over a number of years, and believe me, it’s money.

The first wave is practice funds. You don’t care about them and you don’t really want them on your cap table. It’s the Tier 4s. They will ask all the standard questions and objections and will provide an outstanding base for the next wave. The second wave you sort of care about, the third you do care about, and then the fourth you really care about. Then there’s the fifth: your backup funds, your safety net. You start a wave a week. You schedule partner meetings for each wave on the same Monday, and if you need to accelerate future waves because you’re having so much success with the current one, you do that. (Note: Silicon Valley partner meetings are held Monday mornings. If you are invited to a meeting on a Monday morning and it’s not labeled, it’s a partner meeting.)

Now, when you go out, you are out. There is no starting slowly. Word gets around. Investors are the biggest gossips in the universe. Seriously—associates do this for a living. Their job is to get in bed (often literally) with other associates in order to get a sense of where deals are. They are incestuous in figuring out where a deal is, and then once they’ve decided to do a deal, they are mortal enemies.

Folks will also say to start fundraising when you have no fewer than nine months of cash in the bank. It’s designed to ensure your back isn’t against the wall. While I hear that perspective, timing is everything. I’d hold off on raising until you have enough of something to be able to create interest. Without it, you’re dead in the water anyway and then you’ve wasted three months raising instead of focusing on the business.

Remember—investors want to defer saying yes for as long as possible. By architecting the raise like this, you maximize your ability to have all the landmines identified before you talk to the funds you really care about, and you also maximize your ability to have the raise go quickly. If you get one partner meeting set up, the other funds will scurry to do the same. They don’t want to miss out. FOMO.

Icon of the investor as the Big Bad Wolf

Founder View: People, Products, Markets

The founder narrative is usually primarily about why their company needs to exist in the world: what problem it solves and for whom; how enormous that problem is; and how, paradoxically, no one else has noticed this enormous market.

Your job as an investor is to try to glean some facts from this narrative. What is the entrepreneur telling you about the market, about their product, and about themselves and their team? You need to do this fast, because the sooner you can weed out companies you’re not going to invest in, the more time you can spend learning about the rest. Make sure that in every conversation you are getting the information you need to go to the next step.

To make a decision when you have so little information and you know that even some of that information is not rock-solid, you eventually have to make a leap of faith. A guy I knew—super-smart, ex-McKinsey—was brought on as a partner at a major venture firm. After about a year he had still not made any investments. “There’s something wrong with every company I see,” he told me. Well, yes, same here. But if you don’t write checks, you aren’t a venture capitalist. (He eventually left the industry to be an executive at a large corporation, where he excelled.)

VCs look for three things: people, product, and market. Arthur Rock, the legend- ary venture capitalist and an early backer of Intel and Apple, among others, once said, “I invest in people, not ideas. . . . If you can find good people, if they’re wrong about the product, they’ll make a switch, so what good is it to understand the product that they’re talking about in the first place?”

Some say the product, or idea, is the most important because without a great idea you have nothing, and the person who came up with the idea may or may not be the best person to turn it into a company. If it’s truly a good idea, you can always find someone to monetize it.

All agree that the market has to be huge. Don Valentine, the founder of Sequoia Capital, said, “I like opportunities that are addressing markets so big that even the management team can’t get in its way.” But the best answer I’ve heard to the people/product/ market question, though, is from Andy Weissman, a partner at Union Square Ventures. I once asked him which of the three he thought was most important. He said, “Why would I have to choose?”

Hardcover and audiobook of Founder vs Investor

Founder vs Investor is a no-holds-barred look into the minds, motivations, and machinations of how investors and founders team up to build a successful startup, debated in a brazenly honest way by two of the best in the business.