Funding: how investors work

When the VCs say “NO”

  1. Lay the groundwork to come back later
    VCs don’t say no, they say:

    “maybe”, or “not right now”, or “my partners aren’t sure”, or “that’s interesting, let me think about it”

    They think that your plan is not implementable due to the current facts. If the facts change they might be very well interested to invest.

  2. Consider the environment
    A “NO” from 1 investor means nothing, a “NO” from 8 investors means your plan is seriously flawed, redo it.
  3. Retool your plan
    Remove risks from your startup until the VC finds the remaining risks manageable and is willing to invest.

    1. Founder risk: How good is the founding team?
    2. Market risk: Will anyone want it? | Will anyone pay for it? | How much will they pay? | Competitors… | How do we know?
    3. Timing risk: Too early? / Too late?
    4. Financing
      risk      : how many additional rounds of financing are required for the
      company to be profitable? | How certain are the estimates? | How do we
      know?
    5. Marketing risk: will it cut through
      the noise? | How much will marketing cost? | Acquiring a customer is
      cheaper than the income from a new customer?
    6. Distribution risk: Does it need partners?
    7. Technological risk: Is the technology available?
    8. Product risk: can the product be build? | can this team build it?
    9. Hiring risk: Will the team be able to hire good staff?
    10. Location risk: is the location suitable for the needs of the business?
  4. How to retool your plan:
    1. Founder risk: maybe you have to find more founders who have all the skills your startup need
    2. Market risk: more detailed analysis | get some customers → prove that the market exists
    3. Competition risk: Is your USP really unique? Make sure it is! | NEVER, EVER say that you have no competition | NEVER, EVER say that you go for 2% of the market, because the companies who have the other 98% will crush you.
    4. Timing risk: Demonstrate that you are neither too late / too early. You will get the customers
    5. Financing risk: Plan realistically, but spend as little as possible.
    6. Marketing risk: Show that you get more revenue from each customer than it costs to acquire them.
    7. Distribution risk: If you need a distribution partner, better you have an agreement with them before you apply for financing
    8. Technology risk: get it to beta, then raise money.
    9. Product risk: same as technology risk
    10. Hiring risk: figure out what positions the VCs will be worried about and add them to the team
    11. Location risk: if that is any problem, you must move to the money.
  5. What to focus on:
    1. Get your product out
    2. Get customers
    3. Recraft the pitch around the risks

VCs really want to hear:

(11:02)

  1. Exploding market (a big market is better)
  2. Customers are desperate for your solution (willing to overpay)
  3. Current solutions are not good enough
  4. We have best solution
  5. We have the best team
  6. VCs look for unique: (10:48) Product, Market, Team (which they put first depends on the VC)
  7. A perfect exit strategy (IPO / sell the company)

The Equity Equation

the investment should increase your companies value more than the amount invested

n = % someone wants to invest
r = Expected increase in outcome
if r > 1/(1-n) take it
r > 6.4

It is not only important how much money you get, but how much the investor will be able to increase your outcome.

How to Negotiate a Term Sheet with a VC

The most important part of financing is negotiating the term sheet.

  1. Get a good lawyer (better an attorney than just a lawyer)
    one who worked on both sides ( VC side and founder side)
  2. Focus on terms that matter – Pick your battles
    1. Sacrifice valuation for a clean security
      The price of the startup is less important than secure terms (other investors can join in)
  3. Always have a BATNA (Best Alternative To Negotiated Agreement)
    just like in Dating, have a backup plan
  4. Be prepared to pay up for high quality investors
    good VCs will give you worse terms
  5. Ask for references
    Ask for CEOs the VC has worked with [ ideally ones that failed ]
  6. Don’t let the VC get away with negotiating a point by saying “We always do it that way”
  7. Multiple investors -> demand for a lead investor
    1. keep sanity
    2. cuts legal costs
  8. Deal in advance with follow-on financing
    insist on protection if an VC will not participate in a upcoming financing round.
    Pre-emptive rights = right for a VC to be the first to invest in the next round
  9. Handle the term sheet negotiation carefully
    It determines your relationship with the VC
  10. Say thank you
    handwritten notes can do wonders

The Hacker’s Guide to Investors

  1. Angel Investors are extremely important
    1. They have technical knowledge
    2. They are willing to take more risk
  2. Most investors are not like founders (they are not likely to think technical)
  3. Most investors are momentum investors
    1. They don’t know about technical superiority, they just figure out that some company takes off a little quicker than other companies
    2. Your traffic is extremely important
    3. Other investors opinions are extremely important
    4. if someone offers you a decent deal, take it
  4. Most investors are looking for big hits
    1. VCs like companies that could go public
    2. they want to see a chance (no matter how small) that you become a big hit
  5. VCs want to invests large amounts
    1. if you need a lot of money, that might make you even more attractive
  6. Company-Validations are fictional (in the beginning you only can guess the value of an company)
  7. VCs look for founders like current famous founders
  8. Contribution of VCs tends to be underestimated
    1. connections
    2. advice
  9. VCs are afraid of looking bad for their risky choices (looking for reliable founders)
  10. VC that turns you down, does not mean anything
  11. Investors are emotional
  12. The negotiation does not stop until the ink is dry
    1. always sell your self to the investor
  13. Investors like to co-invest
    1. if another VC is on board it means they will not be likely to invest in an competing startup
  14. Investors collude with each other
  15. Big VCs care about their portfolio, not individual companies
    1. Success (soon to be bought, or go public)
    2. Failures (go bankrupt)
    3. Living-Dead (company far from bankruptcy, but not likely to be bought, or IPO)
  16. Investors vary greatly
    1. winning investors tend to win in the future
    2. loosing investors tend to continue loosing
  17. Investors don’t know how much raising money absorbs in energy
  18. Investors don’t like to say no (they want to stretch a deal to see if you are worth it)
  19. Investors like it when you don’t need them (be successful with, or without them)

How to Fund a Startup

  1. Friends & Family
  2. Angel Investors are individual rich People. Their money is not the only valuable, also their connections + knowledge.
    1. they invest much earlier than VCs
    2. you have to think about an “Exit strategy”
    3. the startup has to be valued equal for every investor
    4. Angels will invest usually with less constrictions than VCs
    5. find them through personal introduction
    6. experienced Angels are much easier to deal with
  3. Seed Funding (like angles, but not individuals, but companies who invest in earliest startups)
  4. Venture Capital Funds
    1. VCs will invest because they think another VC wants to invest in you (same rules like in dating)
    2. there is a VC pecking order. If you make a deal with a big VC, all the others want you as well.
    3. VCs don’t want to hear so much about your company, but more about MONEY
    4. if you get a term-sheet ask how many % those sheet get real deals
    5. have a protection against getting fired by the VC and loosing your unvested stock
    6. if you mail a business plan to a VC, make sure it is addressed to a person working there
    7. It is very tricky to decide when to approach an VC as they will:
      1. ask you: Who else did you talk to?
      2. talk amongst each other
    8. approach VCs when you have shown that users love it
    9. Several VCs interested in a company, might split the deal amongst them (more connections + more knowledge + they are all checking each other)

The Stages of Investing:

  1. Seed Round: Money to get a prototype out and running
  2. Angel Round: Get a working model
    1. Angels might want to have a convertible loan, that can be transformed into stock later
  3. Series A Round:
    1. Who else have you talked to?
    2. Termsheet (Founder will not have contact to other VCs for some time) checking for patent infringements, design flaws, other bombs waiting to blow up.
    3. The deal falls through
    4. Next Serieas A Round…

How to Make Wealth

The rate for which one gets hired, is really the added value for the user
How hard is it for competitors to copy your technology? –> The harder it is for them the easier you get VC capital
A startup either succeeds gloriously or fails miserably as it is a high risk bet, but there is no way to absorb shocks like a big company can
You get bought not because of the potential gain of the buyer, but rather because of the fear of someone else buying you, or becoming big and more expensive or even a competitor.
Measure the success of your business by the number of users [not some technical successes].

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Rating: 5.0/5 (1 vote cast)
Funding: how investors work, 5.0 out of 5 based on 1 rating
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2009
19/10
CATEGORY
edu:Business
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