Power dynamics when raising capital
August 24, 2014
If it’s your first time raising startup capital, it’s easy to feel like you’re in the deep end. Most commonly, the game feels like it is weighted in the investors favor. I wanted to share a few lessons I learned raising capital and talking to investors.
1. There is more capital than there are good deals.
At the moment, public market performance and poor bond markets are driving capital towards venture investment. Combine that with the fact that it’s become cheaper and cheaper to start a company, and the capital requirements of new businesses are lower.
That makes for an interesting game of hot potato. Investors have to get rid of money in the lowest risk / highest return way.
Having more money than ways to get rid of it leads investors further down market (which also makes it hard to get rid of a lot of money since deals are smaller).
Most companies fail so if you’re building a company that achieves success, you will be able to raise money.
2. The worst time to raise money is when you need it.
Nothing stinks worse than desperation. But lets face it, most businesses (at some point) are spending more money than they make. If you have employees and dwindling cash reserves, you have little power in the investor - entrepreneur relationship.
3. Growth gives you power
When top-tier startup raise rounds, they point to their growth numbers, brand name, and traction and that changes the conversation from the startup needing money to the investor wanting to own a piece of it.
A friend of mine bootstrapped his company to over a million in revenue, and then raised money in a competitive round. The demand from investors drove up the valuation he received for his company and the amount of cash he was able to raise. He had fantastic revenue growth numbers and a clear vision for the future making it a really easy round for him to raise.
4. Profitability is a double edged sword
If you have “profitability” as a goal, some investors will view you as unambitious. In many ways, the whole goal of a startup is to spend money and operate at a deficit to capture a large piece of the pie. It is a land grab after all.
However, profitability also gives you the ability to walk away from any deal. Profitability lets you build your business on your own, and it means that you’re not beholden to anyone.
We decided to get off the funding treadmill after our seed round and became profitable. Profitable for a 1 person company is a negative, but for a team of 7, that shouldn’t hinder us if we wanted to raise money now.
5. If you’ve got a hot deal, no investor cares if you ignored their associate.
If investors get you on their radar, you’ll start getting inbound interest from associates – more junior people working for a VC who are not the decision makers. Remember #1? Since there is more capital than good deals, partners hire associates to weed through the deals to find good ones, or fish for information if they’re considering investing in a competitor.
They get paid to talk to you. You lose time and money by talking to them.
When you’re looking to do a deal, as long as you have a warm intro to partner (preferably from another one of their investments), and if your deal ticks all the other boxes, nobody will care if you ignored a cold email from an associate.
6. Nothing you can read will train you to deal with investors…
… including this. Sure, there’s some etiquette that you can pick up from reading and from friends. I can remember feeling completely clueless in the beginning even after spending 3 weeks reading everything I could. I felt more comfortable after pitching 20 different people. I’d still get nervous doing a pitch at a partner meeting, but earning your stripes in battle is the only way to learn to deal with investors.