The Challenge of Raising Funds
9 minute read
Liz Cain is a venture capital expert, experienced in all things go-to-market. On February 24th, 2021, she sat down with me to discuss the challenges of raising funds. The following is an unabridged transcript of our conversation.
Liz:
Before we begin, I'll quickly introduce you. You're a great consultant for entrepreneurs and among your many talents, you certainly know how to raise funds for clients when that is needed and deserving.
Adam:
And I will introduce you by saying you have been very successful in the world of venture capital, you know fundraising inside and out, and I always benefit from your insights.
Liz:
Right back at you. Let's start with the reality that raising money from investors usually isn't easy. A lot of stories in the media make it seem like it's simple and fast, but it's not. What do you first tell founders about the difficulties?
Adam:
There are two fallacies I try to dispel up front. Some founders think that raising capital is the equivalent of winning a big victory. I explain why that’s not necessarily true. And some founders think if they can't secure investors, that means their venture isn't all that worthy. But that's often not true either. The reality is that numerous successful ventures got where they are without having to raise outside money.
And investors often fund companies whose returns don't play out the way they planned, so for them, they are not the big wins they hoped for. So, raising a bunch of money isn't right for everybody. And when it is, getting that funding is not the finish line. It's certainly something to celebrate as a milestone, but you're still early in the race.
Liz:
So, you help entrepreneurs have the right perspective -- they can be optimistic if they're also realistic?
Adam:
Absolutely. And that starts with a founder understanding the true stage of their venture. Ultimately, to be successful, they've got to meet a real need and in a real market. But that's not going to happen overnight. You've got to realize that some of the investment will get used just to figure out if there's a market. Then you might need more money to be able to say the product is going to produce something for the market that it cares about. Once you do those two things, hopefully more money comes in so you can grow the venture like crazy. But, yes, it’s a mix of optimism and realism.
Liz:
What fundraising options are usually available to acquire capital or the sufficient cash needed at various stages?
Adam:
There are several broad sources. The first I call the gift in disguise. Most call it friends and family money -- money given the founder because of a personal relationship. The next source is angel investors. These professionals offer a combo, hopefully -- money and advice. And while it’s nice if they like you personally, they really care about generating a return on their investment.
The third source is institutional money. That's any entity that's got other people to answer to, maybe their own investors. It could include angel groups, VCs, and strategic businesses that invest as part of the things they do as a company. The fourth, and last, is the most valuable but often overlooked -- revenue. It's possible to generate cash and use that to grow the business.
Liz:
Yes, that bootstrap option seems to be used less often these days, but it’s absolutely an advantageous one if you can make it work. Some say, if you don't need to raise money, don't. Do you think that's universally true?
Adam:
To some degree it's true, but not universally true because if you collect the right type of investment, you should gain a lot more than just the money that comes into the bank. Strategic investors should be offering advice, connections, opportunities, and other assets you couldn't acquire otherwise. They also introduce something else important: accountability.
When I completely self-funded my first startup, I overlooked two things. The first was that if successful professional investors have a great track record and agree to give you money, that is validation that you're on the right track. On the flip side, if you go to a bunch of them and they all say no, that's pretty good evidence that you've got challenges you need to work through. The second thing was that having to answer to a partner helps keep you objective and clear in your thinking. When you're only accountable to yourself, it is difficult to maintain your objectivity.
Liz:
Do you feel there's a time when a founder should absolutely take capital -- a tipping point for deciding it's time or not?
Adam:
You should first consider what the capital is going to afford you, and the opportunities available to you outside of it. I work with some clients where they can't bootstrap it. The market's too big, the competition is too great, and the speed to market they need is too fast. They've got something novel that maybe they can't get a patent on, or as soon as the world hears about it, they've got to be able to move quickly. Those are cases where they should raise the money from the outside.
Liz:
That's a great example of capital being the only constraint. ‘If I have this money, I know how I would spend it. I know how I can deploy it to grow faster.’
Adam:
Yes, many founders think capital is their only constraint, but usually it's not. They have other aspects they need to work out as well – it could be a team issue or product issue. And when they focus on those other things, they realize that capital may be less of a constraint than they thought. I've also seen examples where it's a good idea not to take the money even if it's critical. If there's only one offer on the table, it's hard to say no, but that is more rare than founders realize.
Let's assume you've got one offer, but the investor isn't bringing anything but money to the table -- not needed knowledge, nor connections. You should wonder, if you can collect thoughtful investment from great investors and this is the only offer on the table, why couldn't you find more? So you should consider the old, sage advice to not always take the first offer that comes to you. If you're worth it and if it's a good legitimate investor, there will be more. On the flip side, if no one else is willing to fund you, collect that information, take a step back and maybe adjust the approach, if need be.
Liz:
Recently, a founder presented me with an interesting scenario. She had a preemptive offer in front of her and a term sheet that was pretty good. She had been planning to go out to fundraise at the end of Q1, but now she was debating whether to take the bird in hand with an investor she likes, but the terms a bit lower than she expected if she was going out to do a full competitive raise process. And there's the opportunity cost of her time too. I don't know if you've given much thought to that trade-off, but it's something a lot of founders face.
Adam:
It's a big trade-off. And it's not just a question of the time, it's also the distraction, the head space, because for some founders fund raising is pretty much all they're doing. So, the ability to collect the money as soon as you can and put it to work is huge, and the ability to take it out of your head space and focus is also huge. I'd argue that unless you thought you're going to get materially better terms or you’re materially going to be able to change the whole calculus of what comes next, the bird in the hand is worth a ton -- as long as it doesn't check one of the negative deal-breaker boxes. It’s not very smart if they're going to put pressures on you that you don't want, such as influence on your board that you're concerned about. But if the terms are pretty straightforward and you feel like you could spend another three months seeking funds and get a two or five percent better deal, that doesn't seem like the best use of your time or your head space.
Liz:
Makes total sense. Generally, investors and founders want the same things, right? They're on the same team?
Adam:
Yes and no. I think what's important to founders is how the investor expects to make their money. If an investor is investing in a small number of companies, they need all of them, at least to some degree, to succeed. A bunch of losses is not going to work well. And that's usually the case for angel investors who don't have huge portfolios; they're sort of dabbling and putting investments in a few different companies. That's good because it leads to great alignment with the founder, because your success is their success.
But let's assume an investor didn't have the same approach. Maybe they are making lots of investments and must answer to others. Maybe they have their own investors like a fund might. In that case, things change. As much as it's unfortunate, a lot of startups don't pay out the way you might hope. Many of them don't succeed. Because of that, a lot of these portfolio-based approaches have a plan for it.
They design portfolios based on a couple of really big winners to make up for all the companies that don't play out the way they hoped. That's all well and good until that source of money comes to you and starts asking you to take some risks you weren't comfortable taking, because for them, a little win doesn't make up for the losses. They need big wins. So if your plan isn't big enough to match up with their plans or what they need, they might prefer you not to be a success than for you to be a really small success; they'd prefer you take a shot at the big prize. If that happens, sometimes alignment can fall apart.
Liz:
That brings up an interesting point of how to learn more about people who are offering you money and sitting on the other side of the table. Generally, I think people offer references with their winners, and you need to take some time to reference downside scenarios -- what happens when there are difficulties or disagreements in the business. I think seeking out those references is important for founders.
Adam:
Yes, it's a great idea and it's underutilized because what often happens is that first-time founders think, ‘Oh my gosh, these investors have given me a meeting. They are really taking an interest in me, and now they're ready to give me a term sheet.’ So founders don’t feel like they are in a position to say, ‘That's great, but I'm going to need to learn a little more about you, Mr. and Mrs. Investor with a huge successful portfolio.’ Founders can feel like they don't have the position, clout or nerve to say that. But great investors want them to think that way because it shows the kind of grit, confidence and approach they want in their portfolio of founders.
Liz:
To many founders, the investor community can seem like a members-only club. Is that true? And if so, how can they get on the inside?
Adam:
To some degree, it is true, but I think they want to open up membership. Most really good investors don't want to just be seen as a source of funds. They want to be seen as advisors -- people who founders can learn from. They want partnership. If an investor's first impression is a founder saying, ‘Here's my pitch deck, now give me some money,’ you are not getting an invite to the party. The founders who get on the inside are the ones who build relationships before they need the money. They get introductions early. They say, ‘I'm not here looking for cash, I'm here to learn, I want advice so I can make smart choices.’ So, not surprisingly, when it does come time to pitch, these founders have many more doors open to them.
Liz:
When should entrepreneurs start thinking about raising money? And what do the stages of fundraising look like?
Adam:
The short answer on when to start is immediately. But that doesn't mean immediately start knocking on doors to get meetings to raise money. I think there are three distinct phases in fundraising. The first is preparing to raise. The second is preparing to pitch. And the third is engaging with investors. The second and third are the phases that most people think of as the process. But the first -- preparing to raise -- is often neglected. When you're preparing to raise, you try to figure out what sources possibly make sense. So, if some angel or institutional money seems like it makes sense, this is when informational relationship building is supposed to start. Now, you've also got the natural things you need to figure out -- how much money you need and when you need it. Founders need answers to predictable investor questions, like: how are you going to use our money, when are you going to use it, and when are we going to get it back? When you do all this, you should define the profile of ideal investors. You may not find them, but it’s essential to do your homework on them, and figure out the milestones you must hit to be attractive to them.
Liz:
Great insights -- thank you, Adam. Any final thoughts? Maybe advice for entrepreneurs who think they need to raise funds?t
Adam:
First, don’t let a fundraising story about your friend's startup or an article on TechCrunch define your road to success. No two paths on startup mountain are the same. There are many ways to think about funding, and multiple ways to engage investors. Second, being realistic is important, but creativity and an optimistic outlook should be part of that realism. If you’ve developed a great product and are determined to build a great team, you can raise the capital you need to grow a successful business.
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