U.S. venture capital is heading for another record-breaking year in 2018 as some high-profile exits early in the year, like Dropbox’s $756 million IPO, fueled investment.
From my point of view, startups are raising more money than ever and likely more than they need to. Companies that might have raised $5 million to $7 million three or four years ago for their Series A are now raising $12 million to $15 million for the same round.
But just because you can raise money doesn’t mean you should. Founders eager to post large valuations often find a few years later that they own a smaller slice of their companies than they would like.
To navigate the current landscape, start with the end in mind and figure out exactly how much funding you need and why. After that, consider who you will be doing business with. The VC-startup relationship is kind of like a marriage. You don’t want to get into a bad one.
Fundraising may seem like something that startups just do, like setting up a website or hiring employees. But seeking funding isn’t always necessary and it shouldn’t be perfunctory. When I ask startups why they’re raising a predetermined amount, it’s often because a VC told them to do it.
That’s the wrong answer.
The right answer should be that the company has performed analyses that show what the go-to-market investment should be and how much of a cushion beyond that the company has left over to function. It’s first and foremost figuring out what exactly you’re going to use the funding for.
If the company realizes that the figure is small – like $2 million – then friends and family or a small capital line with a bank might be a better option than working with VCs.
There’s no perfect time to raise money but it’s a good idea to raise it when you don’t need it. As in sales, prospects can smell desperation so it’s better to avoid putting yourself in that situation. The last thing you want to be doing is seeking funding because you need it to make payroll the next month.
And Most Importantly, the Who
When it comes to fundraising, not all of the elements have equal stature. The question of who you’re taking money from is of supreme importance.
Remember there’s a good chance you’ll be dealing with these investors for years. That charge you get from seeing a big raise and valuation in TechCrunch will fade. At OpenView we often spend 18 to 24 months getting to know founders before we invest.
That isn’t just a technique to test the founders’ resolve. It’s also a means to establish a mutually beneficial dialogue. As a VC, you can learn a lot from the conversations. Startups can provide valuable market intel. But it should be a two-way street. Get information out of your VCs as well instead of letting them continuously pump you dry for information.
Taking money from people you know and like is also an insurance policy against the inevitable tough times that will come. You should ask yourself, “Is this someone that I want to go to war with?” Because things aren’t always going to go well. You’re going to hit bumps along the way. Make sure that’s a person you want to be in the trenches with.
Governance, structure and price
Establishing relationships with your investors will allow you to map out a funding arrangement that works. The key points of contention are governance, structure and price. When it comes to governance, founders need to acknowledge that they’re giving up some control for capital. You need to ask, “What can the board and or the investor prevent me from doing as a founder, or prevent us from doing as a company?” Don’t settle until you get to the right answer, but recognize that there will be compromise.
Structure refers to the terms of the agreement. Founders should look for any unique features of the deal and ask what will happen in various exit scenarios. Ask if there’s a dividend and if the liquidation preferences are participating or non-participating.
All fundraising should begin with that end in mind. Rather than have a VC dictate the fundraising process, figure out how much money you need and how much control you need to succeed. The next step is to figure out if you really want to be dealing with this particular investor over a long period of time. That part of the equation is much more important that the dollar figure, even if TechCrunch thinks otherwise.