A VC’s best practices for early-stage founders
With rising interest rates and overvalued tech companies, we have seen down rounds in the private market, affecting entrepreneurs and their businesses.
Early-stage tech founders are facing fewer trigger-happy investors compared to just 6 months ago, which has put a cap on valuation expectations and round sizes.
But bad times also represent great investment opportunities, so risk capital is still plentiful — it just comes with more security requirements like liquidation preferences and investment tranches.
Founders should recognize and deal with market uncertainty by becoming more thorough in their fundraising efforts.
Generally, I would advise early-stage tech founders (at Angel, Pre-Seed, Seed, Series A) to make good use of these fundraising practices:
- Build ties to investors way before you need them.
- Have strong arguments for your timing, i.e., “why now”.
- Be realistic about your revenue multiple/ownership offer.
- Consider raising a bridge/smaller round.
Building investor confidence is a key activity to securing funding. Unfortunately, some founders neglect the importance of it, which is a shame.
The confidence, or let us call it the mutual compatibility that you need from both sides of the table, usually comes from spending time together and watching everyone’s behavior up close.
And since an investment relationship is longer than the average American marriage, being aligned and able to trust each other is paramount.
If you want to raise capital — especially under current market conditions — you should begin talking to investors between 6–12 months before you need the money in your account. Here, cold outreach to VCs is fine because you do not need the money immediately, but warm introductions through your network are always preferred and work best.
One of the best strategies for cold outreach is to call and email the VCs you would like to work with and share a teaser deck (8–12 slides) with them. To get a warm introduction, you need to find a common connection, for instance, on LinkedIn. Or ask the VCs who they can recommend you talk to and if they can connect you by email.
Generally, when talking to investors, I would highlight why you think they would be a good fit for your upcoming round. And I would be precise about when you expect to raise the next round again. Investors want to see you understand your cash flow runway and know your business.
It is the question many VCs would like a good answer to.
Acceptable replies include,
- You do not have enough runway to wait for better market conditions.
- You have great momentum in your sales, product, etc., and raising capital would propel those efforts meaningfully, perhaps giving you a strong competitive edge.
Nevertheless, timing is everything, and investors know it. Diligent investors would want to challenge you on your timing and scrutinize the maturity of the company on parameters such as team size & capabilities, product & technical debt, growth & sales metrics, etc. For venture investors, it is all about investing at the growth inflection point, which is hard. So, we pay a lot of attention to timing both internally in the company and externally.
To demonstrate your timing in the company is strong, you need an organization and product that are ready for scaling — or at least have proof of concept, which should be sufficient at the Angel and Pre-Seed stage. Externally, or say in the market, investors would look at whether or not there are severe market frictions, such as a very uneducated market segment or hefty regulations. The first may, however, also be an advantage.
Make sure you, as the founder, understand your market and customer segment(s) very well because many do not! The most successful companies I have seen spend a lot of their time talking to customers, collecting feedback, and then improving their products with that knowledge.
Finally, investors want to know about your valuation and expected round size. If you are meeting investors 6–12 months in advance, I would advise against discussing valuation simply because your business should change so much that the old valuation quickly becomes irrelevant. Instead, I would focus on the expected round size and how you can work together post-investment to help you scale the business successfully.
Around 3 months before you want to close the round, it is time to re-initiate your investor dialogues and have your material ready. Here you will begin the valuation and round-size discussions, albeit not upfront.
It can be tricky to assess when to have the valuation negotiation; should you discuss it within the first couple of meetings to avoid wasting time with the wrong investors? Or should you lure them into your business through several meetings and workshops and make them bite the hook before you hail them in at your desired valuation? This is the game that both sides of the table play, and there is no good answer to it.
Regarding round size, you could consider raising less now and more later at a better valuation. I sometimes meet founders who want to raise very large amounts but who do not need to do so from a cash flow perspective. It is hard to spend a lot of money quickly — and even harder to generate a nice return on it for your investors. Do not raise more than what is needed, plus a six months buffer. Generally, a round should give you 18–24 months of runway.