Thursday, March 17, 2011

How to Raise a Successful VC Round or Series A

Running a Great Series A Fundraising Process
A number of companies I started working with at the seed level are now hitting Series A fundraises.   I have been helping some of them think through the process and thought I would capture some of the key components of how to raise a Series A effectively.

How a Series A is different from a Seed Round.
  • VC is an oligopoly market, Angel is a highly fragmented one. While there are literally hundreds of angels you can take money from, there are only a dozen or so venture firms that really matter. This changes the timing and approach to negotiation dramatically (See below).
  • Everyone on the investor side is a professional.  #prostyle
    • While many angels you meet with may be doing it on the side or to “give back”, all VCs are doing this for a living. Their goal is to make money for their LPs, and they have been through this negotiation many many times. Use your existing investors and advisors well.
    • Terms are more complex. If you raised a convertible note, you had a 3-5 page document you negotiated. Venture rounds such as Series A are almost always equity rounds, and you will get into all sorts of issues that will really matter in the long run for the company including board structure and governance. Study up on these key terms, as they can make the difference between your being CEO in 5 years, or being kicked out of your company. See e.g. Sean Parker help Mark Zuckerberg navigate this for Facebook.
Tactics for running a Series A Process:
1. Line up all the meetings in a short period of time.  Many seed rounds these days lack a lead investor. This means from the first check you collect to the last, you may take a few months as you round up a number of individual investors.  In contrast, Series A/venture rounds have a very different dynamic as there are a limited number of firms to talk to, and there is only 1 person you will take money from.  Similarly, VCs talk to each other a lot.  You want to limit the time period over which information will leak and VCs have a chance to collude (see below).

You should schedule all your VC meetings in as short a time period as possible. This does a few things:
  • Creates buzz. Suddenly, every VC is talking about your co at the same time.
  • Creates an auction dynamic and perception of momentum. Everyone is talking about you at the same time, so it is very credible that you have alternative options. This means VCs will give on more terms.
  • Prevents an early “no” from hurting you. The time frame is compressed enough that an early no won’t make it through all the ranks of the VC community fast enough to hurt you.
    • Makes you more confident. If you talk to lots of people, a subset of them will want to have a follow up conversation. This increases your confidence which increases both your presentation skills and negotiation leverage.
      • Prevents you from getting a term sheet too early in the process. One of the hardest dynamics to navigate is getting a term sheet from a VC before everyone else has a chance to talk with you. You end up with a dilemma – how do you keep momentum with the first investor high (in case they are your only good option) while still gauging interest from everyone else? Once a VC gives you a term sheet, they often expect a fast yes or no answer from you. Lining everyone up in a 2 week period for the first conversation helps bypass this risk to the fundraise as you will get a quick gauge of the market all at once.
      2. Create an auction.
      • Never, never, never tell a venture fund who else you are talking to until a term sheet is signed. 
        • They will call each other and collude.  A friend of mine was successfully running a fundraise until she told the two VCs interested in her company she was talking to both of them. The two VCs immediately called each other and came in with a joint term sheet substantially worse then what she had discussed with each individually.   
        • VCs talk to each other a lot.  When a company is raising a series A some VCs will literally call their friends (other VCs) and ask them if they are also looking at the company and what their opinion is. This happens with angels, but to a much smaller degree as the number of angels and their subnetworks is quite large.  Most of the traditional angels have much more fragmented networks and may not know what deals have been active or who else has taken a look. This lack of transparency helps you as an entrepreneur make a deal look “fresh” even if you have been fundraising for months.  In contrast, all the VCs know each other, and many will ask their friends if they have already passed on your company.
        • You want all the funds to be competing against one another to drive up your price.  If asked who else is interested, only allude to “the usual brand name suspects”.  Never have a venture firm “pull together a syndicate” for you. As the entrepreneur, you should be driving the fundraising process. Once you chose a lead investor and agree on terms, then you can agree to a syndicate or not.
      • Say no if people ask if you plan to build a syndicate of multiple VCs.
        • You want other VCs to be their competitors on the deal, not their allies. 
        • If 2 VCs invest in you, you will usually get 2X the dilution. Often VCs ask if you want to do a syndicate. Typically this is code that really means “Instead of selling 25% of the company for $5M, why don’t you sell 25% of the company to *each* of us, for $5M and 50% total dilution.” The exception to this is if one VC is clearly leading, and the other is putting in a smaller amount for the relationship, in which case dilution is constrained.
      • Collect all the term sheets at once.  If possible, create a dynamic by which the timing is tight enough that you get all the term sheets within a few days of each other.  This gives you optimal leverage and transparency into what each player will give you.  Don't over do this - e.g. don't meet with a partner Monday and ask for a term sheet Friday.  They won't have time to get the partnership to approve it and will drop out of the race, decreasing competition for the round.  This is one of the reasons the timing of the initial set of meetings in a short time frame is key - as you will also collect all the terms sheets within a short period of one another.
      • Go to a bake off with multiple "finalist" VCs.  Once you have all the term sheets, chose a small number of VCs that seem the most interested in your company, and create a bake off.  Even if there is one VC you really like, keep at least one or two others in the race as you negotiate final terms, in order to have a BATNA and be able to negotiate credibly.  
      3. Make the first 2-3 meetings “practice meetings” if at all possible. You know that partner from the venture fund who wont leave you alone, that you would never take money from? Make him or her your first meeting in the process. They will provide valuable feedback on your pitch you should iterate on before meeting the top tier guys you really care about.

      4. Find the right partners at the right firms to talk to. I can not overemphasize this point enough. Too many people just get intro’d “to Sequoia” or "to Accel" rather then being introduced to “the partner at VentureFirmX who has funded companies in this area before”, or “the partner at VentureFirmX who is actually helpful”.
      • Ask your angel or friend doing the intro why they think the partner is the right one. They should be able to justify why this partner is the right one. It is possible it is the only partner they know. If this is the case, you may want to try to find another lead in. However, if you lack real alternatives, go with their warm intro.
      • Make sure they are not just currying favor or trading deals.
        • Some angels will send a deal to a venture fund because they feel they owe the venture fund. For example, the venture fund helped them invest in a company they couldn’t get into otherwise, or the VC has them as a limited partner. This leads to bad dynamics for you as an entrepreneur. You are not being introduced to the best partner for you, you are being introduced to the VC partner that the angel owes something to.  Sadly, I have seen this happen too frequently.
      • You will be stuck with the first partner you meet as a board member most of the time.  This is due to the reward mechanisms a venture partnership has set up.  At most venture funds the VC who takes the lead on the startup often takes the board seat and gets a bigger share of the carry on the investment.  So their economics and incentives are skewed to take the board seat, even if another partner at the firm is a better fit.
        • Do your research. Who has a good reputation? Who undermines entrepreneurs? Who has had a string of successful exits and the confidence to not screw you over as an entrepreneur?
        • The first partner you talk with at a venture fund often “owns” the deal. They will negotiate your term sheet and try to join your board, even if partner X down the hall is a much better fit for you both personally and from a market/product perspective.  This is not always the case (e.g. Benchmark has a great reputation for trying to let the entrepreneur and the various partners choose together) but it often is.
      5. Use Backchannel to your advantage.
      • Ask existing angels or advisors to talk you up before you go into the meeting with the VC. After the meeting, if the VC is interested, have the angel help drive the auction dynamic by acting as an informal bridge to the various VCs to let them know there is a lot of excitement in the deal, an what terms they are off on. This is sort of like the behind the scenes diplomatic talks that take place prior to e.g. a summit between the US and China.
      6. Treat the pitch a product – iterate on it until it is great.
      • Make the pitch “conversational”. Don’t walk people through slide by slide. Make it more of a conversation and refer to the slides as backup material. This will make it more engaging to both sides.
      • Tell them who you are up front, and who else is on the team. This will optimally legitimize everything you say afterwards. They also want to understand who will be running the company day to day. VCs will typically ask you who the 2-3 key hires you need to make for the company are. Be prepared to answer this question.  (I have another post ready to go on the questions VCs will ask you during the Series A process).
      7. Important: Know what you are optimizing for.
      What do you really care about?  Control?  Valuation?  Expertise?  Have a check list in your head of what you want from your VC/future board member, as well as the terms that matter to you most.  Don't forget these things in the fog of the fundraise.  Make sure you are optimizing for the right thing.  Keep coming back to this during the multiple weeks it will take to get to term sheets.
      Any other tips for raising a Series A, or ideas on how series A fundraising differs from seed rounds?  Let me know in the comments section!

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