Friday, February 10, 2017

Don't Ask For Too Much Money

A common mistake that founders make when raising a venture round is to anchor high and ask for too much money, at too high a valuation, with the hope the VC will bid them down. This is a common failure mode that prevents people from raising money successfully when they otherwise could. Asking for too much money is driven by misunderstanding the nature of a fundraise negotiation. When fundraising, you are trying to create an auction dynamic - not a 1:1 negotiation.

In a traditional negotiation, you want to anchor high and then have people bid you down. In a venture round, you actually want to do the opposite - you want to anchor low and pull multiple VCs into an auction around the company. Once a VC is emotionally engaged in the auction they will want to win against their peers. This will drive up the dollar amount you are raising and along with it your valuation (as VCs tend to want to buy a certain % ownership). In other words, the VCs will start to bid against each other and drive up your value.

A tangible example of this - suppose you want to raise a $10M series A. Rather then telling VCs you want to raise $15M (and an implied valuation of $60M to $75M post-money for 20-25% of the company), you should tell VCs you want to raise $6-7M (and thus a $24M to $35M valuation)[1]. VCs will view this as a potentially cheap company and kick off diligence, multiple meetings, and will get emotionally invested in the business and excited about the team and their prospects. Once the VC is emotionally engaged and excited, they are more likely to drive up your valuation so they can win the deal and you will get to $10M. In contrast, if you ask for $15M they will never put in the effort to get to know you and will just pass up front.

It Is Hard (Close To Impossible) To Go Back Once A VC Passes
Once an investor passes on your round it is almost impossible to go back at a lower price / dollar amount. You have already burnt that bridge. The VC has moved on to other potential investments and your company is seen as a "stale" or unattractive deal. After all, you could not convince anyone to give you money before, so that means the herd of other VCs is not interested (and therefore your company must not be great).[2]

What To Do If Everyone Passes On Valuation
If you get a consistent message that VCs are passing on you due to valuation you should:
1. Ask for additional feedback on what your company is doing and your story. Sometimes it is purely valuation, but sometimes VCs also use valuation as an excuse to pass if they don't like something else. Incorporate this feedback into your pitch and iterate on it. If at all possible, ask for this feedback over the phone. VCs will be less willing to be up front with you over email then on a call[3].

2. Add more people into the pipeline for your fundraise and go to them with a lower valuation then before. Even a $3M-4M drop in requested dollars raise can make all the difference (e.g. raising $6-7M versus $10M).

3. Iterate on (1) and (2).

If you can not raise money even after dropping your up front ask, there may be something more fundamentally at issue. Dig in and see what is turning investors off about your company.

Notes
[1] VCs tend to try to buy between 18-30% of the company in a series A with most falling between 20-25%. So, a rough rule of thumb for valuation is to multiple your capital raise by 4-5X to get your post money valuation.

[2] You can always engage with the VC at a later round e.g. 6-12 months later. You just can not go back to them for the same round.

[3] You can of course, ask a VC for 5 minutes by phone to get the feedback. Tell them up front on the call that your company culture is one of continuous improvement and getting feedback on your pitch is part of it.

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