In no way are venture investments made on a purely rational basis, as much as investors may like to think so. They involve all the same cognitive biases in any sales deal from false scarcity to price anchoring to confirmation biases. For founders, you'll need to leverage these biases to your advantage to quickly and successfully secure funding (unless your business is performing so incredibly well that people are throwing money at you). Here are key learnings from my fundraising experience that are most useful to founders raising early stage (Seed-Series A) startup capital.
Venture investments follow the second law of thermodynamics, the greater the time, the greater the instability. For every hour that passes, there are new unpredictable and random things that can happen to stifle the investment - many of which are completely outside of your control. The partner in the firm backing you left and the others don't have the same passion for your business. A global pandemic hits and firms have to double down on current struggling portfolio companies instead of initiating new investments. A key staff member decides to quit during the fundraising process. There's a limitless number of scenarios in which investors could pull out and every day that passes is another day one of those things might happen and you run the risk of failing to hit your target. With enough days, one of them is going to happen.
You may also think that you want to stall fundraising for next month's performance, which is going to be so amazing it's going to pump up your valuation and make fundraising even easier. If that's true, then you should've closed the money you have now to move even faster. Any which way, taking too long to fundraise is a bad move.
It is most likely that you have committed investors that have different half lives. Some may be stable and others may be uranium-235. It's important to know the stability profile of your committments to know the overall risk profile of the round which will in turn determine how long you have left before the bomb goes off. Here are some criteria for assessing stability:
Investor Type: Funds are more stable than angels
Due Diligence process: Long DD process means they don't take decisions lightly, meaning reversing those decisions is more difficult. Short DD process means the investor still has a lot to discover, which may change their mind as new information becomes available.
Fund History: New funds are much more unstable than long-standing ones.
Reputation: Does the investor have a positive or negative reputation from other investors or founders.
Integrity: Did you get a sense that the investor is a person of their word or are untrustworthy.
Other markers to help/hinder stability are:
Then map out the risk profile of the round. Look at the Cartesian coordinate system below that maps risk on the x axis and ticket size on the y axis
Following the second law of fundraising thermodynamics, all the dots will shift towards the left with the passing of time to become increasingly more unstable. On the example above, point A would represent your ideal anchor investor - they're bringing in the largest ticket size and are most stable. You cannot afford to lose this investor, but fortunately, they're also the hardest to lose.
If you don't have such an investor, and the lead of your round is more like point B, then you need to close the round as quickly as possible. They are very close to becoming unstable and you need to do whatever you can to close the commitment.
If you're beyond the angel round stage, you'll likely have an anchor investor in the upper half with a range of smaller angels/funds in the bottom half. Typically angels are more unstable than funds. Funds have a lot of process involved in making an offer, such as a well-defined due dilligence process and investment committees. They are also highly concerned with their reputation as it is the essence of their business, so undoing a commitment is not particularly easy. Angels on the other hand have none of these measures. It's their own capital and they are more susceptible to changing their minds. Most of your angels will be close to point C. Whilst individually losing 1 or 2 of these tickets may not be consequential, in aggregate they can form a critical piece of the round. If your angels equate to more than 40% of the round, you should treat the situation as very unstable and again, look to close as quickly as possible. An added problem is the chain reaction effect that one unstable investor can have on the others. If any pull-out, you should immediately shift all other investors further to the left, as their probability of pulling out will also increase.
When you start fundraising, mark each of your commitments on the graph and look out for too many close to or already in a state of instability. If you don't have many that are absolutely solid as a rock, recognise that you are in a fragile state and ensure the time between recognising your condition and closing should be a small as physically possible.
This begs the question how small is small? Minutes, days or months? Fundraising should take a maximum of 3 months to close, and 2 months is a more viable target. Rounds that take longer than 2 months could have either been done more effectively or are not likely to make it. You should set a 2 month deadline for the round for both yourself and investors and stick to it. All investors can move on very quick timelines if they have to. The worst thing to do is letting firms create their own timeline. It needs to be, 'it's done by this date or you're out'. Otherwise you'll hold out for their response, they may take a long time to reply and then get a no. You then risk losing existing commitments as they have crossed the instability line over time and the whole round could unravel, taking your company with it.
Based on the profiles of investors as mapped out on the graph above, if your position is looking unstable, then you need to close within 2-3 weeks of commitments being given. That may mean you need to negotiate and get creative on how you're going to do that. Here are some ideas for plays you have if you have commitments but can't close the round target:
Rolling Close
Use a rolling close if you have an anchor that is highly unstable and company performance is doing well, but you need more time to close current discussions. This may make sense, for example, if you got a big commitment from an unstable investor at the end of June and you're about to enter the summer period where everyone is off (more on this later). You want to close the cash and the rest of the round would come together - it's just being slowed by external factors not pertaining to the company.
The biggest drawback of a rolling close is that you will find yourself in perpetual fundraising mode. If you're a small company, this may not be the best strategic choice, as you'll want the CEO to be levelling up product and performance rather than fundraising which is quite a detached activity from the rest of the team.
Convertible Note
Use the convertible note if you've unlocked something important for the company that you didn't when you opened your fundraise. It might be a feature that transformed stickiness or unlocking a key marketing channel that means growth is on the ascent. You may be feeling very confident about your new position, but are fundraising based on outdated performance and want to furnish investors with more months of the new position. In that case, raising a note can extend your runway enough to then go on to raise a more ambitious round.
The biggest drawback of a convertible note is it heavily relies on performance of the months of runway you have until the liquidity event (which you can expect to be less than 6 months). If you have 1-2 months with something going wrong, you might really struggle. Hence it has a high risk profile, though it comes with a requisite reward.
Raise a Smaller Round
Use a smaller round if you are not certain about future company performance. If there are key things to unlock still (for example finding product-market fit or channel-market fit) you are essentially in the highest risk phase of the product and want the lowest risk option for funding. This option will allow the CEO to fully return to the team to solve key challenges and provide a well-defined runway to plan the business around.
The biggest drawback of a smaller round is that you've decreased your immediate risk profile, but increased your future risk profile at the next round. For example, you may end up raising a small Series A round, but Series B investors will still expect to see certain performance benchmarks. That means you'll need to hit the same targets as companies that have had 2 or 3 times as much capital to get there. It also signals to investors that you may not be the high functioning star performer they are looking for, and find your next round challenging. It heavily relies on you discovering key inflections moments for growth and exhibiting the commercial benefits of those discoveries to secure your next round.
Just don't do it. Don't even think about doing it. Most funds have an investment committee that ranges from 3-10 people and reaching a quorum during Summer or Christmas is nigh impossible. Someone is almost always away and they can't make a decision without IC. As a result, you may get some of the partners very excited to then have to wait 2-3 months for the others to comeback and say they don't like it. Trying to raise in these key holiday periods is a genuine strategic error that can be fatal. No matter how well it might fit into the company's plan or lifecycle, don't do it.
The goldilocks zone for raising is between February - April and September - November. If you are giving yourself a 2-3 month window to raise, make sure the entire process will fit into these slots in the year. That ultimately means the key months to start fundraising are February or September.
You cannot take the same approach with partners as you do with associates, because they are completely different functions. If you're raising from a fund, your initial conversations are likely to be with associates or principals of the fund. The function of these associates is to tick off the quantitative side of your business. They exist to dive into the numbers of the company and match up those numbers with the investment thesis they have learned the partners like to invest in. Associates are judged by the hit-rate of recommended companies they push through the pipeline that the firm end up investing in. As a result, they don't have much room for creative freedom, because they need something to support their case. For meetings with associates, come prepared with figures, models and information to equip them to make their data-based case.
Partners on the other hand are completely different. They want to invest in the next big thing and to subsequently change the world (plus make a lot of money in the process). When speaking to a partner, leave the numbers at the door and bring the emotion. You need to tell them stories so that they connect emotionally with your company. You want them to dream about your business, not think about it. Telling a compelling story is the method for doing that and you should spend a huge amount of time crafting, rehearsing and delivering that vision. If you take the same approach you do with associates as you do with partners, you're likely to end up being stuck in the weeds with figures rather than painting a picture of the huge opportunity ahead, which is what is going to bring them closer to investing. Take a good 2-3 weeks out to formulate this story and practice is it over and over again. It feels completely insane to think this is the way venture works, but the future of your company will actually depend on how well you can tell a compelling story to another human being.