How to Kung-Fu battle with investors

Posted on April 5, 2007. Filed under: Uncategorized |

So I have lots of pent up blogging to do, it’s been a while and now I’m back in the UK it’s a good point at which to pause for a little reflection. The first post I want to do is about the process of raising investment. I’ve been through it once when we raised our first round of angel funding back in August and then since YC investor day although we’ve not gone all out on raising another big round (for reasons I’ll explain below) investors have still found us and we’re going through the investor dance once again.

Actually when we practiced our pitch at Obvious HQ before investor day, Jason Goldman referred to the whole process a “weird kung-fu battle” and that analogy has stuck with me. I think it’s a good way to look at it. I don’t pretend to offer anything new here, I’m sure this advice is available around on the net somewhere but here’s a collection of all the lessons I’ve learnt re investment raising since YC which hopefully may be of use to some of you, they’re in no particular order.

1. Believe you’re a hot deal– When you’re a first time founder and you’ve never raised funding before, the whole investment raising process takes on a disproportionate level of importance. I think this often leads to founders creating a mental unbalance between how important they are to potential investors and how important those investors is to them. Always remember investing is a two way process – you need the money but the investors also need good deals. You can’t afford to act desperate or not full of belief, you have to convince investors that you’re the next Google and that starts by believing it yourself. It’s harder to do this if you’re not in the Valley, where there are literally way more investors than there are good deals, but it still needs to be done.

2. Investor and founder intentions are not always aligned – One thing to keep in the back of your mind is that what’s in the best interests of your investors is not necessarily in the best interest of you as a founder. This generally applies more to VC’s than angels but it’s still true to some degree for both. Investors are looking for one thing – a MASSIVE hit in their portfolio – and that is built into their mentality. What might be a good result for you, might not be a good enough result for your investor and that has potential to cause friction further down the road. This basically comes down to managing your investors well and if you’ve retained control of your company then you don’t have to worry about it so much (and it’s not necessarily a bad thing to have that think big mentality pushing you) but what it does mean is that you should always make your own decisions and not blindly follow advice.

3. Know the investor – I’m going to use two speakers from YC dinners to highlight this point. First up is Ron Conway, probably the most prominent/well-known angel investor of all time. When asked what he criteria he looked for when investing he replied “Obviously I want to see an opportunity I’m excited about but generally I don’t invest in ideas. By the time a startup reaches the point of being successful it’s hardly recognizable from the initial idea anyway. I invest in people and teams – I want the founders to be flexible and have the courage to change their business model”. Next up is Greg McAdoo of Sequoia Capital, who said that the first thing he looks for in an investment is the market opportunity. He wants to know how big the market is and see in-depth research of it. So it’s pretty obvious then that in your one-pager to Ron, you want to place a little more emphasis on the team and with Greg you might want some more market data. I know this is pretty obvious advice but when you’re in the midst of the fundraising storm and meeting a load of investors, it’s easy to forget the importance of researching each investor you meet. Do it ruthlessly, know their best investments and which ones blew up in their face. Treat knowledge like ammunition, the more you have the better off you are.

4. Talk is cheap – They say a picture paints a thousand words, if that’s true then a well rehearsed demo of your product must paint a million. I’ve now seen tons of people pitching ideas to investors and I can categorically state that nothing is as powerful as a well rehearsed demo. Being able to sum up your idea in a few sentences is not a competitive advantage/something to feel good about – that’s the minimum standard just to enter the game. Showing a good demo to an investor has a lot of positives 1) It shows you’re not talking bullshit, you can actually build something 2) It saves investors time, you can paint a clearer picture in a 5 minute demo than 5 minutes of talk 3) A demo is visual and sticks in the memory more than talk/one pager. Always have a demo ready – of our current YC batch Weebly and Zenter have awesomely slick demos and it’s not a coincidence that they’re doing very well in the investment raising process.

5. Don’t think in % equity, think in % success – This is something PG has said countless times and is a v important point. Don’t waste time trying to hold onto every last grain of equity, you’re better off deciding how much that particular investor increases your chances of success and use that as a guide as to how much to negotiate with them. There have been enough blogs about this point so I’ll leave it at that.

6. Don’t let your ego dictate your valuation – It’s very easy to take the bigger is better approach when negotiating the valuation at which investors invest in you at. It’s not as simple as that – if you’re a first time founder the one thing you really don’t want to do is lose all your investors money. You want to give them at least some form of return on their investment – even if it’s just 1x or 2x. The likelihood is they’ll put that money straight back into your next venture and so the circle continues – having a set of angels you can always call on is an incredibly powerful asset to have. But let’s say you are a superstar/superhuman negotiator and you manage to raise $5 million and only give away 5% of your company. You might pat yourself on the back and congratulate your success. But what that really means now is that your company is valued at $100 million already – so if you want to give your investors their expected return (about 10x) you need to create a $1 billion company. Even just to give the investors their money back, you need to create a company worth $100 million. Of course you should be aiming high and believing in yourself but you can see why trying to get the highest valuation possible can actually limit your options somewhat.

7. Think of money as a commodity – This is something we only did this time around and it’s incredibly liberating. When you first raise money it’s tempting to grab the money from the first person to make you an offer, after all cash is cash right? Logically though it can never be that simple, if all investment was about was putting money into a business then it’d be totally irrelevant where the money came from. That’s obviously not true though – having $100k put into your company from Ron Conway is worth ALOT more than $100k from Mr X who made all his money from pharmaceuticals (assuming you’re a web startup). When you realise that it’s somewhat liberating, you start to ask the right questions about investors which naturally gives you more power (linking in to point 1) and means you’re less likely to end up with an investor you don’t get along with.

8. VC or not VC – One thing a number of YC speakers have repeated is how the VC’s think behind the scenes and why founders should be careful. To sum it up – VC’s raise their cash from Limited Partners (a VC is really nothing more than a fund manager who takes money from rich people and invests it – they just happen to invest it in startups and not stocks). There are a few implications of this:

  • VC’s get a % of the fund they raise so it’s in their interest to raise as big a fund as possible. They have a lot of money.
  • They need to invest this money but there are only so many investments a VC can physically make in a year (only so many hours in the day and board seats one person can handle
  • So now it’s pretty obvious – if VC’s have a lot of cash but only so much investment capacity, they have an underlying motive to pump a lot of cash into the investments they do make (Limited Partners don’t want to see their money sitting around gathering dust). For a lot of startups this means VC’s offering they way more cash than they actually need.
  • So that’s the first big thing to keep in mind about VC’s, they have incentives to offer you more money than you probably need. That’s not by definition a bad thing but it can be (a lot of people argue that the best innovation happens when a startup has to bootstrap for survival – having $5 million sitting in the bank isn’t bootstrapping but you might counter that eliminating financial concerns lowers stress and helps founders concentrate on the business). Either way, keep it in mind.

    Another thing to remember is that VC can also limit your exit potentials – once a VC invests a successful exit = BIG bucks and quite simply, there are not as many $500 million deals happening each year as there $10 million ones. This comes down to what you want to do, if you’re thinking big then this isn’t an issue but worth keeping in mind (especially if you give away control and wouldn’t be able to sell even if you wanted to). (Just a quick note on this: VC’s are increasingly allowing founders to cash out so if you did get a lowball offer, you might be able to cash out i.e. the VC buys some of your stock which could be a nice compromise if you’re torn).

    So I think that’s about it – as I said this is nothing new but I figure it’s probably useful to have this stuff collected together in one place. Good luck with the fund raising!

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    7 Responses to “How to Kung-Fu battle with investors”

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    Good article, I liked the inside experience of the investor process its so true what you say that a 100k from Ron Conway is worth so much more than 100k from a random Mr X, that’s why its important to try and meet people in the industry, if you “know” your investors the relationship is so much more likely to be a success.

    PS. I noticed you started using “$” signs! stick with the British roots ££££££

    hey Harj – great post – would be good to hear about how you do equity deals with your other co-founders/ employees also.

    @Jamescoops: I don’t really have much experience of this yet (Kul and I have always just split equity 50:50) but as we’re hiring I’ll be going through it and will blog about it when I contribute some insight on it.

    @JohnN: Lol, I’m going to have to think of a compromise between using $ and £, maybe I’ll just say Euros?!

    Thanks for the input, excellent blog entry!

    Konnichiwa!
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