The Latest Changes in VC Deal Terms — How to Raise Money
There have been some serious changes in the major players and the basic terms of some of those deals, but that's not all. There have also been substantial changes to one of the most important aspects of VC deal terms: how you raise money.
Your investors are an incredibly valuable asset for your business. Without them, you may not have the ability to launch your business or to move through the latest round of improvements. Investors can also help your startup grow further, faster than bootstrapping (which I talk about here). How you raise money, however, has changed in recent years along with the recent landscape of VC deal terms. Consider these key changes.
1. You need to have a clear idea of how much you really need.
While the financing environment remains overall robust, that doesn't mean that you can afford to ask for substantially more funds than you really need. Brad Feld offers a few key pieces of advice when it comes to fundraising.
Take a look at what "getting to the next level" really means for your business.
When you're entering into the latest round of fundraising — whether that's the first round of fundraising for a new startup or a round of fundraising intending to take your business to the next level — you need to know what "next level" really means for your business specifically. Get a clear picture of what improvements you're planning to make and what it will really mean to take your business to that next step. Think about the current round of improvements, not six rounds ahead. If you do raise more funds than anticipated, you can always add improvements that you would have liked to make down the road. By clearly defining what you really need, however, you can launch the next round of changes to your business as soon as you meet those goals.
When it comes to fundraising, minimize.
You can always take things to a new level if you make more than anticipated. If you have all of your plans set based on raising a higher amount and you fail to make it, however, you may find it much more difficult to scale back your plans.
Don't put too much emphasis on what other businesses are doing or have done.
Sure, there are other businesses in your industry — including other startups — that are taking similar steps. They may have already run their fundraisers, and you can certainly use their numbers as a basis for what you might need to kick off your own next round. When it comes to your fundraising efforts, however, make sure that you have a clear idea of exactly how much you really need for your business. Don't copy what those other businesses may have used in the past.
Don't fundraise with a range.
If you make X amount, you'll be able to expand your startup by implementing plans A, B, and C. If you make Y amount, you'll be able to move on to plan Z. While it's important to have an idea of what you'll do with funds that exceed your minimums, you shouldn't start fundraising with a minimum, notes Feld. Instead, start with that minimum amount. Once you've raised that amount, you can start moving forward with those plans. With this strategy, you won't find yourself pushing off those improvements because you haven't met your full fundraising goals yet.
2. Pre-money valuations are going up.
In the third quarter of 2019, it became clear that the pre-money valuations of startups are increasing substantially. Pre-money valuations represent the value of the company before it turns to any financing measures. In Q3, the median pre-money valuations increased substantially in rounds A, B, and D+ of financing (note: this does not apply to oil & gas...I will write a separate narrative of the big oil apocalypse and how the capital markets have demonized the category, institutional investors are walking away from fossil fuel focused private equity firms, and many venture capitalists are pivoting towards clean ESG (great drug if you can find it). In other words, oil & gas focused startups better hold on...it is going to be good, bad, and ugly.)
When you're making plans for your startup, you may need to either have a solid source of capital or prove that the business is something tangible before financing begins. Investors are looking for businesses that they can invest in confidently. That means you may need to invest your own funds or choose some other method to increase the value of the business before you start looking for investors.
3. Savvy entrepreneurs let their investors know when they need help.
As part of the changing VC landscape, Anna Patterson notes, "Repeat entrepreneurs ask for help more frequently. When you need help, ask for it. That's what we are here for."
Many entrepreneurs are reluctant to ask for future funding. You've already turned to your investors for one round of funding. If you turn to them again, does that mean that you aren't successfully operating your business?
Of course not! Economic downturns, circumstances beyond your control, and even the need to expand your business can all lead to you needing to raise more funds for your business. As a savvy entrepreneur, when you need it, you'll ask for it — plain and simple.
Avoiding asking for help can leave you struggling to raise the funds you need to move to the next stage or, in many cases, putting off needed improvements to your business. Ultimately, turning back to your investors can help you expand your business and what it can offer. This raises its value and helps both you and your investors. But it won't happen if you aren't willing to reach out.
Cooley Group asks its investors, "If your company had $30 million in the bank, what would you be doing differently?... If their answer sounds like a solid and promising growth trajectory, then why aren't we pursuing that path?" Ask yourself that question:
What would you be doing differently if you had that extra $30 million in the bank?
Does it show a serious improvement to your business, both to what you can offer for yourself and what you can offer to your investors? Then ask for it. Consider how money can help you make the improvements your business needs, and don't be afraid to ask for those funds when you need them. The current deal landscape will support those advancements and allow you to see more growth.
4. Late-stage investments continue to grow more than the early rounds.
There's plenty of funding out there in venture capital (maybe not for oil & gas...I digress). Unfortunately, not all of it is readily available, especially to early-round fundraisers. If you're moving toward late-stage investments, you may find that it's much easier to get those large investments — in many cases, totaling over $100 million — than if you approach the same VC investors in the early stages of the fundraising process. I talk more about approaching CVCs in this article.
Late-stage investments, in fact, now represent a much larger percentage of the venture capital game than early-stage investments. In spite of the wealth of funds available for VC investing, which continues to grow year over year, investors are getting savvier. They're trying to find investments they can trust to pay out long-term.
As a result, those late-stage investments often have much greater financial possibilities. If you're entering the late stages of launching your business or you need to expand, you might be wary of committing because of the limits of your initial rounds of fundraising. In reality, however, those limits might not define the future of your fundraising efforts — and you might bring in more in those later stages than you think.
5. Investors are choosing to buy in before the company goes public.
The difference in readily available funds, according to many venture capitalists, can be attributed to one simple thing: many investors are choosing to get in during the early stages before a company goes public. They're not waiting until the company goes public to buy in. If you're looking for funds for your business, this is an important trend to note.
Eventually, you probably want to take your company public. This will allow investors to buy in more easily. Prior to that point, your investors are private venture capitalists. Traditionally, when the IPO window is closed, it's primarily because the market is poor. That is, it's because the company does not feel that it can get the funds that it needs by going public.
As an entrepreneur, you do want to consider that IPO window and when you want to allow public access to company stocks. At the same time, it's important to note that many VC investors are buying in before the end of that window. They're committing the funds they need to businesses that aren't quite ready to launch yet. Investors have discovered just how valuable it can be to support a company in those early startup stages, especially when that company has the potential to go to greater heights than most people notice immediately. As a result, they're buying in early and sticking it out to see how much the company can grow.
There are many changes in VC deal terms, all of which have shaped the landscape. If you have something you want to say about raising money in today's VC paradigm, let me know. In the next post in this series, I'll deal with changes to the term sheet and how they could impact the way you approach it.