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12 things founders should keep in mind from day 1
Being a founder of a startup is like being a sailor in a storm. There are certain mistakes which founders can avoid, especially when raising venture capital. Second time entrepreneurs can relate well!
Early stage VC funds often look for complimentary founders, an attractive market opportunity and ‘potential PMF’. Although the market landscape (subsequently PMF) may change unpredictably (say, Covid-19), the same uncertainty is less likely to apply to founders.
Interacting with several founders, I have identified some sticky points that can lower an investor’s confidence in a company, especially in the first institutional round of funding.
Companies with at least 2 co-founders are common, but occasionally I speak to solo founders as well. Being a solo-founder can be advantageous, especially in terms of holding significant equity and control of the company, but it also means single-handedly managing fundraise and business operations, which may not leave enough time for thorough decision-making.
As an investor, a single founder company is not a definite ‘no-go’, however it makes betting on the company riskier, and may result in a discounted valuation.
I advise onboarding a co-founder early on, even if the company is your brainchild. In terms of value, consider it equal to raising your first round! Bringing in a co-founder at a later stage, say series A, will be a challenge considering the chunk of equity that will go with the title.
I personally prefer companies where equity is not divided equally between the co-founders, as I believe it is rare to have all founders adding equal value, i.e. a fair equity allocation from day 1 should be based on the amount of value brought in, and not just the time commitment.
2. ESOP Pool:
Often ESOP pools are created only after the first institutional investor(s) come in. I recommend having one early on with an ideal allocation of 10%-15% (latter is better in case you want to bring on some key hires).
3. Cap Table
Typically, first capital infusion comes from angel investors. I have often seen 'complicated cap tables’ with about 2 dozen angel investors at a pre-seed round (this one time I found 100+ angel investors on a cap table!). I recommend pursuing a syndicate route if you have multiple angel investors, to minimize the names on the cap table.
4. Planning fundraise/ Skin in the game:
Once you have decided to raise capital, arriving at the right amount is crucial. There may be instances where an investor offers more than your ask. While preparing financial projections, estimate the capital requirement for 18-24 months. Say you need $1M (average burn of $50K pm), at an early stage, valuation is more of an art with standard 20% (or 25%) dilution, which gives you a pre money valuation of $4M. If there are offers for another $1M investment, it might feel exhilarating to raise more than your ask, but you may dilute up to 33% in the process.
Venture funds like to invest in companies whose founders have enough skin in the game. Hence, keep subsequent dilution in mind when raising capital.
5. Cold Connects:
Though the best way of connecting with VCs is through common friends/ network, not everyone has that network early on. Reaching out through cold pitches does have room for success, however sending a template message on Linkedin along with your pitch deck (as a first message) will be of no help.
Most VCs read emails! And locating their email IDsis fairly easy (and often publicly available). Send short emails, and avoid a template/promotional structure.
6. Investment Bankers/ Startup Consultants
Whiler early stage startups have a lot going on, it may look easier to access capital through bankers/capitals. For no obvious reason, there’s a preference for companies connecting with investors independently rather than through such channels. I have had consultants pitch for startups, but those deals see less amount of interest. As a founder, limit a banker’s scope of work to making introductions, andt pitch yourself.
Make sure to convey relevant information (preferably data) upfront rather than having the investor dig that information. This is since if an important information point does not come out in the presentation, a VC may assume that it does not exist, and may pass the deal on this assumption. I once gave a company the benefit of doubt to a SAAS company, requesting for MIS and discovered great retention metrics along with expansion revenue, which were missing in the deck!
Being very well researched about competition is important. “Oh, I haven’t heard about this company” does not cut as a response! While it is impossible to know about every player out there, at least ensure that the competition slide is comprehensive and conveys that you know your space much better than the VC on the other end.
9. Data Room/ MIS
If your first meeting goes well, typically you will be asked to share a data room/ MIS for the VCs to have an inside view of the company. While data may convey important information about the company’s health, know that a seasoned VC is also reviewing your data management practices and the key metrics you track to improve your business. An underwhelming data room (and not just unattractive data) could be a reason for passing early stage deals.
10. Term Sheet
Congratulations on your first term sheet! Please do not ask the VC to explain standards terms to you. Do secondary research, understand terms such as anti-dilution and liquidation preferences.
Also, avoid surprises during the due diligence process. Let your (potential) investors know about any red flags that may pop up.
11. Handling Rejection
Rejection is a part of most entrepreneur’s journey, hence better to handle it in the right way. The broad reasons for passing a deal typically relate to the founders, market space or specific solution. In my experience, most founders do not reply to ‘pass’ emails, which is fine by me, but it reduces the ease of coming back for subsequent rounds. If my fund’s mandate does not match the ask of a potentially good investee company, I often connect such companies with other funds.
A friend at another fund wanted to connect me with a company they had passed, but see how the founder’s sub-optimal (read: arrogant) reply to the ‘pass’ email created a negative domino effect for the company…
Also, use your response to ‘pass’ emails as an opportunity to schedule a feedback call with the VC, you will likely get useful points for future raise or conversation with other funds.
12. Look for Feedback
It’s ideal to get some feedback after someone has passed (or otherwise as well) but make sure to not over-share things OR ask for too much feedback.
Very recently a founder started brainstorming with me on a key aspect of his startup, which gave me the impression that the founder had not thought through his business. His chances of getting recommendations OR being in the good books for future rounds reduced.
To conclude, while there are no hard rules to success, it is crucial to learn from others’ mistakes to avoid repeating them!. I often find 2nd-time founders spot on when it comes to the above list (likely since they may have experienced these before)
Finally, always share your learnings with fellow founders. And if you’re a startup raising investment, feel free to write to me on email@example.com