CHAPTER TWENTY-ONE

WHEN AND HOW TO RAISE MONEY

The answer to both of these questions, of course, depends on the stage of your business. The general rule is that the best time to start looking for money is when you don't need it—but not so early that a potential investor can watch your business closely for too long a period of time before the deal. All startups have hiccups along the way and many investors are easily spooked by reality.

WHEN TO START LOOKING FOR MONEY

If you're looking for seed capital, you may not have too many options in terms of timing but it's best to do everything you can to keep bootstrapping things along with consulting or one-off projects. Why? At the proof-of-concept stage, the value of your company increases sharply with every new customer or new release, so it's best not to take capital too early—as long as you can live without it.

If you have a business that's generating real customer revenue, with a cash balance and a predictable burn rate and you have never taken in institutional capital before, you should probably start talking to VCs six months before you run out of cash. While you don't want VCs to anchor a valuation in their mind too early, the reality is that it takes time to get these your first institutional deal done. Furthermore, you definitely want to talk to several different firms, so a little more lead time is better. This is especially true if your window of time interferes with August or the holiday season, when not much new business gets done at VCs unless you have a super-hot deal.

If you're looking for expansion capital and are near or at profitability, deals will probably take less time to get done and valuations are likely to fluctuate less. In these cases, I'd say less lead time is required, although if you're in a volatile industry, you may need the capital sooner than you think!

Again, the best time to look for money is when you don't need it. Investors (even the nicest ones) aren't afraid to “market-price” a deal lower if they sense desperation—or, more important, a lack of alternatives. To that end, the most important piece of advice I can give you is—have a BATNA (Best Alternative to a Negotiated Agreement).

THE TOP 11 TAKEAWAYS FOR FINANCING NEGOTIATIONS

The most important part of the venture financing process is negotiating the term sheet. Although they're only two to three pages long, term sheets contain summaries of all the critical aspects of a financing and once they're signed, the remainder of the financing process is significantly more automatic.

For the real meat on term sheets, see Brad Feld and Jason Mendelson's Venture Deals, with my contributions on “The Entrepreneur's Perspective.”

Based on the financings I've seen and worked on—both as a VC many years ago and as an entrepreneur and board member—my top 11 biggest takeaways for entrepreneurs are as follows:

1. Get a good lawyer. I mean a really good one. Not just one whom you are comfortable with and who is productive and doesn't charge you too much (as Brad and Jason say in Venture Deals, “your wife's brother's friend's neighbor”) but one who knows venture financings like the back of his or her hand. No matter how many deals you have worked on, your lawyer has worked on more of them.
2. Focus on terms that matter, otherwise known as “pick your battles.” A typical VC term sheet will have at least 20 terms spelled out in it. There are only a few that really matter in the end, although you should at least make sure your lawyer is comfortable that the others are reasonable and somewhat standard. Spend time on valuation, the type of security, the option pool, board composition, and your own compensation and rights.
3. Sacrifice valuation for a clean security. Everyone always thinks that price/valuation is the most important thing to maximize in a deal. However, the structure of the security can be much more important in the long run. Whether the VCs buy 33 percent of your company or 30 percent of your company is much less important than having a capital structure that's easy for an outsider to understand and want to join (e.g., investment banker or later-stage VC).
4. Always have a BATNA (a fancy way of saying Plan B). This is probably the most important piece of advice I can offer. This is true of any negotiation, not just a term sheet (see the sidebar at the end of this chapter).
5. Be prepared to pay up for high-quality investors. There is a world of difference between good VCs and bad VCs (both the individual partners and the firms) that will ultimately have a lot to do with how successful your company can become. The quality of your VC isn't more important than the quality of your product or your team but it's right up there. But—and this is an important but—you should expect to pay for quality in the form of slightly weaker terms (whether valuation or type of security). This is where having a BATNA really comes in handy.
6. Ask for references. Don't be shy: prospective VCs are checking up on you and you have every right to do the same with them. Ask them for references of CEOs they've worked with. Ask them for a CEO they've had to fire as a reference. The good ones will give you the full roster of everyone they've ever funded and tell you to call them all. The bad ones will give you two names and ask for time to prep them ahead of time.
7. Don't let the VC get away with negotiating a point by saying “we always do it this way.” That's just not true. VCs may have a preferred way of doing deals or handling a specific term but every deal they've ever done is different—and they know it. If there's a compelling reason for them to insist on a particular term, you have the right to hear it, if it's important to you. (But remember to pick your battles!)
8. If you have multiple investors in the syndicate, insist on a single investor counsel and a lead investor. This is essential to (a) protect your sanity and (b) prevent you from paying zillions of dollars in legal fees. You have to make the VCs stick to it, though—they can't come back and retrade the deal after it's been negotiated. This is also helpful in getting a syndicate cooperating with each other and aligning the members' interests, particularly if it has investors who have participated in different rounds of the company's financing. Do expect to play moderator constantly throughout the process, however, to ensure that it goes smoothly.
9. Try to deal in advance with follow-on financings. When an investor doesn't participate in a follow-on financing, it creates a total night-mare for you. Other investors will want to punish their wayward colleague and can create massive collateral damage in the process to common shareholders and management. Just as VCs will insist on something called “preemptive rights” (the right to invest in future financings if they want), you and your lawyer should insist on some protection in the event that one of your investors abandons you when you are raising more capital.
10. Handle the term sheet negotiation carefully. Whether it's an initial round or a follow-on round, how you handle yourself in this negotiation sets the tone for the next stage of your relationship with the VC. The financing is the line of demarcation between you and the VC courting each other and the VC joining your board and effectively becoming your boss.
11. Don't forget to say thank you at the end of the process. Whether you send a formal email, a handwritten note, or a token gift, be sure to thank your VCs after a financing. They're putting their butt on the line for your company; they're investing in you; and they're making it possible for you to pursue your dream. That deserves a thoughtful “thanks.”