Stephen McDermid of Andreessen Horowitz recently shared a list of the most common questions investors hear from founders raising capital. Raising capital can be a frustrating and difficult process for founders. Understanding the process before hitting the ground running can help the process.
Tech.Co selected the top 10 questions startup founders ask investors, followed by advice from the investor:
1. On the Right Time to Raise Capital
McDermid explained that the time to raise capital is when the startup is “ready” to execute a process. The challenge is determining when you're “ready.”
In the best case scenario, McDermid suggested that in determining when to raise capital, three criteria are true:
1) You have sufficient cash runway to provide you flexibility in the fundraising process so your back isn’t up against the wall. Runway = negotiating leverage.
2) You’ve achieved the necessary milestones to get the valuation you think you deserve.
3) You’re thoroughly prepared to deliver a knock-out pitch and efficiently respond to requests.
2. On Asking Investors for Specific Valuation
According to McDermid, asking for a specific valuation can be a risky strategy.
If you ask for a valuation of $x and the investors pass on the opportunity because they don’t think the company is worth $x yet, going back to that same investor with a lower valuation rarely leads to a different outcome.
When assessing a “valuation ask” by an entrepreneur, investors also consider implicit signals like the proposed size of the raise, the price of the last round, the total amount of capital raised, and the number of rounds of capital raised.
3. On How Much Capital to Raise
Founders to be strategic about the amount of capital raised, not least because of sensitivities about dilution.
In investor jargon, “tweener” is a polite way of saying your valuation expectations are too high for the financial or operational traction you’ve achieved so far.
To get yourself out of this position, you can (1) lower valuation expectations or (2) improve execution and grow into those valuation expectations. Neither are optimal in the middle of a fundraising process.
4. On Investors to Target
The most important thing to focus on here, explained McDermid, is finding investors that are appropriate for the stage of the company.
5. On the Amount of Investors to Approach
Find a balance between efficiency and high probability of success.
This is why you don’t want to talk to so few investors that you end up running a fundraising process multiples times — i.e., starting from scratch each time. That kind of ‘serial processing’ is exhausting. At the same time, you don’t want to cast such a wide net that you can’t deliver the personal attention required to identify the best partner for your company.
6. On the Time it Takes to Raise a Round
The advice is to be prepared for the process to take longer than expected.
To maximize your probability of success, the most important thing you can do is spend a little extra time upfront preparing for a process; remember, you don’t want to run the process twice in a short amount of time. In fact, the strongest leading indicator of successful financing — flawlessly executing on the business — happens before you talk to investors. Companies that consistently deliver strong revenue growth and attractive profit margins rarely have problems raising capital.
7. Sharing confidential information with Investors
The venture capital community is built on trust and reputation. High quality venture capital firms will respect the confidentiality of your private information. One of the potential risks of not sharing sufficient information upfront and waiting until after signing a term sheet is that the investor may change their mind after signing.
8. On the Financial Model for Investors
Every company should be utilizing some sort of financial model or set of financial projections. Even if you’re at a super early stage, you should be managing to some sort of budget in order to understand cash burn and optimally time raising capital.
9. On Raising Debt Instead of Equity
Equity is a complement to — not replacement for — debt.
Debt can be a great source of capital when used appropriately. It can dramatically lower the overall cost of capital and provide a lot of financial flexibility.
10. On What Happens if Market Conditions Change
McDermid advised founders to always have a backup plan.
Backup plans can include doing a bridge from insiders, tapping debt lines, and reducing cash burn. In general, having alternatives provide you leverage in the fundraising process.
Read all 16 questions and answers here.