Tag Archives: Fundraising

The benefits of raising at a slight valuation discount

In an earlier post on fundraising do’s and don’ts, I wrote that startups should optimize for success rather than valuation. Specifically, I wrote that sometimes it’s worth “taking a few additional points of dilution [by accepting a lower valuation] to get the right partner in your company”.

Marc Lore, the founder of Jet.com which was acquired by Wal-Mart for about $3 billion in cash and $300 million in Wal-Mart shares, gives several other reasons why taking a slight discount on your company’s valuation is likely to increase your company’s likelihood of success.

In addition to letting you work with the right partner for your company, the benefits of taking a slight discount on your company’s valuation are that it:

1. Increases investor demand for the round, thereby creating scarcity which sometimes even results in a higher final valuation for the round.

2. Makes it more likely that the round’s investors have a nice paper return by the time of the next round, thereby making them more likely to be happy investors who refer the company to other investors.

3. Lowers the likelihood of a potentially morale hindering future down round.

4. Increases the pool of potential buyers of the company by not boxing out smaller buyers who would otherwise not put in the time to evaluate the company due to believing that they wouldn’t be able to meet its valuation expectations.

Investor support for startups’ external and internal activities

There’s a wide spectrum of support that an investor can provide a startup. At one extreme, we can provide capital without any interference. At the other extreme, we can effectively serve as core team members, helping with everything from building the team to designing the product to identifying and building out distribution channels to raising future funding to structuring an exit.

However, based on my experiences, there are 4 specific types of support that great startups can benefit from:

  1. Identifying and helping recruit/transition team members
  2. Thinking of and helping structure partnerships with other companies
  3. Preparing for and raising future funding
  4. Structuring an exit

There are also certain types of support that, if an investor finds themself giving a company, are usually an indication that things aren’t going well:

  1. Designing and providing feedback on product
  2. Identifying, building out, and measuring the return of different distribution channels

What’s common across the 4 types of support that great startups can benefit from is that they’re external activities. Specifically, they’re about connecting the startup with external talent, companies, and financing opportunities.

What’s common across the types of support that great startups don’t need is that they’re internal activities. Specifically, they’re activities that require detailed immersion to do well. As such, great startups do it themselves. So if an investor finds themself being requested to or feeling the need to contribute in these areas, that’s often a negative signal.

The corollary to this analysis is that you should invest in startups who either don’t need you, or benefit from your support in external activities. You shouldn’t invest in startups who need you to perform their internal activities.

When to prioritize investors during your fundraising process

I was recently speaking with a Turkish entrepreneur about the company’s fundraising when he asked which funds he should prioritize. The company has started discussions but has yet to receive a term sheet from any fund.

In a market where capital is plenty and there are many funds, you’re unlikely to have the time to have deep discussions with each. As a result, you need to prioritize who you reach out to and have deep dives with, even before receiving a term sheet.

However, in a market like Turkey where there are less than a dozen tech startup investors with the capacity to invest a sizable amount in your company, you can actually have deep dives with each interested investor. In fact, you should until you receive a term sheet.

The reason is that if you prioritize before receiving a term sheet and the funds you prioritized don’t come through, you’ll have to start from scratch with the unprioritized funds. This means, at best, a delay in closing the funding which will grow your business, and, at worst, not enough time to close the funding necessary for your business to survive.

Once you hopefully have multiple term sheets in hand, that’s when you should prioritize. Not before.

Managing for profitability rather than growth

When a startup with a history of growing with external funding finds that it is unable to raise a new round in its expected timeframe, many founders’ initial reaction is to panic. Since the company’s growth so far has been fueled by external capital, they can’t imagine how to survive, let alone grow, without it.

In reality, there are several options available for a company to generate the cash necessary to either break-even or significantly increase its runway while accepting a lower level of growth. These include:

  1. Raising prices or commission rates
  2. Renegotiating the terms of variable cost sources
  3. Cutting less effective marketing channels
  4. Renegotiating employment contracts or downsizing
  5. Moving to a cheaper office
  6. Ending external consultant and agency contracts
  7. Improving the company’s cash cycle by collecting sooner and paying later
  8. Improving the company’s cash position by selling fixed assets and inventory

The availability of each of these sources of cash depends on the context of the company. But, very often they are available.

And sometimes these measures aren’t enough to save the company. But, often they are.

Rather than panic, or more accurately after you’ve panicked for a while, you have to take the painful short-term actions that are necessary for your company’s long-term survival. You have to manage for short-term profitability so that you can hope to have another chance at long-term growth.

When no reply means no

I was recently speaking with an entrepreneur who shared that he hasn’t received a reply from an investor to whom he reached out for funding. The entrepreneur had sent the investor a reminder email about a week after the initial contact, over a week had passed since the second email, and since he had yet to receive a reply he wanted to know whether he should try a third time.

I’ve faced similar situations when fundraisi g from limited partners. Around 90% of investors who eventually end up investing reply to your first email. Every once in a while, let’s say 10% of the time, there are valid reasons (personal or a very busy time period professionally) why an eventual investor doesn’t respond to your first outreach but does respond to your second. I haven’t come across an investor who didn’t respond to my first two outreaches respond to the third and end up investing.

So here’s my recommendation:

Try once. If you don’t get a reply, try again a week or two later. If you still don’t get a reply, understand that no reply means no.

Buldumbuldum’s new round

Buldumbuldum, a mass customized products marketplace serving both consumers and businesses where we’re investors, announced its latest funding round last week.

All of the existing investors of the company including Nevzat Aydin, Melih Odemis, Can Yucaoglu, Birol Yucel, and us participated in the round.

The round’s proceeds will go towards Buldumbuldum’s capex investments in new printing machines and towards attracting and serving its first international customers. We look forward to following the company’s progress on both fronts.

Carbon’s new round

Carbon is a digital healthcare system where we’re seed investors.

The company recently announced its new funding round which brings the total funding raised by the company across two rounds to $6.5M. We participated in both rounds.

We welcome this round’s new investors including its lead BuildersVC to the company, and look forward to continuing to watch Carbon’s CEO Eren Bali and his team execute on their ambitious vision.

Getting investors to act fast

When fundraising, the best way for an entrepreneur to get investors to act fast to complete an investment (and to get a healthy valuation) is to create demand for the company from competing investors.

However, this isn’t always possible. Especially in markets where capital is scarce, even very promising companies might not have many investors at the table.

When this is the case, some entrepreneurs resort to fabricating demand that doesn’t exist. They claim that investors who aren’t interested actually are, or they exaggerate the interest level of investors who have expressed initial interest. This often backfires because investors talk to each other.

Another approach is to set an arbitrary deadline. This doesn’t work because it doesn’t tell the investor what they have to gain from investing early and the investor knows that they’re the only party at the table. If the deadline were to pass it would simply be extended. In other words the deadline isn’t credible.

Rather than fabricate demand that doesn’t exist or set an arbitrary deadline, a better approach to get investors to cross the finish line is to show them the growth opportunities that the company will miss out on or have to delay due to the lack of funding. This also means that the investor who’s evaluating an investment in the company will miss out on them.

This includes highlighting the great team members that the company isn’t able to hire, demonstrating the foregone revenue or cost savings potential from not making a particular capex investment, and quantifying the opportunity cost of not conducting a specific marketing campaign, all due to delayed funding.

The reason why this works is two-fold. First off, unlike fabricated demand that doesn’t actually exist, it’s truthful. And second, unlike an arbitrary and uncredible deadline, it shows the investor what they have to gain from investing early.

Prioritizing your investor outreach

Let’s say you have a list of investors who you’ve targeted for your startup’s fundraising. Some you know well and some you don’t. Some you believe are likely to invest and some you believe are less likely. Perhaps the latter group are in this position because they don’t know you.

How do you go about reaching out to these investors?

One approach is to reach out to them all at once, contacting those you know well yourself and requesting your mutual contacts to introduce you to those you don’t know well. While this approach is fast, it’s unlikely to produce the best results. The reason is that the investor candidates you don’t know well are unlikely to decide to invest if you reach out to them through a mutual contact with no stake in the fund. A recommendation from someone without skin in the game is a less effective recommendation than one from someone with skin in the game.

A better approach is to prioritize your investor outreach. First, you should approach those investors who you know well and who are likely to invest. As you receive positive responses from these investors, you should then request that they introduce you to other potential investors who you know less well.

There are two advantages to this approach. First, by having someone with skin in the game introduce you to investors you don’t know, you greatly increase the chance that the latter decide to invest. Second, independent of whether the person introducing you to a potential investor has skin in the game or not, investors are more likely to invest when there are others already onboard than when they need to be the first to commit.

A prioritized investor outreach takes more time than an all-at-once shotgun approach. However, the better results make the approach well worth it.

Investors requesting cash payment for their support

This post is to share my thoughts on investment offers where the investor requests a support fee in the form of cash for the post-investment services that they’ll be providing the startup. I’m writing about it because, although it’s rare, I’ve seen such offers, and entrepreneurs would do well to avoid them.

As investors, we’re motivated to help the startups we invest in because of the resulting appreciation in the value of our investment that will take place following this help. That’s how we’re compensated.

Support fees attempt to extract resources from a startup which is already undercapitalized relative to the bigger companies that it’s competing with. The startup needs to use its limited capital very effectively in order to have a chance of winning, and getting paid for the support you provide as an investor makes it less likely that the startup you back will have the resources necessary to win. This also makes it less likely that you win.

In addition to this argument based on self-interest, it’s also the wrong way to treat an entrepreneur.

We offer advice to our startups and we don’t charge for it. We open our network to our startups and we don’t charge for it. In the past, we offered functional support in the areas of HR, IT, marketing, and finance to our startups, and we didn’t charge for it. The reasons are simple. Our upside comes from the appreciation in the value of our investment, and our startups need to use every dollar that we give them effectively. Paying us for support services isn’t an example of this.

So if you’re an entrepreneur and you receive an investment offer where the investor also requests cash compensation for the support that they should already be providing you as part of their investment, be very skeptical.