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The most successful founders know that raising money from investors is a skill that takes a lot of hard work. However, what is not often talked about is the fact that the relationship between a founder and a venture capitalist can be complicated.
VCs are better at fundraising than entrepreneurs because they know what to expect from VCs and how to negotiate with them.
Before you start asking people for money to invest in your business, it's important to learn about some of the dynamics of fundraising. This will help you communicate more effectively with potential investors and raise money more efficiently. At NFX, we call this "high leverage fundraising" because it can help you save a lot of time and effort.
A VC might ask a Founder to meet with one of their other companies that does something similar, so they can get that company's opinion. But this is usually not a good situation. The Founder doesn't want to share their plans with a company that's so close to their space, and the other company is likely to prefer that the VC not invest in another company in their space. Most of the time, the existing Founders will tell the VC not to invest in the other company. This makes it very hard for the VC to invest in the Founder's company. The existing Founders have no reason to let their VC invest in the other company. So the behavior is understandable, but it's a pain for the Founder. And it's part of the trap of a portfolio check. For VCs, this can be a sincere attempt to make a good decision or, in a bad scenario, an attempt to educate their portfolio company. Answers like: 'I would be happy to meet anyone you want in general, but this company is just too close to our business to feel comfortable. Maybe there are other industry experts you would like us to meet instead?'
Founders should be careful when communicating their company's valuation to potential investors. If a founder names a low valuation, the investor may use that as the starting point for negotiation, which could end up costing the founder more money in the long run.
We don't know how much something is worth until we see how much other people are willing to pay for it. How to reply: The best way to approach this situation is to politely say: 'We don't know yet. We will let the market set the price'.
It's important to know what to expect in a meeting with a potential investor. Sometimes, if an investor seems friendly and supportive, a founder might think they will get a high valuation for their company - even though no specific number was ever discussed. If the investor then offers a lowball offer, the founder might feel emotional and pressured into accepting it, even though it's not a good deal.
It's important not to get too excited when a VC expresses interest in your company. Just because they like you doesn't mean they'll agree with your valuation. Say something like: 'Thank you but this valuation is just so low that it seems out of market. Let us think about it and get back to you'.
A VC may try to talk about investing in a company at a certain post-money valuation, but it's important for Founders to be aware that this can actually lead to a lower valuation. For example, if a VC tries to invest $2M at an $8M post-money valuation, that would actually be a $6M pre-money valuation. However, if the company then wants to raise an additional $1M, the VC may say that the agreed-upon valuation was $8M, meaning that the company would be valued at $5M pre-money. This would give the VCs 37.5% ownership (3/8) instead of 33 _% (3/9). The Founder who agreed to the post-money valuation would have no choice but to accept this lower valuation. Reply something like: 'Thanks for the offer, but we need to agree on a pre-money valuation first'.
If you're a Founder, you usually have about a week to make decisions on offers from VCs. But sometimes VCs will give you much shorter deadlines, as little as one day. This isn't enough time to evaluate your options and make the best decision, and often leads to deals that aren't as good as they could be. To make matters worse, short deadlines are often accompanied by lowball offers.
It's really important for people who are raising money for their projects to be aware of their own strengths and weaknesses. This will help them a lot in successfully negotiating with potential donors. The more you know about the things you're not good at when it comes to raising money for your startup, the more power you will have to get what you need.
We believe that it's important to have a clear understanding of what's going on. We'll continue to openly share information that might be overlooked by others, because we believe that it's in everyone's best interest to have aligned interests.
If you liked this info feel free to comment and share. Thanks for reading!
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