You have a potential investor on the hook a few weeks before demo day, and he tells you he wants to write a check. Woohoo! But wait….. Paul Graham is telling you NOT to take his check? Wait for a better fish, Paul says! What should you do? Take a minute to think ahead to your series A….
We hear a lot about the Series A “crunch”. While seed companies and investments are proliferating, Series A rounds are not (they’re about flat). This creates the increasing competition for Series A dollars seen below. (For nerds: Note that the black line doesn’t include the myriad seed cos competing for Series A that raise unreported small angel rounds or friends and family rounds … which is why the A to seed ratio level seems okay. Focus on the downward trend.)
Source: Dow Jones VentureSource, Data for IT companies; YC; TechStars; data for 500 Startups estimated based on press interviews
Accelerators are, in fact, a major driver behind the increasing competition for Series A dollars; they, angels/super angels and lowering cost of tech have changed the equilibrium of a 40 year old industry. The phenomenon is well covered… the question is what to do about it as an entrepreneur.
I’ve had the pleasure of working with a number of the current TechStars Chicago companies (demo day Aug 28th). They are an amazing group of founders, and the companies have real legs. In meetings last week, several asked for advice on fundraising:
- We have angels who want to write us checks? Should we take them?
- Should we take the money before or after demo day?
- Should we do a priced round or a note?
- How big a round should we ask for at demo day?
… all excellent questions. The basic answer is TAKE THE MONEY NOW (like NOW, now) and as much as you can.
Paul Graham, David Cohen, Dave McClure and other leaders of the best accelerators provide their flocks advice on how to game the demo day fundraise process to get the best angels and funds in at the highest price: how much and who to take before demo day, how much to take right after, how long to wait to get the right investor, etc… This no doubt leads to great outcomes (less dilution and branded backers) for founders of the very best companies, but leaders’ interests and this advice are not well aligned with the average company in the flock.
Paul, David and Dave give this advice because they make all their returns on the rockstars (the DropBox), not on the average company, so they try to optimize outcomes for those chosen few. You probably don’t know if you’re average or rockstar yet, so filter their advice and protect your downside. Use the accelerator process as a once-in-a-lifetime chance to raise a lot of money easily.
(Added later: Please see replies and comments below from @davemcclure @davidcohen and @troyhenikoff; thanks guys for weighing in!)
Companies going through top accelerators are shiny new objects to investors with solid brands behind them, great teams and often terrific progress over their short programs. They are promise and hope and eternal youth all in a cute concatenated name with a cool laptop sticker on top. To explain why they should take as much money as they can, as early as they can, think of an accelerator backed company’s fundraise journey in three epochs.
First epoch – the month before demo day – YOU ARE BECOMING A STAR: Angels, VCs and mentors are meeting with the companies and deciding on the prettiest girl. Most or all of the companies seem attractive to different types of investors. Investors ask themselves, “what if this company is so hot at demo day, I can’t get in after… let me see if I can get in now.” Demo day creates urgency and excitement which brings out the checkbooks. Most companies can garner interest in this month before demo day. TAKE THE MONEY!
Second epoch – demo day and 2-4 months after – ARE YOU THE CHOSEN ONE? The companies present, and the top 2-3 really stand out to super angels and VCs. The other 7-8 get some angel interest. The 2-3 chosen ones do road shows and get some term sheets. There are lots of discussions about valuation, round size and dilution where teams steer towards smaller less dilutive rounds on the premise that “12-18 months from now we’ll raise a big A”. This is a great choice if you know you will be in the top 1% of performing startups 12-18 months later – rocket ships can raise any time. But the odds are against you (like 99 to 1). More likely, you will get Series A crunched. So again, TAKE THE BIGGER ROUND, EVEN IF MORE DILUTIVE! For the “other” group of companies, take as many angel checks as you can.
Third epoch – the rest of your life – THE SHINE WEARS OFF: For most companies the shine wears off, and the promises made at demo day are compared to real performance which often isn’t there. Suddenly it is harder to raise money. Investors ask “why didn’t this company raise money right out of TechStars or YC?” The golden touch is now working against you. YOU SHOULD HAVE TAKEN ALL THE MONEY WHEN YOU COULD! Remember… the choice you are making now between 20% and 15% dilution may really be a choice between 20% dilution and hitting the wall. Well, if you say it that way…
You are probably thinking, “but, Guy!”:
- If I raise too much in a seed note, it will make raising an A tough
- Raising more now at a lower valuation means more dilution and less founder control
- You shouldn’t just take any investor; most investors are dumb and don’t add value
These are reasonable concerns, but ANT HILLS next to the MOUNTAIN OF PAIN of hitting the wall as you look for your Series A in 12-18 months. The “raise more when you can” strategy, however, plays out well no matter what. For all companies, showing up at demo day with money circled or in the bank will drive more investor interest because investors are afraid of being left behind. If you are not one of the chosen few at demo day, well then you took as much as you could before the market decided that. If you are one of the chosen, then you have a better start towards a VC round and some breathing room to raise it and make it big.
Moreover, the number 12 in the 12-18 runway range is a systematic mistake we see in seed raises given the known Series A crunch. Most successful startups pivot at least once or twice in the early days, so you need at least a few “Acts” without fundraising to get it right. Let’s say you pivot once before you get it right: Act 1, you try your first approach for 6 months and have limited success. Act 2, your try your second approach for 6 months and do well to great. Don’t forget Act 3… 6 months to raise your A with your Act 2 results. 6 + 6 + 6 = 18 months minimum, assuming just one pivot, and most successful ventures take more. Give yourself the time and the money to do this. TAKE THE MONEY!
Other ways to solve the crunch problem? Use the “customerstrapping” approach. Revenue is the cheapest funding.
Even if you’re not an accelerator backed company, all of this thinking applies. If you have fundraising momentum in the early seed days, take advantage of it to raise more. Series A will be tough.