Weekly Briefing Note for Founders 1/8/24

4th August 2024
CATEGORY:

Knowing how to raise capital is different from actually doing it 

The decision to raise the first round of institutional finance is an exciting moment for any startup. A significant milestone has been reached: The scale of the 'experiment' is now moving beyond the means of the early private investors.

For first-time founders this is also a moment of great trepidation. Raising money from a fund, typically a VC, is a wholly different game compared to convincing Angel investors. Yet this is now a mission-critical task to fuel the next stage of the journey.

We know that less than 1% of all startups successfully raise investment from VCs or other similar funds - although we don't know how many actually try. Anecdotal evidence suggests it's many times that figure.

There is endless analysis of graduation rates by funding stage or by industry, but very little about the early transition from Angels to VCs. As a result, it is often a step into the dark.

What we do know is that, in the aftermath, founders nearly always say they significantly underestimated the scale of the task. And these were the startups that were successful. Many startups that choose to take the venture pathway never manage to make this transition.

Why should this be such an uncertain and daunting step? It's not difficult to create a list of the things that VCs care about. Any founder has instant access to an almost infinite amount of startup advice, from blogs, podcasts, books, accelerators, incubators, online courses, and of course VCs themselves.

According to serial entrepreneur and former VC Michael Wolfe, we are in an era of startup information overload. Information overload is a good problem to have, but it’s still a problem.

Founders must carve out time and energy to find the best resources, study and learn from them, filter the good advice from the bad, and not fall into analysis paralysis.

But even if they solve that, they face an even bigger challenge:

Knowing what to do is very different from actually doing it.

Applying the knowledge is always the hardest part.


Speed of learning is critical

First-time founders face a unique set of challenges. Every aspect of the mission is new, and the pressure is on from day one.

You must be right about your insight into a market and the product to serve that market (or quickly pivot to something that is right). But even of you are right, it seems like you also need a vast array of skills to develop early momentum and build the evidence to progress.

You must learn enough about hiring people, managing them, building your offering, getting to product/market fit, finding a business model, creating a financial plan, generating pipeline, and dozens of other things.

On top of all that you must learn how to raise money, without which all the above just stops. And on this front, founders are constantly fighting the most resilient foe - time.

As Wolfe says: "No one starts out knowing these things, so how quickly you learn will determine your success."

And the best cheat code of all? Learning practical lessons from others that have done all this before.


Learn from serial founders

Serial founders often move at a pace that first-timers can often only dream of. They have figured out how to bypass what Wolfe calls 'friction points'.

"Multiple-time startup founders can move quicker because they’ve developed the pattern recognition to spot these friction points and quickly push through them. Less experienced founders can get stuck, and since the margin of error between success and failure for a startup is often just a few weeks or a few thousand dollars, losing momentum can be lethal."

But beware - founder stories are often sanitised as they are retold. It's very rare that any successful founder followed a straight pathway. False starts, pivots and near-death experiences are common. The lessons of one founder may not always be relevant to another.

The good news is that you don't need to be an expert at everything - but you need to know what you don't know and how to get it. In most cases you just need to learn enough to be dangerous. The rest you can work out as you go.

But in some cases, muddling through is going to be very high risk. Working out where you can iterate to success and where you might only have a narrow margin for error is crucial.

The classic case of iterating to success is in product development. Even if the insight is perfect the initial solution might fall short. So, by applying the fail-fast approach from lean startup theory you can gradually converge on product/market fit.

At the other end of the scale is fundraising. This is a game of fine margins. At best, you only ever get one shot with an investor to make your case. Anything short of a direct hit on the first attempt and you're out of the game until the next round - at the earliest.


Counterbalancing asymmetry

Error margins in fundraising are a function of supply and demand. When the supply of capital exceeds the demand created by startups, bubbles form. They eventually burst - just as they did in 2022. During the build-up to the bubble the market favours the startups. But such phases are rare and typically short-lived.

VCs always want the demand for capital to exceed the supply. That way they can be pickier about what they pursue and then do deals on their terms. Generally speaking (with the exception of the current 'mini bubble' in AI), that's exactly where we are today.

Venture investors of all types, not just VCs, want to create market conditions that are heavily 'asymmetric'. In other words, they want all the conditions to favour their negotiating position.

Serial founders become very astute at counterbalancing this asymmetry. They intentionally develop an 'edge' that allows them to combat the prevailing conditions and secure the funding they seek.

In the current funding environment, demand is far outstripping supply. In this case the demand is for 'deals not dollars'. In other words, there is no shortage of money to invest, just a shortage of investment opportunities that investors find sufficiently compelling.

If that wasn't enough of a challenge, first-time founders must constantly wrestle with 3 other areas of asymmetry. These are:

  1. Investment process asymmetry
    Investors are highly experienced and well-versed in the fundraising process. Under 'normal' market conditions they set the rules of engagement. They define the steps which are geared around their internal decision-making processes. Rarely do they reveal the specific topics that are covered in their investment committee (IC) meetings. Founders are often left in the dark as to how investment decisions are made and how offers, when forthcoming, are formulated.

    First-time founders are often reticent to probe too deeply. It's taken so much effort to get to this stage they don't want to rock the boat. This puts the entire process and timeline in the hands of the investor, which they will use to their advantage!

  2. Market information asymmetry
    Investors will typically have access to the very latest global market data. They will see all the transaction information across the entire VC universe. This enables them to monitor key investment trends, capital flows by industry/vertical/sector, deal sizes, valuations, and the like. They can assess competitors and quickly evaluate key comparators. They can even leverage AI-driven predictive analytics to evaluate potential ROI outcomes across an entire peer group, and much, much more.

    Founders have access to some of this information via free or low-cost platforms. But this is nowhere near the level of detail that investors (who are spending $100k's per year on these advanced research platforms) have.

  3. Dealmaking asymmetry.
    Institutional investors, especially VCs, are transaction specialists. The accumulated knowledge within any particular firm that has done dozens if not hundreds of investments is therefore extensive. As a result, they become expert negotiators. They know how to strike deals that give them the highest chance of delivering the greatest upside whilst, at the same time, carefully protecting their downside.

    Unsurprisingly, first-time founders often find themselves at a disadvantage when trying to navigate to the right shape of deal. This begins even before a Term Sheet is offered and continues through to the final investment agreements. Good lawyers are always vital but their main value-add is towards the back end of this process, not the beginning.

Levelling the playing field

Experienced founders know where the key points of asymmetry will lie. They design the funding campaign and the research that precedes it to ensure they are not heavily disadvantaged.

All founders can minimise the points of asymmetry by enlisting the support of others with greater experience. This is particularly important for first-time founders undertaking the first round of institutional finance.

When Duet is enlisted to support the founder (through our Guided Fundraise) we essentially coach the founder and the exec team through the entire funding process. We can immediately neutralise any asymmetry investors may have in the investment process, market information and in dealmaking.

Over the years, we have studied the methods and investment techniques of dozens of investors. We also use the very same investment market research that the top funds have access to. And we have the latest lowdown on how VCs are crafting offers and negotiating deals from the many Term Sheets we see.


Applying the knowledge

The first institutional raise should not be such a daunting and uncertain step for first-time founders. No one starts out knowing how to raise money, so it's how quickly you can learn that will determine your success.

Fundraising is a game of fine margins. Investors expect to have the advantage by driving the investment process, using better market information, and applying their deal-making expertise. Founders seek to level the playing field by studying these topics. But it's the application of this knowledge that really counts.

First-time founders can achieve this by enlisting the support of others more experienced. Practical guidance from those that have done this all before is of greatest value. This helps them avoid information overload, accelerate their own learning, and navigate the path of institutional funding.


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