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More in the 50 Questions Series50 questions: Will a VC bring in a pro CEO once the round is closed? | How does the structure of the VC industry impact investment strategy? | 50 questions: How does a VC evaluate a company’s product? |
50 questions: Do i need “competitive tension” in my fundraising process?
Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful. This is #33 in the series.
How many VCs do you want competing to invest in you?
It’s not a facetious question. Too few, and there is no sense of urgency or competitive tension. Too many, and you can be bewildered by choice, leaving hot prospects to go cold and chasing the next potential investor. Net result in both cases: no deal.
I saw this first hand when I was CFO at Shopsmart. We were raising money shortly after NASDAQ peaked in March 2000, although many people thought that we were still just suffering a “correction”.
The process tended to go something like this: a VC would get interested. We would talk through our metrics, financials, growth rates and strategy. The initial heady impression of achieving an enormous valuation from this investor would be tempered downwards as the reality of raising money in a competitive sector in a cooling market became clearer. The VC, while interested, started to see more risk in the investment, and we rapidly got a sense that the valuation was going to be lower than the founders wanted.
Meanwhile, another VC had heard about the deal, and were desperate to get a look in. They would call us and say they were interested, and we’d get a hint of a high valuation again. Then they would dig deep into our metrics, financials, growth rates and strategy, and the hinted valuation would decline.
Then a third VC would call….
In the end, although Shopsmart raised an eight-figure sum during its short existence, we didn’t get large professional VCs on board who would help us weather the post-boom hangover and build a long-term, sustainable business.
We spent too much time chasing possible deals, and not enough time focused on a closing a reasonable round with a good partner.
I hope I never make that mistake again.
* * *
Competitive tension can be hard to manufacture. If you are the hottest kid on the block, the competitive tension is there already – VCs are falling over themselves to invest. Assuming you are not in that lucky position, do you need competitive tension, and can you manufacture it?
Do you need competitive tension?
Yes, you do. Back when I was an investment banker, we talked about the need to “keep people honest”. For example, in a sale process, we might also prepare for an IPO. That way, a buyer could not believe that he was the only transaction available for the company, which prevented him from springing a massive valuation drop at the last minute.
You don’t need lots of potential investors to have competitive tension. Two is enough. Of course, finding the two who are actually going to invest is tough. I generally expect that if you have 20 initial meetings, you might get 5-10 second meetings and 2-3 serious candidates. (Those numbers depend on careful selection of the initial 20 potential investors. If you take a more scattergun approach, you might need 40-50 initial meetings).
Can you manufacture competitive tension?
Yes you can. The golden rule is not to lie. The venture capital world is very small. Partners socialise all the time. They may sit on boards together, be discussing the potential syndication of another deal or simply hanging out at the same networking events.
So if you say to Index “Yes, well Accel are hot for this deal and we’re close to a termsheet”, expect that Index could check this pretty easily. Once you are caught out in that lie, it will be hard to recover credibility. Investors will start wondering how truthful you are being about everything else that you have said.
On the other hand, it is fine to say that you are in process, that other investors (potentially even naming them) are 2-4 weeks ahead of the investor you are talking to and that you are keen to move everyone forward to the same place.
Your #1 objective is to have all the potential investors in roughly the same place – have received the same information, have discussed it with colleagues or the investment committee, had enough meetings – at roughly the same time.
So rather than pushing everyone along at the same place, consider moving a little more slowly with the front runner and pushing hard on the laggards.
How important is this?
Raising money is an art, not a science. You want to get everyone to the same point if possible. You don’t want to risk losing an investor by dilly-dallying. You are unlikely to be able to make an investor move really fast unless you are the hottest deal in town.
If you can possibly get two or more investors to termsheet at the same time, you have significantly improved your chances of closing a deal.