I’ve always wondered why funding begins with fun. Those three letters. F. U. N. Fun. For entrepreneurs, seeking seed capital means meeting with numerous VC firms and sometimes dozens of angels… fun? Telling the same pitch over and over again… taking time away from more immediately impactful endeavors like recruiting and customer development… the endless follow-ups and inevitable radio silence… fun? And then there’s hearing “no” constantly – perhaps that’s why funding ends in “ding,” as it’s the repetitious sound of hearing reasons for why not, instead of why.
Maybe fundraising isn’t supposed to be fun, after all. But that doesn’t mean it can’t be productive beyond obtaining the capital itself:
- Running a great fundraising process involves crafting real story and not just a pitch. This end-result can take additional time to develop, but having completed it, it can be beneficial in more than dealing with just potential investors. Having a crisp story about the vision behind a business can be leveraged multiple times with other constituents to effectively reach customers, partners, press, and even potential acquirers with the right communications message.
- Fundraising encompasses trial-by-fire circumstances which almost always necessitates professional development. Unless Sales just runs in the blood, running a fundraising process will naturally hone those skills. These soft-skills of persuasiveness undoubtedly make one a better leader.
- A process which is inherently about meeting people… provides an excuse to meet people. Fundraising is about evangelizing a vision. Along the way there will be encounters where the story resonates in conjunction with a real personal connection. Sometimes these people don’t become investors, but rather than quickly moving on, these people can be co-opted into useful allies to help in other ways. Introductions to customers, long-term advisors, business development partners can result from the fundraising process, as those early conversations turn into real relationships.
Yes, often the best part of fundraising is the end of it. That’s the fun part – getting back to spending 100% the time building a company. But there can real benefits that come out of a fundraising process if you’re proactively seeking them as a by-product beyond just adding cash to the bank account.
One Jackson is a new online children’s clothing retailer which is surprisingly fresh – all of its designs were created by independent designers and then curated with love from its community of parents. The results are high-quality fashionable creations at an affordable pricepoint – which look great and are uniquely different from mass clothing brands. Today the company announced that it has raised $2M from a number of investors including us at NextView Ventures. We’re of course are very excited about working with the team and what’s ahead for this company. For us, the investment is certainly fresh and newest in our portfolio, but it also feels familiar.
The company’s familiarity is along what we consider to be the three most important criteria for an investment in a seed-stage startup – team, market, and product:
- Team – Two of the co-founders were well-known to the NextView partnership years before a line of code was even written. CEO Anne Raimondi and my partner Rob were colleagues together at eBay in the early 2000’s before she went on the lead product and/or marketing at many household internet names like Zazzle, InsiderPages, and SurveyMonkey. Her co-founder and CTO Yee Lee worked with both my partner Lee Hower and myself (at PayPal and Venrock, respectively). And Board Member James Reinhart is already part of the NextView family, as CEO of portfolio company, thredUP.
- Market – Through our existing investment in the largest online consignment store for kids clothing, thredUP, which has begun to scale, we were already familiar with the children’s clothing market. Including how large it is – there is $15B spent on U.S. children’s apparel annually, and online retail sales overall are growing 10% year over year. And as a new parent myself, I have first-hand experienced the consumer opportunity for great clothes with fresh designs.
- Product – Lastly, what makes One Jackson unique is the source of the original clothing designs – a community of independent artisans. And while this design sourcing strategy is a unique approach to this category, at NextView we’re very familiar with, and have been actively pursuing investments that fit into a theme of a distributed creative workforce. At our portfolio company CustomMade, we’ve seen the power of a skilled artists community making everything from jewelry to furniture which delight the consumer. Similarly at GrabCAD, where CAD engineers collaborate and create in a community, the collective output has been remarkable. So given our experiences with these businesses which very much rhyme with One Jackson, the familiarity lead us to excitement about another company taking this social-enabled model to a different vertical.
Many of the inputs going into this investment were known to us at NextView. But the end result is something extraordinary, and beyond our expectations. The company has already quietly run a handful of design contests with spectacular results – one-of-a-kind clothing creations, some of which you can purchase right now as part of their initial back-to-school launch line. Through harnessing an intimate community of designers, and a broader one of parents to providing input on their favorite designs, One Jackson has already begun to create a crowd of loyal followers to their brand and unique children’s clothing. Including us here at NextView.
As more transparency to seed-round funding transaction details have emerged, especially with the advent of Angelist and accelerator programs (which both educate and even sometimes set terms & structure for graduating companies), I’ve noticed an increasing number of entrepreneurs signal pricing expectations much earlier in the seed fundraising process. By communicating pricing expectations with potential lead investors, I mean sharing either an “ask” or even stated floor for the pre-money valuation of the company (with a priced preferred round) or explicitly stating a valuation cap (for convertible note round). Sharing these expectations early in potential lead investor discussions fundamentally qualifies the conversations, but it also runs the risk of prematurely losing a potential financing partner or reducing options to maximize a financing process outcome.
Like any economic transaction, the pricing of a startup’s seed round ultimately depends on the equation of perceived supply (the quality of the team, product, & market) and demand (how many competitive alternatives there are to any one given funder, including non-consumption). In theory, there are three levels of pricing for an entrepreneur to potentially signal to a prospective investor:
- Lower than “market.” This approach is almost never a good idea. Although some investors will certainly recognize value in a startup which is raising at a modest valuation level, sharing this aspect as a feature to the investment (which I have seen) will likely result in the perception that the company is weak and undeserving of additional capital.
- “Market.” By overtly sharing that an entrepreneur is “looking for the best partner and will accept whatever the market dictates” -or- by stating a figure or range which falls within market, it sets the tone for the fundraising discussion about a collaborative process moving forward looking for a mutual fit.
- Above market. By definition, all entrepreneurs should think that their endeavor is truly exceptional. But, also by definition, that just can’t be the case. Directly stating a high valuation expectation up-front can, on the positive side for an entrepreneur, anchor the negotiations to a higher level (assuming that investor takes the leap of faith to invest). Setting a structure and price in advance can also expedite the negotiation process, especially when it’s with multiple parties. Yet stating a high valuation number early can risk unnecessarily disqualifying a potential investor because it can create the perception that a zone of possible agreement doesn’t exist. With finite time to spend on exploring new investments, a potential investor isn’t going to spend time on an opportunity where he doesn’t think a plausible scenario for him to participate exists.
The key to the calculus above is that an entrepreneur knows what the market range for his startup based on its current state, his ability to generate meaningful funding options, and the external funding landscape. I’ve observed frequently that situation #3 occurs not because an entrepreneur is savvy in negotiating towards a more favorable outcome, but because there was ignorance as to what the prevailing valuation rate is.
The challenge of early price signaling is further exasperated, as different seed funders are going to have varying degrees of sensitivity to pricing. Angels can be the most wildly unpredictable about how they’ll react to differing valuation levels. Probably the most price-sensitive seed investors I know are sophisticated individual angel investors. This handful of people is extremely and unabashedly cheap, as they’re fully self-aware of their role within the funding ecosystem and are accordingly systematically seeking to invest in startups at the lowest cost-basis possible. On the other end, I’ve seen the highest-priced seed rounds come from a syndicate of individual angel investors who were essentially price-insensitive (investing in a convertible note without a valuation cap). At the end of the day, this latter cohort is backing a particular entrepreneurial team and vision no matter what the financing circumstances.
Larger venture firms are probably next in line in terms of seed pricing (along decreasing variability), depending on what their stated (or implicit) seed strategy approach is. As a general rule, the more seed investments a firm of this profile makes per year, the less price sensitive they are. With an “option approach” to seed funding, larger firms worry less about ownership initially and more about just being investors in the startup to maximize pole position for later rounds of funding. Whereas, if the firm only makes a small select few seeds which it treats like a “normal investment,” the same filter for valuation typically applies for the seed rounds as it does for the firm’s later round investments.
Lastly, seed-focus venture firms are going to be least variable in valuation sensitivity. Fundamentally these firms are financially-driven with the seed round being either the or one of the few rounds of financing where they’re deploying their capital, so there is a bias to focus on pricing in the seed.
Regardless of profile and seed strategy, all investors just have differing philosophies about how to treat valuation. On side of the spectrum are those who believe that overall asymmetric returns will be derived from being an investor in the one exceptional company regardless of entry price, and on the other side are those who are especially cognizant of the exit market skewing towards moderate-sized outcomes and want to position their investments to be able to capitalize on that reality. Both profiles are valid because they’re both true; it’s a matter of how investors translate these factors into their own decision-making.
On one hand, sharing valuation expectations early can qualify an investor to ensure he is worth spending time with given their valuation philosophy. Also, if executed effectively, it can also set a positive direct tone towards all proceeding discussions. However, sharing valuation expectations too early can communicate that the search for investors is largely about price, not about finding a good partner for the business moving forward. It’s like opening a job interview by sharing salary requirements. So the communication may needlessly shy away some investors from the table who would otherwise be good partners. Over the course of a fundraising process, pricing expectations may shift (either downwards or even upwards given demand), and it’s challenging to re-open a conversation about the business when the dialog broke down early on over pricing expectations which have since changed.
Of course, as a funding conversation progresses from an initial to subsequent meetings, the topic of round structure and pricing become much more natural. A good investor relationship is born out of fundamental mutual interest in the startup itself, not the deal structure. So the foundation for that partnership begins with a discussion about the shared opportunity, not the details of the arrangement.
In the past few weeks, we’ve seen extremely positive headlines about the surge in VC fundings like “Venture Capital Hits Highest Level Since Dot-Com Bubble.” It must be the best of times for the industry with $8.1B invested in startups during the second quarter of 2012 (the highest in a decade!) along “…with seed-round venture capital hit[ing] an all-time high” [According to CB Insights].
But during this same month, there was a sobering report from Thompson Reuters & NVCA suggesting that perhaps rather it’s still the worst of times, with only $5.9B raised from LPs brought into the asset class this past quarter and the number of funds raising new capital its lowest in years. Sure, that figure is up from immediately after the Great Recession hit, but annualized it’s not nearly a full recovery, and nowhere near the height of the late nineties boom.
In fact, as the two above citied figures show, venture capital firms are actually actively deploying capital at a faster pace than they are raising it. Obviously that imbalance cannot continue in perpetuity, and some have said that “this won’t end well.” But what’s really going on here? Are VCs drunken sailors soon to spend themselves off of a cliff?
Quite the opposite – this fundraising paradox has resulted given the dynamic changes occurring within the industry. Two years ago, I wrote a blog post analogizing the beer industry to the VC industry as it has matured to create two bifurcated poles. On one side are the large VC firms resembling Budweiser-type macrobrews, competing based on scale and brand with a standardized product across multiple geographies, sectors, and stages. And much like the emergence of microbreweries specializing in craft beer, new Micro VCs (like my own firm NextView Ventures) are thriving by specializing along at least one or more of these three dimensions (geo, sector, stage) with a unique offering for a specific subset of entrepreneurs.
Included in the July 9th NVCA report where the figures above originated, Mark Heesen, President of the organization wrote: “As the number of venture capital firms continues to contract, we are beginning to see a clear bar bell forming with several large funds weighing in heavily on one side of the spectrum and a multitude of smaller funds on the other side… As the venture industry bifurcates further, successful LPs and portfolio CEOs are going to have to search for quality firms on both sides of the barbell.”
Given the size and scale of the macrobrews of the VC business, it’s increasingly the largest venture capital firms driving all of the fundraising figures quoted in the media. In fact, according to the NVCA report, “the top five funds accounted for nearly 80 percent of total fundraising.” The two largest funds this past quarter (NEA and IVP) raised over a $1B in capital each.
The imbalance between venture capital deployed and raised isn’t a collective irrational action of the industry – rather, it’s a leading indicator about the fundamental bullishness of the largest funds’ ability to raise additional capital. As there has been a flight of LPs to concentration in fewer VC names, the largest firms have been empowered to raise even larger funds as they expand their footprints. The meaningful dollars currently being deployed are not an unhealthy reflection backward, but instead an optimistic point-of-view about the capabilities to raise additional capital in the future.
This conclusion seems counter-intuitive given the anecdotal stories about the challenges that many venture capital firms have experienced in fundraising since the 2008 collapse as the industry has contracted into two distinct winning strategies of either a macrobrew or microbrew1. But again, the aggregate numbers are being driven by just a few of the largest macrobrew firms. Take just the two largest funds raised from this past quarter: both firms raised this most recent fund more quickly after their last one than the time-period of the previous fund cycle. Surely that conveys optimism.
So while the fundraising environment is more challenging than it was during the middle of the past decade, the pain has been felt unevenly across the industry. And there are many of the largest firms in the venture industry which not at all negative, but rather just plain wildly bullish. The bifurcation has by definition hit the middle the hardest while stirring the pot on the smallest end to create unique situation, the subject of my next post in this two part series on the best and worst of times in venture capital.
1Of course there are exceptions of unique firms with heritage brands, unique positional advantage, and/or exceptional historical returns which don’t fall neatly into one of these categories but are able to presently succeed by leveraging their own past success – call them the “Samuel Adams of VCs,” perhaps the subject of another post.
Personal networking is a key business skill. And as a VC, I get plenty of practice doing it. As one of my former high school coaches used to put it, “Practice doesn’t make perfect. Practice makes better.” While I guess you could develop a “strategy” to networking successfully (… with many a book written about the subject), I think becoming especially productive at networking is largely tactical. Along the way, I’ve stumbled across two tactics which I think are valuable.
First is leveraging the pretty obvious concept of giving-to-get, but being specific about it. In any two-way relationship which builds based on the trust that the exchange between the parties will be equal over time, someone needs to give first. With any potentially valuable relationship, it’s just best to do something for the other person first and not worry about reciprocity initially.
- As a tactical matter, I try to end each networking conversation with “How can I specifically help you?” Rather than just getting to know someone with the hope that you may be helpful in some way in the future, directly asking the other person how clarifies and sets expectations immediately so that a meaningful relationship can develop sooner rather than later.
The second tactic is just the reciprocal of above. When networking to ask for help, I’ve found that after a rapport is established, it’s best to be as specific as possible about what you’re looking for. Even though it narrows the scope of possibilities, an extra level of specificity jogs the thinking for things that are current, as well as plants the seed for recognition recall in the future.
- For the job seeker, instead of saying “I’m looking for new job opportunities,” rather communicate “I am looking for a VP Product role at a consumer-mobile startup.”
- In seeking new customers, instead of saying “I’m looking for people to buy my product which does XYZ,” rather communicate “My product which does XYZ most resonates most with individuals in ABC roles at companies with DEF profiles that face GHI problems.”
- For VCs (including myself), instead of saying “I’m looking for innovative early-stage startup investment opportunities,” rather these days I am saying “I’m proactively seeking seed-stage investments in both ad tech and those which leverage the trend towards ubiquitous computing through device proliferation.”