Even as the U.S. economy suffers its biggest contraction ever, the news is not all bad for new businesses. Venture capitalists are still willing to put their dollars behind promising startups, and some companies are actually seeing increased levels of financing.

For most startup founders and executives, the keys to fundraising success in the new, COVID-19-dominated world are preparing for a more competitive environment and planning for longer timelines when assessing how much capital to raise. Those are some of the findings discussed at a June webinar hosted by the Women Founders Network.

Venture capitalists told us in March that they were continuing to look at deals, even in the midst of the worldwide lockdowns and the pandemic spread. In fact, even though valuations of companies that investors funded in April were lower than normal, they still showed improvement over March, Fenwick’s Silicon Valley Venture Capital Flash report for April found. And deal volume actually rose to levels close to 2019 monthly numbers.

But for founders looking to position themselves for funding – especially those in pursuit of their first investment – it’s important to look behind those numbers. Below are a few key takeaways for startups in that situation.

  1. Be prepared for a more competitive market for early-stage investments. Series A and earlier financings have fallen by almost three-quarters, and money has shifted into later-stage deals. Venture capitalists are increasingly holding much of their capital back for late-stage investments. The share of financings that occur at Series D and E+ was the highest in two years in April. Some of the most popular investments were internet, new media, and software companies, as well as e-commerce-driven consumer products.
  2. Make sure you have a clear market opportunity and the ability to scale. Founder DNA is the top factor for most investors in evaluating startups, but these are next on the list. Because the venture capital business model relies on a small number of their portfolio companies generating outsized returns, they need massive wins. That’s why market size is so important. The market your startup is addressing needs to be generating a billion dollars or more in revenue and growing quickly. To reach that market cost-effectively, companies need scalability, or the ability to grow exponentially with diminishing marginal costs. That’s why software startups, for example, are so attractive to VCs.
  3. Build a strong team and toot your own horn. Founder DNA is shorthand for the idea that venture capitalists are investing in you, as a founder. They’re looking at your knowledge, experience, quality, passion, commitment, grit and integrity. This is especially important for women founders. Research has shown that women are excellent at advocating for other people, but not so good when it comes to themselves. Founders need to be able to talk about their track record, domain expertise and personal story, especially any anecdotes that demonstrate how far they’re willing to go to make the company succeed. It’s also important to have a well-rounded team who have the expertise and ability to make the startup grow.
  4. Friends and family funding can be critical to later financing rounds. Usually founders not only invest their own funds but also raise seed capital from friends and family. These funds can be key to exploring, and finding, product-market fit, as well as for proving traction through early user acquisition or revenue. Professional investors often see friends and family investment as a powerful motivator to make the company succeed, given the discomfort most people would feel about losing their loved ones’ money. Because oftentimes founders don’t feel comfortable negotiating with friends and family, they can use a “most favored nations” SAFE (or Simple Agreement for Future Equity) to document the investment in a straightforward and fair manner.
  5. Add at least six months to your fundraising timelines. Startup war chests need to be bigger and last longer in the COVID-19 world. Before March, a company closing an angel round of financing might have needed to ensure it had 12 to 18 months of operating funds on hand. Now VCs are asking their portfolio companies to rewrite their projections to include 18 to 24 months of capital. That’s partly because the next round is likely to take six to 12 months to close. Make sure you are entering funding discussions with future investors with six to 12 months of runway in the bank.
  6. Use your funding strategically. Once the startup has enough capital to make it to the next round, use it to propel the company to the next milestone. To protect friends and family, as well as the founders, from dilution, it’s critical to increase the company’s valuation between rounds. Then the founder can tell VCs that not only did the company raise, say, $500,000, it used those funds to file a patent, prove product market fit, and acquire a quarter million customers who created $1 million in revenue – or whatever the relevant milestones may be. The result should be a higher valuation.
  7. Understand how valuation is key to avoiding dilution. With each new round of financing comes the possibility that earlier investors and founders will see their equity stakes diluted, or shrunk to a smaller share of overall equity, by the terms negotiated with new investors. Getting a sense of the startup’s valuation at various stages can help founders negotiate to avoid some of that dilution. Of course, valuation is specific to each company, but it can also be roughly tied to the stage of the company. For example, a pre-product company would probably be worth $4 million or less, while a pre-launch, pre-revenue startup with some intellectual property and a minimum viable product might be valued at between $4 million and $6 million. A post-launch company with some early revenue might garner a valuation above $6 million. These rules of thumb vary by industry and according to a founder’s experience, but such rules of thumb do exist.
  8. Get professional help in negotiating term sheets. Look for a lawyer who works with early-stage startups to help you handle investor negotiations. They may offer fee deferral and flat-fee arrangements that make them more affordable to startups. Someone with experience in deal strategy is worth their weight in gold. They can help you not just avoid pitfalls and negotiate valuation, they can guide you through other thorny but important considerations. For example, they can help you think about board composition and how to handle certain rights – such as pro-rata rights or information rights – that investors may want to receive.
  9. Choose investors wisely. The search for investors can be facilitated by experienced legal counsel, but there are other routes founders can take to get in front of VCs, including LinkedIn, events (though these may have been more effective pre-COVID-19), and pitch contests. Once you have some potential investors lined up, get to know them. Many have experience in a specific area. Others take an active role in managing the company and may even be interested in a board seat. Others take a “spray and pray” approach and you never hear from them again after they write the check. Whatever the case, it’s painful and expensive to part ways with an investor that isn’t a good fit. Do your homework.

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