Startup founders tend to ask a pretty common sense question during their meetings with venture capitalists, “What is your process?” This is a good question, because the CEOs want to know how much of their life they are going to have to waste trying to raise venture capital. It’s helpful to know where the goal line is so that you have an idea of how close you are getting. The bad news is that early stage VCs tend to have pretty non-defined processes - assuming that there ANY process at all. As such, I’ve created this helpful diagram so that you can try to guess where your company is in its capital raise:
The analogy is pretty simple; raising venture capital is a lot like pushing a boulder up a mountain. It is really hard at first, but at some point things start to click and eventually it is all about making sure the appropriate issues are examined and that the company has a real plan to execute on its vision. Unfortunately, as a startup founder, you really don’t know how tall the mountain is, how heavy the boulder is, how steep the slope is, where the top is, if there is only one mountain, or really anything at all when you first start the process. The good news is that the venture capitalist is in the same boat. In fact, if venture capitalists weren’t such stupid optimists I don’t think there would be any venture capitalists. Actually getting an investment done is so difficult and the hit rate of closed investments to companies met is so low that it’s depressing.
Here is a little bit more about each step:
- Figuring it out. This is where the VC tries to decide if the investment idea could possibly make any sense. Is the team creditable? Is there a real market, and is it big enough? Can the technology work? Do customers exist and what do they say? Most companies in the fund raising process don’t make it past this stage.
- Making some sense. The venture capitalist is starting to gel with the idea and team. Management might actually be able to pull it off. Key introductions around the team are clicking. The technology has survived numerous demos, and the back-end looks like it can scale. Customers are suggesting they’d buy the product. Usually a good piece of news or development is enough to push the startup into the next phase - a key customer sign up, or a top tier person agrees to join the team.
- Checking the boxes. Now the VC is on board. Instead of looking for reasons to not do the deal, he or she is simply turning over all the necessary stones to make sure nothing important is missed. Probably making final reference and background checks, and carefully monitoring the target market and customer group. While this might feel a bit easier, it is still a critical step. Don’t drop the ball here, keep pressing hard!
- Counting the Benjamins. Congratulations. Now it’s time to execute…
Note that I haven’t mentioned valuation or term sheets. Valuation is usually discussed at a high level somewhat early in the process. This is usually done quickly, just to make sure that the management team has expectations that align with the venture capitalist. For most early stage investors the term sheet is delivered after most of the important due diligence has been conducted. Most top tier VCs use pretty standard terms, so you should visit the NVCA to see what to expect. Also, make sure you have an experienced lawyer helping you - one who has done other early stage deals numerous times and recently. If you are going to use a really inexperienced lawyer you should tell the venture capitalist early, so that they don’t waste their time talking with you.
It is a bit of an exaggeration that there is NO process. Certain steps have to be taken, and these usually include reference checking everything, getting arms around the market in general, poking and prodding technology infrastructure/architecture, meeting with partner groups or investment committees, paying a lot of lawyers to spend time trying to find other ways that additional lawyers can spend time, sometimes talking to accountants, nailing down use of proceeds in the form of a detailed expense and operating model, etc.
The truth is that raising early stage venture capital is a discovery process, not a straight line. If your startup is doing something truly novel, and you are really attacking and opening up a new market or solving a problem in an innovative way, then there can be no map to fund raising. I feel blessed that I get to spend so much time with entrepreneurs as they are developing their business plans and go to market strategies. It can be fun… and I wish you luck if you’re raising VC!
