Fundraising: Validation, Vilifying VCs and Optionality

Yesterday I met with a founder just starting out on a new company and towards the end of our chat she asked me about fundraising advice -- particularly with venture capital. I don't think I said anything earth-shattering but I realized that my advice has evolved quite a bit over the years so I thought I'd share it here along with a few other points.

The first thing I mentioned was getting a good grip on the psychology of the situation. What I have noticed in myself and others is that in fundraising there's a tendency to adopt a defensive posture that vilifies the venture capitalist. This is because of the power relation that exists, much of it real but some of it self-imposed. Here's my thoughts on this:

  • Fundraising often becomes more about validation than money. With startups, there are very few checkpoints for a founder to measure how they are objectively doing especially when they are pre-revenue. There are no grades from teachers, or performance reviews by managers. This tends to confuse the whole process. I often see companies raising without a real rationale for what they want to do with the money. It becomes a way to gauge that the company is on track. This is why hearing "No" hurts. We don't process it as "No it doesn't make sense for us" but rather "No I don't think you are good enough to invest in".
  • Seeking external validation is human nature and frankly generally a valuable signal, so as much as I'd like to just give the advice that the only validation that counts is your own, that's just not a realistic way of being. So this whole fundraising process for validation may be useful if it weren't for another problem. Namely, that there isn't a great mapping of Startup to Venture Capital. What I mean is that many (actually most) startups are not a good fit for Venture Capital.
  • This is where that famous refrain of VC really irks founders:  "We only invest in billion dollar outcomes". This seems ludicrous when you look at your own startup doing well, growing at a nice clip and maybe even profitable. Here I either see companies contort themselves in all sorts of odd configurations in order to become "venture-worthy" -- or they become cynical about the whole process as the validation they feel they deserve isn't being granted. But here I'd really suggest entrepreneurs study the structure of VC and the overall industry returns. Once you come to appreciate the game that a VC is playing you realize that you likely aren't a match (it really is "its not you, its me") and that you are seeking validation in the wrong place.
  • The biggest issue in my opinion is that startups don't have prominent sources of funding/validation outside of Venture Capital. This is what's so exciting about developments like Indie VC and Clearbanc. They are recognizing that in between the 0 (failure) and 1 (billion dollar business) of the venture world are a large swath of attractive companies that still need funding and still deliver returns -- they just require new structures to be invented.
  • The ideal from an entrepreneur's point-of-view is fundraising such that you preserve optionality. Usually it's not obvious to a founder whether their new company is a billion dollar opportunity or not. So in the earliest stages, you want to raise such that you can kick the can down the road on your commitment to a particular path (further rounds of financing or sustainability). This is why I like structures that can either be treated as debt or equity depending on how things play out post-investment. These arrangements are clearly good for the majority of entrepreneurs and the real unknown is whether these funds can be successful with this strategy.
  • Ultimately, founders generally need to spend more time making sure they are seeking validation in the right places. You have evangelists on either side telling you the right way to build: bootstrapping (from entrepreneurs) vs. venture capital (from VCs and the media). The truth, in my opinion, is less dramatic than the evangelists would have you believe. VCs aren't evil, and bootstrapping isn't a holy path. Most of us will be undecided on which path is best for our business, so raise with optionality in mind and make that decision when you are better informed.
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