“A great man is coming to eat at my house. I do not wish to please him; I wish that he should wish to please me.” -Emerson
Rejected for a vital business loan, FedEx founder Fred Smith took the young company’s final $5,000 to Las Vegas, where he successfully ‘raised’ $24,000 at the blackjack table just in time to pay their fuel bill and keep the company afloat. Today FedEx has over $46 billion in assets. I have always admired the resourcefulness Fred displayed to save his company. There is always another way.
A startup may have little to no revenues and insufficient operating history to be considered for a bank loan, yet one of a founder’s chief responsibilities is ensuring their company has sufficient capital to operate and grow. Hence, an entire industry of “angel investing” and “venture capital” has sprung up to help fledgling companies and share some of the value if the are successful.
As a young entrepreneur I felt somewhat overwhelmed by the process and terminology (IRR? pari passu? clawback?? oh my…) of fundraising, so I have written this in the hopes of helping an inexperienced founder navigate the stormy waters of one of the most exciting yet infuriating parts of growing a business: fundraising
1. Are you sure you need to raise?
It is entirely possible to build a company with little to no outside funding. Mailchimp did it. Amazon raised less than $10m before going public. In fact, according to Fundable, only 0.91 percent of startups are funded by angel investors at all, while merely 0.05 percent are funded by VCs.
There are numerous sources of capital besides equity financing. Have you considered crowdfunding? An SBA loan? An SBIR grant? Your city, county, and state may have economic development programs that would consider you for a low interest loan or even a grant – free money! For example, the Los Angeles Economic & Workforce Development Department (EWDD) has an annual budget of almost $75m and provides loans and grants.
Don’t raise money for the wrong reasons or at the wrong time. If you are losing money on your customers don’t go pay to acquire more. Fix your margins first. Don’t scale an inefficient process.
Don’t optimize your business for investors. Optimize your business for customers. If significant equity financing and many years are required to reach profitability you may want to reconsider your product or business model. A big raise may get you a sexy headline but might not be the best thing for the business. Employees will inexorably become less disciplined with how they spend.
2. The Process
As the great PG says, fundraising is a huge distraction. If you are raising you are not focusing on the business, which is going to make it harder to raise money. Investors are chronic teases. They love talking and they hate writing checks. Get in, get your money, and get out as quickly and cleanly as possible. They have all the time in the world on their side. Don’t let them waste yours. Everyone evolves their own style but here is a textbook fundraising process:
a. Determine how much you want to raise and at what price
b. Make a list of 8-10 investors that match the profile you want
c. Set a timeline (I suggest 4-6 weeks) and stick to it
One of the most common rookie mistakes is trying to raise too much at too high of a valuation too early. Investors need to see their investment go up with subsequent rounds (IRR). The lower your early rounds the happier they’ll be with the progress of a subsequent round. And few things are more demoralizing than a down round.
Take your metrics and accounting seriously. If you raise money on false numbers, even mistakenly, it’s fraud. Hire a professional experienced in finance and accounting. Investment bankers can help you with valuation services and auditing and it’s never too early to start building a relationship. They can also help you pick potential investors and make introductions. I highly recommend Pitchbook for seeing which investors know your space, like making investments of your size, and are at a good point in their funding cycle. Remember VCs themselves raise money from LPs and are looking for returns within 8-10 years. Bigger and more famous funds aren’t always better. It’s about finding the right fit.
Now package up your sell story (most investors expect a slide deck but some bold entrepreneurs go without) and metrics and go pitch. Remember you are selling each other. They want to sell money as much as you want to sell shares. What makes their money better than the firm across the street? What makes your shares more valuable than the last pitch? There is a bit of an art to picking the right time to raise and playing different funds off each other, but people will remember if you shop around a term sheet and provoke a bidding war.
Choose the partner you will work with very carefully. This is even more important than the fund. You are going to spend a lot of time and go through a lot of stress with this person. Make sure you are a good match. Chris Dixon has been a rock for Soylent. We have been through a lot and he and his firm have always been there for me.
If someone likes you you’ll get a term sheet. Congratulations! Nobody ever wants to make the first offer so if you get this far you’re in a good place. Now sit down with a good lawyer and make sure you understand each and every term in exhaustive detail. There is a lot more to a deal than share price. Do they want a board seat? A liquidation preference? Preferences on future rounds? Preferred stock or common? The details matter. It can be smart to take a lower price for better terms.
A good partner can be a huge asset as a board member, but try not to load up your board with too many VCs. A good board is balanced between investors, independents, and founders. Don’t put too many executives or cofounders on the board. You don’t want to report to the same people that report to you. Find thought leaders of your industry and offer them independent board seats.
Before the round is “closed” the lead investor will conduct “due diligence”. This can vary by fund but the process with Andreessen Horowitz was pretty grueling, which I suppose is to be expected of a top tier firm.
After some negotiations, I signed their term sheet and was invited to their headquarters on Sand Hill road. The attractive secretaries greeted me and ushered me toward a wing of the building I had never been in before. I walked alone down a long hallway with photos of exploding nuclear weapons lining the walls. I could have sworn the corridor became narrower as I walked down but maybe it was just my imagination. At last I reach the door at the end. Only then I noticed a placard, similar to the ones on all the other offices reading “000 – Data Room”. The moment I open the door a hand reaches out from the darkness inside, grabs my wrist, and violently pulls me in. The door slams shut behind me.
Slowly my eyes adjust to the twilight. Pillars of flame that seem to be suspended in mid air provide the only source of illumination. Silhouetted against them I count 10 figures in black, silk, body-length robes with hoods over their heads. I note this corresponds to the number of general partners at the firm. The one exception is Chris Dixon, the lead partner on the deal, who has his hood down and is wearing a white robe with a large jewel encrusted dollar sign emblazoned on the chest.
“Greetings, Mr Rhinehart” a deep, disembodied voice bellows from the darkness.
“Welcome to the Data Room”
“DATA ROOM DATA ROOM DATA ROOM” the hooded figures repeat in unison
“The time has come to conduct our diligence”
“DILIGENCE DILIGENCE DILIGENCE” they repeat again, louder this time
Chris Dixon approaches me. With trepidation and care in his eyes he produces a weighty bronze key from his robe and places it in my hands. Wordlessly he motions to my left, where I see a large, circular door, like the entrance to a bank vault. A small keyhole is recessed in the center.
A bit unsure of myself, I shuffle toward the door and lift the key toward the hole. Before it even makes contact a beam of coherent light shoots from the end to the back of the keyhole. Immediately I hear the rush of gas escaping and the huge door disengages from its locks and lumbers to the side.
“Good luck” Chris whispers, with no small amount of consternation in his voice. As soon as I enter the door slams shut behind me.
More pillars of flame light this room, which is bright enough I can see its extremities. An archway leads to a cavernous expanse where I hear deafening creaking and whooshing noises. Above the archway, in gilded Helvetica the words – “BOARD ROOM” are printed. A plaque on the ground has an inscription
“The entrepreneur must be an expert of timing under pressure”
A twisting stone walkway extends before me. On either side is a sheer drop of at least 50 feet, with boiling Soylent at the bottom. That’s just the beginning though. Huge columns of timber are swinging violently across the walkway, suspended by frayed ropes and actuators at the top that help them keep their momentum. At the end of the walkway is another round door, behind a rectangular glass case, the contents of which I can’t quite make out.
“This will be a cakewalk” I think, scarfing down the two Food Bars I keep in my pocket.
The swinging logs follow a regular pattern so by simply timing my sprints I make it across most of the serpentine walkway, which grows narrower near the end. The hardest part was the last round with two logs in tandem so that I could either jump over the lower one as it passes, or slide under the upper one. I choose to jump and roll and make it through unscathed, then sprint up a hill toward the glass case and door.
I wrap my fist in my hoodie and punch through the glass. The glass is thin enough and I avoid getting cut. In the case lies another key and an immaculate pair of Moon Boots. Nice. I throw my Birkenstocks in to the Soylent lake and don the Moon Boots, noticing a new spring in my step. The soles must be quite elastic.
This door opens in a similar fashion to the first. Behind it another archway opens to another cavern, this one much larger than the last. “LIQUIDATION PREFERENCE” is the marking on this one. An inscription reads
“The entrepreneur must be able to find balance among the many competing forces of the business universe”
On a cube of stone just past the archway sits a Soma pitcher, filled to the brim with Soylent. A simple diagram shows the pitcher pouring in to a spherical gold reservoir, resembling one I can barely make out at the other end of a sight of terror.
Small, irregular stones dot a vast lake of water, filled with sharks and alligators who are embroiled in a bloody battle royale throughout the entire scene.
“Let’s do this” I say aloud, though my voice cracks a bit.
My Moon Boots allow me to jump farther and higher, though I have to be careful not to spill any Soylent. I land on the first stone squarely in the middle, but some of the sea carnivores have noticed me, and I jump off just as a row of razor sharp alligator teeth snap behind me.
I keep my momentum going, barely outpacing the violence, and around jump 10 start to near the end. Except, there is no stone to bridge the final expanse. Trying not to panic I see a particularly large shark gathering momentum toward me through the depths.
“If I time it just right…”
I jump just as the shark’s head breaks the water in front of me, then land one foot barely on its nose, deftly take two steps down its back and jump again with both legs. But I undershoot.
My feet enter the water and I desperately grasp at the edge with one hand, while keeping the pitcher upright with the other. It slams on the stone with a sickening thud, but doesn’t crack. I notice with near panic a splash of Soylent on the ground beside it.
“I hope I didn’t spill too much…”
I pull myself up before the gator to my right can reach me and run to the gold sphere. It has a funnel on top, in to which I pour the Soylent. I hear a sound as it fills reminiscent of Link refilling his health in the Legend of Zelda, but even as the pitcher empties the reservoir seems to deem my offering inadequate. At last, with the final, slow, drop I hear a sound of 8-bit victory and a glass case rises from beneath the ground.
I kick through the glass with my Moon Boots and recover another key and 2 identical steel warglaives, sharp to the touch. They remind me of The Twin Blades of Azzinoth, wielded by Illidan Stormrage. Sweet.
Another chamber. I had hoped that was the end. “CLAWBACK PROVISION” is the inscription on this one.
“That doesn’t sound fun”
“The entrepreneur must persevere through the forces of status quo and entropy”
Inside appears a vast, lush forest. I smell sweet wildflowers and damp soil. Hm, doesn’t seem to be so bad. Suddenly living vines grasp me from all directions and I notice towering carnivorous plants approaching. Thinking quickly, I shred through the biomass with my blades and continue forward. They are too many, though. For every vine I slash two more seem to grasp me.
I am about to lose hope when I realize that the thick trees are not bearing typical fruit, but packaged food products like twizzlers and oreos and…Coffiest! I rejoice. I free one hand by slashing a particularly thick vine, and lunge at the bottle, severing it neatly from the tree and the cap in one motion. I catch it in the same hand and promptly imbibe it.
With newfound strength and energy I begin making forward progress again. These plants can’t hold me back. At the end is a sheer wall with a single redwood tree, must be 30 in diameter, climbing to the top. I dig in to the trunk with my blades and make the grueling climb to the top.
Another glass case, which I slash cleanly through with my left blade, contain two matching Asus Zenwatch 3’s. Awesome. I put them on, one on each wrist, and use the key to open the circular door.
“Well done Mr Rhinehart” the same voice from before booms through the chamber. “But greater founders than you have failed the final test”
I notice I am standing on a vast expanse of steel grating with bubbling lava beneath me. The room seems to expand infinitely in all directions. I am just beginning to feel the extreme heat and tearing off what is left of my shirt when suddenly something hits me in the chest like a sledgehammer. I double over, the wind knocked out of me, and feel the steel grid shaking beneath me.
As I look up from my crouched position I see a massive white unicorn charging directly towards me, its brilliant skin reflecting heat and light and its sinuous muscles rippling with rage. Its horn is razor sharp and covered with diamonds. Thick pink laser beams periodically blast from its eyes. Another beam strikes me in the shoulder and knocks me flat on my back. I skid backwards several feet and panic when I realize I’ve lost grip on my right blade.
Another beam seems trained on my skull when I instinctively lift my right wrist to protect my face. The laser beam harmlessly bounces off the face of the Asus ZenWatch 3 and disappears in to the darkness. Suddenly I realize I stand a chance.
I take a moment and marvel at the beauty of the creature.
“Such a shame I must destroy you, beast” I shout in its direction, which seems to anger it even further.
We sprint toward each other, each covering huge swaths of ground in a short time. I start bouncing farther and faster directly toward the unicorn with my moon boots and deflect its lasers with my watches. Just as we are about to collide I fake another jump, instead using my momentum to duck and slide under the rampaging horse-like mammal. Using my left blade I slice the belly of the beast open and emerge on the other side.
After skidding to a stop I slowly stand up and notice an unnatural calm and quiet fill the room. Turning around gradually I see the unicorn has stopped, but is still standing. An ear-splitting scream explodes from its mystical lungs and out of its belly pours not flesh and blood but gears and wires. Of course! Unicorns aren’t real. It’s animatronic. No wonder VCs invest so much in robotics and AI. It helps with their diligence.
I walk toward the dying creature, almost sympathetic. It falls in spasms and sparks and I taste victory. But it was premature.
Without warning the front half of the robo-beast gains a supernatural burst of strength and lunges at me. I am knocked over and my blade falls behind. Sharpened steel teeth are at my neck and emblazoned pink eyes stare in to mine, ready to execute.
I have failed my company…tears well in my eyes and I am about to accept the end when I hear the unicorn speak, its mouth unmoving. It has the tender voice of a woman.
“Did you fudge your churn numbers?” it says
“Yes! Yes!” I cry in desperation. “I’m sorry! It was my CFO’s idea! He said it was ‘investor accounting’ but I knew it was wrong! I’m sorry I’ll never do it again! The true number is 2% higher!”
The unicorn’s eyes go dark and its strength deflates like a balloon. Instantaneously I see a square outline of light open from the ceiling far above. A platform suspended by chains gradually lowers in to the chamber. On it stands Marc Andreessen, donning a full suit of barbarian armor and holding a massive jewel-encrusted broadsword. At his side is Ben Horowitz, in purple regalia holding a crooked wooden staff with a glowing blue orb at the top.
“Oh no…” I think. My stamina exhausted, my flesh covered with cuts, bruises, and burns, my watch batteries deceased.
“Do not worry Mr Rhinehart” Marc says, his rapid speech dripping with wisdom and strength, his face beaming with pride. “Your trials are over. You did well.” He offers me a hand and helps me up. Then he reaches in to his leather pouch and pulls out a check for $20 million. It is addressed to Rosa Foods, Inc from Andreessen Horowitz Fund IV.
My trembling hand grasps the fragile paper in disbelief. I see Marc’s eyes glow radiant gold and he points his broadsword at the check in my hand. A signature materializes on the endorsement line.
Ben points his staff at me and I feel myself lifted off the ground on to the platform. As we rise in to the blinding light I feel myself drift off to sleep.
I awake in a fresh set of clothes and realize I am sitting at the head of a long table on the patio of the Rosewood. Nobody else is there. They must have bought out the restaurant. The whole partnership is there, however, dressed in their normal clothes. We feast on roast boar and shark, drinking goblets of wine as the partners recount their own tales of diligence. It was a blur but I do recall Chris Dixon telling a vivid story of wrestling an alligator in the Liquidation Preference room, while Lars Dalgaard rolls his eyes.
After a good night’s rest I get back to work. But I can’t help but wonder…what will the Series B be like?