7 pitfalls to avoid when taking money from friends and family
StartFast typically works with companies that have raised < $3MM prior to the accelerator so it's fairly common for me to work with founders who are thinking about raising money from "friends and family". These are accredited investors within your personal network, such as the stereotypical rich uncle or successful college friend who are willing to invest in your company during the high-risk early stages.
While this is very common and often essential to a company's survival, I've also seen an unfortunate number of cases result in either stunting the company's growth or putting it in financial jeopardy due to totally avoidable errors on the part of the investor. To make sure this doesn't happen to you, I've outlined some of the most common pitfalls and areas for prospective investors to become familiar with before writing a check.
While there are many potential issues to watch out for with friends and family investors including: how it will effect your relationship, how much value they bring beyond their money, do they have dry powder, etc. these are not our primary concern here. Instead our focus is on the fact that the vast majority of friends and family are what I will call "unsophisticated investors". This DOES NOT mean they aren't intelligent or business savvy by any stretch. In fact this categorizes a number of self-made billionaires! This is referring specifcially to their lack of knowledge and experience with the very specialized nature of investing in early-stage tech companies. An investor's experience on Wall Street, as a family business operator, or CFO can be just as helpful as it can be misleading in this context.
There are really two areas to watch out for when working with unsophisticated investors: 1) things that can bite you when you're raising funding and 2) things the can hurt you after you've taken their money.
What to watch out for while you're fundraising
Terms: I highly recommend that founders and prospective angel investors become knowledgeable about standard financing deal terms before participating in an investment. A great reference is Brad Feld and Jason Mendelson's book "Venture Deals". Important terms like: preferred stock, vesting of shares, etc. are all covered. The last thing you want is to have your friend hold up their $150K check because they don't understand what a liquidation preference is or worse, start a long negotiation process about terms that don't really matter or aren't standard in early-stage deals.Company Valuation: Most experienced business people tend to think about valuation in terms of things like: book value, discounted cash flows, or even having an independent audit done to value the company. If you were to consider the majority of private company valuations, that is typically how it is done but not so when you're considering a high-growth, early-stage, tech company, with almost no physical assets or historical financial data. Valuations are dependent on a huge variety of aspects such as business model, geography, traction, market conditions, etc. Even if an investor is willing to accept a valuation, it's important they understand where it came from and the implications that will have down the line in future financings or an exit event.The lack of Intellectual Property: The lack of patents or other intellectual property is something very common to tech startups and yet totally foreign to many unsophisticated investors. Even if a tech company has patents it's very unlikely those patents actually have much impact on the company's valuation at this stage. The reasons behind this could warrant their own blog post (or even book) but, suffice to say this can also become a sticking point for people who don't quite understand how an early-stage company can have value without intellectual property. The bottom line here is that in the age of the Internet, the barrier to entry usually has little to do with IP and more to do with differentiators and competitive road blocks the company can set up as it grows.Poor Due Diligence Practices: as Nasir likes to say "they're attempting to make a high risk investment by mitigating risk rather than by maximizing potential returns." Unsophisticated investors will inevitably raise concerns during their due diligence that essentially boil down to a lack of data or predictability. The reality of any early-stage company is that the future is never very clear. Prospective investors needs to accept a reasonable degree uncertainty in this regard and focus more about how to maximize the value of the company than reduce the likelihood of losing their investment.Not Taking a Portfolio Perspective: Earlier this year I had a meeting with an up and coming local business person who decided to start angel investing. Despite advice to the contrary he essentially stated that rather than invest in a portfolio of companies he's instead planning to invest in his friend's company when they raise their round. Aside from the fact that the particular company in this story is almost surely a poor investment, this is a common issue with unsophisticated angel investors. They go all-in on a single high risk bet rather than playing the odds and making 10's of investments. It's an almost sure-fire way to lose money as an angel investor and the equivalent of trying to "out smart the market".
What to watch out for after fundraising
Considering the Need for Future Financings: Most tech companies will raise more than one round of investment. When a company raises future rounds any current shareholder who doesn't at least invest their pro rata share of the new round of capital will face "dilution". In other words, the overall equity percentage that they own of the company will decrease slightly. Dilution tends to cause all sorts of (usually) unnecessary panic and confusion among unsophisticated investors. It's important that they learn it's true implications and to understand where the value increase on their investment actually comes from.These are Illiquid Investments: These investments are naturally illiquid until some kind of merger, acquisition, IPO, or change of control type of transaction occurs. That means there are no dividends, there is no interest paid, and investors should not expect to be able to "sell their stake" prior to such an event. Investors need to understand and be comfortable with this fact or founders will inevitably spend an inordinate amount of time managing their investors instead of working on their business.
There are a number of other issues that could be added to this list but the moral of the story is that before you take money from any unsophisticated investors, they need to establish a basic level of sophistication prior to writing a check for everyone's sake. If you have experience with other pitfalls, share your thoughts in the comments below!
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You won't raise money with a TED Talk
I'll start off by sharing what might be an unpopular opinion: I tend to roll my eyes at 90% of TED Talks. It's not that I don't like the concept or find the topics interesting. It's because each presenter follows a very prescribed affect which is perfectly satirized by this video. There are outliers that can pull this off but in the vast majority of cases, when entrepreneurs approach an investor conversation the same way, no one ever takes them seriously. And by the way, sprinkling buzz words into your business/pitch (drones, AI, blockchain, machine learning, ICO, etc.) doesn't help your case either.
As much VCs like to talk about how they invest in "visionaries" the truth is it's largely B.S. Because unless you can figure out how to build a real business addressing a real problem, need, or want from a real customer, you'll never get two feet off the ground.
This problem is not exclusive to younger founders either. I heard a pitch from someone earlier this week who probably has 15 years on me that did this exact same thing! He's trying to launch five different products simultaneously and in total denial about whether a tangible market need for any of them actually exists.
Most of the "great entrepreneurs" that helped to establish this persona (Jeff Bezos, Elon Musk, Steve Jobs, etc.) built that personal brand first through much more concrete enterprises. If you think you have a vision at that scale, keep it in your back pocket and start off by creating something real, something tangible, something realistic and achievable first. Amazon started off selling books, Elon started with PayPal, Steve sold early versions of computers to enthusiasts.
A journey of a thousand miles begins with a single step and you can't build a mega unicorn until you earn your first dollar. Figure out how to do that first, then how to earn the thousandth, then the millionth and then revaluate where you are before you decide you're then next Google.
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4 ways to make a better first impression with investors
We specialize in working with experienced founders so the majority of pitches I hear tend to be from entrepreneurs that have every right to be confident in their background. They may have run companies before, have years of industry experience, been an early employee, or just graduated from Wharton with their MBA. So you'd think I'm jumping into the lions den here when it comes to working with founders with big egos but truthfully, I've found little correlation between a founder's background and their level of arrogance.
Unfortunately that means this problem is pretty pervasive throughout the entrepreneurial community and it's an important point to address because an entrepreneur's job is primarily dealing with people and an investors job is primarily to invest in people. The impression an entrepreneur makes during a pitch can have a tremendous impact on their ability to raise funding. If even one prospective investor walks away saying "what was with that a-hole!?" that's a needlessly missed opportunity! It had nothing to do with how lucrative your business was and everything to do with how you presented yourself. It's an easily avoidable mistake and it all comes down to establishing empathy.
This takes a lot of self reflection to get right. Try to take a third party perspective in how previous pitches have gone. For most experienced founders, when the conversation goes South it's not because there is a fundamental flaw in your business (though that can be a catalyst) it's because of how the entrepreneur handled an investor's response. To avoid your conversation taking a turn for the worse and to make sure an investor feels confident in you as a founder, here are 4 tips I regularly use when coaching entrepreneurs on their pitch.
DO NOT argue. No matter how much you disagree with a comment or the premise of a question. Acknowledge the validity of their point, provide the data upon which you based your decision and if needed outline your thinking about how you interpreted that data to arrive at your conclusion. Be mindful of your tone in responding and emotional state. Do not be offended. Be open to criticism and opportunities to improve your pitch and/or business.Search for a misunderstanding. Is there something about this topic they don't understand or you are not explaining well? Did they not catch a point made earlier in the presentation which is causing confusion? Are you making an assumption about their baseline understanding? Perhaps you are so in the weeds that the investor is missing the high-level idea? Pitches create an artificial barrier between the entrepreneur and investor. Many investors will not admit when they don't understand something and instead will try to call you out on a mistake. Your job is press pause and test the waters to make sure everyone is on the same page before responding.Establish empathy. What is the person's background and perspective? Put yourself in their position and see if you can figure out how they arrived at the conclusion they have. Is there a gap in their thinking? A poor assumption being made? Or perhaps you even missed something in your thinking and you can take the feedback constructively.Consider why a questions is being asked. What are they actually looking for in the answer? Often times I will ask a question not so much because I care about the specific answer but because it provides further insight about: the entrepreneur's abilities, they're progress to date, something fundamental about the business, how potential customers view this problem/solution, etc. For example: Earlier this week I heard a pitch from an entrepreneur with an ambulance product for EMS departments. I asked "Of the EMS departments you have spoken to, how many have asked their suppliers if they have a solution to this problem?" Her answer essentially consisted of a bunch of rambling followed by "EMS departments don't really ask their suppliers for new products" followed by some scoffing laughter. Horrible response. Why did I ask that question? It's not because I expected any EMS departments to be asking their suppliers for new products. It's perfectly plausible there is a potentially successful business to be had even if EMS departments didn't do that. I asked because if any of them were it would signify this is such a big problem for them that they've done something above and beyond the ordinary to look for a solution. It's a signal not a prophecy. If the entrepreneur took the time to consider that or even asked me to clarify my thinking, that exchange would have gone a lot better.
When investors make their decisions, a huge part of that decision comes down to the founding team. An entrepreneur that doesn't communicate well will create problems that go beyond their ability to pitch including aspects such as your ability to recruit top talent and generate sales. You do not want to the first thing that comes to mind for a prospective investor to be that the founder is hard headed and uncoachable. It's a huge redherring that completely distracts someone about whether you are actually presenting a lucrative opportunity. I have never know a person to invest in a founder that they had a combative exchange with during a pitch presentation.
Your demeanor when approaching an investor is a tough thing to master. You need to be both confident and coachable, very well researched and transparent. It can seem like a fine line when you think about it that way but if you follow those four tips you'll master walking the tightrope sooner than you think.
Differentiation is about more than just trash talking your competition
Differentiation is another topic where founders can lear a lot from considering the perspective on the otherside side of the table. As a founder you often have a relatively narrow focus: your specific company operating in your specific market. When a founder looks at their competitive landscape, it's easy to take a cynical perspective of any other company. I used to do this myself all the time! Of course you believe "you're doing it better"! So do the others guys. So let me tell you something that should sound pretty obvious in retrospect. Telling an investor (or customer for that matter) that your competitor "doesn't have the same technology" "is all hype" "has an inferior product" or "doesn't have the same vision" is not exactly an original statement.
Understanding your competitive landscape is more complex than that. Resist the urge to simply trash talk competitors and establish concrete customer centric ways that differentiate yourself. The best differentiators for early-stage companies are those rooted in customer value and customer segmentation.
Here's a hypothetical example. ABC startup has a SaaS platform for daycare providers to organize all of the important compliance information for the Office of Children and Family Services. Let's assume competitor DEF startup has entered the space. Here are a few ways in which ABC startup might differentiate itself:
Market segment: DEF startup is better suited to daycare centers while ABC startup is focused on in-home daycare providers.Customer problem: DEF startup is really more of a Quickbooks plug-in that has some compliance capability whereas ABC startup was designed from the beginning as a compliance software.Locking out competitors: ABC startup is the only solution integrated with OCFS software to help make the inspection process that much easier for licensed providers.
Hopefully you'll notice a pattern here in that each of the above examples is not trying to argue that ABC is "better" than DEF. Each takes the perspective of the customer and describes the circumstances under which they are making an objective decision to purchase ABC instead of DEF. This is an important distinction because it's the more accurate description of reality.
Creating a legitimate differentiator is about more than just answering a standard investor question. This has a very meaningful impact on the likelihood of your success as an entrepreneur. In my experience, the entrepreneurs that have figured out how to scale their businesses are directly correlated to those who have a very deep and objective understanding of their competitive landscape. All of that being said, eventually you will very likely run into a direct competitor. The goal however is that by positioning yourself correctly and focusing in on the best target market in the early days, by the time your competitors emerge you'll already be miles ahead of them.
Clueless Founders Don't Get Funded
One of the most tragic occurrences in the start-up world in my opinion is when a founder fails to raise funding for totally preventable reasons. In other words, they're addressing an important problem for a big market, have a unique, valuable, and defensible value proposition, etc. but then totally drop the ball during an investor conversation.
It's no secret that investors place a significant weight on the founding team. Every investor panel discussion and VC fund's website will inevitably mention something related to why they only invest in the most skilled/experienced founders. It may seem repetitive or cliche' but the reason this is so common is because start-up investing is inherently high-risk and yet there is very little data to base the investment decision on. Investors therefore try to decipher how much confidence they should place in the founders' ability to make their vision a reality. Proving you and your team are worthy of this confidence is about demonstrating your ability not just to create traction but to intimately understand what is driving it and how to drive more of it.
Let me give you a real-world example. ABC company has a SaaS product for law firms. They're very capital efficient, they grew their subscription base 20% compared to last month, they're beating their pro forma goals without funding, have little to no customer churn, and are essentially dominating the space. The time comes to raise their first institutional capital so they can grow their sales/customer success teams and update the product a bit. Their pitch deck looks great and the prospective investor is all but salivating about the opportunity prior to the intro meeting. The pitch is given, and the Q&A portion starts with simple questions: What was your revenue like this past month? What is your current customer acquisition cost (CAC)? What has your month over month (MoM) revenue growth rate been like over the past quarter? By all means fairly fundamental questions for a SaaS company even in the early days. The entrepreneur responds: "Uhhhh that's a good question hold on let me check .... You know I'm not sure because I'd have to pull out all of the records from our Quickbooks account."
Cue awkward silence ...
Unfortunately this entrepreneur is either going to receive a straight "pass" or the investor will forever hold off on making a decision and leave the entrepreneurs in limbo. The investor wants to know they are betting on a team that has not only proven traction but knows exactly how they will leverage the investor's funding to accelerate even more growth. If the entrepreneur is not living and breathing by the key performance indicators of their business then why should anyone believe they truly understand what's led to their growth let alone how they will achieve more of it?
The end result is that your company may represent a very lucrative opportunity but the investor will be left feeling the team is unable to cease it. In their eyes, it's not worth the risk of having the founding team burn cash on activities that aren't proven to drive growth while a more skilled competitor comes along and overtakes them.
Before you roll your eyes and think "Oh my god why are investors so determined to get me to jump through more hoops!?" it's important to recognize that in this instance the investor's best interest are aligned with the entrepreneur's best interest. There is a direct correlation between entrepreneurs who make data driven projections and those that ultimately achieve a successful exit.
While we're on the subject of data, the answers to an investor's questions should never include phrases like "well we hired a PR agent that has been creating a lot of great content marketing for us." or "we really believe our cold calling efforts are paying off." Why? Because both of those statements are either theoretical or subjective. There's little objective data demonstrating what you actually did let alone how those actions correlate to your results. Even if you have good traction, for all I know it was just good luck and word of mouth that got you there, in which case how is more funding going to help you accelerate that process?
Personally whenever I enter an investor discussion or deliver a pitch, I find the best way to prepare is not by memorizing various facts or scripts. It's a far better use of your time to simply make sure you know your business inside and out on a day-to-day basis. When the time comes to present, this data should already be top of mind. Try to look at your business like a machine and figure out what formulas and metrics seem to govern its success. If you can understand how your business operates from that perspective, so will investors and that's the only way they're going to write you a check.
Founders want money to grow. Here's why Investors want growth before funding
The founder's paradox: you "need" funding to drive growth and yet investors won't fund you unless you're already growing organically. If you have ever founded a company before or even considered starting one then chances are you can sympathize with that situation. There are few problems I've found that are as common as this one among both experienced founders and first-timers.
Before I dive into the solution here, I'd like to first address the logic behind this situation because I get so much pushback from entrepreneurs on it. Without any background context as to why this situation is so common, it would seem completely unreasonable to set such an expectation. "How am I supposed to build something, let alone something that will sell so fast I can't keep up, without any resources to help me do it?"
I suggest that the reason that seems so unreasonable is because you are looking at it from the entrepreneur's perspective and not the investor's.
So let's examine the investor's perspective. What is driving them to set what seem like such "unreasonable" expectations and push entrepreneurs into a corner like that? There are two primary reasons why this occurs and it has to do with: the venture capital market, and fund managers' incentive structure.
The first reason is that founders assume this is driven by an individual's perspective and not based on a broader market context. In other words, entrepreneurs are often quick to blame the individual investor as being "too greedy" or "unreasonable" because they only see that single investment interaction. They aren't really considering all of the other companies out there raising money and what they look like. You might find it unreasonable that the investors requires you to find traction without funding but of the 99 other companies that investor is looking at, a sizable portion of them have all figure out how to do just that. So now put yourself in their position. If you're looking at two opportunities, all else being equal, where one founder thinks they need money to get started and the other has already proven out a recipe for growth and how funding will accelerate that process, which would you invest in? Take Paul Singh's advice on this, "Founders should look at more deals."
The second reason is driven by the incentive structure for early stage funds (especially larger early-stage funds on the West Coast). Most of these guys are first and foremost looking for companies that are already growing organically at a tremendous rate. They're thinking is that any hiccups in tech, the business model, governance, customer support, etc. can be ironed out later. They just want to ride the biggest wave they can find.
What is creating this incentive structure? The answer is quite simply that big growth stories are what attract more high profile investors and drive higher and higher valuations, which in turn tends to create larger exits and more home run names for the fund's portfolio. Those last two items are what allow fund managers to make a bigger name for themselves and raise larger funds. (just look at the Twitter bio for many fund managers. They don't talk about their thesis they just list the names of the most famous companies they invested in) Unfortunately little of this story has much to do with whether the company in question is either sustainable or profitable, but that's nevertheless the incentive structure. Side note: This is also why 90% of the big tech IPO's you see have insane price to earnings ratios. They grew insanely fast but aren't necessarily generating the same level of cash flow.
So while you may be looking at funding as an insurmountable hurdle, the truth is on a macro level it's easier than ever to start a company. That also means that investors are looking at more deals than ever and a fair portion of those entrepreneurs have figured out how to start growing without funding. At the same time Fund managers are all on the lookout for the next Uber, Coinbbase, or Instagram to base their reputation on.
Alright so that's why founders are expected to start growing before getting funded but how exactly do you do that? Checkout FastThoughts again next week where I'll dive into that question head-on.
How to brand your startup
I have very mixed feelings about "branding". Marc Benioff claims "A brand is not just a logo its your most important asset." On the other hand, "branding" is perhaps one of the most overused and cliche' B school terms you'll come across. It's also tough for entrepreneurs to understand how much value to actually place on branding (read: how much time & effort to devote to building it).
Rather than focus on all of the actions items that branding typically entails (logos, slogans, advertisements, value statements, digital marketing, etc.) branding takes on an entirely new meaning when you think of it in terms of its end goal. My personal definition of a brand is nothing more than how people categorize and position you in their minds.
As you may have expected, unfortunately the rest of the world doesn't really think of branding in that way or at the very least they certainly imply differently. I suspect a primary reason for this is because most consultants and thought leaders have a different incentive structure (no offense). That crowd tends to talk about branding in terms of action items because that's what they can charge for. Design content, advertisements, events, influencer marketing, pitch decks, etc. Good marketers however (like many of our StartFast mentors) who truly have the entrepreneur's best interest in mind instead focus on how the company is positioned in the minds of stakeholders.
So how should founders establish their brand? Perhaps this is best illustrated by an example from one of our portfolio companies Automation Intellect (AI). The company sells a SaaS product to manufacturers to help them gain insights about the performance of their automated equipment. This allows customers to boost manufacturing efficiency and reduce costs. I discussed AI in a previous post with regards to defining their target market. The company has also made tremendous progress selling their software to machine builders, the companies who actually make the automated manufacturing machines. When a manufacturer buys one of these machines, AI comes preinstalled.
This strategy has a number of incredible benefits but one very important side effect is the credibility it created for AI's brand. Imagine you are a manufacturer with 100 different machines on your floor. You just placed an order for 10 new machines all of which have AI's software preinstalled on them. When it comes time to look for ways to improve the efficiency of the other machines on your floor, what's the first company that will come to your mind? They established the credibility of a massive brand even though they're still an early-stage company. That's branding. At no point did I even talk about the company name, logo, slogans, mission statement, etc. So when you start to think about building your brand, skip all of the cliche' stuff and jump right to the punchline. Focus on the end goal, positioning yourself in the minds of your customers.
You need an army to build an empire
There is a pivotal moment in the career of every business owner where they transform from a founder into to a leader. It's the moment when you realize people are not your biggest cost item but your most valuable asset.
For fear of coming off too much like a sounding board for your favorite business book let me explain. It doesn't matter how smart or efficient you are at some point you will hit a wall where you become the bottle neck to your own growth. I see this time and time again where founders are either oblivious or adamantly resistant to the need to recruit more people. The simple fact is that you need an army to build an empire.
Just so we are clear, there are also some founders that have the opposite problem. They want to start hiring too many people too quickly, or they simply want to pass off tasks to people they can hire (most commonly sales). That is also a big problem but that's for another day.
The audience I want to address right now is group of founders taking too long to build their teams. If you are familiar with my writing it will come as no surprise to you that this too is a category I once fell into. It started with a solar technology company I founded right out of college. I was an engineer by trade and knowledgable enough about business that I scoffed at mentors who told me I needed a co-founder. Why would I when I'm perfectly capable of handling the two most important aspects of the company, technical and sales development!?
It's hard for me to fathom that I genuinely believed that at one point. Of course reality slapped me in the face eventually. I was nowhere near skilled enough to fully execute either role on my own. Furthermore even if I did have such superpowers I completely underestimated the bandwidth necessary to fulfill either job. As a result I essentially floundered for over a year before coming to terms with the fact I needed a team of co-founders if I wanted to get anywhere. That's a lot of opportunity cost to pay simply to preserve one's pride.
Whenever I tell that story I find most people have one of two reactions, either this all sounds incredibly obvious to you, or you nevertheless believe you're an exception to the rule. It's the second category that I'm most concerned about. I still see very smart and capable entrepreneurs make this mistake today. More often then not the result is that they turn their companies into the living dead, just strolling along month after month making no significant progress just like I did. Most of these founders will never admit this to be the case not even to themselves. Every conversation with them sounds like they are right on the cusp of greatness and yet 12 months later they haven't moved an inch.
Let me put this into perspective for you. Amazon currently employs a half a million people. There is no such thing as a billion dollar company run by a single hardheaded optimist out of a garage. If that's your goal then you're better off buying a lottery ticket. Your chances of success are greater and it's the only way you're going to get there solo.
Once I got over my pride however, I then found two new reasons to resist growing my team: 1) not wanting to be bothered with creating a staffing plan, recruiting, managing, etc. and 2) a fear of the unknown: can I afford this person? Will I see an ROI? Will I hire the right person? etc.
It's perfectly understandable that when you're constantly being pulled in 500 directions it can be hard to dedicate time to HR. There's always going to be a higher priority you'll want to address first. I have no advice other than that you just simply need to budget time and do it. Personally for me that meant literally blocking out time in my calendar for such activities. Just remember, this is an investment and like any other investment the costs are upfront and the returns will take time.
The fear of the unknown is counterintuitive for an entrepreneur. If we're being honest, I suspect this is combined with a fear of a lack of control. Like most gambles of this nature the best way to motivate yourself is to compare the risk of taking action to the risk of taking no action. If you hire the wrong person or they don't deliver what you need then sure that's a tough situation to be in. Failure is a possibility. If you hire no-one however, you destine yourself to become the living dead. Failure becomes inevitable.
Investors need a reason to move faster
Were you able to review the pitch deck and docs for our current round? Are there any other investors you could introduce us to to help fill it out? We have about 1 month of runway left.
Your friend the entrepreneur raising money"
What's wrong with this email? There's a clear action time. There's certainly a sense of urgency. What's lacking is any clear motivation on the part of the investor to want to move faster.
Raising money is a much about understanding the psychology of the process as it is about building a compelling business to invest in. I dislike that element just as much you probably do but it's the reality of how fundraising works.
Unfortunately for entrepreneurs fundraising usually results in 1 of 2 extreme outcomes. Scenario 1 is the good one: there is so much excitement to invest that you have multiple offers to lead, investors fighting to get in, you can "oversubscribe" your round, and you can close it fairly quickly. Scenario 2 is 90%+ of circumstances where it's an uphill battle and you have to fight and claw to build momentum to fill your round.
In scenario 2 investors tend to have the upper hand. You need money, they have it, and there isn't a line of other people waiting to give it to you. It's a very typical high demand - low supply situation. This means you have little leverage to negotiate the terms and are usually stuck operating on the investor's timeline.
Scenario 2 can take 10 times as long to fill the round. As I've written about before, investors are incentivized to wait as long as possible before pulling out their checkbook. Every day that passes is just more information for the investor to consider their decision, one more day they weren't exposed to the risk, one more chance to see if you signed that partner you said you would or acquired as many customers as you set out to or closed those other investors you said were interested in participating. Until there is some kind of external pressure, there's no reason for the investor to move faster.
That doesn't mean you can't still fill your round in scenario 2. It just means you didn't hit the viral loop of investment circumstances in scenario 1 and will have to make up for that with persistence, perseverance, leadership, and strategy. After a conversation with an interested investor you should, as you suspect, follow-up to provide any deliverables you said you would. The only time you ever reconnect after that however is when you can share news that momentum is building: signed a big new partner, brought on that key VP sales you needed, closed a key or high-profile investor, dramatically increased your sales growth rate, etc.
As the leader of your business it is your job to give the impression that there is a growing army behind you and generate FOMO among interested investors. Persistence is not just about the number of follow-ups you make. It's about leveraging every significant victory you achieve as an opportunity to advance the fundraising process.
It's not how you see the world that matters, it's how the world sees you
During the Fall and Spring semesters I teach entrepreneurship classes at Le Moyne College as an adjunct professor. My lectures for this week are covering the most basic questions regarding target markets and solving real problems, needs, and wants. At the same time, I'm also in the process of helping our 2018 StartFast companies raise their next round of capital. What's interesting about these two events happening simultaneously, is that it truly highlights the importance of the fundamentals. A number of potential investors are getting hung-up on the exact same questions I talk about in my intro to entrepreneurship class. That's because it's not enough just to have a great team and traction. Investors are people too. We have our biases and are prone to heuristics. What might seem to you like an obvious home run idea can often be met with stone cold skepticism. The truth is unless you can objectively prove answers to basic questions with data, they aren't going to pull out their checkbook.
I do not claim this to be a comprehensive list but below are 8 fundamental questions every entrepreneur raising capital should have objective, data based answers to:
What is the specific target customer base?Are you solving a "need to have" problem/need/want for them?How are your customers currently solving this problem?How do you know you can deliver value to them?Why does this opportunity exist now?Why is your team the one that is going to win?What is the repeatable sales process?How do you quantify the market opportunity?
When I say data based answers I do not mean just cherrypicking information from secondary sources. Those a required too but they are not sufficient. This is not a college business plan assignment it's an investor pitch. Investors want to see statistically significant primary sourced market data that you've collected first-hand. That means 100's of customer interactions from which you can see patterns and draw insights. It means removing as much bias as possible and asking questions which will provide you with objective answers.
Entrepreneurs are always very quick to add a flavored spin to their communications. Investors however are not interested in how you see the world they are interested in how the world sees you because that is ultimately what will determine your potential for success.
This is another reason why Customer Discovery is so very important. It is the foundation upon which you are building your business. Without that information your business stands as a house of cards waiting to fall over. Yes, sales traction is the ultimate validation but, it is still just a measure of past success. Unless you have a compelling story to explain that traction, to demonstrate that traction is predictable, then selling most investors will be difficult.
So here's how to approach that list. Your first job is to be able to answer each of those 8 questions using mostly quantitative data from primary and secondary sources. For example: "What is the specific target customer base?" A compelling answer could be: "We spoke with 100 potential customers and found that the 60% who expressed having this problem, and were in search for a solution, all fit the following profile ... "
Your second job is to be able to explain why this is the case. What is the background context to this story? Continuing the same example: "Based on our conversations and this latest industry report, we believe this to be the case because customers fitting this profile all have a particular characteristic, or are facing the same challenges in the marketplace, which are causing this problem to occur. The current solutions to this problem are all either targeting different markets, focused on different or broader problems, or are just simply the best solution that customers could cobble together by themselves."
Do you see how the storyline begins to unfold? That is what you are aiming for. You've objectively shown not how you see the world but how the world sees you. You are not pushing a solution for which no problem exists. You identified a market problem for which no valuable solution exists and formed a company to solve it. You are going to be successful not because your product has the best features and the best price but because you have your finger on the pulse of this market better than anyone else.