unwritten rules for venture savvy founders
Because there’s unfortunately no user manual for venture capital.
I’m old enough to remember when VC firms did not compete to see who is the most founder friendly. Overall, this has been a very welcome development for founders. (The firm where I work, Founder Collective was explicitly started with the mission of being a founder-aligned VC because this didn’t always exist.) Luckily, these days there are fewer trap doors for founders and slow-release poison pills in term sheets. But they do sometimes exist and from my viewpoint as a former founder, venture dynamics are still tricky for founders to navigate, at least until they’ve been through multiple rounds of funding and sometimes an acquisition — whether successful or unrealized.
In my ongoing quest to make VC more transparent, here are some guidelines for founders on some of these dynamics, and I hope that it will help drive better outcomes for you and your team.
Rule 1: Raising more money does NOT translate into building a more valuable startup.
We have the receipts here (in the form of post-IPO outcomes for a set of startups compared with how much cash they raised). In fact, if you raise too much money, you may increase the chances of a binary outcome, “hitting the wall” when you get to the growth stage. The fascinating takeaway: frugal founders are “smarter”…. in that they make smarter, more strategic choices throughout the lifetime of their company which results in more overall value creation.
Rule 2: “Growing into” a high valuation is binary.
You should absolutely be happy about a high valuation because it shows there is high demand for your deal, but you should NOT decouple those numbers from what they mean for your next round. If you are pre-revenue at the time of round 1, then by the time of round 2, the next round of investors will expect you to have meaningful revenue (or in a few stretch cases, meaningful progress) which will justify a valuation higher than the valuation of this round. If you do not make it, you could be in an existentially challenging situation.
Rule 3: Beware vanity metrics, including headcount.
Did I say headcount? Yep…. someone else said this and I can’t find the reference, but I think it’s absolutely true. It feels like your team size is the metric for your growth, but if this is way out ahead of your run rate, it could indicate a problem. Namely, long term, how revenue efficient (i.e. efficient at generating revenue) are you? Excluding long-range, capital intensive hardware and healthcare startups — if your startup makes $1M for every $3M of capital invested (without an endpoint in sight), your model is not working.
Rule 4: Momentum is the most straightforward way to game your raise.
Sorry, that I don’t have a fancy spreadsheet with formulas or something else more clever here (although you can use this). But this does include both momentum in terms of your traction and momentum in terms of your actual fundraise.
Rule 5: In successive rounds, you will be measured against different things.
Pre-seed: Vision →
Seed: Team & Product →
Series A: Traction →
Growth rounds: Growth economics
Growth economics are your unit economics plus the economics and key metrics around scaling. Long term they incentivize capital efficiency to achieve revenue and growth. Keep your eye on the ball — which is the next funding round — but make sure you have thought all the way through to the end. Or you get unicorn implosions….
Rule 6: Derisk the toughest questions first, including before you raise anything.
Think you can just build a product, point it at a market and hire some salespeople who can “scale this thing?” Maybe that’s a gross oversimplification and you would never try to do that (although I have had founders pitch me that a few times too often to dismiss this). But building a beautiful and/or useful product is the first step of very many. If you want to build a $100M+ startup, you should test your assumptions about the cost of scaling (again what I collectively refer to as your growth economics) from the start.
Rule 7: Different investors have different levels of financial alignment with you the founders, and it *will* meaningfully affect how they interact with you.
If an investor writes a check which is 1) a tiny part of an enormous fund, 2) not providing any meaningful economics to them, 3) at best, an option for the next round, then this may affect their incentives for the next round AND for meaningful outcomes which could then affect you, the founder, very differently than they affect that investor.
Rule 8: Be aware of signaling risk.
When those who have perfect information about you (say, investors with information rights) decline to invest, then this is a powerful signal to others. Manage this risk by trying to align with investors who are aligned with you, and who are invested in your success (not just placing a bet or placing an option for the next round).
Rule 9: Fund size is fund strategy. (All credit to David Frankel for this gem).
Understand this to understand your potential investors’ alignment with you, and what sorts of financial outcomes there are incentivized to drive towards. This will explain their advice to you as well as help you predict where they may land down the line on crucial decisions … or board votes.
Rule 10: Other founders are gold.
Other founders are your best resource. They will help you figure out who to pitch, will know what it’s like to work with a specific investor; can share what lawyer / CFO / growth agency / deck designer to have on speed dial; and can relate to “staring into the abyss + eating glass” (credit to Elon for that colorfully accurate description). Always ask.
If you found this helpful, disagree, or want to discuss, please drop a comment below or hit me up on twitter.