Startup Fundraising Guide - Ep. #6 - Post Close

Hey everyone, I'm John Coogan and welcome to my guide to startup fundraising. Last week I talked about closing a deal and went into some details about the safe. Today I want to talk about what happens when you close your round and start to plan for the next one. If you're following my advice from the last video, then you're probably raising with standard post money safes that have a valuation cap and no discount. But fundraising is a messy process and and even though you might have a few angel investors already committed on those terms, a larger investor could come along and want to do a priced round. So what happens then? As we've mentioned before, your goal as a founder is to build a great business, and that means making your customers happy, growing your customer base significantly every month, and finding a large market. You can't focus on any of that if you're tied up in fundraising negotiations for months at a time. That's why so much work has been done by the startup community to simplify fundraising. Raising a priced round means you will actually be issuing shares to the investor, as opposed to signing an agreement to give them shares in the future, because shares are actually changing hands. A priced round is usually more complicated than using safes, but that doesn't mean it's worth walking away from a great investor just because they want to do a priced round. Let's go through some of the pros and cons of both the safe and the price round. First is speed. If you're using a standard safe like the one on Y Combinator's documents page, you can execute it in a single day using an E signature service like DocuSign. These documents have been used thousands of times, and there's nothing to negotiate except for the valuation cap. With a priced round, the closing process usually takes at least a few weeks, which could be distracting if you're in a particularly hectic period of growth. The second is cost. Since you don't need a lawyer to review it, the safe essentially costs nothing to execute. Priced rounds not only require you to have your lawyer review documents and manage a closing process, but often you will be required to pay for the legal costs of the lead investor. This can be as low as 5k or as high as 60k. A good rule of thumb, though, is to multiply whatever the investor is asking for in legal reimbursement by 3, since you will likely need to do more legal work on your end to close the deal. The third is terms. Priced rounds have very different expectations about what terms are included by default. It's common for priced rounds to have founder vesting requirements, board seats, block rights, and lots of other items that will need to be negotiated line by line. To be fair, all of these items can be included in safe side letters or excluded from priced round documents, but the default state here matters. It's easier to ask an investor not to add a side letter to a safe than to ask that investor to remove an item from a priced round term sheet. Lastly, there is sequencing. Because safes can be executed individually, you can close the first investor very early and avoid a situation where an investor is soft committed but waiting for you to get a lead investor before they sign documents or wire any money. Additionally, it's not uncommon for the announcement of a fundraising round to attract more investors, and it's harder to capitalize on those when you've already closed a priced round. With safes, you can always just issue one more safe to get that investor in. This is a double edged sword though. On the one hand, it can be great to roll your fundraising from 100k to 1 million as you gain heat on your round, but on the other hand, having SAFEs at different valuation caps can make tracking your total dilution very difficult. Being overwhelmed by complicated safes is so common that it even has a nickname, the Waterfall. To put it simply, the waterfall is a situation where the founder loses control of the round by issuing dozens of safes at increasing valuations. No single safe in this case causes massive dilution, but taken together they can add up to 30 or more percent of the company. It's essentially a death by a thousand cuts. In 2017, Pascal Levinson and Andrew Crown published an article on the waterfall effect in TechCrunch, and while it does a good job of warning entrepreneurs about the risk of early stage dilution, I think it wrongly targets the safe, since the waterfall effect can also occur when founders use convertible notes. Fear of the waterfall alone isn't enough of a reason in my mind to abandon safes entirely, but if you do want to do a priced round, here's my advice. Try and use standard documents from SeriesC.com whenever possible. They're simpler than what you would be using if you did a Series A, and it's much cheaper and quicker to execute. Second, make sure you understand what provisions are included in the docs that you're signing. There are generally two types of provisions in a financing document, financial provisions and control provisions. Financial provisions govern a few things, mainly who owns the financial interest in the company, whether or not they have the right to buy more shares in the future and what protections they have if the company sells or goes bankrupt. Control provisions are all about who runs the board of directors, who can hire and fire the executives, and who makes the final decisions on big company issues. If you look around the technology industry, you will notice that many companies have special provisions where the founders control the company even though they don't own 51% or more of the financial interest in the business anymore. Whether you care more about financial provisions or control provisions will depend on your personal life goals. But if you really want to understand deal structures and the associated trade offs, I recommend reading Venture Deals by Brad Feld and Jason Mendelsohn, which I've linked below. Regardless of the exact investment vehicle you use or once you close the deal, it's your job to get back to building. But things will be different in a few key ways. You'll need to send regular updates to your investors and hold board meetings, even if the founders are the only board members. Since investors expect further growth, you need to start solidifying your key performance indicators or KPIs, and start thinking about what milestones you want to hit before your next round. When it comes to investor updates, the key to success is focusing on a single, consistent metric like active users or revenue and committing to a cadence with everything else going on at your startup on a daily basis, it can be really easy to let these updates slip, so create a schedule that you can stick to consistently. Aside from your KPIs, you'll also want to include information about important product milestones, new customer wins, key hires, and any asks you have for the investors. Investor updates are a great way to get your investors to add value and help you make connections that they wouldn't have thought of otherwise. Running an effective board meeting could be the subject of an entire video, but in short, you should figure out what topics you want to discuss, then build a board deck, circulate it beforehand to everyone who's going to attend, and then make sure to present the decisions that were made at the meeting to the rest of the team so everyone stays aligned. In terms of your Series A milestone, you will need to forecast your primary KPI out roughly 1218 months to figure out what growth rate you need to hit that goal. If you're tracking monthly revenue, your investors should be able to help you understand what monthly revenue numbers they are typically seeing at Series A for your sector, as well as how fast that number should be growing. Once you have that milestone in mind, it's your responsibility to deploy the funds you raised judiciously raising a Series A will always be significantly harder than raising a seed round, so you need to plan for profitability. Never assume that you will be able to raise more money no matter how easy the last round was. Avoid letting your expenses spike and focus on letting growth Justify Hiring it's common for investors to recommend hiring fast and in some cases that is the best strategy. But you need to make sure that the new hires will justify the added costs. Investors often overemphasize hiring quickly. This is because as investors they're used to deploying capital to solve problems and encouraging overspending to a small degree will lead to bigger future rounds where they can buy a larger share of the company. Just make sure that you have a solid financial plan and can get to profitability if need be. The market can shift at the drop of a hat and you need to be able to react quickly to stay alive. Even though I've now published nearly a full hour of content on fundraising, it's important to try and keep it as simple as possible. Things can get complicated quickly and that will drain the energy you need to build a great business. The easiest way to keep things simple is to use the fundraising best practices outlined here and try and push back on any complications that are introduced by investors. Ultimately, fundraising is a game of give and take. Understanding the trade offs between different investors, documents and terms will give you the ability to close your round quickly and focus on building a great business. If you enjoyed this video or this series, please consider subscribing to the channel for more content. And if you have any questions, just leave me a comment below. I'm definitely reading them. Thanks for watching.