Thursday, July 25, 2013

Go Big? Go Small? - Who Knows!? Part I

Why deciding the right size for your early round is so very vexing! 

Part I

What is the "right size" for my raise and why do I get so many conflicting opinions from investors on it? What am I missing and what am I doing/saying wrong?

Having had several conversations with entrepreneurs along these lines recently here are some thoughts from me on the subject. I suspect that I will be accused of giving a long non answer ... but ultimately I think entrepreneurs need to adopt the policy of: "Taking advice, not following advice." As an entrepreneur, realizing that you will get as many views on your raise as there are investors, means that you need to reach your own view and pursue it based on at least five key considerations:
  1. Valuation
  2. How much do you "need"
  3. The trade off between value creation and control
  4. Location: where you are based and hence where you will be pitching the most
  5. Whether are you focused on securing angel or VC investment

Sorry, it's complicated

I will start off by saying that this dilemma reminds me about the old saw about economists: Ask five economists their views on something ... and you will get at least six different answers!

It's my experience that in early stage land investors (individual angels, angel groups, seed funds, early stage VCs) have so many different opinions on raise size that there is indeed little consistency. Hence my first point to entrepreneurs - no, don't worry, you are not going crazy! The center of gravity of all these voices is indeed hard to discern and is influenced by self interest too. For example and totally understandably a VC will look at any proposition through their own lens - including their usual ticket size. So they might favor a "bigger" raise than an entrepreneur had in mind since that would equate to the minimum ticket size they prefer to invest.

This contrasts with the public markets where the capital markets desks of investment banks pricing deals have at least some chance of consistent price and size discovery. This because of the volume of transactions, more substantial financial data and much more consensus around valuation methodologies and metrics. (Although from from time to time they do get pricing badly "wrong" with resultant often gleeful cheap shots from the media and other commentators.)

Recognizing there is no one "right answer" is at least helpful to maintaining an entrepreneur's sanity. The five factors listed above seem to me to be the key ones that might help you, as the entrepreneur seeking to frame your thinking and head towards as good an answer as you can get. I address these five points in more detail in a separate post. Also note that I am not making a call here between convertible notes (which duck or at least defer the issue of valuation) and a priced round - that is yet another discussion.

A footnote on flexibility

To further complicate the entrepreneur thought process ... be prepared to be flexible. Entrepreneurs need to due diligence investors like they due diligence you. As the saying goes, all money is fungible but good advice and relationships are not. So if you get talking with an investor or group of investors where you see a good fit and relationship developing but where there is some angst on the other side of the table around the size of the raise it makes sense to be prepared to be accommodative to the extent you are comfortable. So have ready an answer to the question: "If we funded you with $1.5mn not $2mn ... how would you make that work?" In fact this can work both ways because the (and indeed real life occasional) question might be: "We really like what you are doing ... if we funded you with $4mn how would you put that to work and how much more quickly could you grow!?"

And what about gender?

Some women entrepreneurs struggle with this challenge more than men, in my experience. But to the extent that gender comes in to play it seems most acute at the first time entrepreneur/first raise level. In part that might be a confidence, some might say integrity, issue borne of a lesser willingness of women to self promote, indeed exaggerate. As one (female) founder politely put it to me: "there are a subset of male entrepreneurs who just make it up and are comfortable with that" pointing out the bravado shown by the RapGenius founders. This is a Silicon Valley classic: How Rap Genius Raised $1.8mn in Seed Funding Without Knowing What We Were Doing 

However I have heard from (women) VCs on both the East and West Coasts that they see no difference at all in terms of their dialog. They note that the choices that need to be made, as I outlined above, apply equally based on their experience. ie they report no obvious gender based differences in the way entrepreneurs handle them. With that in mind my suspicion is that, by the VC/Series A level, every start up has been through the pain of pitching and iterating their message more times than they care to remember. And having got early angel/seed funding they have built up a network of investors, advisors and entrepreneur contacts that means that they are all better placed to "play the game" ... as best it can be played.

More in Part II

In part II of this blog I look into each of the five factors mentioned above in more detail.