Category: Fundraising

A reader named Turner Dean recently asked me whether it’s better to raise seed money on convertible notes or straight-up equity.  Since this is a hefty topic that we could discuss for days, in this post I’ll aim to cover just the pros and cons of each from a founder’s perspective; I will NOT cover:

• What is a convertible note, equity, or convertible security?
• What major terms you should look for, be aware of, and ask for?

There are a ton of other blogs out there that will cover these two topics in great detail.  My expectation is that you’ll check out some of those other resources first if you’re not familiar with any of this.  Just do a Google search.

In general, I’m a big fan of convertible notes and convertible securities for seed stage founders.  These are the big pros; they are:

• Cheap
• Quick — you can start bringing in money immediately
• Flexible — there’s no such thing as a round, so you can start and stop raising at any time

Cheap

Because convertible notes and convertible securities are basically standard — in fact, if you’re not using one from the internet, your lawyer (at least most lawyers in Silicon Valley) should be able to provide you with a free template that you can modify —  these should be basically free.   I think my total legal bill for getting my seed round done for LaunchBit was < $3000.  In contrast, if you do an equity round, you as the founder will often have to pay $20k-$50k in legal bills.  You may also be on the hook for your investors’ legal bills, though this is changing a lot these days.

Quick

Once you get a convertible note signed, you can ask your investor to wire you the money or send you a check.  You can start bringing money into your bank account right away and can start deploying it immediately.  In contrast, if you do an equity round, you have to complete the entire round and go through the full due diligence process before anyone wires you money.  This process can take a couple of months.  Frankly, in my opinion, if you’re a fast-growing startup that’s deploying capital into your growth process, you really can’t afford to wait months.

Flexibility

In an equity round, you’re raising a specific amount of money.  With a convertible note or a convertible security, while there may be an upper bound to a note, there’s no fixed amount that you need to raise.  You can always create new notes easily if you need to raise more money or raise an amount less than what you intended under your existing note.  Flexibility is good because you may want to change the nature of your round as you see what the uptake is.  If you have great uptake, you may end up wanting to raise more money on another tranche of notes at a higher cap.  If the uptake is bad, you may want to wrap up your round shy of your initial target round and go back out into the market to raise again later once you’ve made more progress.

In reality, it almost doesn’t make sense to do a priced round at such an early stage because you don’t know what the fundraising landscape will be a priori.  You may not know what you’ll be able to raise or what makes sense to raise before you start.

Cons

Jason Lemkin has referenced a lot of the cons of doing convertible notes and convertible securities in his blog post here.  Namely:

• Investors spend less time with you, feel less committed to the company, and won’t help you as much with your next round
• Your legal bill will be higher when you have to sort out all of your notes later when they convert to equity

Investors

A big reason investors feel less committed when they sign convertible notes is that they don’t know what their stake will be in the end.  Downstream investors can potentially rewrite a lot of the conversion terms later, screwing over earlier investors.  This happens more than you might imagine.  So, early stage investors tend to be more wary of convertible notes and convertible securities.  Some early stage investors, especially outside of Silicon Valley, still won’t do any deal that is on a convertible note or convertible security; if you’re not based in Silicon Valley, this is something to consider.  Despite this, I still think convertible notes and convertible securities are founder-friendly and worth doing as an investor.  The bigger lessons for us investors are probably on trying to steer founders away from piranha-like, downstream VCs.

Legal bill

Sorting out all of your convertible notes at what caps, etc., will become a bear when you raise your first equity round.  This is especially true if you follow the tranche strategy of which I’m a big proponent (more on this later).  You’ll pay for this later when you sort it out with your lawyer.  That being said, I still think it’s better to raise money in tranches on a convertible note or convertible security and defer your complicated conversion to equity later.  I see this a bit akin to technical debt.  As a startup, you often need to do what is best for you now in the quickest, scrappiest, and cheapest way possible, otherwise you just won’t make it.  We hold this to be true in product development, and it should also hold true when raising your seed round.  You just don’t have time or money to worry about making things clean now.  When you have more resources later, you will pay for it.  And that’s ok.  If you get there, big props to you.  Most companies never get to a true series A equity round and never have to worry about this deferred legal bill.

While there are a lot of pros and cons to raising on a convertible note or convertible security, if you are based in Silicon Valley, I think it makes a lot of sense to do so as a founder at the seed round.

One question that seed investors love to ask is whether you have a lead investor in your seed round.  I’ve written before about what every entrepreneur needs to clarify when answering this question.

Once you figure out why an investor is asking this question, tactically speaking, what do you do?  Let’s say that you find out that an investor is asking because he/she does not invest without a lead investor in place.  Let’s say the investor simply relies on other people to do due diligence and does not believe in party rounds.

Now what?  Do you try to find a lead?  Do you ignore an investor who will only invest if you have a lead?

At this point, you need to move on.  Any investor who tells you, “We are definitely in if you have a lead!”  or “We want to co-lead if you find another co-lead!” are not in your round.  It may sound like they are in, but they really are not.

Next, you should not hold up your round simply because you do not have a lead investor.  Lots of seed rounds are done with party rounds these days, and so it is not the end of the world if you do not have a lead investor.  A few of my friends’ companies had no lead investors in their seed rounds, and they are now valued at hundreds of millions of dollars.  Get a standard convertible note (or convertible security such as 500 Startups’ KISS A), and fill it out.  Then, start bringing checks in.  Remember, with a convertible note, you can quickly get e-signatures, and investors can start sending you money that you can put to work right away even if you have not yet reached your target raise.

But what happens if you’re raising money on your note, and a lead investor wants to come into your round?  This is a very good problem to have and is both common and solvable.  Typically, a lead investor will want to do a priced equity round, and so you can convert your convertible notes into this equity round.  Sometimes, though, I’ve seen lead investors respect the fact that a round is already happening and will just put a big chunk of money into a company on the same terms as the note (this really depends on how much leverage you have or investor interest you have). Regardless, the mechanics of this will work out, and in most cases, your existing smaller investors will actually be very excited that you have a lead investor (unless that lead is a big asshole), and will be accommodating to make the round work.

Now, there are pros and cons to having a lead investor:

Pros:

• If it’s the right person, he/she could be a great partner to get advice from and hold you accountable like a good coach
• They could potentially lead your next round

Cons:

• If it’s the wrong person, he/she could make your life hell
• If he/she doesn’t invest in the next round, it could be bad signaling

You’ll want to do your homework before agreeing to work with a lead investor.  However, once you get a term sheet from a potential lead investor, you have a lot of leverage.  You can use this as a forcing function to see if some other firm that typically leads would also be interesting in giving you a term sheet.  This can help you increase your valuation, and/or you could potentially get a co-lead to mitigate signaling issues if one firm does not join your next round.

The bottom line is, don’t hold up progress on your round because you get too fixated on having a lead – I see this happen all too often with founders.

Cover photo by rawpixel on Unsplash

Fundraising is freakin’ hard.

It’s time-consuming and draining.  It requires being energetic and up 110% even when you’ve already been rejected a million times over.  It’s a big sales job.

But there’s one aspect of fundraising that no one talks about: how to balance growth and fundraising at the same time.  

For most companies, growing your revenue (or user base for consumer apps) while you’re fundraising is incredibly important, especially since the typical raise will span over a couple of months (in a good case scenario).  Investors want to see things progressing, and so you can’t let customer acquisition slip.

However, for seed stage companies that have small teams, this is incredibly difficult.  If it’s just you and your co-founder in your startup, 50% of your team has dropped out of the business entirely during this time period.  Moreover, often the CEO is still either doing all sales and marketing or is still heavily involved at this stage.  So, the remaining team members are often people on the team who may not have been involved in customer acquisition at all nor have the skill set.  So what do you do?

If you’re going to fundraise well, you’re definitely going to need to spend 100% of your time on it as the CEO.  So that means that before you start fundraising, you’ll need to look at all the projects on your plate and:

• Dump them altogether
• Train and hand them off to teammates
• Exchange them for outsourced help or automate them

Inevitably, this actually turns into a prioritization exercise, which is useful for a lot of teams.  You may find tasks that really aren’t that important.  Dumping projects and finding focus is good!

For tasks that are super important to keep running as-is, you’ll need to train up teammates or bring in help to continue them.  Sales, marketing, and customer acquisition most likely fall in this bucket.  Is your technical co-founder an introvert?  It doesn’t matter – he/she might need to do sales.  This can be incredibly difficult for some, but he/she has to step up.

Lastly, you’ll find that you can modify or automate some tasks so that they are no longer on your plate or so that it’s easier for someone else to do.  For example, perhaps you are doing all the lead generation right now.  You can likely modify the task and outsource that work to another company or person.  Perhaps there are scripts you can write to take over tasks you’ve been doing manually. This is probably what you’ll need to do to prepare to scale anyway.

This whole transition will take time, and so you cannot just start fundraising without planning for this transition.  

This process can take typically between 1-4 weeks depending on how many moving pieces you have.  It’s incredibly involved, and yet no one talks about it when they discuss fundraising.  Keep this in mind before you start your next early stage raise.

I’ve previously written about the importance of having multiple decks.  So, last week I talked about what I like to see in an email deck.  This week, I’m going to address in-person decks.

There are a lot of great resources that other people have written on what should go into an in-person decks.  For example: Here and here.  So, I’m just going to quickly gloss over the basics and do a deeper dive into some of the nuances that are less discussed.

Your in-person deck is a bit tricky because you should be able to use it as a good overview (for a first meeting) but also a deeper dive (for an all-partner meeting or a later in-depth mtg).  Ultimately, you will need to be able to close people with this deck.

The basics

Here are the basics that you’ll need to cover (not in this order per se):

• Problem
• Solution / your product
• Team
• Traction
• Unit economics & Customer acq channels
• Business model
• Market Size
• Competition / Alternatives / Differentiation

Well-designed slides do not need to look pretty, but they do need to be

• Concise
• Easy-to-read
• Digestible content / easily understandable / simple

In addition, you should create an appendix slide for each point you want to make.  Although you might only create 6-10 basic slides, it’s possible you may have anywhere from 0 to A LOT of slides in your appendix.  Different investors will want to focus on different things; some investors may want to talk more in depth about product while others may want to dive into your customer acquisition details.  So, it’s unlikely you will cover most of your appendix slides.

Nuances you should consider

Different investors have different styles, but I personally think you should think of each slide as a building block.  Investors have REALLY POOR ATTENTION SPANS, so you should order your slides based on your strengths.  For example, if you think your best foot forward is your team, lead with that block.  If it’s your unit metrics, lead with that.  Then craft a story that goes through this order.  It’s important to start out by wowing your prospective investor for as long as you can, otherwise you will be quickly dismissed within the first minute.

Additionally, many of the nuances I mentioned in my previous post on email decks also apply to the in-person deck:

Problem

As I mention here, the problem slide is often the most poorly articulated by entrepreneurs.  Think deeply about what specific problem you are solving.  When you start taking meetings with investors, you’ll likely change this slide a LOT either because the problem doesn’t feel big, meaty, and important, is too vague, or is too confusing. Don’t be afraid to change this slide a lot.  Part of the reason you need to do so many investor meetings is to be able to iterate on your specific messaging.

Solution / your product

Your solution slide will likely change, too, if you end up changing your problem slide a lot.  Let me give you an example: several of our newer portfolio companies are both marketplaces and SaaS workflow tools.  This is a growing trend.  How you explain your product matters a lot because if you say you’re building a marketplace and a SaaS tool, it feels really unfocused and distracting.  However, it could make perfect sense for your business to have a slew of workflow SaaS tools for your marketplace customers because it may create stickiness for the marketplace.  Alternatively, it could make sense for your business to have a marketplace for your SaaS customers because it creates lead-gen for them, which retains their subscriptions.  But you need to position this correctly.  When one of our marketplace-SaaS companies first started pitching their business, they started positioning this as a marketplace with workflow tools. It turned out that there were a lot of alternative marketplaces, so this didn’t resonate with investors – it felt like too crowded of a space – there were too many marketplaces doing something similar.  However, when they flipped it around and positioned it as a SaaS tool that helped with lead gen, they started getting a lot of investor traction.  This product positioning matters a lot, so be aware of the feedback you’re receiving and change your messaging accordingly.

Team / Traction / Unit Metrics / Market Size

I’d recommend checking out my other post on email decks where I mention some things to consider for these slides

Business Model

Most teams I encounter make this slide way too complicated.  If you have multiple revenue streams, please just list your primary revenue model.  In fact, most focused businesses will only have 1 revenue stream, but there are exceptions (see above regarding new SaaS-marketplace models).  Keep things simple.  Generally speaking, most investors are not the sharpest crayons in the box and also don’t have time to think deeply about your business until you are further along in the process.

Competition

You’re going to have a lot of competitors or alternatives.  If you say that you have zero competition, it suggests that you either are naive or are lying.  Even if you are running the next Twitter, which does not have a direct competitor, the alternative activity to tweeting on the toilet is reading a magazine on the toilet or posting FB status messages.  Every company has a competitor or alternative.

In addition, you’ll want to think deeply about which primary competitor you want to say you are going up against.  Ideally that competitor is big (suggesting a big market) but also an old dinosaur company that you can run circles around.  When I see entrepreneurs list other startups as competitors, my immediate reaction is that there is no market.  On the flip side, if you end up listing a big competitor that moves fast, such as Google, a lot of investors will get scared.  I see a lot of entrepreneurs try to create some sort of McKinsey-esque matrix slide of competitors, and that’s fine.  Again, simpler is better, so I personally like it when companies say this is the one major company (or alternative activity) that I am up against and this is how I will beat them.  Obviously, startups have many competitors and alternatives flanking them on multiple sides, but it helps me to understand how you think if you pick just one competitor or alternative so that we can do a deep dive on how you plan to beat them.  The last caveat here is that obviously whatever you end up picking must make sense!

Editing your deck

As you start to take meetings, you’ll start to hear common questions and concerns.  As these come up, it’s worth creating a slide for these issues.  If the concern or question is only brought up once, put this slide in your appendix, but if you’ve heard it multiple times, it needs to be addressed upfront in your story.

When I was fundraising, there were a ton of investors who rejected me.  Worse yet, there were many more investors who gave me no-response, went MIA, or were non-committal.  So what do you do with all of these people?  Are they worth re-approaching later?

The short answer is yes.  A “no” or non-response today isn’t a “no” forever.

The natural response that most entrepreneurs have is, “Oh, this investor doesn’t like me,” and he/she just shrinks away from talking with that investor ever again.  At least, that’s how I felt. Now I’m connected to a whole flock of VCs whom I’ve only met once and to whom I have never spoken again.  This is definitely the WRONG way to approach things.

When an investor rejects you – and most investors will – you should figure out why you’re being rejected.  There are a few basic categories for why you’re being rejected.

1. The investor doesn’t or no longer invests in your vertical or space.

If an investor doesn’t invest in your space, it won’t be helpful to re-approach him/her later about investing in your business.

For example, say you approach a pharma investor about your new mobile app.  This obviously isn’t going to be a good fit, because he/she knows nothing about your business.

Similarly, within software, there are lots of nuances between, say, mobile apps and B2B software, and even within B2B (say, adtech and HR SaaS).

Now, the confusing and annoying part of this, is that very often you’ll see a company in an investor’s portfolio that is in your space, but then he/she will say that he/she doesn’t invest in your area.  For example, at 500 Startups, we don’t invest in game studios (because we know nothing about building hit games), but we have at least one game studio in our portfolio.  This type of situation happens when

1. A portfolio company starts out doing something and then pivots into something completely different.  For example, Glitch was a game that pivoted into a B2B communication software platform called Slack.  The products could not be more night and day, but they are the same company.
2. The investor knows a founding team really well, and the founding team has a great past track record.  That’s a great reason to invest regardless of what the team is building.
3. The investor invested a TON in a particular space but, feeling over-indexed in that space, wants to diversify their portfolio and so has paused investments in that space.  Worse yet, maybe those investments haven’t gone well, and the investor has decided he/she does not know how to pick companies in that space OR is bearish on the space.  3D printing and bitcoin companies are examples of two such spaces where a lot of investors have pulled back dramatically (but may later want to invest in as they see how the market unfolds).

2. The investor thinks you’re too early.

This is the number one reason an investor will pass on your business.  I used to think that you can waltz into an investor meeting with just an idea and you’d get funded.

The reality is that unless you have a track record or are pitching to friends or family, no one will fund you at the idea stage.  They simply don’t know you.

Traction = a way to prove your abilities and to prove that you know how to execute.

If an investor is passing for this reason, then you should definitely keep him/her abreast of your progress.  This allows him/her to get to know you as a person and your abilities.

3. The investor doesn’t think you’re impressive.

It’s going to be near impossible to figure out if an investor thinks you’re not impressive.

It’s much easier to figure out if the investor is impressed with you.  For example, if you get a rejection email that goes something like this, “We thought your team was impressive, but…” then you know the team is not the problem.

In most cases, you can still change a person’s mind about you or your team later on.

Traction = Impressive.  I was once at an Ex-Googler meeting, which consisted of ex-Google entrepreneurs and ex-Googler investors. One entrepreneur-CEO got up and did a presentation, and he basically pointed to the crowd, saying,  “All of you passed on me because I wasn’t an engineer.  Look at where we are now.”  Then he wowed the crowd with a slide of their impressive growth.  That company is now one of the hottest consumer companies today (and you can probably guess which one that is).

4. The investor thinks your market is small or crowded.

Usually, investors are pretty upfront about what they think about your market.  The weird thing is that, although seemingly unrelated, you can also change someone’s mind about your market through your traction.

Traction = You can rise above the crowd.  It also suggests that you may be able to capture more of the market than an investor would ordinarily think you can.

So, if an investor rejects you for this reason, you have the chance to change his/her mind about the market.

Interestingly enough, you don’t have to necessarily wait that long to change someone’s mind. Last year, one of our portfolio companies at 500 Startups approached an angel investor who passed for this reason.  About a month later, the entrepreneur-CEO re-approached him, showed him their new numbers at continued strong growth along with a list of other investors who had come onboard.  That angel investor joined the round.

Bucketing rejections

Those are the basic reasons why you’re being rejected.  The problem is with you or your team, your progress, your market, and/or investment-fit.  However, the biggest challenge for entrepreneurs is trying to figure out which bucket an investor-rejection falls into; often you’ll get no response, or an investor will be very vague about why he/she is rejecting you.

You should try to ask for feedback.  Something like, “Thanks for your response – can you give me some quick feedback on why you’re passing?  It would be super helpful for me.”

I realize this isn’t easy.  No one likes to be rejected and then further discuss why he/she is being rejected (as an aside, you should check out my side project Hustleathon, which helps with this).  But, you absolutely need to do this in order to figure out when you should next get back in touch with that investor.  You may have heard the expression, “Investors invest in lines not dots.”  It is actually much easier to get an investment from someone who has tracked you over time (which may include several rejections along the way) than from someone new who has just met you.  So, you will need those rejections in order to get to a “Yes.”

As difficult as it is, embrace the rejection and get comfortable with talking about it.

We talk about the importance of demonstrating traction and being in a big market, but we don’t talk about founder-likability because it’s such a touchy topic.

tl;dr If an investor doesn’t like you, he/she won’t invest.

Ouch.

How do you know if you like someone after knowing him/her for only a short time?!  Shouldn’t it be about whether you are running an awesome business or not? Seems unfair.

Actually, this is the norm in the job market as well.  If you are applying to a job, you need to be likable, otherwise, regardless of how qualified you are, you won’t get the job.  Ultimately, there is only a limited number of positions (or funding dollars), and there are a lot of really qualified people out there. Investors and employers can afford to choose people they like and enjoy working with.

Unfortunately, some people are just more likable than others.  Some people are more gregarious and cheery.  Others are wittier.  Some people are just super-charismatic.  Or charming.  Or, less often discussed, some people just feel more connected to people who are like them in demographics or socioeconomics or pedigree.

Some of these things will take time to change, but there are a few things that every entrepreneur can practice to make themselves more likable.

1. Sell on facts not bombastic language.

“We have a genius 24 year old programmer who can code like no other.”

Someone literally said that to me last week.  Given that just about every entrepreneur tells me something like this, I’m skeptical that most teams have a truly genius-amazing programmer – and that’s ok!

Saying something like, “And we have a developer who previously won a gold medal at the international math olympiad and a silver at the international computer science olympiad,”  is a much stronger statement.  You don’t need to tell me how smart your employee is because I now know.  Tell me facts, not your opinion.

2. Address issues head-on and then explain them.

Every business is going to have flaws.  If they didn’t, they wouldn’t be startups!

If an issue with your business comes up in a conversation with an investor, downplaying it or sweeping it under the rug will make people trust you less.  The thing to do is to briefly address that the issue exists and then confidently discuss how you are fixing the problem or how you will fix the problem.

3. Answer questions directly and concisely.

Part of this is cultural. In America, we prefer people to answer a question head-on and then elaborate rather than the opposite.  We perceive the latter to be cagey and evasive.

I still talk with MANY American entrepreneurs who neither answer questions directly nor concisely.  For example, last week, I was asking an entrepreneur to tell me about his team.  It was a very open ended question.  There are a myriad of ways to answer this question, and the challenge is to pick out the bits that are most relevant for others to know about your business.  If a piece of information is not relevant, I would not recommend bringing it up.  In this particular case, the entrepreneur first told me about who is NOT on his team – all the potential co-founders he had tried working with (and none of them had any relevance to any part of his business).  Eventually, he got around to telling me who was on his actual team.

This was not a good way to start.

These are just a couple of tips that may be able to help.  As in a job interview, I think it’s perfectly valid for entrepreneurs to practice with peers.  It’s super important to come across as likable.

Cover photo by Hybrid on Unsplash

Dear elizy: I’m raising my seed round right now.  An investor I met with got really excited about joining my round.  He said he would like to join once we have a lead. Do I need a lead?  What is a lead?  What should I do?

-Leadless in Mtn View

Dear Leadless: Without knowing the details, here’s some general advice.

1. Technically speaking, you do not need a lead.

You can certainly feel free to raise your round by setting your own terms on standard convertible notes or convertible securities.  Investors will simply look at the terms and decide whether they want in or not.  If they think your terms are unreasonable, they will simply decline to join your round.

Typically, these investors will not invest a whole lot of money – i.e. angels and seed VCs  (~$5k-$300k).

The benefit to doing this type of “party round” is that it’s typically cheaper in legal fees and you can start collecting checks right away.

2. Practically speaking, many investors are sheep (followers) and will want you to have a lead investor to validate your business.

If an investor says that they will come in when you have a lead, that may sound like a good thing, but it’s actually a bad sign.  It means they would like to be a follower.  It means they do not have enough conviction about your business without validation from other people.  These investors are not first-movers, and you should move on immediately and approach other investors.

 

HOWEVER, it is common for almost all investors to ask you if you have a lead.  This does not automatically mean that the asking-investor is a follower.  An investor may be curious because he/she wants to know:

• If you are setting the terms yourself or if someone else is
• Who the lead investor is (if you have one); some investors work well together and others do not
• If you are raising a priced round or not
• If you are not raising a round w/ a lead, how much money you are raising and what happens if you don’t hit that goal
• If the lead position is still open and may potentially want to lead your round

So, when an investor asks you if you have a lead, it is your job as the entrepreneur to understand the rationale for this question and figure out if the investor is a follower or an independent.

Cover photo by NordWood Themes on Unsplash

I was talking with a Sand Hill VC the other day.  They do Series A deals:

“We don’t have a consensus model here.  If someone on the team loves a company, we’ll do the deal.  But conversely, if someone on my team really hates a deal I love, I would probably back away.  As much as possible, we want to have a united front here at our firm.”

This was a really telling statement and confirmed what I’ve known all along as a VC but was clueless about when I was an entrepreneur.  A few takeaways:

1. If you’re talking to a VC, you should find out how decision-making happens.

I’m not just talking about the decision-making process (although you should definitely figure that out).  You should also figure out if a firm has a consensus-based decision-making model or a champion-based decision-making model.

A consensus-based model means that all partners need to agree to do a deal.  If one partner dissents, then the deal is off.

In a champion-based model, if one of the partners really, really wants to do your deal, the others will let him/her.

And then there’s everything in-between: hybrid models.

Now, this is important because it says a lot about how your interactions will go with the firm as a whole.  For example, at a consensus-based VC firm, you know that if they do your deal, everyone at the firm loves you and your company.  All the partners will go to bat for you and will help you out.  The firm is truly behind you.  But, it’s very difficult to get a deal with this type of firm.

At a champion-based VC firm, it is much easier to get your deal done because you don’t need the whole investment team to agree.  But, there may be a lot of contention within the investment team of that firm.  Other investors at the firm may think you’re an idiot or that you’re in a small market and may not want to help you.  But you won’t know who, and you won’t know why.  You only know that your champion is your advocate.  So, the right way to think about this is whether you would love working with the partner who is your champion rather than whether you like that VC firm.

2. Find your champion at a VC firm.

Your champion at a VC firm is going to be the person or people who interviewed you in the early stages.  In order to make it to later due diligence stages, you’ll need to win over these people first so you know where they stand if you continue the conversation with the firm.

In many cases, there’s a lot of luck here.  If a firm says “No” in the initial stages, it’s because you were not able to convince the initial partner to champion your deal.  However, in a parallel universe, it’s possible that another partner at the firm – had you met him/her first – may have loved your deal and championed you.

Now, before you go off and try to find other investors at all the VC firms who’ve already dinged you, it’s important to understand why you were dinged in the first place.  For example, if your company was considered “too early” for the firm, then meeting with someone else in the partnership will not help you find a champion.  But, if the initial partner you met with thought that your market was “too small” or he/she just simply “couldn’t get excited” about your deal because he/she knows nothing about the space, then it’s possible that winning over a different person at that same firm might be more helpful.  THAT SAID, in general, VC firms try to have a united front about their stance.  Most organized VCs are using CRMs or other methods to track deals so that all partners know if someone at the firm has met with you before.

Trying to approach a different partner about championing you after being dinged may not help you UNLESS something SIGNIFICANT has changed between when you last met with the first partner and now.  It could be a difference in traction or strategy or customer audience or product offering or whatever – but, you must have a compelling reason for someone at the firm to talk with you again.

In general, I personally find it most compelling when an entrepreneur a) owns up to the fact that he/she has already talked with others at 500 Startups but b) wants to talk with me for particular reasons pertaining to my personal, unique background.  Otherwise, my belief is that if my colleagues, whom I trust, dinged you already, then there is no reason for me to take the call.  Do some research here on individuals at the firm.

Whether the firm you’re talking to has a consensus-model or a champion-model, you will still need a champion. This is the person who will shepherd you through the whole fundraising process with his/her firm and will likely be working with you for years after he/she does the deal.  So, make sure that you like him/her and think that he/she is useful.

3. Befriend and win over the firm

So let’s say that a champion-based VC decides to do your deal.  Hurrah! Congrats!  This means that you know at least one person loves you and your company.  But, the other investors may be indifferent to your deal because they don’t really know you or your company.  Worse yet, there may be investors who hate your deal at the same firm.  Some of the best deals are the most contentious ones.  If picking startups were so easy, there would not be so many failing VCs.

An extreme case where you should apply this thinking is at 500 Startups.  We do SO MANY DEALS. Right now, I think we are averaging about 1 deal per weekday, worldwide, across all our funds.  There is no way that I have personally met every company we’ve invested in, let alone championed.  As such, I can’t just start opening up my rolodex to entrepreneurs I don’t know – even if they are portfolio founders.  So, if a champion-based VC does your deal, it’s in your best interest to try to befriend other partners at the firm.  Get to know them.  Don’t just become Facebook or LinkedIn friends with them. It goes without saying that you definitely should NOT assume that someone championing your deal at a firm automatically means that someone more prominent at the firm is your champion.  For example, if I champion your deal, you should not expect Dave McClure or Christine Tsai to love you and your company.  They simply don’t know you.  So, work on befriending them and winning them over as well.  And, if you can do this, you can potentially get lots of different kinds of help from within the same firm.

(Side note: This is how you befriend us at 500.  Maybe.)

The flip side is that if you meet with someone on the investment team who just doesn’t seem very helpful after meeting him/her a few times, either he/she is not a helpful person or you know what he/she really thinks about your deal.  And that’s OK.  You can’t win them all (and as you make progress in your business, you may be able to win him/her later by showing traction and progress).  This is why it’s important for you to love and value working with your initial champion in case no one else at the firm is your champion.

In conclusion, even though entrepreneurs will say things like, “Oh, Sequoia is in my round,” they should really say, “Oh, Alfred Lin from Sequoia is in my round.”  It’s really about working with an individual champion and in some cases, upselling into a firm to get more individual champions.  VC firm dynamics are not altogether clear to entrepreneurs, and it’s important to understand how these dynamics work.

I was in Atlanta this past week and spoke at an event about raising capital.  One of the questions from the audience was really interesting:

What’s the difference between angels and seed VCs?

If you had asked that question 5 years ago, the answer would’ve been really different.  It would’ve been something like:

Angels:

• Use his/her own money to do investments
• Write small checks
• Mostly sole decision maker

VCs:

• Use 3rd party money to do investments (from limited partners)
• Write large checks
• Multiple decision makers and a concrete process

But today, some of these things have changed.

A lot of new micro VCs have popped up (500 Startups is one example).  They write small checks – typically between $50k and $300k.  They also make decisions really fast because they typically have only 1-3 decision makers in their process.

Through the rise of syndicates, angels are now more akin to VCs.  They can write much bigger checks through essentially a band of angels coming together on a deal.  A couple of Gil Penchina’s AngelList syndicates, for example, rival big series A firms; he has millions of dollars to do a deal.

On the surface, there is seemingly little difference between angels and micro VCs these days.

There is one big difference: where the money comes from.

As entrepreneurs, we don’t usually think about where our investors’ money is coming from, but in this case, it matters a lot.

Let’s say I start a VC firm called Hippo Fund.  Whether it’s a micro fund or not, I need to raise money from 3rd party investors (Limited Partners) and convince them that Hippo Fund is going to make them A LOT of money.  Like I mean A LOT.  Potential limited partners are weighing their options – “Should I invest in Hippo Fund or in NYC real estate?  Or should I invest in someone else’s VC fund?”  The decision is not about whether investing in Hippo Fund will be profitable; it’s about whether it is THE BEST INVESTMENT for your money.

This means that in running Hippo Fund, I need to make big big bets that could either go nowhere or be the next Google.  Entrepreneurs often complain about why VCs seem to make stupid investment decisions – i.e. pass on profitable growing businesses but bet big on companies that make you wonder what people are smoking.  This is where these decisions comes from.

On top of that, because Hippo Fund needs to swing for the fences, most investments will fail.  If 9 out of 10 portfolio companies fail, then the 1 winner will need return a LOT in order to make up for all our losses.  A winner who returns just 10x will get us to not quite break-even on the whole portfolio; this is bad.  (As a side note: lots of entrepreneurs pitch their company to me saying they will make us 10x our investment.  Please do not do this . You will lose us money.)  We need our winning companies to be returning 100x-1000x.

Ok, now let’s say we dump Hippo Fund and instead create an AngelList Syndicate.  I round up a whole bunch of my rich friends to back this syndicate.  So now, for every deal I do as an angel, I share it with my friends, and they can decide whether they want to do the investment.  If I get enough friends to back my syndicate, collectively, we can invest as much as Hippo Fund.

In this capacity as an angel investor, I can invest however I want.  I can decide to invest in companies where I just love the product and think the market is small.  I can invest in companies who have proven nothing (zero traction, etc.).  I can invest in companies because I like the logo.  I can do whatever I want.

My rich friends can decide to join me in my investment decisions or not; that’s up to them.  I no longer have to be concerned with trying to make the most money ever.

Follow the money

Lastly, it’s important to follow the money and see how fund managers are incentivized.

As a VC, typically, I’ll get 20% of the upside on my entire portfolio.  So let’s say I have a fund size of $10m and I have:

• 10 companies in my portfolio
• Invested $1m in each
• 9 of them failed
• 1 winner that made me $20m.

My upside as a fund manager is roughly ($20m – $10m fund size) * 20% = $2m.

I would personally make $2m for this type of portfolio (assume no management fees.)

Now, what does this look like when running my AngelList syndicate?  Let’s assume the same situation with the 10 deals I did in Hippo Fund.

I still get 20% upside but now it’s per deal and not by portfolio, since my backers can decide for themselves which deals they want to be a part of.  Look at my one winner – the one that made me $20m; now I get ($20m – $1m invested in that deal) * 20% = $3.8m.

So in running an AngelList syndicate, I would personally make $3.8m, because upside in syndicate deals is on a per-deal basis, not a portfolio basis.  I no longer have to consider the losses of the other companies.  This means that I don’t need to think about my one winner trying to cover for all my losses and can invest in the growing profitable companies and not just the “shoot for the moon” companies because I will still make money.

It’s important to understand where the money comes from because this tells you a lot about how fund managers are incentivized.  And as an entrepreneur, you can use this to your advantage in how you message or pitch your company to different investors.

Special thanks to my colleague (and basically brother) Tim Chae for shaping a lot of my thoughts around this when I first jumped into venture.