In the past year at Globevestor, I have closely witnessed a few instances of startup fundraises where key investors behaved un-admirably, by failing to honor their commitment or trying to re-negotiate previously agreed terms of investment at the last minute. Mostly this happened at the round closure stage, i.e. post term sheet/ due diligence & during paper-work/ money transfer, despite the investors being well aware of the limited runway & options available to the startup. At worst, they possibly happened specifically because of this knowledge!
[Note: This post is in continuation of a recent tweet storm. I did the tweet storm wrong, so don’t have a single tweet link to share, but here they are: 0, 1, 2, 3, 4, 5, 6, 7, 8, End.]
For founders, having a funding round fall apart is a very difficult situation and brings immense stress. They may feel trapped and helpless when key investors threaten to walk, and may end up agreeing to the new draconian terms on offer to avoid a fundraise collapse. While it is true that most investors act responsibly and don’t want bad press turning away good deal flow, there are some bad fish out in the world.
Remarkably, all the startups I saw whose lead investor walked are alive and well today. They used different ways to wriggle out of the tough spot — internal round using convertible, smaller angel round, going profitable or reformulating the round. Of course, this is anecdotal data and may represent only exceptions. But the big takeaway is that founders of well-known startups have faced this and prevailed.
Learning from those examples, here are 7 tips for founders to avoid getting in a tangle with hawkish investors and, if unavoidable, navigate through it.
1. Have enough runway when fundraising
The primary reason investors are able to squeeze founders right at the end is because they know you have only a few weeks of runway left. And if the investor walks when you’ve already assumed money is in the bank, you’re as good as dead. So most probably, you’ll agree to worse terms. Best way to avoid this is to not be vulnerable due to an empty bank account.
Now, unless you’re a serial entrepreneur with a past successful exit, have good rapport with senior management at VC funds, or have a large HNI friends & family network, your fundraise will take time. Usually, from the day VCs start getting really interested (3–4 quick follow ups or them specifically mentioning it), it will easily take 4–6 months for money to hit the bank. For an angel round, it’ll usually be 2–4 months.
Lots of times, founders plan a seed round to last only 9–12 months. This is harakiri! It gives you only 3–6 months to move your traction to a point where VCs start getting seriously interested, providing no room for any failed experiments or hiccups. And things never go as per plan. So always raise for 18–24 months, as even in the best of times the fastest Seed-to-Series A in India took 14 months. And hopefully within an year, you’ll get enough traction to excite VCs, yet have no runway blues.
2. Don’t celebrate early (Keep creating options)
Another point of vulnerability is when the investor knows that your conversations with other investors are not as advanced. This means if the investor walks, you wouldn’t have the time to get others in to replace them. And hence, again, you might agree to worse terms. This can be avoided if they know that other investors are in the fray (or you just manage that perception well).
Therefore, always keep talking to everyone. Don’t start banking on one investor too early and lose interest with others. Keep conversations going so that more than one investor is interested at the same time. An extreme version of this is FOMO among investors, but those days are well behind us.
Of course, institutional investors will mostly have exclusivity clause in term sheets. But you could push back to ensure it is time bound, say 1.5–2 months, and drop hints that you’d rather close it early with others than drag it out with them. A ploy founders use (which investors hate) is to not counter-sign the term sheet (hence, avoid exclusivity) for a few days while shopping around for better offers. This has its own demerits as it impacts relationships for future rounds.
3. Value all investors in the round
Even if your round has multiple investors along with the lead, do value the minority investors equally and be fair to them in shareholder rights. Keep regular communication going with them and do not make them feel neglected due to the size of their cheque.
This allows you to lean on them when the lead acts funny. If they’re in the round due to you, and not because of the lead, there’s a very high chance they’ll help out to put a revised round together. In one instance, after the lead demanded unfairly preferential rights over other investors, we’ve seen the angels/ smaller funds get into overdrive mode to get newer investors in and kick the lead out (3). It resulted in a much better marquee set of investors in the round than before.
4. Keep your existing investors engaged
Similar to the previous tip, even if a new big name investor is leading the new round, ensure that the existing investors remain your confidantes. Keep them engaged and again, be fair to them in shareholder rights. Existing investors can most times put together a bridge round if you’re doing well. Usually, existing investors will also be able to do the internal round with speed and bring in additional minority investors even when running against time (2).
In reality, you should keep all your existing investors engaged on a continuous basis and not just during a fundraise. Apart from valuable advice/ connections, you would also get a good sense of which existing investor is still bullish on you and hence, will help you out.
5. Be prepared for a smaller round
Instead of agreeing to draconian terms by the lead, it is better to revise your plan and raise lesser from friendly investors. However, instead of scrambling to make a plan B after the fundraise falls apart and when you’re under tremendous stress, it’s better to plan ahead. Ask yourself how would you keep running the business for another 18 months even if you raise much lower than the target. And accordingly, keep the budget, hiring plan and revised business targets ready.
If things go really wrong with a lead investor, and you have no replacement lead, consider getting the minority investors to still invest a smaller round on your revised plan (4). Of course, the revised plan would still need to be exciting enough for someone to invest in you.
6. Take control of your own destiny (Turn profitable)
This is true regardless of the day in your startup life — you’re in control if you’re making money, and dependent on others till you’re losing money. However, if you’re not yet profitable, your fundraise blows out and you have no other option, consider becoming a cockroach startup (5). Cut as many expenses as you can, get to the smallest possible team, explore alternate revenue streams, and turn ramen profitable.
This in my opinion, is much better than going down with a bang, as opportunities you don’t see today open up when you spend considerable time mulling over a problem. Pivots become possible. You might not immediately see how you’ll scale as a cockroach, but you’ll never know if you could have if you don’t try.
7. Challenge your understanding of investment terms
As an anti-thesis, consider if the new terms proposed are really draconian or if you’re unaware of standard terms. It may be possible that the fault lies in your understanding and personal expectation management. To ensure this is not the case, speak to your advisors to find out standard industry terms of investment. We’ve seen founders get worked up even regarding standard equity vesting schedules, so it’s not unimaginable that the new terms investor demands might actually be fair.
Going into a fundraising mode with the above tips in mind might hopefully protect you from being at the receiving end of draconian investors.
Or have you already lived to tell the tale?