#5 — Raising from VC for the first time — Part 3 of 3
In part 2/3 I talked about being transparent, understanding that fundraising is a full time commitment, and not bullsh!tting VC’s because everyone talks.
In the third and final part of my learnings raising our Seed from VC’s in the UK, I’ll share more around the stuff nobody talks about. Without this insight, you’ll generally be sucked into a lot of time wasting.
Before I get into it, I wanted to share a statement our new CTO Greig Rapley shared with me, which resonated so well, and is something all early stage founders should hear. “Raising seed capital is not winning the lottery, it’s a stay of execution. Everything from here on should be laser focussed on delivering our goals and executing at a speed to ensure we survive to break-even or Series A”
Start with the bottom of your list
Don’t hate me Francois Mazoudier, because I’m opening with disagreeing with you on this point, I recommend starting with the bottom of your list.
Don’t get me wrong, there is a “method to the madness” in pitching your top 10 first, but as I said in part 1, you’ll be utterly shit the first time you pitch. One time I completely lost my words, I was literally talking gibberish (basically a glitch in the Matrix), and after a few minutes stopped myself and said “sorry, not quite sure what happened there” — Proper facepalm moment! There were many of these.
The thinking around approaching your top 10 first, is that word spreads, and if the tier 2 & 3 firms turn you down, then the tier one firms my catch wind of this and decline meeting you. I personally didn’t experience this, but I can see how this could look.
I found it incredibly valuable pitching with less pressure, because let’s face it, pitching Sequoia, Index or Balderton is hyper pressure regardless, and I would much prefer taking a few punches in the face, iterating, and then putting my absolute best foot forward.
That said, Francois Mazoudier knows his stuff. Read more on his structure for prioritising investors: Not all investors are equal. This is why, and how, you must prioritise them using the pyramid of priorities
Term Sheet (TS)
The infamous term sheet. The first light at the end of the tunnel, of a 4–6 month blood, sweat and tears process — it’s finally arrived and you immediately feel a sense of relief. Have we finally done it? Well, almost, but you still have a few hurdles ahead of you.
First things first, get a lawyer. You’ll want a firm experienced in dealing with VC’s, not your brothers, girlfriends cousin who has helped you until now. In the UK Orrick, Cooleys, Bird & Bird and Wilson Sonsini are a few to look at.
While a term sheet is likely a couple of pages, it sets the precedent for the legal agreements. It’s important to understand what you’re agreeing to, and push back where you are not comfortable. Your lawyer will know precisely what terms the VC you’re working with is generally comfortable relaxing on, and which are deal breakers.
Some key terms to understand (also see what Francois Mazoudier has to say here):
- Liquidation Preference: This term defines the order in which shareholders are paid in the event of a liquidation or exit event, such as an acquisition or IPO. A higher liquidation preference for VCs may limit founders’ payouts in an exit.
- Anti-Dilution Provisions: These clauses protect investors from future dilution of their equity stake. It typically comes into play if the company issues new shares at a lower price than what the VC paid
- Vesting: Vesting is the process through which founders and employees earn their equity in the company over time. A common vesting schedule is 4 years with a 1-year cliff, meaning that 25% of the equity vests after one year, with the remaining shares vesting monthly over the next three years. More on this in my 2nd post on fundraising
- Board Representation: This term outlines the composition of the company’s board of directors, including the number of seats and any reserved seats for the VC firm or their designees.
- Option Pool: An option pool is a set of shares set aside for future issuance to employees, advisors, and consultants as equity-based compensation. The size of the option pool and its impact on the founders’ ownership should be carefully considered.
- Protective Provisions: These clauses give the investor certain veto rights over specific actions taken by the company, such as issuing new shares, selling the company, or changing the company’s bylaws.
- Pre-emption Rights: This provision gives existing investors the right to participate in future funding rounds to maintain their ownership percentage.
VC vs VCT
In the UK, there are specific tax efficient investments. Most commonly know, EIS & SEIS which are reserved for angels.
Most of you will be familiar with traditional Venture Capital (VC) firms. What you may not be aware of are Venture Capital Trusts (VCT), I wasn’t.
A VCT in the UK is a public investment vehicle supporting small, high-potential businesses. VCTs offer tax-efficient investment opportunities for individuals, fostering economic growth. Investors can benefit from income tax relief, tax-free dividends, and capital gains tax exemption on VCT shares, subject to conditions and limits.
VCT’s are great in that they generally have a broader investment strategy and are slightly de-risked due to the tax incentives. However, VCT’s don’t come free. Along with their investment will generally follow a “finders fee”, a % of the total investment (1%-3%) they do is paid back to the fund, as well as an annual management fee, which is generally £20k — £40k p/a.
The challenge with VCT is that due to their public structure, there are a number of “disqualifying” criteria that you always need to be aware of post your raise. This goes for EIS/SEIS as well. Things like share buy-backs are generally a no no, as could disqualify your EIS/SEIS investors. It’s always good to take advise from specialists in this case — Philip Hare Associates are great.
Have an answer for the obvious questions
Obviously! Right? You’d be surprised how many don’t, and how many compliments we got because we knew our numbers, we were prepared, and we had the answers. BUT, at the same time don’t be afraid to say “I don’t know and I’ll get back to you” if it’s a question you were not expecting and don’t know the answer.
This stuff is basic, but it makes a big impact when you are prepared, so spend the time on it.
Some questions that will almost certainly come up:
- How big is the market, and how big can this business become? (do the work, have the data!) But don’t ever say “all we need is a tiny % of this multi $bn TAM and we’ll have a $100m business” — nobody likes to here this!
- What is your vision — Where do you see your business in 10 years? You don’t need to know how you’ll get there in 10 years, but the narrative as to where you want to go is important (important not to overcomplicate your revenue model in the 10 year vision by saying “we charge x now, and in 5 years will charge y etc. and there are potentially these areas we can generate revenue.” These are generally wild assumptions and will be ignored)
- How much are you raising and what will you use the funds for? Back to knowing your VC — some VC’s only invest at growth stage, others pre product market fit etc. Have a very clear answer for use of funds and how much you need. In this current market, VC’s are suggesting you raise more to extend runway.
- Later on in the process, you’ll be asked the terms of your raise. You’ll likely be doing a priced round and similar will apply to convertible notes, and you’ll be wanting to slap on a big valuation. Whatever value you are thinking, make sure you have a data driven answer to why you’re asking for what you are. VC’s have all the data, and they’ll eat you alive if you just slap a number on for the sake of it.
- Cost cover — come to terms early with the fact that you’ll be covering the fees of the DD for the investment. For a seed round up to £5m, you’re likely in for £30k — £50k in fees on behalf of the VC, plus you’ll need to cover your own fees
- I found using Docsend to send my pitch deck didn’t work as well as I’d hoped. I didn’t really pay attention to the stats, and at times felt awkward — so I ended up just using the traditional PDF approach
- Don’t underestimate the time needed to manage your board and investors — Once you take money from VC, there is a new level of expectation in your business and of you. This inevitably takes up a lot of time from the CEO when prepping board packs, investor updates, investor calls and so on. Plan your weeks/months accordingly so you can give the right level of attention to these engagements
- Less is more — There is a fine balance between sharing too much with your VC, and it takes some time to find that perfect balance. On one hand you don’t want to overcommunicate, but on the other you want them to have context of the business when you need to discuss bigger strategic decisions / challenges. Find what works for you, for me it’s less is more, but very structured communication and being clear about my asks
You’re the CEO, now get back to business!
Once the round has closed, and the high fives have settled in, you’ll soon realise you’re already a month into your first quarter post closing, and you’re in a new world. A world driven by metrics, high velocity, and a demand to reach your goals that you’ve likely never experienced before.
You’ll likely have your first board meeting coming up with your new investors, and all eyes will be on you, the CEO. All the promises you made, the dreams you sold, it’s now time to deliver!
Personally, I live for this. But, it’s not for everyone, so make sure you know what you’re in for, talk to founders who have raised from VC. Hear the good, the bad, the ugly, and get ready for the ride.