Wednesday, February 24, 2016

Winter 2016: raising funds may become more difficult for some startups

I attended several VC events in New York City recently, including Ask a VC forum on February 4, organized by DLA Piper, and the VC Summit on January 26, organized by Gotham Media.  I learned some interesting insights, which may be useful for those startup founders looking to raise capital now.

Current investment climate.  Everybody noted that the current investment climate has changed. VCs who participated in the panel discussions all agreed that the valuations have come down (some said "a bit" and others said "aggressively"), and that it now takes longer for companies to raise their first round of capital. Recent posts by Brad Feld and Mark Suster confirm that. As Mark said: "The startup industry may be “resetting,” which doesn’t mean a “crash” but rather just a resetting of valuations, timescales, winners/losers, capital sources and the relative emphasis of growth rates vs. burn rates." So, startups should perhaps re-think their valuations and allocate extra 1-2 months to raise the needed capital, stretching the capital raising efforts from 4 to about 6 months. Having said that, great startups will still get funded pretty quickly regardless of the current downturn.

How to find VCs that will fund you.  This has been talked about so much, that it is really no longer a mystery.  VCs will rarely fund companies that have emailed them at random.  VCs tend to consider only those companies that have been pre-filtered by a trusted referral source (other VCs, advisors, their portfolio companies, etc.).  VCs like to fund repeat entrepreneurs who have already successfully existed from at least one startup.  If you are not that, then you need to do your homework.  Select VCs that are likely to invest in your company (VCs that focus on your industry and  invest in seed rounds).  Read all you can about them.  Figure out which companies they've funded in the past.  Reach out to the portfolio companies founders, and see if you can get them to like you and your startup.  Then, they may introduce you to their VCs.  Also, do not despair if these introductions do not produce immediate funding results: establish connections with the VCs and keep in touch through regular updates. Funding from them may come at a later stage.

Angel investors vs VCs.  An interesting phenomenon has developed: the appearance of micro VCs (i.e., smaller venture capital firms that are focused on early stage financing).  In my experience, an average startup would first get funded up to $1 million by angel investors (wealthy, accredited individuals).  These may be family members and friends, or other accredited investors.  Angel investors don't typically get a seat on the board, or help out with industry expertise or connections (but I've seen exceptions).  Later stages of financing are typically handled by VCs.  Now, I see more VCs come in at the seed rounds, including convertible debt financings.  It is an overall positive development for the companies because VCs tend to invest in subsequent rounds as well, and have industry expertise and connections that may prove useful to the companies. Finally, VCs bring with them expertise in running a startup.  Of course, there are disadvantages as well (since VCs want board seats, there is always a danger that once they have control of the board, they may oust the founders).

How much money to raise in the seed round?  The rule of thumb seems to be: raise enough cash to last 18 months and give up 15-20% of your company in exchange.  Just remember to start your next fundraising campaign 4-6 months before you run out of money.

What are VCs looking for?  They are looking for a scalable business model.  VCs don't want beautiful power point slides or well-scripted presentations.  They want to see substance, such as a well-stated problem, the proposed solution, clear execution plan and milestones.  Also, be prepared to explain why you need this much money and how you plan to spend it.  During the presentation, the founders should be able to explain the whole business in 20 slides or less.

Finders.  Be careful about signing any agreements with finders (people who offer to make introductions to potential funding sources in exchange for a referral fee).  First, if they are not registered with the SEC, they may get themselves and your company into trouble.  I wrote about it here.  Second, VCs don't like to see their money going to pay somebody's referral fees.

In conclusion, please remember that only a small fraction of all startups gets funded by VCs at any stage of their development, and you need to prepare well for the fundraising campaign.  As for those who are not successful with the VCs: Regulation Crowdfunding, which becomes effective on May 16, 2016, will soon open more funding sources for startup companies.  More on this topic later.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.