February 21, 2018

CEO School: Fundraising Red Flags





VCs are good at pattern recognition. They've seen a lot of failures, know why, and they can overlay those negative experiences on top of you and your company. When some traits match up, you get hit with a red flag, which likely means no money for you.

Here's a list of red flags that typical VCs have encountered before. Now that you know, be sure to fix your red flags before your next meeting.

However, if you feel like you have one or more of these red flags, just remember the words of Marc Andreessen:

One of the cautionary lessons of VC is, 
if you don't invest on the basis of serious flaws, 
you don't invest in most of the big winners!
  1. You send someone else to do your meeting with investors — Not really sure why this would ever happen for an early stage company. The Founder needs to be able to sell a vision in order to be successful and by having someone else represent them in a meeting with investors it stirs up all sorts of question marks.
  2. When Founders take more than 48 hours to respond to emails — From what I’ve seen the best Founders in our portfolio respond to emails within 24 hours. Especially when they were out fundraising. Clearly there are some exceptions, but Founders who are detail oriented, hardworking and get stuff done (like a fundraise) are usually not letting investor emails go unanswered for 48+ hours.
  3. KPI Knowledge —How do you define your KPIs? Vanity metrics are one thing, but often times they don’t paint the picture of how and why a business is actually performing well or poorly. Being able to define your KPIs “correctly,” or at least presenting why you believe those are the drivers of your business vs. other ones, is an important testament as to whether the investor believes you truly understand your business model or not. This also directly correlates with how much homework/research/experience the Founder did/had before jumping into this venture. Most VCs are looking for Founders that will build data driven cultures internally (having internal KPI dashboards is always a plus) and if their list of KPIs for your business doesn’t closely resemble your list of KPIs for the business then you may be in trouble.    *Most Founders will be asked to send over a breakdown of their KPIs by month or quarter. If the Founder says that they’ll send them over, but then it takes days or weeks to “pull together the data,” VCs may question whether or not you’re tracking them and/or actually using them to help form the strategy for your business.
  4. Roles and responsibilities aren’t clearly defined…especially within a team of friends or siblings — When best friends or siblings start companies together it’s essential that the roles and responsibilities are clearly defined AND that the other people are 10X better at their specific role than one another. Too many times Founders have given friends or siblings C-level role titles when they start the company, but one friend or sibling ends up growing/developing at a much faster rate of speed, which ultimately creates a difficult decision and conversation for the executive team members and/or investors.
  5. Unfamiliar with industry specific acronyms for their vertical — Quite a few VCs have been entrepreneurs themselves or have invested in the past in companies within a various verticals. As a result they’re familiar with some of the nuances and “lingo.” Understanding the intricacies of your industry is critical to success and doing your homework on it should occur long before raising venture. Thus, when hardware Founders don’t know what a DVT is, apparel founders don’t know what a CBS looks like, or app Founders don’t know what k-factor means, it can make the startup an automatic pass.
  6. Founder not grounded in reality — $10M in revenue by the end of Year 1 with a net income of $4M is ambitious, but is it realistic? VCs can and will be wrong, but they’ve seen a lot of scenarios play out before. If they don’t think a Founder is grounded in reality it’s usually a quick pass. With that said as moonshots start to become more frequently funded, I’m interested in seeing what that types of personalities are behind them.
  7. Overselling your prior experience — VCs don’t have a problem with first time founders or people who are a bit inexperienced. However, they do have a problem with people overselling what they did in their past. Being up front about your role and responsibilities at startup X or company Y is important as much of it will come out in diligence and you don’t want to oversell it.
  8. Suggesting a fancy/expensive restaurant for lunch meetings AND/OR leaving before the bill is paid — Almost anytime you meet with a VC over coffee or lunch they’ll pay for it. Especially at large funds. However, that doesn’t mean that you should take advantage of the situation to an extreme or just be a rude.
  9. When they treat analysts or associates like 2nd class citizens — Maybe one of the most resurfaced topics of 2016? I won’t dive into details, but associates are people too. And they can play a major role in you getting funded or not. Read Michelle Tandler’s post here for more info.
  10. When they have Executive Assistants — If you’re post-Series A this is different, but many seed investors don’t want to see Founders paying an EA to help them. They want to see Founders who are grinding things out and getting things done in the early days — showing off perseverance, resourcefulness, and grit.  (MM note: I disagree with this as long as the EA is truly valuable to the overall productivity of the CEO, and it can be demonstrated. Especially if the EA has worked wit the CEO before.)
  11. Saying “we’re looking to close next week” — The old FOMO trick can work in your favor or against it. First Round wrote one of the best blog posts I’ve ever seen about how to manage a fundraising process. Managing it poorly may end up having an investor walk away from the table or just make it that much harder for a deal to get done.
  12. When Founders don’t jump at the opportunity to show off the office, team and culture — What are you hiding? Building a strong team and culture plays a huge role in the success of your business. Even if it’s not perfect, you should invite the VC by so they can meet the other people they may be working with and figure out how they may be able out with other things as well.
  13. Saying you’re not raising when you’re raising — We’re just all sorts of confused…But you’re starting to raise in a couple weeks? So should I not offer you money? Why can’t we just be straightforward with one another?
  14. Evasiveness — when the founder tells a long story, with caveats, to get to a number in response to a simple questions like “What was 2016 revenue?” I’ve been guilty of this too, but when asked yes or no questions just give yes or no responses. If you don’t know the answers to questions tell them you’ll figure it out. Different people have different views on the whole “what if I don’t know the answer?” question, but ultimately I think just be concise, direct and truthful with the investor and they’ll respect you more because of it.
  15. Not sharing materials digitally that were previously shared during a meeting — this just becomes a pain during the diligence process and a Founders goal should be to make things as easy as possible for them to get an investment. Some Founders actually have good reasons as to why they don’t share certain materials, but for the most part not sharing them leads to a bad start in the relationship.
  16. Being overly dilution sensitive or optimizing on price — Would you rather own a small slice of a large pie or a large slice of a small pie? Do you want value-add investors or dumb money? These questions are ones that each Founder needs to consider individually, but quite a few VCs sent over red flags pertaining to this topic. Eric Paley from Founder Collective has been writing a lot about efficient venture capital funding for startups and his post Venture Capital is a hell of a drug is worth a read.
  17. When a Founder says another VC is “soft committed” but you find out they are not — Venture is a weirdly small community. Something I quickly realized in my first 6 months. Chances are that investors at the early stage will talk to each other and nothing will kill a conversation as fast as an entrepreneur lying to you. Reading the interest level of another VC happens all the time, but telling a VC that another VC is committed when they’re not is a big no-no.
  18. Talking about downside protection — Let’s talk about the great things to come. Napoleon Hill once said “what the mind can conceive, it can achieve.” Founders have a long road ahead of them and we don’t necessarily want them thinking about downside protection in the early stages. Think positively.
  19. Won’t share financials after the first meeting — Do you not have them readily available? Because that’s the initial thought that many VCs come to when you refuse to share them after a first meeting.
  20. Talking about potential exit opportunities within the first 12–18 months — Quick exits are a tough game to play in and an even harder game to predict. Lets build a massive, sustainable business. If you happen to exit early great. That’s what most VCs want to see/hear.
  21. Prior investors not re-upping without good reason — Possibly the first red flag you learn about in venture. If these people invested in you and believed in you before, why aren’t they investing again? Sometimes the answer is a lack of resources (e.g. angel investors), but other times investors will find out a more specific reason that ultimately turns them off.
  22. If in the pitch the Founder is trying to convince him or herself of things — Confidence, self-awareness, focus and an incredibly strong understanding of your business strategy are important factors in every pitch. VCs may not believe in a certain direction for your business, but they may try to push you down that path with leading questions to see if they can get you to convince yourself of it. This may lead to the raising of a red flag.
  23. Citing partners, advisors, customers or potential customers in your deck who aren’t real relationships — One investor told me a story about a couple of his portfolio companies being listed in a company deck as customers. Long story short is that he liked the product, but after calling his companies to find out their thoughts he found out they they weren’t customers. That led to a quick pass…Honesty is key.
  24. An entrepreneur that thinks they know everything already — One of my personal favorite traits of an entrepreneur is admitting what they don’t know, both personally and about their business, but also the ability to admit their weaknesses. Stubbornness can be good in some situations, but no one likes a know it all.
  25. When a founder is so enamored with the product that they exclude speaking about other major business elements — Too often “product Founders” are able to build great products, but they never take off. They believe that the product alone can create success for the company, but in reality so many other factors need to a support it as well. Excluding these other “major elements” from your pitch will typically make a VC thing that you may be one of those “product only” founders.
  26. Spinning information instead of giving us the facts — this happens a lot with data and deals. VCs aren’t fans of getting excited about the data presented on a chart because of the way it was presented, but when looking at the raw data realizing that things are a lot chunkier. The lack of transparency thing again will come back to get you.
  27. Bad breath — an absolute no go. Partially because this specific investor brushes his teeth 3–4X a day, but also because it shows a lack of attention to detail which every founder needs to have and secondly a lack of empathy for others.
  28. When a Founder is raising seed funding but hasn’t raised from any local angels/people from their startup ecosystem — Have you hustled and made a name for yourself in your local ecosystem? Have you been resourceful and learned from some of the best entrepreneurs and investors there? Do people in your ecosystem have good things to say about you? If so, why haven’t you taken some money from them? They all know you better than an investor who has just met you a few times. Thus, VCs see a lot of value in people like that investing in you.
  29. When Founders are dating — A dangerous game on multiple fronts that you can imagine. 
  30. We are basically company X meets company Y with some elements of company Z — I wish I was taking this out of a Silicon Valley episode, but far too often VCs hear that we’re the Uber for X or other comments along those lines. While that may be a good description for some, it’s usually a red flag because it show an inability to articulate the vision and a lack of understanding of the other companies business model of value proposition.
  31. Company has been raising for more than 4 months — Unfortunately fundraising risk is a real thing. Whether it’s the founders inability to fundraise or other VCs just not liking the space, many venture firms are signal investing to an extent these days so raising for 4 months isn’t a good sign to them.
  32. Name dropping/saying “X, Y and Z think our business is cool” — VCs do not look at this as proxy of the quality of team, product or business.
  33. Vacationing during a fundraise — the best Founders I know didn’t take a vacation during the first couple years of their startup, let alone during a fundraise. If getting a fundraise done is such a priority and goal of yours then shouldn’t taking a vacation be a sacrifice worth making at the moment?
  34. Being rude to office managers or receptionists — If you’re going to treat them poorly, how are you going to treat your employees?
  35. Having no mentors — Almost guaranteed, the most successful people in the world have all had mentors. Most of these mentors are people that they speak to regularly and usually it’s for specific reasons. When shit hits the fan in your startup, which it will, VCs want to know that you have a list of people who you will call. If they’re good VCs they’ll want to be added to that list as well.
  36. Manufacturing a product in China, but not knowing when the Chinese New Year is — Chinese factories shut down and they also prioritize large companies over startup right before this. The little details are important to learn and keep track of. This is one of them.
  37. Too High of a Salary for the Founder(s) — A successful seed investor out West said the only correlation he could find in the success of his portfolio over the last 5–10 years was the salary of the Founder pre and post-seed round. The best Founders wanted to put as much money back in the business as possible. While investors don’t want you worrying about how you’re going to eat or live, they also don’t want to see you making ridiculous money either.
  38. Flirty Founders — This just isn’t tolerated.
  39. Collegiate or Young Founders focused on PR — Go out and build a business. Built a great product, get traction and then get famous. Too often young founders in college are taking advantage of their age to get a ton of PR early and aren’t concerned with the fundamentals. They speak at events, write for blogs, etc., and aren’t focused on what’s actually important…building the business!
  40. Haven’t Done Any Homework on the VC They’re Meeting With — Call it a selfish one, but not knowing the firms portfolio, strategy or which partner is right for you to approach can be a red flag. Founders wouldn’t (hopefully) walk into a sales meeting without being prepared and knowing about the company they’re selling to, so why should investors be any different.
  41. Inability to Articulate Assumptions in Financial Model — VCs want to see that you were thoughtful about the financial model you built because it directly impacts the strategy that you’ll be implementing and the hires you’ll be making.
  42. “Companies where the product isn’t already awesome” — When a founder says they now need to hire a designer, red flags are going off. Quite a few well-known investors have been quoted stating that “UX is built into great products from the beginning.” Although that is a popular opinion, most VCs will also have a big picture conversation with you around product, the roadmap and the process of how decisions will be made. You can have a great MVP that lacks certain features, but showing an incredibly high level of thoughtfulness and execution around the original product and the future is critical to landing investment.
  43. Neutral or negative customer calls — Investors are going to speak to customers during diligence. It’s always better to give an investor a heads up if there was an issue that will surface during a customer call…if they know it’s coming, it carries less weight, and you don’t look sneaky.
  44. Not talking to your customers — Many early stage investors are going to ask you about how often you speak with customers. Starting from day 1, it’s important to build in a continuous feedback loop from customers, that includes: customer calls, emails, etc. If you don’t have the ability to articulate, with confidence, the feedback you’ve received from customers or how often/how many customers you’ve spoken with, then a red flag is going off. It’s tough to build a great product without feedback.
  45. When an entrepreneur says “we have no competition” — This is by far the most commonly submitted red flag from investors. VCs want to know that you’ve not only done your homework on your direct competition, but that you’ve been thoughtful about potential substitutes. People have a finite amount of time and money to spend, so you’re most likely taking a consumer’s time away from using or spending on something else. Being thoughtful about this topic is the main thing, but knowing as many granular details about your competition is always helpful as well. As mentioned above, investors will do diligence, so they’ll figure out your competition regardless. The more you can help them out, the faster and easier their diligence will be. Have crystal clear thinking about your product and how you view where it fits into the market.
  46. Having a huge incumbent addressable market — Benchmark’s Matt Cohler said:“This might sound counterintuitive, but when you’re trying to build something new or disruptive within a huge existing market it can be much harder to get into a position of leverage and leadership than if you start with a smaller market and grow or reshape it over time. Facebook, Uber and even Google (in terms of the web search advertising market) are all great examples of this.
  47. Unrealistic valuation expectations — When there is a huge disconnect between expected private company valuation v. public market comps or when a founder wants a valuation that is 40X top-line revenue, but public market comps are trading at 4X best, you probably only have a limited number of investors that are willing to play ball. If you’re not sure which ones they are, ask around the investment community.
  48. Sky high burn rates — Bill Gurley has said on the record numerous times that “unlike valuations, which can be fixed, burn rates are a permanent outcome.” Founders need to be thoughtful about their burn and be able to articulate why each dollar is being spent in a certain way. Capital inefficiency is a turnoff, and scrappy founders who are willing to sacrifice personal dollars for the future of their companies, is a turn-on.
  49. LTV:CAC — LTV = Lifetime value of customer. CAC = Customer acquisition cost. According to most VCs, this should be 4–5x. 3x is okay but most businesses have fixed costs, and the 3 will quickly compress to 1.5–2 when you are doing several hundred million in revenue. Use this as a benchmark as this is a pretty strong rule of thumb.
  50. If revenue growth is slowing <~30%, and all new future growth initiatives are coming post raise — VCs see this a lot. Founders will often say “once we get this deal we’ll grow by X” or “as soon as we turn on this channel the CAC will drop by Y.” Unfortunately these things don’t tend to work out the way that we all hope/project, so many VCs look at these types of comments or slowing growth as a red flag.
  51. When all of your business comes from one customer — What if that customer walks away? Everyone is familiar with the 80/20 rule, but the further along a company gets, the less VCs want to see their revenue concentrated to very few clients. There are always exceptions to the rule, especially at the seed stage, but quite a few Series A investors and beyond brought this up in various forms.
  52. Generating demand primarily through direct paid marketing — What many people don’t realize is that many of the top consumer companies today grew organically for the most part in their early days. Matt Cohler noted that “users and customers acquired through direct-response advertising tend to be of lower quality than those acquired organically, and acquiring this way gets harder and more competitive as you get bigger — not a great foundation, and from an investment perspective, not great evidence that you’re creating something people deeply want.” The best companies have found ways to create incredible products that people want to talk about and share with their friends. There is nothing better than seeing word-of-mouth helping to grow a business because paid is a dangerous and competitive game to get into; especially before you’re at scale.
  53. If nothing is particularly compelling in the metrics — Some investors have no hard set rules, but everyone has said that without anything particularly compelling that it is a pretty easy pass. Meaning, VCs would rather have a few points of greatness (e.g. CAC is really low even if other parts of the business aren’t strong yet), because their view is that you can improve things, but if nothing is great, then they question whether you can ever be great.
  54. If consumer facing, what is the unfair advantage around distribution — you can’t just say PR or brand. Be as formulaic as possible — both around depth of channels, scalability and sustainability over the long term.
  55. Gross dollar retention is less than logo retention — Losing big customers is a big concern for VCs. SaaS investors are looking for negative churn and losing big money customers doesn’t help with this.
  56. Services salaries not included in COGS — Manipulating the data to make things look better to a VC isn’t a great way of going about things. It’s okay to have lower gross margin when you’re a young company, but pretending to be a SaaS business if you’re a tech-enabled services company is a dangerous game to play for both you and the potential investor. It’ll drive strategy in the wrong direction and put things in a bad place.
  57. “Outs” in contracts — When customers have the right not to proceed with the full value of the contract. An example of this is when a customer wants to start with 2 sites and expand to 10, but with the ability to get out of expanding to 10 sites.
  58. Consumer products with gross margins < ~25% and no path to margin expansion — the question is, “does scale actually lead to reducing COGS, or is it more likely to lead to margin compression from new entrants?” Consumer products is a tough game to play and Founders can easily over raise and find themselves in a difficult position when it comes to generating returns for their investors and themselves. Having <25 back="" even="" from="" getting="" hold="" li="" likely="" margins="" most="" there.="" will="" you="">
  59. Marketplaces / subscription businesses with customer payback period > 1 year, or multiple purchases (e.g. the business only breaks even on CAC after multiple, distinct purchases) — It’s easy for investors to get caught staring at GMV numbers for marketplaces. However, for companies like Uber, Zeel, Minibar and others, that take a percentage of total revenue flowing through the system, investors are really keeping a close eye on net revenue and how that relates to CAC. Many marketplaces these days are trying to create additional revenue streams via SaaS revenue or ad revenue, so it’ll be interesting to see how this impacts the other metrics of the business.
  60. When a business is pre-renewal (or signs multi-yr contracts upfront), but does not know how to track/measure customer success — How do you gain confidence that customers are using and liking the product? If you don’t have data around usage or engagement then that is often a reason VCs will quickly become concerned and probably pass. They’ve been burned by aspirational purchases (security, workflow, collaboration etc.) that ultimately don’t get adopted by a wider user group and will result in churn.
  61. Improving numbers by reducing quality of customer experience — we’re not in private equity so we don’t want to see a “customer first” company making decisions that will improve margin, but throw their values down the drain. These types of shortcuts are red flags and should be avoided.
  62. For content businesses, when 90% of traffic is from social (primarily facebook) — this is a large flag — huge duopoly these days with Facebook and Google and very hard to underwrite a strategy that depends solely on traffic earned through social click bait.
  63. No true marketing plan — When Founders pitch a consumer brand, they need to be able to articulate what the brand stands for, who their customers are, what the various customer personas are, and what the channels/strategies are AND how they want to test them. Although some of these may not be fully flushed out and you plan to hire a marketing person, it’s important to investors that you’ve done your homework, been resourceful and learned about the basics.
  64. Churn >5% for SaaS businesses — 5% becomes a larger and larger total number over time as you grow, which is going to put more pressure on your sales team to maintain a strong growth rate. Do everything in your power to keep churn below 5%.
  65. Team DNA — If it’s a consumer transaction business, VCs bias heavily towards founding teams that have acquisition DNA in the business. Often times we’re looking for “Founder/ market fit” and that usually means either someone who has experienced the pain point themselves before, and/or worked in the industry OR a Founder with strengths that match the core competencies of the business.
  66. In-House tech — If you’re building a company where tech is a core competency, but it’s not in-house, then it’s usually a quick pass for investors. Some firms are getting more comfortable with the idea of managing off-shore dev teams, but it’s an interesting topic of conversation that’s easier to have if the tech isn’t core to the success of the business.
  67. A huge miss (+/- 50% variance on budgeted financials) — No one expects financials to be accurate but they are directional for how a CEO will manage future cash flows. Goal setting is an important skill for a CEO to have. However, poor goal setting can hurt employee morale and the health of the business as well.
  68. Over hiring — Marc Andreessen has discussed that in times of plenty, it’s easy to think bringing on more workers will fix everything. However, he also points out that this creates a culture where “your managers get trained and incentivized ONLY to hire as the answer to every question.” Ultimately, The Company bloats and becomes badly run at [the] same time.” So be thoughtful about your hiring strategy and be able to discuss the reasons behind hires, along with their roles and responsibilities.
  69. Raising too much money, at too high of a valuation, too early — This was alluded to in the market section, but also included here because this fundraising strategy has a lot to do with how the Founder is running the business. Just because you can get $15M from a family office at a $100M valuation before you have true product-market fit, doesn’t mean that you should. Often times it leads to more problems than not as you’ll eventually have to grow into that valuation and it’ll put unnecessary pressures on you during the next fundraising round.
  70. Not knowing the right tools — A big part of being a Founder is being resourceful and learning from other founders/people who have been there before. While early stage investors don’t expect you to be perfect and know every business intelligence or marketing tool in the world, we do have the expectation that you have a basic understanding of what CRM system you’re going to use if you’re a SaaS business, or what email marketing platform you want to leverage as an eCommerce brand. Not knowing these makes an investor question the work/research put in ahead of time.

From posts by Jason Shuman, Part 1 and Part 2


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In my experience as CEO, I found that the most important decisions tested my courage far more than my intelligence.
Ben Horowitz