31Jan

6 reasons why you should not raise money in first round from VC


Great article by my linked in colleague Sanjay Mehta

 

Less money raised at seed stage, leads to more success. 

Being an angel investor for me start-up means a business which requires external funding for an accelerated business growth till it reaches to profitability. Raising funds from investors is an uphill battle for entrepreneurs. Entrepreneurs typically pitch to angel investors for their first cheques. We now are witnessing VCs entering in seed stage funding scene. The lines between VCs & Angels for the first round funding is getting blurred. To get funding in the first round itself from a VC firm sounds exciting & glamorous. Getting a VC firm as a partner involved early, who is fully committed & also get more money early is a great story to go after. But there are a number of serious drawbacks that have profound implications if VC firm comes up on the start-up cap table very early. Let me try to help explain why it is not a good idea to raise money from a VC at seed stage.

The fact is that the valuations & the amount of capital start-ups raise in their first round from Venture Capital firm is inversely correlated with start-up success. 

Below mention points are in order of importance why first cheques should not be taken from VC firm.

1.   For start-up if the VC firm decides not to write the second cheque Series A then it’s sure shot curtains for that business as NO other VC firm in the town is going to write that second cheque Series A. If the seed round first cheque was from angel investor group, then it’s not expected for angels to write the second cheque Series A. Entrepreneurs is then free to pitch to multiple VC firms for the next round of Series A raise. The entrepreneur is not locked & nor at the mercy of the VC firm if they raise the first cheque seed stage funding from angel investor group.

2.   VC firms write $250K – $500K first cheques or even up to $1Million depending on their size of the fund. Once seed investment is done VC firm will put in lower rung junior team to manage this early stage portfolio. General Partners of that VC firm do not invest their precious time with the early stage start-up hence the business outcomes success becomes the sole responsibility of the founders. These portfolio companies are given step motherly treatment with no real attention, nurturing from GPs. In comparison angel investor group, will have a lead investor who would have enough & more expertise, face time and mentoring to the founding team so that the business is successful. 

3.   Angel investor are proud of their seed stage first cheque investments and parade the entrepreneurs proudly in media, customer, investors & otherwise whereas for VC firms their pride is with their second cheque Series A & third cheque Series B invested firms & not the first cheque seed stage companies. Seed stage first cheque funded companies will never be a priority for a VC firm. Emotionally it’s a big drain for the entrepreneur when the VC firm is not proud nor excited about the future of its own invested company.

4.   Failure, losing money is accepted norm for the VC firm with the seed stage first cheque invested companies. They expect very high mortality rates at early stage. Investment thesis of the VC firm is to find that one out of the dozen early stage portfolio wherein they can write the second cheque of Series A. In comparison being part of the angel investor portfolio works for the entrepreneur as these investor put in their own money & they hate to lose money so they will work hard with entrepreneur to ensure the company thrives and gets the next round of funding. Many angel investors are entrepreneurs themselves hence like shepherds they can help building initial team, helping with product pricing and marketing. 

5.   VC firm funding round requirements be it in equity dilution terms or share holder agreements is very different than angel groups. VC firm writing the first cheque would like to go solo investments. They provide no scope for another VC firm to join the first cheque round. First cheque is the only opportunity for entrepreneurs to bring in marquee names or valuable experts on the cap table. Angel group can bring lot of variety & breadth of industry connections required for the start-up. It’s a lot more fun dealing with angel investor groups variety of collective intelligence than pandering to VC firm needs. 

6.   When there is large sum of capital invested early with the first cheque, it creates a pressure cooker type situation for entrepreneur and forces them to throw money to problems. VC capital always comes with non negotiable deadline to deliver. In comparison, the angel investor rounds are more measured, it’s optimum use of capital and focused approach to experimentation and more flexibly to adapt the learning as it’s not a stoned deadline.

In the VC game the very few winners pay for the losers, so most VCs are playing a high-stakes all-or-nothing game.

Jumping the natural funding sequence by getting VC firm to write the first cheque instead of angel investor group may seem like a good idea if you hit the bulls eye by being first time right. In reality with first cheque seed stage funding from angel investor can help build real value for the start-up, get a higher valuation before raising large sums of capital and diluting the equity. Entrepreneurs don’t skip the line!

Follow me on twitter @mehtasanjay

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