Why Your Choice of Seed Investor Matters - Part II (Great Companies Are Built on Strong Foundations)
In this second part of Entrada’s view on "Why Your Seed Investor Matters More Than Ever” we talk about some of the primary things we work on with founders to increase their odds of successfully raising that elusive Series A.
What are those foundations that should be built in anticipation of raising a Series A from a leading institutional fund? As long-time angel investors, now with a seed stage accelerator fund, the partners at Entrada Ventures have spent years considering this question and working to answer it.
Here is a partial list of the areas that we see most portfolio companies needing additional support in (of course this is not meant to be a complete list and may vary greatly based on each individual company and its needs):
Cleaning up the cap table; implementing proper financial records, controls, and modeling; being realistic about competitive analysis and comparisons; understanding key differentiators and business model moats; building a history of monitoring and tracking relevant KPIs; having a solid legal structure and performing legal due diligence of all records and contracts; building a strong history of meeting and exceeding projections; putting appropriate IP protections and strategies in place; building a history of quarterly investor reporting and regular board meetings; building a strong leadership team and board; documenting a history of consistent and predictable revenue generation; reviewing material contracts; understanding and building company culture; reviewing the organizational chart, compensation, and stock option agreements for all employees; maintaining 409A compliance; implementing management contracts, employee incentive plans, employment policies, and manuals; perfecting the story and pitch; and more…
Ideally, before raising a Series A, the company will document these important foundations and upload them into an online data room like securedocs™ or something similar.
Here are more details on the major aspects of those things that we see institutional investors looking for – and the ways we can help with them.
Legal Due Diligence
In the early days, it may seem reasonable for companies to download legal documents from online sources, but before approaching institutional investors you need to have these documents reviewed by experienced start-up attorneys. Like anything legal, there are intricacies that can really matter and a generalist attorney or generic document may not be in tune with all the little things that a Series A investor would expect to see. Having clear, reasonable, and appropriate sets of terms around ownership, voting rights, protective provisions, board seats, etc. is really important. We’ve seen some legal issues that have caused months of delay in financing rounds or worse – including some deals that didn’t close at all because of problems with legal documents that were not easy to resolve.
Recognizing the importance of these things, we decided early on that Entrada Ventures would work closely with the executive and legal teams of our portfolio companies to review, correct, and properly organize all important legal documents and significant contracts. We want to find the issues and correct them before the next round of institutional investors conduct their legal due-diligence because mistakes or omissions here can kill a deal quickly.
Anyone who’s been investing for awhile has probably seen some cap table nightmares and knows that the sooner they are resolved the better. At Entrada, we are willing to roll up our sleeves and work with the founders and existing investors to clean those issues up so the company can move forward properly. The goal is not just to understand who actually owns what, but also to make sure that liquidation preferences, conversion rights and rates, and other related elements are clear, concise, and ‘as expected’. When raising your Series A, the last thing you want are surprise ownership issues and/or complicated structure that can cause potential VC partners to get spooked. This happens more than most people realize.
BEFORE you approach institutional investors, make sure your cap table is “clean”, presented in a standard format, and, most of all, be sure it’s complete and correct! Many of our portfolio companies use Carta™ as it takes some of the complexity out of these activities and we love it too.
First and foremost, your financial records must be presented as appropriate and customary for your industry. This is not the time to get creative.
Secondly, we also suggest that periodically, (usually before the beginning of each year), each company review and set a monthly budget for the next 12 months. We also like to work with founders to make sure they are tracking actual spending and producing variance reports regularly. This will not only improve the leadership team’s reporting and prediction skills, but also add forecasting credibility. It’s a lot harder for a VC to poke holes in your forecast if you can show a great track record at predicting revenue and expenses in the past. It also shows that you understand the levers of your business and your KPIs – adding further credibility to the management team.
Intellectual Property Protection
Institutional investors expect that you have done everything possible to create a “moat” that protects your business from competitive attack. This may mean patent protection or copyrights, but it also includes security, non-disclosure, and IP assignment agreements. All successful companies have trade secrets (IP) that they don’t want to see fall in the hands of the competition. These are rarely defensible through patent and copyright law. More often, they are protected by keeping certain aspects of the businesses or technology closely held for as long as possible. It’s important to be able to demonstrate how you protect your valuable IP when meeting with institutional investors. It is equally important to show potential investors that you have ownership rights for all the work done by employees and contractors. Proper invention rights assignments, consulting agreements, and employment documentation are critical in this aspect.
Realistic Competitive Analysis
A company ready for venture investment is a company that has a realistic view of where they stand in the competitive landscape. It’s fairly common for founders to have a jaded perspective of their competition, and as such, discount or minimize the threats. Therefore, true competitive analysis often benefits from the perspective of outside advisors or investors who can help you paint a more accurate and objective picture of how you fit into the marketplace. How you communicate that competitive and strategic advantage is important as well. For example, a simple chart showing competitors and checking boxes to show feature differentiation doesn’t really explain your strategic advantage. It just makes it seem like all the competition needs to do is add a feature or two to check those boxes in order to match or exceed your positioning. In order to truly differentiate yourself from competitors you want to demonstrate that your company’s strengths and core competencies are more strategic and visionary and less feature driven. How you format and communicate this information can play a big role in helping outsiders quickly understand your core strategic advantages. We prefer Gartner’s “Magic Quadrant” along with a concise and powerful verbal explanation of high-level differences that are not ‘matched’ by simply adding features.
Key Performance Indicators (KPIs) and Reporting
What are the important and objectively measurable components that correlate to company’s revenue and business success? All successful management teams have a “living dashboard” that they constantly monitor to predict and manage growth and help overcome inevitable barriers. One of the skills that Entrada Ventures brings to our portfolio companies is the ability to work closely with the management team to develop the proper KPIs. We help the leadership team develop and evolve the KPI dashboard – which is different for every business. Usually, you’ll find gross and net revenues on the top line, followed by the drivers of that revenue. Whether revenue falls short or takes off, we can quickly determine the reasons for that difference and adjust or accelerate accordingly. Some common KPIs are: total pipeline value, demos completed, proposals requested, proposals signed, CAC, LTV, upgrades, churn, NPS (net promoter score), cost per demo, cost per lead, inbound leads, outbound leads, etc.
As with the finances, a variance report for KPIs can help the management team evolve these KPIs into a dashboard that will give them a quick and reliable look at the state of the business, greatly improving their ability to impact the important metrics.
Repeatable and Predictable Sales and Marketing processes
As Series A institutional investors have moved more towards growth stage companies, it’s important for management teams to show that they understand how to predictably manage their sales process. They need to be able to answer questions like:
How many marketing dollars do you need to fill the sales funnel with qualified leads?What channels produce the strongest leads?How many leads turn into demos?How many demos will it take to sell your product?How many sales can be driven through an account executive?What is your cost of sales and how will that vary as you scale?What are the anticipated barriers to scale and growth and how can they be avoided?
We have worked closely with dozens of companies on developing go-to-market strategies and predictable revenue models. The foundational process of building a sales machine should never be underrated.
Presentation and Pitch Perfection
The most important function of the CEO is to raise money. In the first few years this is through investment. In later years it’s (hopefully) through sales.
It’s essential that the CEO can tell the company’s story better than anyone as she will be the primary person pitching investors. You need to be able to explain what your company does and why it matters in two sentences or less, in one minute or less, in three minutes or less, and in 20 minutes, depending on your audience. Institutional investors understand that the CEO needs to lead and inspire. This is done by sharing the vision and excitement of the company. A great CEO surrounds herself with great investors, great team members, and great customers. Storytelling is the key to sharing that vision.
We’ve sat through far too many pitches that have confused us instead of convincing us of why this is an important company and opportunity. We’ve also coached dozens of CEOs on pitch refinement and storytelling. It comes down to crafting the right story for the storyteller, and then it’s practice, practice, and practice until it’s perfected. The time you spend perfecting your pitch will save you countless hours of disappointing meetings and lost opportunities. At Entrada Ventures, we put our CEOs in front of many experienced colleagues and investors who help craft the story and improve the pitch. These colleagues are entrepreneurs and investors who have sat on both sides of the fundraising table and have both seen and delivered hundreds or thousands of fundraising pitches.
Determine the Right VC’s and Begin the Conversations Now
Conversations with your Series A investors should start early. Over time, open and transparent communication builds knowledge, understanding, and trust. Once you determine who your likely Series A investors are and have met with them you should immediately begin to provide them with regular updates. Don’t just send them your quarterly investor updates but also share exciting wins along the way -- make them feel like part of the team and build a history of positive results together.
Of course, you first need to determine who your likely investors may be. Most Series A investment groups specialize in particular genres. In other words, if you’re a SaaS company, you don’t want to waste your time reaching out to VR or CPG investors. There is a short list of Series A investment groups that you should target, and you need to do the research in order to determine which groups those are and who the decision makers are at each firm. For the committed founder this is not that difficult to determine as most VCs list their portfolio companies on their website. However, personal introductions to that target list of VCs is essential.
Most VCs are inundated with decks and business plans on a daily basis, and many VC groups will ONLY talk to companies that come through an introduction. It’s important to understand that their most valuable and scarce resource is time. Founders should review their target list of VCs and work to find a common link in order to get that personal introduction to one of the partners. One easy way to do that is to look at their Linkedin and check out their background and portfolio companies to find a personal connection. There are only a few degrees of separation in the startup world; who do you know that can introduce you properly?
This is yet another area where the Entrada Ventures’ Partners can help our portfolio companies. We have worked personally with many of the top-tier Series A investors due to our vast network developed over many years of investing and operating in the startup world. We can review the target list with our portfolio company CEOs and then make the appropriate introductions, help set up meetings, and, when the time comes, advise the company on term sheet negotiations and invest our pro-rata.
When is it the right time to raise the Series A?
This, of course, is the $6.3 million question. If you do your job properly, you are already talking to and updating the right groups on a regular basis. When they get excited and you move into their target range, they will let you know.
The Entrada Accelerator Program
These are just some of the major foundational elements that need to be built before expecting a strong Series A. There are many more and each company is different and has different needs. Although founders can often go it on their own, we believe strongly that the best way to accomplish this is through partnership with firms like Entrada that provide active mentorship, leadership, and support. We select only a handful of companies per year for our accelerator program. Then we work directly and closely with the founding team to roll up our sleeves and help build these foundations. Once the business and team are executing well, we help with pitch preparation, introduce the company to the right potential Series A partners, navigate the term sheet negotiation and secure funding.
Our process normally takes 6-9 months of hard work and concerted effort and will pay off in the end for all involved as a strong Series A with the right investor group will greatly increase the likelihood of a positive outcome for the founders, employees, and investors.
Specifically, we look for companies with demonstrated product-market fit that have a strong coachable leadership team.
If this sounds exciting to you, reach out to us at Entrada Ventures so we can talk.