Stay in Check: The Sky Is Not Falling

A few weeks ago, a company I’m close to reached out to me seeking advice on their upcoming fundraise and expressing concerns about the increasingly negative sentiment in the market. When I got off the call, what struck me most was the amount of negative energy from every team member – a real shame given that they are amongst the most positive, optimistic people I know.

And it wasn’t that they’d gotten 100 rejections on the new round. They hadn’t even started fundraising yet. They’d simply been reading the negativity in the tech media and chatting with their existing investors who’d communicated that there was “blood in the water.” It occurred to me that numerous entrepreneurs with real, growing businesses are getting the RIP Good Times communique, and losing hope before they’ve even started.

That’s crazy. And it makes me angry. So I decided to publish the note I sent them. Look, no one disputes that valuations are likely to come down or that low-discipline, high burn companies may struggle. But tech/startups aren’t just collectively dead as an asset class. And that’s how many entrepreneurs seem to be feeling it. [All numbers etc have been changed to protect the company.]

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Hey gang –

Here are my thoughts after our chat yesterday. I’ve tried to break it up into a few sections. I know its a bit long, how I roll.

1. First things first, you guys have a built a really impressive platform. Think about it, you raised your first money barely over 18 months ago and you are going to process $X million in sales this month. $XM!!!!! So let’s start with that mindset. Holy crap, we’re building a real business here. We have real customers who depend on us, we drive meaningful lift to their bottom line with a beautiful frontend product. We help them gain back productivity and earnings. We are a mission driven company – and it is working. In spite of the general negativity of external market around tech startups, we are building something really special. That needs to be the mindset 100% of the time. We are building something great, we have amazing potential. Repeat, repeat, repeat.

2. The next 6 months for the company are all about re-discovering that spark from the founding days that excited the whole world and made everyone want to work with you, no matter what. The truth is this: you are going to have to hustle and grind harder over the next 90 days than you have over the past 2 years. You cannot take a break. You cannot take anything for granted. You need to grind, grind, grind with the same energy you did on the road to your first $50k in sales. The two of you have only one real job for the next few months: close a round of financing. That and keep your employees energized and in great spirits about the future of the biz.

3. I would re-calibrate your raise expectations on two fronts: (a) You need to forget all about valuation. I’m serious. Don’t mention it again to any investor. If anyone asks if you have a number in your head, you should answer: “We did our last round at an $XX post and we believe we’ve made material traction since then, but it’s up to the market to put a price.” Here’s what Josh Stein, GP at DFJ said yesterday at the Upfront Summit: “We have an expression at DFJ that is, ‘A1 is the new B.’ We invest flat to last round, & people are open to it.” Of course, we all hope that’s not the case here, but there has to be no ego. Absolutely no ego. Investors are resentful of being gamed by entrepreneurs running fast processes with little diligence over the past 4 years and repulsed at the first sign of arrogance or ego. Confidence? Yes, bring it in droves. Ego? Kill it. It is all about humility. (b) I would basically cut your raise # in half. Don’t go out to raise $XM. Your burn is really healthy and, yes, we want to pump more money into sales&marketing, so let’s say we are worst case burning $X/mo at the peak post-raise. $.4-.6XM should be the go to market number here. Here’s the thing: you want to oversubscribe, you don’t want to fall short. Last time around, there was what $8M of demand for your $3M round? That’s the goal here. $XM rounds are really tightening. Let’s go to market at $.4-.6XM, hope to hit $.7-1XM and give ourselves a solid 18+ months of growth.

4. Concurrent with the fundraise you need to go immediately to your corp dev contacts at companies X&Y who’ve expressed interest in the business before and start talking about strategic investment possibilities. No we do not want to sell the company right now, but the reasons for this are twofold: (a) Ideally one of these guys says: hmm, we actually want to buy this thing. And they give you an LOI. I don’t care whether you’d take that and yes it’s a time consuming process but like I said: no sleep for the next few months. It will do wonders for your fundraise if you can say companies X&Y have both approached us about M&A in the $XX range. It de-risks the investment for a potential investor in a climate largely devoid of M&A. It makes liquidity appear both practical and obvious. (b) In the event that we don’t find an institutional lead for the round (unlikely, but look this is a tough market), it gives us both the time and the energy to close a strategic investment from one of those parties. I’d rather have that option than no option. Remember, we are looking to generate both optionality & leverage.
 
5. You need to work with investors X&Y to develop the proper target list of new investors to approach. These intros all need to be warm. We need to cast a diverse, yet, focused net. My feeling is to basically hone in on ~12 people we think are really likely to write a check based on a historical interest in the business or the model. You can put together a spreadsheet or just go to people individually, whatever. But you need to coach each of your existing investors (who are making intros) on what the story you’re going to market is, what your milestones are, where you see the money taking you, etc. The new investors are going to call us, they’re going to ask us what we really think and we need to be really sure that we all understand exactly how you view the next 18 months.
 
6. Let’s talk about the next 18 months. And milestones. I’ll help you work on the deck & financials, but imo, here’s how you need to think about it:
– If we raise $X, $Y or $Z what numbers do we need to hit on a top-line basis to reach operational break-even?
– If growth isn’t meeting plan, what are the levers we can pull to cut burn and reach breakeven? (options are: cut staff in departments X or Y, cut marketing spend, cut engineering spend, etc.) AND – given that we have a consistent $XM (and growing) flowing through the platform just from existing customers, there should at least be enough room to have a breakeven biz in a worst case scenario.
– What milestones will we need to likely achieve in order to hit top line numbers (and therefore break/even)? X# of new customers via sales team, X# of new customers per/mo via paid marketing, increase in conversion rate from X to Y, increase in gross margin from X to Y, etc?
– New investors are going to want to feel that you’re really fluent and comfortable with these questions and issues so you need to put a lot of thought into them over the next few days.
Growth matters, but so does sustainability. You need to prove that you are thinking about how to build a sustainable business, not just a growing one. We all buy you can acquire more customers at a cost, but what else do you do to amplify the health of your business?
 
Myself (and other investors) can work with you on the story, etc, but this is a more of a coaching/pump up letter to get everyone aligned on how to approach the next 90 days. You guys have many of the elements and data points of a great story, but it will require the right perspective and energy to get this round done quickly.

Lots of love,

Ezra

About the author

Ezra Galston
Ezra Galston

Consumer focused hustling @Chicago Ventures, Young Entrepreneur @Foundation Capital, Class 18 @Kauffman Fellow, and Chicago Booth MBA. Former professional poker player, with 4 years experience doing marketing/biz dev in the online gaming industry. Launched a "poker hedge fund" in 2011, a record label in College, and produced a festival screened short film in 2006.

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