Lead Investors Posts

Daddy, what's a soft circle?

Nivi · June 17th, 2008

feld.pngBrad Feld recently proposed good criteria to distinguish true followers from tire-kickers when you’re raising money:

“While you can’t contractually commit the supporting investors [followers], you can usually separate the real ones from the tire-kickers (or—more generously—the call option people). Committed supporting investors are going to let you use their names with potential lead investors, will engage in active networking, and will name a specific amount they are willing to invest.

“These supporting investors are typically called “soft circles”—you’ve got a commitment from them, but it’s not a legally binding one. A soft circle will always have a dollar amount attached to it [emphasis added].”

True followers will also make strong introductions to potential leads.

Learn more about followers and leads in How do I find a lead investor?, Parts 1, 2, and 3.

How do I find a lead investor? Part 3

Nivi · January 27th, 2008

Summary: Here are 2 more microhacks for finding a lead investor: (4) Incent followers to lead by telling them the truth: there probably won’t be room in the round for followers. (5) The best way to find a lead is to build something that attracts a lead: keep building your company and reducing risk.

In parts 1 and 2, we presented three microhacks for finding a lead investor. Here are two more microhacks, in continuing order of importance.

4. Incent a follower to lead.

Whenever someone says “find a lead”, you should say,

“We’re happy you’re interested. We’re interested in working with you too.

“We’re looking for a lead and a lead is going to want the entire round. Or he will bring in his own co-investors. Or we’ll build a syndicate out of investors who want to lead. So we may be back but we probably won’t.

“Most likely, the investors who get to participate in this round are those who want to lead. If you’re interested, you can secure a spot in the round by leading and we’ll work with you to set the terms and decide who gets to invest.”

Note: Make an exception for (1) angels you are trying to mass syndicate and (2) investors who have good reasons to follow and are partnering with you to find a lead.

This polite diatribe combines positive leverage (“you can secure a spot in the round by leading and we’ll work with you to set the terms and decide who gets to invest”) and negative leverage (“the only people who get to participate in this round are those who want to lead”, i.e. you may lose the option to invest if you don’t act now.) Their reaction to this message will tell you whether they have good reasons to follow or they just don’t want to say no.

If you have existing seed investors, you can also use them as the bad cop:

“We really like you but my existing investors are pushing me to find a lead and not spend time building a syndicate. Are you willing to lead the round?”

5. Get past no.

“If you’ve got a good idea, market, and team, raising money won’t be your problem.”

— Sam Altman, Founder of Loopt

“Nobody said this would be easy.”

— Marc Andreessen

Your company may not be good enough to raise money. So how do you get good enough? Read Marc Andreessen’s When the VCs say “no”:

“If you’re an investor, you look at the risk around an investment as if it’s an onion. Just like you peel an onion and remove each layer in turn, risk in a startup investment comes in layers that get peeled away—reduced—one by one.

Your challenge as an entrepreneur trying to raise venture capital is to keep peeling layers of risk off of your particular onion until the VCs say “yes”—until the risk in your startup is reduced to the point where investing in your startup doesn’t look terrifying and merely looks risky.”

Marc’s goes on to describe the various layers of risk and, even better, he tells you how to peel the layers away. This is the most useful article on improving the effectiveness of startups that we have ever seen—read it.

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Founder risk is the number one reason startups don’t get funded: the team simply does not appear up to the task. If you have a good product in a good market and you can’t figure out why you keep getting rejected, look in the mirror and remove/add people until the team inspires money to fly out of investor’s pockets.

This is the fifth microhack but it should really be the first, second, third, fourth, and fifth. The best way to find a lead is to build something that attracts a lead.

“No one ever got anywhere by lavishing calls on Oprah. The only time I’ve succeeded in my career with Oprah was [when] Oprah called us.”

— Barry Krause, in Made to Stick

How do I find a lead investor? Part 2

Nivi · January 24th, 2008

Summary: Here are 3 microhacks for finding a lead investor: (1) If followers have good reasons to not lead, ask them for introductions to potential leads. (2) If you’re early stage, find seed investors who invest in people and high risk startups. (3) If every prospective investor says “we don’t know the market,” find investors who have invested in your market or similar markets.

In Part 1, we wrote,

“Lead investors want at least half the round—and they often want the entire thing. If they don’t want the entire round, they will help you find followers (and some leads will close immediately even if they’re not taking the entire round). They believe your stock is worth more than they’re paying. They don’t need social proof or scarcity to make an investment decision. Like great entrepreneurs, they are mavericks.”

If you’re doing a seed round, you may be able to mass syndicate the financing without a lead. Otherwise, here are three microhacks for finding a lead, in rough order of importance—but you should probably try them all.

1. Ask the followers for introductions. #

If the followers have good reasons to not lead, ask them for introductions to potential leads:

“Can you suggest any firms who would be interested in leading this investment? Why do you think they would be interested in leading? Would you make an introduction?”

This simple test will tell you whether the follower has good reasons to not lead. If a follower won’t make introductions, he doesn’t have a good reason to not lead. If the introduction doesn’t respond aggressively, the follower probably made a half-hearted introduction—he doesn’t have a good reason to not lead. The follower’s level of effort indicates if he really wants to find a lead or he just doesn’t want to say ‘no’. (Caveat: This logic mostly applies to VCs, not angels.)

If a follower doesn’t have a good reason a priori, don’t ask him for introductions at all. Skip this microhack altogether. An introduction by someone who can and should lead, but would rather follow, is a useless and harmful introduction. It’s a strong negative signal. Go get your own introductions.

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Finally, if a follower introduces you to the eventual leader, the leader will rarely cut out the follower. (Investors who don’t accommodate the middleman who gives them introductions stop getting introductions.) You’ll end up with two investors and more dilution. But that’s better than the alternative: zero investors and no dilution.

2. Find seed stage investors.

Every professional investor’s fantasy investment is a sure thing: zero risk and infinite reward. If you’re early stage, you can circumvent this fun fact by doing a seed round:

  1. Focus on investors who go out of their way to invest in seed stage companies with lots of risk, not investors who say they invest in seed stage companies:

    2. “What seed stage companies have you backed in the last 2 years? What exactly did the company (team, product, traction) look like when you invested?”

    Does your company look similar?

  2. Find non-professional angels whose primary motivation is working with great entrepreneurs, not profit. In particular, talk to folks who already know you well and are willing to to bet on you.

Seed investors increase the probability of raising money from VCs. High-quality seed investors raise your valuation, provide social proof, and obviate the need for extensive due diligence in the VC round. Many companies close a small seed round and do a larger VC round in a few months.

If you want to skip the seed round, mere commitments from high-quality seed investors have a similar effect. And these commitments provide a strong alternative as you negotiate with VCs. Obviously, if you do the VC round, don’t cut out any seed investors you have committed to.

3. Find investors who know your market.

If every prospective investor says “we don’t know your market,” find investors who have backed companies in your market or similar markets.

Educate investors about your market. It’s your job to convince them the market is great. Find successful companies in your market and figure out how they got there, how long it took them to get there, how much money they raised, how much money they’re making, how much money they would be making if they were as smart as you are, et cetera.

Talk to the management at these companies and see if they will personally invest in your business or advise you. Ask if their company wants to be a strategic investor.

Yet more ways to find a lead.

In Part 3, we’ll suggest two more ways to find a lead investor.

Image Source: Funny Treat.

How do I find a lead investor? Part 1

Nivi · January 24th, 2008

“Those kind of ‘sit on the sideline’ investors are worthless to you if you want to get a financing done… if you are raising a financing of any kind, spend all of your time looking for a lead investor.”

— Fred Wilson, Union Square Ventures

Summary: Financings happen when you find a lead investor, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it. Alternatively, if you have a group of seed investors who aren’t asking you to find a lead, you can mass syndicate the round without a lead. Finally, ‘find a lead’ often means ‘no’.

So Bill the Cat writes in:

“We’re out on the warpath, with the aim of raising a Series A round in the $1M range. We’ve had a number of people say they are interested in participating, but nobody wants to lead because they know little/nothing about our market. Is there anything we can do about that, other than just keep searching for a lead? I’m pretty confident that at this point if we found one, we’d be set.”

What’s a lead investor?

From Fred Wilson‘s The “Lead Investor”:

“I got an email from a friend yesterday who… said that he’s got indications of interest from a number of investors but they are all waiting for a “lead investor”.

“I told him that what he has is a bunch of followers who have no real conviction about his business because if they did, they’d step up, negotiate a deal, and get their money into his company. But instead they are going to sit on the sidelines, wait until someone with conviction shows up, and then try to get in alongside the investor with conviction.

“Those kind of “sit on the sideline” investors are worthless to you if you want to get a financing done. They don’t impress the kind of investors who have conviction because investors with conviction are going to want all of the deal for themselves (or their friends they will bring in alongside of them).

“If you are raising a financing of any kind, spend all of your time looking for a lead investor.”

Lead investors want at least half the round—and they often want the entire thing. If they don’t want the entire round, they will help you find followers (and some leads will even close before you find followers). They believe your stock is worth more than they’re paying. They don’t need social proof or scarcity to make an investment decision. Like great entrepreneurs, they are mavericks.

Financings happen when you find a lead, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it.

Lead investors who bet on unproven markets, products, or teams (or all of the above) are rare. If you’re unproven, don’t be surprised if fund-raising takes time.

“Find a lead” might mean “no”. #

“Investors saying that they are waiting for a lead are also saying ‘no’ without saying no… They don’t want to miss out if this thing takes off (e.g., “Hey, we told you we were in, I hope you saved 10 percent for us!”), but they have no conviction and don’t want to say no in case they’re wrong.”

— Dick Costolo, Founder of FeedBurner

Instead of saying “no”, an investor might ask you to “find a lead”. Why? He wants to maintain an option to invest. If you find a great lead or the company starts kicking ass, the follower will say he intended to invest all along.

By telling you to find a lead, the follower is trying to extract a subtle commitment from you and manipulate your psychological desire to follow through on your commitments. Negotiators call this a consistency trap. We’ll show you how to avoid this trap in Part 2.

Professional investors (VCs) have two legitimate reasons to not lead: #

  1. Your business is too far away and they want you to find a local lead, e.g. you’re in Shanghai and your investors are in Boston.
  2. The investor’s typical investment is less than half of your round.

In either case, the follower should partner with you to find a lead. His level of effort will tell you if he really wants to find a lead or he just doesn’t want to say ‘no’.

You can mass syndicate seed rounds without a lead. #

Small seed funds that are investing their personal money and non-professional investors like angels may have other good reasons to not lead: they don’t want to deal with negotiating terms and hiring a lawyer, their portion of the financing is too small to lead, they like you but they don’t know the market, et cetera. #

If this is the case, you might not need a lead. If you have a group of seed investors who are not explicitly asking you to find a lead, you should:

  1. Generate a term sheet. Your advisers and lawyers can help with the terms.
  2. Get feedback on the terms from prospective investors at the end of the first meeting. They will ask about the terms if they’re at all interested.
  3. Incorporate the feedback into the term sheet.
  4. Once enough prospective investors have said ‘yes’, circulate the term sheet with a list of investors who have committed to the financing.
  5. Incorporate any additional feedback and send the closing documents to everyone. Set the closing date two weeks out.

How do you find a lead?

In Part 2, we’ll suggest some ways to find a lead if you can’t mass syndicate the round.

Related: VC Cliche of the Week: We are Passing, The Art of Saying “No” Parts 1 2 and 3, and More favorite VC phrases.