What do Uber, Airbnb, SpaceX, Stripe, and Epic Games all have in common? If you said they’re all unicorns (companies valued at $1 billion without being listed on the stock market), you’re right. Every founder of a new venture dreams of being in this rarified air, but few ever get to breathe it.
However, credit should be given where credit is due. Many founders don’t have such lofty goals. Instead, they’re content with the “green ceiling.” That is, they’re content to cash out as soon as their equity value is high enough to provide them with the lifestyle change they’ve dreamed of, whether moving on to a new venture or sailing off into the sunset in their catamaran.
Plenty of founders would be content to cash out as soon as their personal haul from an exit is $5M to $10M. And hats off to them if this is where they want to exit. We each have our own goals and set of circumstances. Staying just for a season is acceptable in some cases.
A caution to investors in startups
We would be remiss in our discussion on the green ceiling if we didn’t talk about the downside to angel investors.
In general, many VCs make investments with the hope that any one of the portfolio companies can recoup the entire fund. So, a fund investing in 15 deals would want each deal to have 15x potential. Angel investors often do not consider the upside limitations.
In general, 90% of a fund’s return comes from 10% of the deals. If the investor is capped at 2x or 3x on investments due to green ceilings, it’s doubtful the investor’s portfolio will return a positive ROI. The investor is taking all the risks but not seeing all the rewards due to the early exit.
Below is a recent example of a deal we’ve seen at the seed stage. The startup is raising $3M at $15M pre. We are projecting out the Series A & B rounds and the $60M exit. Keep in mind that very few companies ever sell for $60M or more. The chances of any startup selling for $60M or more is under 5%, but for our example, let’s assume they pull it off.
As you can see, the founders walk away with over $30M. Generational wealth and a lifestyle change for sure, if only a few co-founders. We wouldn’t blame any founders for putting $30M in their pockets, and many, especially first-time founders in non-coastal areas, would consider such an exit a huge success.
While the seed investors only walk away with a 2.2x multiple on their capital, that’s a better return than many other investments. However, on a risk-adjusted basis, it’s not quite so favorable.
In their best interests, angel investors should have a heart-to-heart with founders of ventures they’re considering and get the issue of the green ceiling out on the table. In some cases, a founder looking for a fairly quick exit may be an acceptable risk, but it’s a risk worth knowing about and factoring in.
“If you don’t know who the sucker is at the poker table, the sucker is you” is a great metaphor for angel investors to consider when placing bets on startup opportunities. With the explosion of startup accelerators, syndicates, and crowdfunding platforms, angels are investing in companies on much different terms than those closest to the deal. Angel investors should consider the economic interests and motivations of all those participating (or not participating) in any fundraising round before investing.
When the postmortem is written on the startup funding environment at the early part of this decade, we may look back at these valuation accelerants as having contributed to the highest startup valuations since the dotcom bubble:
Startup Accelerators – Accelerators afford entrepreneurs mentorship and networking through two-month to four-month in-person or virtual boot camp programs. The startup receives a nominal investment and the accelerator benefits from a very low valuation. For example, Y Combinator invests $125,000 for a 7% fully-diluted ownership. This equates to a $1.79 million post-money valuation.
Granted, accelerators provide critical services, networking, and early, risky capital to startups and should receive a discount from the market for their sweat equity. However, the most significant service accelerators provide to startups is at the end of the program when the “graduating” startups need to tap the capital markets.
At this time, the accelerator and the startup spin how great the business is, which may still be pre-pre-revenue and/or pre-product. They work in tandem to justify how a low to no-traction business is now worth $5M – $10M because the founders went through a 12-week program.
Ask if any of those folks closest to the startup – the management team, the accelerator’s staff, the mentors, advisors, and board members – are investing in this round on the same terms as you.
Syndicates — A syndicate works through a special purpose vehicle (“SPV”). Typically, a limited liability company is formed to invest in a startup so investors can invest together in a promising company and only take one line on the capitalization (“cap”) table.
Usually, the syndicator is someone well-entrenched in the startup ecosystem and either engages full-time or part-time in the pursuit of finding investable startups.
Frequently, syndicators also have their own funds, and they make a small investment in the startup symbolically to show they have “skin in the game.” For example, a syndicate may have received an allocation of $250,000 in a $2M equity round. The syndicator will then invest $5,000-$25,000, with the rest of the money coming from angel investors, tourist investors, and/or high net worth individuals.
The sales pitch the syndicate gives the startup is “I will pitch your company to my broad network of angel investors, and we will raise capital for you in a short period at attractive terms.” In consideration, the syndicator receives a management carry of 20% of the upside generated from the investment.
Unlike an investment fund with a downside to the general partners for investing in a company that fails, the syndicator has no downside other than the nominal investment they made in the company. As mentioned earlier, the syndicator usually doesn’t put their personal money into the syndicate, but instead invests a token amount from a fund they raised.
In the past, syndicates were better at grounding startups and reasonable valuations and structures because the syndicator is a market maker bringing together buyers (the investors) and sellers (the startups). However, syndicates rarely push back on valuation and structure in a frothy market for fear of being carved out of a transaction.
As a result, angel investors lose their perceived advocate and accept deal terms that are less than ideal. The syndicator has upside but no downside except the nominal amount invested.
Crowdfunding – There has been a proliferation of crowdfunding platforms created over the past decade providing small investors with the opportunity to access an alternative asset class.
The problem with crowdfunding deals in general, especially during The Great Inflation, has been that startups have pegged their valuations and structures to whatever suits their fancy, frequently void of any reality. Even worse, there are very few professional investors (people who make a living investing full-time in early-stage companies), so there is no due diligence done on the startup.
Instead, the angel investor gets a one or two-page teaser complete with all the promising aspects of the deal and devoid of all the hazards associated with the opportunity. Not only is the angel investor starved of information before investing, but many startups don’t provide information rights to the crowdfunding investors as a practical matter as they may add hundreds of small investors to the cap table.
As a result, the angels frequently will not have access to the same information as the major investors post funding. This puts them at a disadvantage when it comes to follow-on rounds, which is often the place where investors see the greatest risk-reward profile.
Angel investors coming through a crowdfunding platform are often excluded from receiving pro-rata rights, which allow existing investors to invest in future following around at the same terms as the other investors based on the percentage of ownership.
Management teams – Frequently, startup management teams are filled with young, energetic entrepreneurs who don’t have two nickels to rub together. In these cases, it’s understandable for the management team not to be putting capital into the business.
Ideally, these young guns will be working on below-market salaries and/or have convinced family members or friends to invest in the earliest rounds. If you see a management team, particularly one formed from former big company executives, raising capital so they can continue earning the same high salaries they were previously, run for the hills.
And, as an angel investor, if you see a deal with a management team of “serial entrepreneurs with successful exits” who are in their 40s or 50s and haven’t written any checks, ask why.
Party rounds – a party round is a round where there is no lead investor who conducts due diligence, negotiates the terms, or coordinates the preparation of the legal documents.
In a party round, the startup takes the initiative to set terms. Because party rounds are usually an amalgamation of time-starved high net-worth individuals, each writing small checks ($25,000 – $50,000 is very common), no one has enough influence on the deal to negotiate on behalf of all angels.
As a result, angels who ask many questions or want more favorable investor terms are simply excluded from the deal and replaced with angels who accept as proposed by the startup.
A Final Thought
When investing in a start-up, look around the room and assess whether you are being taken for a ride. Ask this question to the fundraising CEO, “If this is such a great opportunity, how much is your management team, your board of directors, board of advisors, and existing investors putting into the round?”
Pitching anyone on LinkedIn with a connection or meeting request is a risky proposition, but more so with some professionals than others.
For example, not to diminish their importance, but an insurance agent pitching group health insurance to a small business owner on LinkedIn can afford to mess up a pitch more than an author attempting to connect with an editor from one of the three major publishing houses in New York.
Likewise, an entrepreneur who wants to land a round of funding from a venture capitalist (VC) has a limited market to approach and may not get a second chance if their first pitch goes poorly.
How Not to Pitch a VC on LinkedIn
There are some “cardinal sins” that you must not commit when pitching VCs.
Instead, Do This…
Increase your chances of success by:
Successful Connection Messages
Here are several messages that have proven to be concise, yet successful.
Initial Connection Message:
I’ve spent time reviewing your profile and Rock Star Venture’s website. Since you invest in FinTech, I think a connection will benefit us both. I’d love to be on your radar.
Follow-up Message (a few weeks later):
I wanted to let you know we’re currently raising $2M to $6M in a seed round. We have $2M already committed, including $1M from Best Lead VC. Our company has already generated over $500k in revenues, and we expect to reach $1.5M this year (our pitch deck is attached). Please email or message me if you or a colleague would like to chat.
Final Message (a few weeks after follow-up message):
I promise not to approach you again after this communication, but I wanted to let you know our round is 90% full. I’d still love to chat about our opportunity with you. If you prefer, I can put you on our investor update memos. You can email me at…..
If You Receive a “Thanks, But no Thanks” Response:
Thank you for the courtesy of your response; I won’t initiate further contact. If you think of any VCs I should reach out to, please let me know. Thanks again for getting back to me.
3 Final Pro Tips:
And remember – – your goal is to get the conversation off LinkedIn, not close a deal.
Launching a new company?
If you’re about to begin a new venture, before I get into who you should select as a CEO, board member, or advisor, let me first state a contrarian position – relying on startup boards and advisors to get your enterprise off the ground is overrated.
Initially, your chances for success are much greater when you surround yourself with a CEO and top-flight management team you’ve aligned economic incentives with to work 60+ hours a week with you in the foxhole. I’ve been shocked to see many boneheaded moves made by founders because “the board wanted me to do it.” Trust your instincts and lead your managers.
In fairness to your board members, you can’t expect someone with a high net worth and a busy schedule to be great at making judgment calls about your business if they only spend several hours a month thinking about it.
Remember that board members and advisors showing up for a one-hour Zoom call once a quarter when you and your hand-picked team are hitting the ground running every day won’t compensate for a lack of in-house talent. One way to spot floundering founders is pitch decks showing more board members and advisors than members of their management team.
Your advisors: bigger is rarely better
Having stated my position that relying on board members and other advisors early in your company’s launch is overrated and ineffective, let’s discuss how you should fill out your roster of directors and advisors when the time comes.
In short, I tell founders of startups to look for startup CEOs who have had successful exits.
Founders frequently assume that a VP at a Fortune 500 company would be a great advisor since “if they can do it at BigCo, surely they can figure out my little startup.” BigCo has much different challenges than a capital and talent-starved startup first penetrating the market while raising cash from investors and collecting from customers to make payroll.
Unlike the CEO or VP at BigCo, who had a slew of underlings to handle much of the dirty work, your team must be a generalist who can wear many hats and you want advisors who have done the same. The person who was “at Uber when it went from $1M in revenues to $1B” may have played a small, specialized role in that growth and success.
Do your board members and advisors have experience “beginning with the end in mind?”
Your board members and advisors must have experience raising money from outside investors. Pitching investors, keeping them informed, and making decisions with all investors in mind are keys to your success. Running a lifestyle business where you report to no one is one thing, but having outside investors who will hold you accountable is another.
The exit – selling your business – can be as challenging as the entrance – raising capital. Potential buyers will put you through the wringer, and board members and advisors who have experienced that arduous process can keep you clear-eyed and focused on balancing your business’s needs and meeting your suitors’ due diligence needs.
Surround yourself with a board, advisors, and mentors who have successfully sold their businesses. There are exits, and there are successful exits. When vetting advisors, ask what return on capital the investors received. Many entrepreneurs close businesses or bankrupt them and move on. There’s nothing wrong with that, but that’s a loose interpretation of an “exit” and clearly doesn’t indicate the track record of success you’re looking for.
Who not to pick as an advisor or board member
One cardinal rule when choosing board members and advisors – avoid ultra-high net worth individuals whose investments are not crucial to their net worth. They may be significant assets to your team and essential investors because they can help you raise capital, but they’re unlikely to roll up their sleeves and take the time necessary to understand your business and provide quality advice.
If you can’t find startup CEOs with successful exits to participate at the board level, other options are (in order of preference):
Your plan B if successful CEOs have no interest
If you can’t find successful startup CEOs or other leaders with sales and marketing or industry experience, at a minimum, avoid these attributes in potential CEOs, board members, and advisors by asking these questions:
Attribute: limited time – “How many hours can you commit to every week, and are you willing to work nights and weekends?” (CEO)
Attribute: limited capital – “Would you consider making an investment in our business in the future as a show of support for the business to prospective investors?” (CEO, board member, advisor)
Attribute: limited experience – “How many boards have you been on? How have you been the most impactful on those boards? Can you provide a few founders references I can call?” (board member, advisor)
Attribute: vanity seeker – “Why do you want to join our board as a director or advisor?” (board member, advisor)
When you have the right people in place with the right amount of capital to work with, you’re in the position to start and finish strong. Let me know how I can help.
Let’s face it, as a founder looking to raise capital, most VCs are going to tell you no. The vast majority of VC firms invest in less than 1% of the deals reviewed, so don’t get discouraged. Use those rejections as motivation. To maximize the value from each interaction, ask VCs who decline to invest three questions:
This is an efficient way to keep fence sitters and curious prospective investors informed regarding your progress. As you hit milestones, you may see a few of the NOs reach back out to you unsolicited.
All VCs network with other VCs, and most are familiar with the investment criteria of the VCs with which they network Many time-starved VCs may not think about referring you out unless you ask, so ask at the point at which you are declined since your deal is fresh in their minds.
VCs are trained to be nice and not ruffle feathers. Many times you’ll get a generic reason for declining to invest (e.g., too early, doesn’t match our thesis). There is no upside for them to upset you as a founder. Doing so simply reduces the chances you come back to them for your next deal, and you may potentially trash their reputations to others in the startup ecosystem. This question will help you smoke out some candor from the minority of VCs who are willing to tell you what they really think.
Congratulations to the team at Polco who outpolled everyone in our pitch coaching competition. Our panel of judges, all active, early-stage VCs provided Polco and all the quality startups with excellent feedback to help the founders with their investor pitches. The companies that presented were:
Participating Early-stage Venture Capitalists
VCs love recurring revenue businesses, but don’t love it when founders can’t provide basic data showing the build up in revenues. There are plenty of recurring revenue billing platforms such as baremetrics and Recurly that provide default reports of critical data points such as ARPU, MRR, LTV, and churn. For companies not utilizing a billing platform that provides SaaS metrics, an Excel spreadsheet similar to this is a great way to start tracking this data both for internal consumption and to be shared with potential investors when fundraising: Customers
At Unbridled, we ask SaaS and other recurring revenue companies to provide us this data for the last two years.
Congratulations to the team at Resound for the resounding win in our first pitch coaching competition. Our panel of judges, all active, early-stage VCs provided Resound and all the quality startups with excellent feedback to help the founders with investor pitches. The five companies that presented were:
Back in the old days, entrepreneurs did crazy things like creating well-thought out, detailed business plans for prospective investors to review. In our TL;DR world written business plans have gone the way of the dodo bird. Most entrepreneurs create just one deck and use it for all audiences, which is a disservice to all as the deck is typically too general for savvy investors and too complex for angels.
I would create two pitch decks – a short deck that is 10 – 12 slides maximum and one that is much more detailed – perhaps 20 – 30 slides. Always send the short deck first. And when you pitch to angels and tire kickers, the short deck is all most will ever need. If you get too into the weeds with your deck, angels will pass on the deal because they don’t understand it. Your goal with your initial pitch isn’t to get them to understand all the intricacies of your business in 30 minutes but rather leave them with the impression that you fully understand all the intricacies of your business. So, adhere to the KISS principle with angels – Keep It Simple Stupid.
A small percentage of your prospects will want to see more information, so tell all prospects a longer pitch deck is also available upon request. As Albert Einstein said, “if you can’t explain it, you don’t know it well enough yet.” Creating the long deck will not only be beneficial to your savvy investors, but it will also help you better crystallize strategy and tactics.
The longer deck takes the place of the old school business plan. The people who will want to see more information, which will be limited to 10% or less of all prospects, will be those folks who have considerable experience analyzing and investing in deals – such as very active angel investors (e.g., someone who has done 10+ investments), angel funds, accelerators and incubators, and institutional investors.
You may also get a few novice angels requesting the long deck, which normally comes from subject matter experts (SMEs) who know something about your offering or industry. If the SMEs are in a closely-knit angel network in your town, they may influence others investment decisions regarding your deal. Make sure you give SMEs the attention they need. Some SMEs may be good mentors, advisors, and/or board members as well, so keep that in mind.
After creating your decks, practice your pitch with members of your team. Then pitch people who won’t be investing and get their feedback. Friends and family are fine as they will be candid with you whereas angels won’t – most angels will politely decline to invest to avoid offending (e.g. “great company but I don’t have the liquidity to invest now”). Also, the questions your friends and family ask will point you to the area(s) where you need to apply more KISSes. Don’t blow off their questions as naivete – most angel investors will get tripped up by the same complexities in your pitch as your Uncle Bob.
What should you put in the pitch decks? Here is one of the best articles I’ve ever read regarding pitch decks. It’s an ideal article to help you craft your short deck. For your long deck, just expand on the topics in the short deck. Also, one trick I’ve seen people use with their long decks is to include an “Appendix” section. There you can shove in some wonky technical slides, detailed financial projections, or anything else you think only a select few but important potential investors would like to see. Most investors will feel like they don’t have to review and understand everything in the Appendix, but the content is there in case others want it. Kind of like having dessert on the menu!
One final point on introductory calls with potential investors – email them your short deck but frame up the choices for the introductory call so you and they know what to expect. In general, for meetings with just one or two prospects, tell them you have four typical formats that investors prefer and let them decide which one for your one-on-one meeting:
|Pitch via short pitch deck||Most angels|
|Pitch via long pitch deck||Subject matter experts / professional investors|
|Product demo||Subject matter experts / anyone if a simple product|
|General chat and Q&A||Time starved folks / angels following investors already in your deal|
Be sure to tell your prospects how much time each option will take. Also, offering to do calls, Zooms, or in-person meetings on nights or weekends as well is an excellent way to convey to your prospects that you work hard on your business while simultaneously affording you perhaps more focus from prospects who have divided attention during the business day.