There are four common pitfalls entrepreneurs fall into while raising venture capital. Here are a few tips on how to avoid them.
Founders that raise venture capital tend to focus on optimizing around four things:
- Getting to the next round of funding as quickly as possible
- Increasing valuation
- Maintaining their reality distortion field
- Attracting and retaining employees that are motivated by potential future value rather than the current mission
Notice that there isn’t anything on that list focused on what it takes to build a great business. Focusing on short-term outcomes and motivations can lead your startup down a dangerous path. Here’s how to avoid these pitfalls.
1. Don’t set an arbitrary deadline for your next fundraise
When you raised your last round of funding, you probably expected that you would be ready for your next fundraise in 18-24 months. As that timeframe approaches, you might feel pressure to raise again from your board and current investors, who are worried that you’re not making enough progress. If you succumb to this pressure before your startup is ready, you’re likely to increase spending to chase vanity metrics and top-line growth, even as your core metrics suffer and cash burn accelerates. You’ll quickly lose sight of product-market fit and pull precious resources away from potentially higher-value initiatives that need more time to play out.
Set key milestones that will support another round of funding. React to data that suggests your original assumptions were off, and give yourself time to find a better growth path. Leave room for the possibility that your startup won’t reach venture scale, recognizing that it could still be personally and financially rewarding. Don’t treat getting to your next round of funding as a Hail Mary pass. The concept of “go big or go home” sucks if you’re the one going home.
2. Avoid over-emphasizing valuation
Founders often over-emphasize the importance of valuation, particularly in the early rounds of funding. Focusing on maintaining or increasing valuation when your business hasn’t achieved the proper milestones leads to longer fundraise cycles, putting your startup at risk. You might save yourself from some dilution only to end up with worse economics and less control in the future. Higher liquidation preferences, ratchets and valuation hurdles can limit future options if you need to raise or sell. And you’ll be more likely to attract mercenaries focused on maximizing their economic outcome rather than missionaries who believe in you and your vision.
What’s more important than maintaining or raising your valuation? Adding high-quality investors who can best support you through the ups and downs of building your startup. Managing your cap table to protect the future economic outcome for you and your team and keep as many options open as possible.
When it comes to startups in distress, valuation gets the headlines, and liquidation preferences and other investor-friendly terms get the cash. A flat or even a down round isn’t the end of the world if it keeps you and your team in the game and your future options open. Play the long game when it comes to valuation.
3. Don’t get trapped by the reality distortion field
Founders have to believe in opportunities that others often can’t see. It’s the fuel that powers you through obstacles and allows you to leap into the unknown. But that power to believe can also be a trap when your best-laid plans run awry and your startup isn’t hitting your milestones.
Too many founders believe that they must put on a brave face for their employees, their board and the press, regardless of their startup’s struggles. They worry that any crack in the perception of inevitability would lead to the downfall of their startup. That’s the trap.
You can truly believe in the future opportunity ahead of you while being honest about the roadblocks and challenges on the path to getting there. If you don’t open up to your employees about where your startup is falling short, you’re no longer aligned, and they won’t solve the right problems or exploit the most important opportunities. If you hide challenges from your board, they can’t help you along the way, and they will pull back when you surprise them with bad news.
4. Hire missionaries, not mercenaries
65% of VC-backed startups fail to return 1x of capital. When you hire employees, if you overemphasize the potential value of stock options in their compensation package, you risk attracting mercenaries that are more motivated by the potential of future riches than in helping you realize your vision.
Even for the most successful startups, the path to creating real value in your equity is never straight up and to the right. Mercenaries will jump ship at the first sign of trouble, in search of the next startup that might be on a stronger path to the mythic unicorn status.
Hire people that, first and foremost, believe in your vision and are excited about the challenges you’re trying to solve. It’s easier to step outside your reality distortion field when you have a team ready to grab an oar and row in the same direction. You will face this moment. Who will be in the trench with you? Who will be the first to jump out and run away?
Take the time to build a great company
When you jump on the venture capital flywheel, you instantly feel the pressure to shorten your time horizon, thinking only of the next fundraise and the sprint to get there. Short-term execution is critical. But don’t optimize your decisions around the fundraise cycle, or you’ll miss the long-term goals that help you build something great.
This post was originally published on Entrepreneur Media on November 14, 2022.