The irrationality of early-stage fundraising

Part of The Family’s job is supporting young entrepreneurs as they learn how startups really work (remember, young is just a question of experience, whether you’re 18 or 63 — anyone can become an entrepreneur ;). And pretty much every young entrepreneur has no idea about how or why investors will give them money.

Start by accepting that most young entrepreneurs struggle to understand fundraising because they try to apply rational thinking to an irrational process. Startups and venture capital are overly optimistic environments — everyone who does this for a living is irrationally optimistic, because that’s the only way to survive in a world with such a high failure rate. That’s why at The Family we joke about always telling our own investors, “This is the best cohort we’ve ever had” — but it’s also why we believe it.

Because of that optimism, theoretically speaking, every VC wants to do every deal — if they had unlimited capital, that’s exactly what they’d do. But they don’t, they have to choose, and that’s when the FOMO takes over.

On any given deal, every professional investor prefers to lose money instead of breaking even. Run the math: You’ve got a fund with $10M to invest, so you can make 10 bets. Your goal isn’t to return $12M; that’s a failure in VC. Instead, you’re looking for the 100x that makes your whole career. You want to invest in companies that will risk your money and do everything they can to find that 100x, not in people who are going to be cautious and careful.

Fundraising obviously changes as you get bigger. During a seed round, lots of investors can put money in, and they do it based purely on emotion. After all, you don’t really have any metrics or data, so the level of uncertainty is so high that traditional due diligence doesn’t really make any sense. You’ve just got to convince them that “X is a huge problem” and “My team’s the one that’s going to solve it”.

But if you then get to product-market fit and you need to raise a Series A, things aren’t that simple.

For an entrepreneur, it’s a super exciting time — you’ve gone from ten clients to hundreds or thousands; your growth rate is exploding; you’re dreaming of everything you’ll do with $10M in the bank account. For an investor, though, they’re not as affected by that excitement — basically because they spend all day, every day with other entrepreneurs who are just as excited as you. (And that’s another reason why FOMO can take over, because during their careers they’ve all said no to people who are now very successful.)

Bigger rounds have more people involved in them. An investor can make a seed decision on their own; but for Series A, a VC also has to convince everyone else at their fund. If one person is very against a deal, it won’t happen, no matter how much the investor you’ve been talking with wants it. So Series A is a matter of both conviction and politics. Those politics usually have absolutely nothing to do with you as an entrepreneur or the business you’re building.

Having an investor whose conviction and politics are both straight is crucial for your future, too, because if you have a Series A investor who doesn’t want to invest in your future rounds, the company is going to struggle a lot. Everybody understands if a seed investor doesn’t follow in a Series A, there are tons of reasons why that can happen. But Series A investors are seen, for better and for worse, as investors for life, the ones who come onto the company board and stay there for years. The board members who came on with the Series A at Uber, they were there through the IPO. Series A means you’re getting married, just without the possibility of divorce. Choose wisely.

So what can you, the entrepreneur, do to maximize your chances of winning the fundraising game in the early stages of your company’s life?

1. Don’t play it like Tinder. Fundraising is about matching with the right people, building a relationship. It’s not just a seduction game. You’ll meet with lots of investors just to get one term sheet, so trust your instincts — if things feel off, don’t waste your time.
2. Have the right attitude and give them something they don’t expect. In Europe, lots of VCs are impressed by irrational behavior or when entrepreneurs stop the process themselves, telling the investor it’s not going to work out. Show them you know it’s not about surviving, it’s about thriving.
3. Don’t lie. Investors are like the police, they hear people lie all the time, they can spot it immediately.
4. Ask questions. You’re evaluating the investor too, figure out why they want to invest in you. The more intense the questions, the better the relationship you’ll be able to build over time.