The New Rules of Startup Fundraising

In February, Hired announced that it had closed its Series C round of funding. This news was the culmination of a process that started last autumn in a market awash with unbridled optimism about unicorns running the world and ended in November with dire predictions of the mass extinction of the species. I’ve worked in the Valley for more than 20 years, and have participated in dozens of fundraises on both the investor and company side, and this go-round was remarkable for a few reasons.

Most notable was the speed with which the conversation changed as the markets shifted dramatically. I started having very preliminary conversations with investors in August of 2015. When word started to get out that we were looking for our next round, more than 30 firms started calling. The more they heard others were talking to us, the more urgent their requests for a meeting became. The talk was of preemptive deals and paying whatever it took.

Initially the conversations echoed ones I’d had while raising Hired’s earlier rounds: How fast can you scale? What rate of growth are you projecting for next year? How big is the TAM? When can this IPO? But as we returned from Labor Day and the public markets convulsed, the mood changed seemingly overnight — and so did the questions.

Now we were being pressed on our burn rate and asked when we’d reach profitability. There were many custom requests for analyses. We were prepared and had good answers to those questions, but the rapid sea change was startling nonetheless. The overall feeling of exuberance I’d witnessed just weeks earlier had all but evaporated and been replaced by something new. Fear Of Missing Out was replaced by Fear Of Getting In.

To be sure, startup funding exists on something of a pendulum that swings back and forth between a feverish sense of FOMO and white-knuckled restraint. This particular swing, however, felt unusual in its speed and decisiveness. Perhaps it’s the fact that plenty of the people who weathered the dot-com collapse and the 2008 financial crisis are still working in the tech industry today and bear the scar tissue of those experiences. Perhaps it’s the fact that platforms like Twitter and Medium have elevated the discourse around a possible market correction into a cottage industry with apocalyptic undertones.

Much has been said about this topic by entrepreneurs, VCs and industry pundits, and my intention is not to rehash those sentiments here. However, the timing of our raise vis-à-vis the overall cooling of the funding environment provided me with a unique perspective on this topic. For that reason, I thought I’d share a few takeaways from my recent trip down Sand Hill Road.

Start early. This one’s no secret. Any entrepreneur worth his or her salt will tell you that you shouldn’t wait to start raising money until you need it. It holds even more true now. Not only should you start talking to investors long before you start running out of cash, you should consider fundraising an integral and ongoing part of your job as CEO. Even if your next round isn’t on the horizon, discussions with investors will build relationships that could uncover potential red flags within your business. If you’re burning through cash too quickly or don’t have enough recurring revenue, it’s best to find out and fix it before it’s too late. For those who are actively thinking about their next round, plan to start the process 4-6 months before you want to have a term sheet in hand.

Craft a compelling story. In a tighter funding environment, it’s more important than ever to understand the view from the other side of the table, anticipate concerns about your business and proactively address them. When you’re creating your pitch deck, think about the story you want to tell — is it one of growth? Are you gearing up for an IPO? If you’re new to fundraising, find mentors or advisors who have raised before and can coach you through the process and help you tell your story in a way that will resonate with investors. If you already have investors from previous rounds, practice your deck in front of them and get as much candid feedback as you can.

Be prepared for tough questions around profitability. This was perhaps the biggest change I noticed in our discussions — the “growth at all costs” mentality had given way to repeated inquiries around when we would be profitable. The most important advice I can give here is to get out in front of this question. Instead of waiting to be asked, have all this information front and center in your deck to address potential objections proactively. Then continue to update your deck as you hear new objections. You need to be able to articulate your path to profitability, lay out exactly how much cash you’ll need to get there, explain how you’ll make your unit economics work and address the risks and how you’ll overcome them.

Be willing to be flexible on your valuation. 2013–2015 was a particularly frothy time in tech that saw the average startup valuation increase by 3x in a matter of just two years. Today lots of entrepreneurs go into the fundraising process gunning for a $1B valuation, regardless of whether or not their business actually warrants it. What many of them don’t realize is that a high valuation comes at a high cost that can come back to haunt you. When you put valuation ahead of everything else, you’re likely sacrificing clean terms and exposing yourself to the possibility of a demoralizing down round if your company can’t meet heightened expectations.

In today’s fundraising climate, valuations are crashing back towards Earth, and you need to be realistic and look at public market comparables. If you’re a SaaS company and other SaaS companies are trading at 5x sales, you can’t ask for a 30x valuation. My advice: don’t walk into the room with a valuation in mind. Focus on how much you need to raise and let the investors come back to you with a number. If you are oversubscribed and have pricing leverage, I always pushed for clean terms first (no “structure”) and then look at valuation. We have consistently chosen not to optimize for valuation — even when there were higher offers on the table — because we know the true long term cost of a nosebleed valuation with onerous provisions in terms of capital strategy, team morale and board dynamics.

Expect scrutiny. In previous rounds, only our lead investor did due diligence. This time around, all of our investors — including existing investors doing pro-ratas — did due diligence, and lots of it. As a result, the typically quick process of filling out a round took several weeks. In the end, this turned out to be a win for us: after doing diligence, all of our existing investors asked to do super pro-ratas that increased their equity stake in Hired. That said, the takeaway from the whole experience is that anyone looking for funding today should expect to be put under the microscope.

Choose your investors wisely. Unless you’re one of a very small handful of companies, the heady days of meeting with four firms and then closing a deal are long gone. You need to start broad, make a long list and take a lot of meetings to find the right partner. I use that term precisely — you should pick the partner, not the firm. You’re getting into a 7–10 year relationship with that partner, so you better feel really good about him/her and be very clear on how they will add value. I’d be concerned if I had just raised at a unicorn valuation with hedge fund board members that are motivated differently from venture investors.

Fundraising is a stressful process at the best of times. In the current environment, it is particularly challenging. That being said, I think this represents an opportunity for great companies to stand out from the crowd as the bar for funding moves higher. As the hubhub of easy capital dies down, the companies that can tell a long term story of profitability and defensibility will strengthen balance sheets, increase their runway and attract the best talent. Having seen multiple cycles, I believe that the best companies are forged when capital is hard to come by. This time should be no different.