No more cheerleaders and today’s need for “founder fit”

Factoring in the dramatic shift in sentiment that has swept the startup world, including the recent eye-popping write-downs of some of fintech’s high-profile favourites, today’s world seems a far cry from the heyday of 2021.

There is simply no such thing as “easy money” for entrepreneurs anymore

When I think about how a younger, fresher version of myself would feel if they were starting their careers, I am grateful for each of my 22 years of experience. During that period I have experienced and learned from all the ups and downs of the market after surviving the infamous dot.com bubble burst. Reflecting on both the good times and the hard times, I find myself redoubled in my belief in the essential value of founder fit.

As today’s market retreat teaches us, investors have a responsibility to devote time and resources to performing proper due diligence, and refrain from overpromising the value they can add to founders. Similarly, when we talk to founders, we always advise them to take the due diligence process seriously, allowing sufficient time for not only potential investors to understand the company, but also for the founders to get to know their investors .

However buoyant the market backdrop, it is important to remember that this more measured, demanding process should not be considered a barrier to achieving a good founder fit for investors. Rather, it is typically the hallmark of an investor who makes sure they are fully prepared to roll up their sleeves if or when things get tough. This approach frees both parties to move beyond a short-term monetary focus and develop a relationship that goes beyond being a friendly voice to the founders, and instead forms a valuable relationship.

The lead up to the gold rush

Before the 2020 acceleration, founder-VC matchmaking operated along what had become a fairly balanced, traditional process. VCs led with more than just their wallets, appreciating the value of their guidance as well as their ability to sign checks. Diligence processes took 6-8 weeks, or longer, with valuation agreements reached at sizes and terms that were fair to both parties. For both sides, the sheer effort required to raise funds meant that there was some relief when a partnership could be struck with minimal barriers to consider.

In 2020 and 2021, the floodgates opened to new investors. These investors included not only crossover funds, but also newly formed, relatively inexperienced, young VCs born in the 2010s and new to declining markets.

Bolstered by confidence in the market, the growing race to complete partnership processes bypassed key due diligence stages, as many founders ignored the investor’s ability to mentor on top of capital. Founders were understandably attracted by the promise of receiving high investments at outrageous valuations, receiving term sheets in days, not months, all without the hassle of due diligence.

The inevitable problem with founders raising money during these gold rush years is the risk of rapid-fire investors who add no value to the company beyond funding. As soon as the market shifts from bullish to bearish, these hasty, inexperienced investors withdraw from the market, now unable to follow through on their financing due to missing out on maintaining critical reserves.

Recalibrate

Today, our advice to founders starts with the message that you need to recalibrate your fundraising strategy. There is simply no such thing as “easy money” anymore. You must take the time to assess investors, including extensive reference checks and significant due diligence processes. If this is done well, your cap table will be the right mix of experience, aligned interests, deep pockets and hopefully strategic support.

With a strong cap table, entrepreneurs can manage their business to survive a colder market. Ideally, founders will partner with an experienced VC investor who has weathered storms before. But if you don’t have a crisis-savvy investor on board, entrepreneurs need to be prepared for an upcoming extended period of very difficult market conditions for at least 18 to 24 months.

To do this, entrepreneurs must self-critically assess their position. Are you one of the handful of companies with a rock-solid business model that is breaking even or close to breaking even? If so, you can ignore the advice below… But if not, you might find this advice useful.

Be self-critical

Entrepreneurs must regularly evaluate the company’s ability to weather economic storms. They need to ask themselves, how strong is my investor base? Are investors able to fund us internally? When do we have to collect money again?

Go back over your accounts with a fine-toothed comb, examine where you can cut costs and ensure at least 18 months of run rate. If this is not possible, your next move is to raise funds from your existing investors and start cutting costs.

If existing investors are able to fund you, be sure to discuss convertibles or reopen your last equity round to gain the necessary runway and prevent you from going back into the market. It may not be a completely comfortable process, but this type of self-evaluation can provide huge and important benefits for entrepreneurs.

Ingredients for a meaningful fit

When approaching investors for the next round of funding, entrepreneurs should be well equipped, having completed the above self-assessment and recognizing the importance of partnerships beyond finance.

As in all strong, long-term relationships, there must be give and take. Be reasonable in terms of valuation and the amount of funding you are asking for. Accept Fair Dilutions – The days when a pre-revenue company could get $10M on a $100M valuation are over.

Do your due diligence on your investors. Research and see if you can learn how they perform when times get tough. Dig a little deeper and take input from their current and former portfolio entrepreneurs.

For investors and founders to achieve a meaningful fit, they must allow sufficient time for both sides to get to know each other. With dark skies ahead, it’s important that entrepreneurs learn from the mistakes of others, fully understand the health of their business and the full potential value each investor brings.