3 Pitfalls of Early Venture Capital Deal Structure

By Nicole Gravagna, Peter K. Adams

If you ask venture capitalists (VCs) or private equity consultants (people who help companies get ready for VCs), they’ll tell you that they see so many companies that have great opportunities but that they can’t raise a new round of funding for because of poorly structured past deals. This unfortunate situation is very common and can permanently ruin a company’s chance for VC funding.

The best way to prevent this kind of critical growth failure is to plan your fundraising from the beginning. Know whether your company plans to use VC funding as part of a growth plan and make sure that your early raises have that goal in mind.

If you were going to take a road trip, you’d get out a map and figure out what your options were to reach your destination. You’d map out cities that you would pass through on your way to your goal. If your goal was to reach your destination as quickly as possible, your route would be as close to a straight line as possible.

Figure out your investment round timing

The timing between investment rounds is critical to your success. The guidelines differ for every industry. In a life science company, a company might go years between investment rounds, whereas a web app company might raise a round only a few months after the last. The general guideline is that funding rounds are separated by 12 to18 months.

Timing is important because you need to accomplish two major objectives between each round. One, you need to achieve your milestones. Two, you need to raise your next round. The tricky thing is that you can’t raise your next round without having achieved your milestones, but if you spend all of your efforts achieving your milestones, you won’t be able to raise your next round, and you could be stuck.

The amount of time raising capital takes is a factor, too. Depending on the economy, the size of your round, your own ability to raise money, and the network surrounding your company, fundraising could be a full time job that lasts a while.

Plan on 6 to 12 months to raise a round of funding. Occasionally you see a few companies do it in weeks, but they would have prepared the deal down to the last detail before they told anyone they were fundraising. You often see companies take more than a year to raise money as well.

Know your company’s burn rate

Investors always ask you about your burn rate, that is, how fast you’re burning through their cash. In a mature company, you don’t talk about burn rate because you have revenues and expenses, and hopefully your revenues are greater than your expenses. In a pre-revenue company, however, it’s all expenses, and the rate at which you burn though cash says a lot about how you’re running the company.

Investors appreciate your understanding of burn rate. It’s helpful to have an analysis of ways to speed up or slow down the spending. In their eyes, a too-slow burn rate is just as bad as a too-fast burn rate. Too slow means that you are not thinking like a venture company with super fast growth. Too fast means that you are out of control and spending the investors’ money recklessly.

Burn rate is also tied to your milestone achievements. You need to match the amount of money you spend each month with the amount of achievement you need to make towards your milestones. Your main objective is to make sure you have enough cash to get your goals achieved and raise the next round before you run out of money.

Tackle finance milestones

Milestones may be the most important part of your finance strategy. You need to think about milestones in a way that involves clusters of value. Just accomplishing a random collection of tasks does not add value in the way that a milestone strategy will.

You see a lot of companies who are fixated on solving the next big challenge in front of them. Software companies focus on finishing the beta and getting the working version done and live on the Internet. That’s great, but if your funding round gets you to a live version of software with no customers, you might be stuck.

Think about your milestones in terms of risk. Each milestone you achieve is a reduction of risk for your investor and an increase in value for your company. Early risks tend to be technology risks. You need to prove that your software, patent, invention, or whatever can do what you say it will do.

Later risks tend to be market risks. Can you establish viable channels for your product? Will people buy it at the price-points you have set? Can you leverage a small marketing budget into measurable results that will be repeatable with a bigger budget?

Your milestone strategy should combine multiple risks so that investors are confident in investing in your next round. Don’t just raise enough money to satisfy your technology risks, but be sure to add another $100,000 to $200,000 to test market your product and be able to consistently demonstrate an increasing conversion rate on customers who see your product.