Secrets venture capitalists may not want founders to know

How does a successful serial fund raiser do it? That’s the question Startup Grind Toronto guest host Matthew Ingram asked Andrew D’Souza at a recent fireside chat. D’Souza said several things that venture capitalists (VCs) probably don’t want you to hear. So, listen up.

First, a sanity check

Those stories about how much easier it is to raise money in San Francisco than Toronto? “It’s totally not the case,” says D’Souza. “It’s really hard to raise money anywhere for everybody. This will be my fourth fundraising and it still takes 50-plus meetings. Most people say ‘no.’ You’ll hear a lot of nos.”

The first part VCs don’t want you to hear

In the bare-knuckle sport of getting a term sheet, D’Souza says, “you get something for team… (if) you know the person… have a relationship for a while. But really, it comes down to leverage. All VCs don’t want to miss out on something. So you have to think about ‘what is the best leverage that I can have?’”

In D’Souza’s experience, “you need to convince them that you don’t need their money. It’s like dating. As soon as you say ‘oh, I’m not that interested in you,’ they go ‘wait, wait, wait – what would you do with our money then?’ The best way to do is to have a business that is making money.”

D’Souza took advantage of this leverage when he raised funds for Top Hat Monocle. “(It) was cash flow positive when we ended up raising, which really put us in the driver’s seat,” says D’Souza. “(We could say) ‘we’re growing, we’re going to continue to grow, it would be great to work with you and grow faster. But if not, we’re going to keep growing until somebody else does.’”

The second part VCs don’t want you to hear

Think of it as Plan B for the, “companies (that) just need capital before they’re worth anything.” D’Souza says, “in that situation, the second best way to convince somebody that you don’t need their money is to convince them that somebody else is going to give you their money.”

“It’s creating scarcity. (There is) an advantage you’ve got coming from Toronto, and other places that are not Silicon Valley. (You can say) ‘we’re in town this week, we’re taking first meetings. We’ll be back in two weeks and taking second meetings. Then we’ll be back two weeks after that and we’re getting term sheets.’ It’s scary, because on that first trip you probably only know two people. (And) you’re going to tell everybody ‘this is what we’re doing, here’s our process, get on the train or get off.’”

“The first two meetings will turn into more meetings and those will turn into meetings very quickly if you’re telling the story in the right way and you’re engaging folks,” says D’Souza. “You have to believe it yourself. (To say with conviction) ‘here’s my process, here’s what’s going to happen’ and then you get people on that train. And then somebody blinks. Once you get that first term sheet, then everybody else is like ‘Oh, no, no, no, wait, you should work with me instead.’”

Myth or reality: Toronto investors prefer to follow

When Toronto founders gather, kvetching is common about how Toronto investors are unwilling to be first movers. D’Souza disagrees. He says founders need to get better at creating and using leverage.

“I think it’s how you play it. When Canadian investors know you’re spending a lot of time in the Valley, and you’re taking second and third meetings, they start to get a little worried. And when US investors know you’re coming back to Toronto to take second and third meetings, they’re like, ‘I don’t want to get scooped.’ So there’s a great opportunity to play them off each other.”

And finally, the back channel

D’Souza works with, “a few key people who know everybody really well. (They’re other) entrepreneurs… people in the ecosystem, (who say to potential investors) ‘have you heard about this company, they’re about to get a term sheet. Seems like it’s going to be a really competitive deal. Do you want me to introduce you?’”

This back channel is an important part of the, “little seeds you can plant to create that (sense of) scarcity.”

“It’s a dance,” says D’Souza. “It’s a big chess game. It’s about sprinkling the right information. All of it is true information. Sprinkled from the right little birdies. It’s really important to have the right friends who know how to tell that story.”

“They don’t call it hardware for nothing”

D’Souza acknowledges that hardware is tougher to fund than software. He should know, he’s operated companies in both categories and raised funds for each.

When he was raising funds for Bionym, a biometrics device startup, “a lot of people couldn’t wrap their heads around the technical challenges,” says D’Souza. There were a lot of questions about the market too.

“When we got to the stage where we were going to put out a prototype it wasn’t a consumer-ready experience. That’s one of the challenges. Apple has set the bar so high for what a consumer electronic device will look like, feel like and do. One of the challenges is that you can’t A-B test hardware. You can’t iterate really quickly. You can’t put a product in users’ hands, (if) they don’t like it and you can tweak it and push an update tomorrow morning. They don’t call it hardware for nothing.”

Does that change the strategy for raising funds for healthcare startups?

In one sense, no. You still have to create leverage. You have to convince investors that you don’t need their money.

The difference is that your chances of using Plan A are pretty low. For Plan A to work, you must build your company to the cashflow positive stage before you seek investment. The probability of that for healthcare startups is pretty low unless you have really deep pockets.

What are the odds like with Plan B? Here’s what D’Souza found: “Bionym was a very early pitch. (We told investors) ‘we’ve got this cool technology. We have some ideas of what we’re going to do with it. But no proof that anybody wants it’ … (and) we ended up raising a large round.”

As the company progressed it came to a fork in the road. It could continue in the direction of the healthcare opportunity that inspired the company. Or it could steer in a different direction, toward the biometric security market. The investors, perhaps mindful of the vagaries of healthcare and feeling more certain of the security market, chose the latter.

Geoff Foulds
Geoff Foulds
What fascinates me are the edges. And nowhere are the edges edgier… the stakes higher… than startups. There are plenty of sources of friction, compression and tension among founders and financiers, engineers and marketeers. How do you mesh all the edges so they transmit power even when loads are heavy? That’s what I write about.

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