How To Fix The Broken Fundraising Process for Entrepreneurs
Raising capital for a startup is a lot like getting a hug … followed by a swift punch in the gut.
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If you’re like the thousands of startup founders we’ve worked with, you understand. You receive a check from your venture capital partner (a massive accomplishment), and the next thing across your desk is a legal bill to cover the tens and thousands of dollars of fees for documentation and diligence.
Before you even pop the champagne to celebrate, your capital begins to dwindle. What’s worse, that money could have been put toward adding a new engineer or business development representative: someone who can actually grow your business.
The private fundraising process is broken, and not just for entrepreneurs.
Everyone contributes to this fractured landscape, and everyone can play a role in making things better.
Entrepreneurs don’t have the time or resources to truly understand legal documentation or the rigorous diligence required in their day-to-day business operations. This leads to messy documents and cap tables as they approach a fundraising round.
Not knowing what to do, scrambling founders turn to attorneys, who partner with VCs. These attorneys are left doing grunt work like checking names, correcting punctuation and collecting signatures: secretarial work far below their pay grade. VCs, meanwhile, are assuming risk by writing a check for a company with dysfunctional diligence.
Startup founders are effectively taking venture capital money out of their business and funneling it to attorneys who should be focusing on more important matters. That means less growth potential, and more friction for all three parties.
Documents matter. At the end of the day, founders don’t dictate equity distribution: the company’s cap table does. Getting core company documents done right, the first time, is good for the entire entrepreneurship ecosystem.
Four ways to fix the fundraising process
Entrepreneurs must get smart. Founders should take the time early on to understand the basics of equity. You don’t have to crack open a law book or become an expert on every single SEC regulation. Entrepreneurs should however, know why things like stock options, restricted stock, preferred stock and 409A agreements are important. Doing so will give them an advantage.
Have tough conversations early. I’ve seen colleagues who left after three months come back to a founder asking for the 50 percent equity they’re owed. I witnessed a legal battle over a founder who promised a girlfriend 2 percent of his company—until they broke up. Things happen, and life gets messy. Entrepreneurs must make sure their early stages aren’t like the Wild West. Do the proper documentation for everything so you have your affairs in order and can stay financing-ready.
Embrace electronic platforms. Entrepreneurs can’t do it alone. There’s equity management software out there that automates granting equity, incorporation, formation documents, stock incentive plans, gathering signatures, scenario modeling and more. It makes life so much easier for everyone involved. I’ve spoken with hundreds of lawyers about this. They’re justifiably cynical of technology solutions that have fallen embarrassingly short of expectations. Fortunately, technology has caught up with the promises and can now deliver.
Play the long game. If entrepreneurs, investors and lawyers get on the same page, there’s real potential for a win-win-win. Founders can trust their data, cap table and data room, knowing that they’ve done their due diligence, utilized their lawyers for specialized work, and delivered what their investors need. The end result is more trust, more confidence and more speed getting from term sheet to close. Growing companies keep more money in the bank, meaning more opportunities for growth. Who doesn’t love that?
In the moment, it’s easy to forget that founders, investors, and attorneys are all on the same team when it comes to fundraising. It’s time we remember that.
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