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Investor Discovery: The Most Important Fundraising Step That (Almost) No One Does

What are you going to achieve after your fundraise, and why? When I ask founders what they expect to achieve with the proceeds of a fundraise and why their goals are what they are, I usually receive answers that fall into one of two buckets: 

1. The Finger In The Air: The founder believes they should achieve X because, well, it feels reasonable and sufficiently aggressive. 

2. The Past Performance Predicts Future Results: The founder has sufficient trailing data from which to extrapolate future projections, which typically will be adjusted until they represent an exponential growth curve. 

Neither of these two approaches are wrong per se, because they both inform what’s possible to achieve. However, they’re both quite insufficient, because neither is driven by what is necessary to achieve. I’ll explain… 

Customer Discovery 
Founders today are steeped in the necessity and virtues of Customer Discovery – the process of deriving truthful insights about and from one’s customers to inform what they want and what the company should build. (Side note: The Mom Test by Rob Fitzpatrick is the best resource I’ve come across for how best to approach this process.)  

And yet as common as Customer Discovery is, I’m frequently surprised by how many founders, in setting their corporate goals and expectations, fail to undertake (sufficient) Investor Discovery – learning from their current and/or future potential investors the benchmarks that must be met in order for the investors to purchase more equity. 

Every founder has received the feedback from a VC that “you’re too early, but please come back to us when you’re further down the road.” But how far down the road the founder needs to get before representing an exciting investment opportunity to the investor is often unclear.  

Investor Discovery
 
Founders who want to raise a venture capital round hope, in essence, to sell a product (their company’s equity) to a customer (an investor). Additionally, if a founder raises venture capital for their company, they and their investors typically expect that the company will raise additional venture capital in the future.  

I’m not the biggest believer in meeting with outside investors over and over again outside of a fundraising process, especially if the startup is still figuring things out, because a founder should spend their time making sure that their company is progressing. A “rocket ship”-performing startup will be funded by VCs, even if the VC-founder relationships don’t start until the fundraising process. A poorly performing company will not be funded by VCs, even if they’ve met and developed strong VC relationships. 

However, there’s one learning that can only come from speaking with potential investors: their startup performance expectations. Thus, before any fundraising process, a founder should meet with two sets of investors: 
1. Those whom you want to invest in your upcoming fundraise 
2. Those whom you want to invest in your subsequent fundraise

The investors whom you want to invest in your upcoming fundraise 

This meeting is not a fundraising meeting, and you should make this clear ahead of time (and again at the outset of the meeting). Your first task is to help the investor understand your business, your background, etc. Your second task is to uncover the investor’s expectations of your business. I would say some version of the following: 

“In six months, I’m going to be back in your office pitching you for our seed round. In a magical parallel universe (side note: I use these words specifically to create mental space for someone to share their honest thinking without the constraint of reality), what am I going to share with you in this future meeting that will make you refuse to let me leave your office without a term sheet?”  

Then, once you learn what the “holy shit!” level of performance is to this investor, ask, “And in this same magical parallel universe, what am I going to share with you in this future meeting that will excite you and your partners so much that though you’ll let me leave the meeting without a term sheet, you’re going to find a way to invest in my company nonetheless?” 

You need to have this conversation with enough investors so that, like learnings from customer discovery, you’re able to triangulate investor expectations and personas with as data-driven an approach as possible. Your strategic planning can now be guided by market realities.  

The investors whom you want to invest in your subsequent fundraise 

Achieving the learnings above is necessary, but still not sufficient. The expected time horizon for liquidity events of successful seed-stage companies is +/- eight years away, which means that a seed stage investor won’t know if their investment in your early stage startup has succeeded for a long time. Because of this long feedback cycle, one of the most meaningful short-term data points for an early stage investor is if a company in which they’ve invested subsequently raises a new round of financing (preferably at a higher valuation to the first round). A seed stage investor whose portfolio raises subsequent higher-valuation financing 75% of the time will look much better than one whose portfolio only does so 25% of the time. To be clear, this metric doesn’t tell the full story, isn’t the sole indicator of an investor’s success, and certainly isn’t a conclusive fund performance metric. But, absent other data, it’s a helpful metric. 

So, while you’re meeting with potential investors in your upcoming fundraise, you also need to meet with potential subsequent-round investors. Using similar language, find out what they want to learn about your company in 18 months that will earn you a term sheet. With enough of these conversations, you should be able to triangulate the market expectations for your startup’s performance. And then, in your strategic planning, you know enough to work backwards: 

If you need to achieve X in 18 months to earn Series A term sheets, how much capital do you need to raise in your current round to meet (or better yet, surpass) these expectations? And then when you’re in a pitch meeting explaining to potential  investors how much you’re raising and what you’ll achieve with the capital, you can share that your milestones are what they are specifically because that’s what you know you need to hit to raise additional capital. This story is so much more compelling than sharing that the milestones are what they are because you think they’re appropriate. For the early stage investor who, again, is going to be judged in the near term on whether or not their portfolio company raises subsequent, higher-valuation financing, the fact that you can explain why you know the goal line to be accurate is a huge positive indicator. 

You still need to convince the investor that you will be able to achieve these goals, but the fact that you have the correct map and compass heading is invaluable. One of the things that sucks almost as much as a startup not getting anywhere is a startup that achieves the milestones its founders set, only for the founders to later discover that their milestones are insufficient to merit VC investment. 

Public companies do this, too 
 
Public companies do this all the time. How often do you hear that “analysts expect Y company to deliver earnings of $A, profit of $B, or growth of C%”? Executing towards these expectations isn’t any easier for public company executives, but knowing what the market expects is a prerequisite for setting and executing the appropriate corporate strategies.  

Conclusion 

Investor Discovery – the process by which a founder (or CEO) uncovers the expectations of current and/or potential investors so that a company’s strategic goals are informed by critical market data – is the most important fundraising step that (almost) no one does. Larry Page once said, “Always deliver more than expected.” Well, the first step towards heeding Larry’s advice is simply figuring out what is expected.