(Unstated) VC Fundraising Risks

Part of unpacking the “black box” of pre-seed/seed fundraising from the founder perspective is figuring out what investors are often thinking but not saying. Some of these risks are obvious and are “fundamental” risks to any investment decision, on team, product, market, competition, AI disruption risk, sales execution, etc, that are likely to come up in fundraise pitch meetings.

But another bucket of often unstated risks a first check investor may be thinking about includes things that are more specific either to fund math, or to founder personalities - both categories that often go unstated by either or both sides. Here’s a short - incomplete - list of some of these types of risks:

• “Go the distance” risk: “Does this team really want to build a $1B+ company, or are they likely to “sell early”?”

  • Founders that talk in “billions” (people, dollars, tokens, hours) - as long as it’s credible - earn points for recognizing that huge, impactful swings are the way to an investor’s heart, and we’re not here to play small-ball.

  • It’s of course sometimes the right thing to do to accept an offer when an M&A offer comes in, but the power law nature of venture dictates that the ambition from the jump needs to be to build a huge business, even if it doesn’t turn out that way.

• Fundraising risk: Who will write the next round check, and are these founders compelling enough to paint the narrative that will raise more capital?

  • Strong product + execution chops are necessary, but often not sufficient to raise more capital.

  • Raising capital is an art and a skill unto itself that founders need to have. It can be learned, but many founders under-appreciate both how critical this skill is beyond the first round, and how elite some of their fellow founders are at this.

  • We can and always will help, but founders that are networked-in, or who are dynamic and energetic in a way that gets people excited to work with them (as investors and as employees), are who rise to the top here.

  • And it’s not just about experience or repeat founders; both first-time founders or repeat founders can dazzle and be incredibly compelling and forces of nature, or they can fall flat amidst a sea of other founders pitching to raise their seed or A after their initial round.

• Opportunity cost risk: “Should I spend time on this one, or should I wait for the next one?”

  • While some investors are more active than others and write more frequent, smaller checks, lead investors - at all stages - generally pace their investments.

  • Founders are battling not just whether their pitch is compelling, but also the question of “is this the one this quarter / year” for the investor they are talking to.

• Dilution risk: “Will this company become huge but at the cost of investors being overly diluted?”

  • Investors think about this a lot - particularly those whose fund models are not built to have reserves in place to continue to buy in size in follow-on rounds to maintain their initial ownership. Dilution is part of the model, but too much could make an outcome potentially not worth making the initial investment.

  • This could be driven by the fundamental nature of the market they’re building in being equity-capital intensive or by whether follow-on rounds are likely to happen at high enough valuations to avoid massive dilution.

  • But its also driven by little things like the size of the option pool top-up in each round. In theory founders + investors have aligned incentives here; but in practice founder equity is often topped-up by follow-on investors, but no such luck for those of us who take the most risk and invest first.

• “Make my investors money” risk:

  • Seems obvious, but the best founders speak in the language not just of their markets and customers, but investors too. They actively think about how to drive returns for their investors - across different rounds and fund sizes - and aspire to be the “breakout” and the “fund returner” in their investors’ portfolio if possible, not just consider what their personal economics will be at an exit. On the other hand, some founders don’t think of VC as a partnership, and more of a means to (their) end only.

• “Cavalier attitude to taking VC money” risk:

  • Related to the prior bullet but somewhat of the inverse. When I hear - directly or indirectly - of founders who say things like “they won’t care if we fail, they have a big portfolio, we’re just one investment”, I cringe. Professional founders take the responsibility of taking investor capital - particularly institutional investors (vs angels) seriously, and treat it as such.

  • Everyone around the table knows going in how unlikely the odds of success are, but that’s no excuse for not recognizing this responsibility and acting accordingly. We want to work with founders that recognize that raising 3rd-party capital is a privilege, not a right. You are a steward of your investors’ capital, just as VCs are to their LPs.

  • This is particularly true for firms like ours at Garuda, that don’t really write “option” checks - every check matters to our fund, and we want to work with founders that recognize that.

If you’re not sure if any of these are going through the mind of investors you’re talking to, raise the topic directly! It can help get investors to say explicitly what they are thinking but not saying, and an open, direct dialogue during the pitch phase is a good indication of a successful longer-term partnership post-investment for both sides.