Steering Clear of Common Deal-Killing Mistakes
When investors and early stage startups start the courting process, there’s inherently a lot of uncertainty and unknowns. Investors and founders have to navigate a complex web of assumptions, information asymmetry, and complex technical and operational diligence, all while maintaining alignment on the goal and structure of the transaction. Deals can fail for a myriad of reasons, some of which the founder can control, and that’s what we’re focusing on today.
For this week’s Insight, we sat down with Shaandiin Cedar, Senior Associate at Powerhouse Ventures, to explore some of the lesser known deal-killing mistakes she’s seen early stage founders make — and how you can avoid them.
1. Your exit vision lacks ambition
Behind the venture capital fund curtain, a lot of thought is put into portfolio construction and fund economics, which drive target returns at the individual company and portfolio level. As a founder, it’s advantageous to show prospective investors you’ve been thoughtful about and are aligned with building a billion dollar company with an exit outcome within the next five to ten years. Your commitment to being in this for the long haul should be apparent throughout your conversation. If this is not the case, then perhaps question if VC dollars are right for your company.
Start by making sure you have a firm grasp on the kind of returns an investor is expecting. Depending on the fund, VCs typically need to see 5-30x returns on their investment. While some companies certainly have “VC-backable” potential, don’t make an investor dig for why your company is positioned for outsized outcomes. Avoid being flippant about future potential or revenue projections; instead provide evidence, examples, and relevant supporting materials that help show the pathways in which your business will achieve a $100M+ revenue scenario. If you can give investors a strong and supported answer to the question “how are you thinking about an exit?” you’ll start to build trust with your investor that you have what it takes to build a category-defining business.
2. Your team falls short - and you don’t have a plan to fill the gaps
One of the first things an investor will try to decipher is whether your team has the requisite skills to build a product, test, pivot, and scale a successful business. This is especially amplified for investors at the pre-seed and seed stage. However, not every early stage founder will show up to an initial meeting with the perfect team already in place, and that’s OK! If you’re missing vital knowledge or skill sets key to the formation and growth of your company’s product — perhaps you haven’t yet found a CTO — this isn’t necessarily a deal breaker, however, come prepared with an explanation and plan that matches any perceived skill gaps that an investor may fixate on. Talk about team gaps candidly, and lay out your plans for hiring the right people. Highlight how you will tap into your network and the list of potential candidates you already have in the pipeline. Being proactive about solving for an incomplete team will help overcome a hurdle that a lot of investors may see as a non-starter.
3. Your idea of TAM isn’t penciling out
Although some early stage founders may not have a lot of hard data to back up their market sizing, many deals fall apart because founders don't have a good handle on their market opportunity. You should be ready to defend your TAM, SAM, SOM (total addressable market, serviceable addressable market, serviceable obtainable market), and be able to show investors the logic, assumptions, and process you used to size the opportunity. There are plenty of tools out there to perform both bottom-up and top-down market sizing analysis.
In fact, the process can matter even more than the specific numbers you present. It’s the investor’s job to pull your model apart and test your assumptions, forming conclusions on how realistic and significant the market opportunity really is. Make it easy for investors to be on your side when they go to their committees by providing them with a market model which clearly outlines the evidence you're relying on, and exactly how you got from A to B. This will lay the foundation for a productive conversation with your investor too if you don’t agree on certain assumptions or methods.
4. Not being upfront about your “hair”
If a previous founder has left your company on bad terms, your cap table is wonky, or you're looking to raise a down round — your company has “hair” AKA things that you cannot change but pose additional hurdles to the investment process. “Hair” does not disqualify you from raising capital, but how you message it might make or break the relationship with your investor and the likelihood of getting funded.
With “hair”, transparency is your friend. Investors are like detectives, taking a microscope to each part of your business, and are likely to uncover new and old blemishes over time.
The best policy for “hairy” fundraising circumstances is to be upfront with investors to build trust and avoid misrepresentation. Tell investors that you fully recognize the extent of the problem and outline the steps you’re taking to address it. If it’s a solvable problem and the investor thinks they have the expertise to help you navigate it, there’s a chance your hair might not be a deal breaker.
When should these conversations occur? The sooner the better. Avoid your investor discovering the issue on their own in diligence. Major issues should be broached early in the diligence process, ideally in the first call.
Shaandiin Cedar is an investor at Powerhouse Ventures, a leading early-stage climate tech venture capital firm focused on backing founders building digital solutions for rapid decarbonization. Shaandiin has worked with a range of clean energy stakeholders—from helping deploy renewable assets and energy efficiency projects in low-income housing to working with Fortune-1000 corporate sustainability teams. Shaandiin is a climate tech writer and climate justice advocate dedicated to the equitable and timely transition to a clean economy.