In economic theory, the trilemma refers to the challenge countries face of only being able to choose 2 of 3 elements when creating their international monetary policy. It was a favorite topic of mine from business school (nerd alert I know) so I couldn’t help but think about it when I saw this tweet from David Frankel:
It may seem like a simple concept, but it’s worth breaking down as a teaching concept in fundraising. Really understanding why David believes that you can only choose two (and I do too) is a window into more deeply understanding investor psychology. And, once you understand investor psychology, you have all you need to creatively problem solve when fundraising (as opposed to blindly following expert opinion on Twitter).
Looking at the 3 elements of high valuation, quick close, and great firm, a founder would love to have all 3 in a fundraise. A high valuation minimizes dilution, a quick close removes stress / distraction, and a great firm better supports the company (oversimplifications I know).
The two elements that they can control in a live deal, quick close and high valuation, both represent things they don’t necessarily want to give. A quick close means less time for diligence, and high valuation depresses returns.
For any deal worth doing, 1 of the 3 alone will not be enough to get a deal done so we need to look at the situation for each 2-element combination.
This situation is a firm whose reputation isn’t a huge positive on its own. This isn’t to say it’s a bad firm. It might be a first-time fund or a fund that’s under the radar. Regardless, for these funds to land a deal (especially when going against a fund with a better reputation), they have to pull out all the stops, move quickly, and show founders the money. By giving everything they possibly can (a quick commit and a high valuation), they are saying “Please choose us!”
Funds like these are great to have in the mix because they can help move a process along and apply pressure to the other investors looking at your deal. And who knows, you might like the VC offering you a quick term sheet with a high valuation enough to go with them!
When a great firm has an opportunity to build a relationship with a founder, meet the team, and really understand how the company operates, they can really fall in love. The high val + great firm situations are usually competitive across a few other great firms. This happens when a highly backable founder takes her time planning a raise with awesome firms who she’s built relationships with. The time from formal “start” to finish might not be that long, but she has already invested time in laying the groundwork. When this is done, the investors can say “We did all our work. We love this founder and the company” and will happily pay up to win the deal.
Great firms don’t love loathe being rushed. Their deal flow allows them to miss quality deals because they know for them it’s like a bus station...there’s always another one coming. All that said, investors, even ones at great firms, are still human. The fear of missing the big one, the one that will return their fund, will get them to jump and speed up their normal process. In these situations, they have the upper hand of being a great firm with a brand that entices founders. In these scenarios, a firm might submit a fast term sheet but won’t come in with the highest offer. They are in some ways saying “We’ll play your fast close game, but we also know you really want to work with us and our brand.” And this often works. Founders- for both good and bad reasons- will give up a higher valuation offer in order to work with a great firm.
There you have it - the Fundraising Trilemma. I don’t make the rules...I just illustrate them!