Instacart went public a couple weeks ago to great anticipation.
I was watching for a couple reasons….
First, I’m excited to see more events that make later stage investors relax a bit. Once later stage investors relax… earlier stage investors feel more comfortable placing bets (something we all want to see).
Second… I was looking to see who actually made money. Which firms were part of… the money round.
Sequoia in the Series A…A16Z in the B. They both were total money rounds…
It’s an interesting concept that is worth spending some time on for you all.
As a founder looking to raise capital, it’s crucial to understand investor psychology and to anticipate what potential investors are looking for, as well as what they seek to avoid.
I want to describe a situation in investing that’s ensnared almost every VC I know, making them increasingly cautious when evaluating potential investments.
When looking at a deal, investors are evaluating whether or not the round that is being raised is the money round. They are looking for the round of investment that comes just before a sharp increase in a company's valuation. The opposite of being in the money round is investing in a round that requires more investment afterwards, causing the valuation to remain flat or increase only slightly.
If you were too early at a company and you were the first money in- before a company figures it out and starts increasing in velocity and growth rate- then you’re going to get diluted down significantly before a company’s value starts being created, and your return profile will be remarkably different than if you had waited for the the money round.
Investors will want to know: If you raise this money now, what will you do with it? What will that actually get you, and what milestones will you achieve? If they’re thinking to themselves, “This company is taking a long time to do ___. They need to develop ___ technology, and they still have a ton of research to do on ___”, these are all things that indicate “This might not be the money round we’re looking at.”
For example, the founder of a men’s wellness company pitched me claiming they’d be able to launch with five or six products, with many more in the pipeline. However, I questioned his ability to do so much in a very short timeframe, and I thought he was underestimating how difficult it would be to launch as an unknown brand in a crowded space, pass safety inspections, etc. I still liked his team and overall vision, but thought there’s a very high chance that he’s going to have to raise more money soon. In that case, this investment round is going to get diluted without too much progress being made.
There is also the case of raising at too high of a valuation. As an investor, I’m thinking “If I invest in this now, will the company be able to grow enough in order to significantly surpass the valuation that I'm investing in? Can they hit all these milestones and then double their valuation from there?“
VCs want to see valuations double at every round after the one they invested in. That's the sort of momentum and velocity of company-building that they want to be a part of. And if they don't think that's going to happen after this round, then a good reason to pass would be “I don't think this is the money round.”
So how can you think about this as a founder and defend against the perception that this is not the money round?
1. Be Clear about Your Milestones: The framework that my friend Parker from Cobli always leans on is, “Does the founder know what they're going to need to do in order to raise the next round of capital?” This shouldn’t be vague, finger-in-the-air projections- have a strong point of view and specific vision about the milestones you’ll hit with the funds and your specific playbook for getting there. Clarity on how much funding you'll need, and the outcome you expect, is crucial to convincing investors.
2. Focus on Your Story and Narrative: Spend time honing your "story" – what milestones will you achieve, and how will you present that to investors in the next round? In 18 months, will you have a fully-built product and generated your first revenue? What does the fundraising storyline look like? Does it feel exciting enough to raise at double the valuation?
3. Build Investor FOMO (Fear of Missing Out): Everything about fundraising is generating the feeling like they can't miss investing now. How will you convince investors they cannot afford to miss out on this funding round? The founder has to feel like every round is the money round for them, and they need to be excellent at communicating that to potential investors
In conclusion, understanding the concept of the money round is essential for understanding investor psychology and telling a narrative that aligns with their expectations. By having clear milestones, crafting an engaging narrative, and generating investor FOMO, founders can successfully convince investors that their current fundraising venture is the money round.