It is always surprising to me that I get contacted by entrepreneurs who tell me that they expect a final closing of the deal in 3 weeks' time. Although this timeframe is compatible with some investors (like business angels who invest their own money), it is certainly not possible for most professional VCs. Why is that?
Before I go into details, you should assume that it will take on average about 4 months for you to close your round (ie. have the money in the bank). And if you have to prepare documentation (a new financial plan, a new business plan, a data room, etc.), maybe work with a fundraiser, you should budget for that extra time as well (1 month at least). This means you should start planning for a new fundraising 5 months in advance. And what if something goes wrong? You’ll have no leeway.
So a good rule of thumb is to plan to fundraise 6 months before you run out of cash. Now, you need to show that you have reduced the risk of your business with the previous round’s money. Said differently, when you raised money last time, you raised it in order to reach a number of new KPIs (new product, MVP, POC, new client, new contract, new IP, new country…). By executing your plan correctly, you proved that you actually are trustworthy, that your venture is solid, and therefore that you have reduced the risk on the business. I would recommend having at least 12 months to do so. You can’t really do much in 6 months (which would mean you don’t have much of a moat with your business), and you shouldn’t really plan for years of development with the money raised (because that means you raised too much money and gave away too much equity; unless of course if you turned profitable). So the proper metric could be to have 12–18 months to execute your plan; adding 6 months to it for fundraising means you should always raise for an 18–24 months runway. Keep in mind that fundraising distracts the CEO (and probably also the CFO and other team members) from executing the business plan, so it’s also not a good idea to always be fundraising. Peter Walker at Carta Insights has very recent data, and suggests longer effective timeframes:
The average startup now takes over 2 years to raise a Series A after their priced Seed round. That same figure is 844 days between A and B rounds, and a whopping 1,090 days between Series B and Series C.
Now — a couple caveats. Obviously this data can only show companies that actually raised their next round, and there are many more that have failed to make it to the following fundraise. (…)
A good rule of thumb is the gap between primary rounds has lengthened about 20%-30% over the past year.
There are exceptions always, and you often read about someone potentially closing a new round of financing, only months after their previous massive round. This does not reflect the needs of the business, as it would show that the investors of the previous round deeply miscalculated the financing need of the company, and would have invested knowing that the company would go bankrupt very shortly. It just reflects supply and demand in this market, with new investors wanting to jump on board and invest money. If money is being thrown at you, why not take it? It’s debatable, and not the point of this article.
Now why do you need on average 4 months?
- Identify your investor(s)
Who are you going to raise money from? Unless you know all investors, their investment stage in the fund (what year in the investment period), their investment strategies, their potential conflicts of interest, and their appetite for your sector, it is going to take some time to find the right sponsor at a venture capital firm. You could do this by pitching at some event on stage, or by cold emailing investors. You could also benefit from a warm intro from someone who knows investors well, like a friend, a business contact, or a professional fundraiser. What you want here is to spark the interest of a specific person, with decision power at a firm, which usually is a general partner; or a principal.
I would estimate this phase to be 2–4 weeks.
2. Confirm the interest of the investor.
VCs see a lot of deals every week. In my case, for the past few years, it was always about 50/week. We would meet with about 10%, so about 5 entrepreneurs per week are invited to a meeting or another call.
Let’s assume here, you are going into another call. What the VC is interested in at that moment is to assess whether your company is investable; to fill in the gaps from your deck, or your presentation. He’ll ask questions about many things: market size, product demo, competition, business model, cash-flow projections, team background, go-to-market strategies, valuation, investment instrument, terms, etc.
Keep in mind he is doing this with 5 other companies every week, and has still a few left in the analysis phase from previous weeks. As a rule of thumb, a partner at a firm will probably invest once every quarter (so 3–4 deals/year; with 3 partners at a firm, that’s about 10 deals/year; the investment period is in the first 3–4 years for a fund). As soon as the partner finds something that is a red flag, he will try to understand how to circumvent it, or just stop the process. Because of the different metrics, he will NOT invest in all investable opportunities.
Of course, again, I know of one prolific investor who only takes 20 min calls, and decides on the spot. Or of another early-stage VC who gives an answer within 24 hours of the 2nd call. Exceptions…
Expect anything between 2–4 weeks for this phase of interaction with the entrepreneur.
3. Confirm the interest of the fund
Once the partner is convinced he wants to invest, unless he has discretionary power, he needs to get approval from his investment committee (IC).
To do this, usually a partner writes an investment memo for his fellow GPs (hence all the questions in step 2), that can be updated after the due diligence phase, before sometimes sharing it with the LPs. Writing this memo also takes time.
Depending on the firm, the IC could be all the partners at the firm; or some representation of the investors in the firm, the LPs; or a group of external advisors who sit on this IC. Depending on the firm, there are ICs every week, every other week, once a month, or ad hoc.
Remember, you are not the only company that the fund is considering, so there is a waiting list, as usually only 1–2 companies are considered at each IC. Why? because usually it requires the CEO to present for 30–60 min, and the IC to ask questions for 30–60 min. If you do it twice, it’s already a good 2 hours meeting. So you might not be scheduled for the next IC, and might have to wait for the next one, or even the one after that.
So expect 1–4 weeks wait time here.
Usually, the IC should say yes, but you can be sent back to the drawing board, to answer some unexpected question, or asked to come back once you confirm a KPI (eg. a contract).
4. Negotiate the Term Sheet
Once you get IC approval, the Partner will send you a term sheet: it’s just a paper that confirms their offer with money they will give you, valuation, and standard terms (or not) such as drag-along, tag-along, liquidation preferences, ratchet clauses, board representation, veto rights, information rights, follow-on rights, reserved matters, etc.
It could come in the same day, or take a week. But now you might want to negotiate some of the terms. Most VCs will include some terms that inexperienced entrepreneurs won’t understand fully, and might need explanation and/or negotiation. It’s a good idea here to hire a lawyer to assist you before signing (=accepting) this term sheet as it is.
Some funds have a very standard entrepreneur-friendly (this means relatively simple terms), and will not modify theirs ever. It is true if they invest very fast, and very often. They know that in any case, investors at later stages will bring in new clauses, new rights, their own shareholder agreements, etc. and it’s not worth their time and money to over-complicate this stage.
If you are using a convertible note template (like a SAFE) there’s nothing much to negotiate here either.
I would expect 1–2 weeks here, mainly because the lawyers on each side don’t reply as fast as you would want them to.
5. Due diligence
Depending on the size of the round, most funds will at this stage launch a series of audits, usually with third-party firms to check that everything you said is true and that there are no skeletons in the closet. What the fund is trying to do here is to check whether the risks are under control.
So they hire:
- a law firm to check the bylaws of the company, contracts with employees, IP, contracts with clients…
- an accounting firm to check past year accounts (if you are early-stage, this does not apply), tax filings, maybe even to check the budget
- a technical expert to validate the solidity of the technical expertise of the company. VCs can’t be experts in everything, such as quantum computing, 3nm semiconductors, AI, space technologies, or biotechnologies.
- I myself added a cybersecurity audit at this stage. Will the company be able to scale with its infrastructure and future plans (meaning will they be able to reach the revenues in the budget)? Will they be able to sustain a Denial of Service attack? You can plan to do it ahead of a round and just share the auditors' report here.
- [updaet on 28/11/23] I recently heard about a fund that will not invest unless a proper full management HR Assessment is performed. It might take up to 2 weeks for interviews and feedback to the fund + 2 weeks for the report to be produced.
They themselves will continue checking other things:
- team background check. I myself would call up to 10 references on a CEO (quick 20 min calls), and on some of the top team.
- as a VC you are also expected to do a KYC on the team, top clients, and other investors (if you don’t know them) to check for money-laundering and other potential reputation risks. There are tools for this.
- customer references: it is very common to call up to 5 or more clients of the company to assess what they liked, not like, what else they would like from the company.
You usually don’t do this before extending a term sheet, and it’s usually left to the Lead investor to coordinate all these calls.
Unfortunately, although this approach is methodical, it is not fool-proof, and every now and then, a rotten apple gets into the basket.
Third-party are not on call, and may need 1–2 weeks to get started, and usually up to 2 weeks before giving a written report of their audit. Clients and references also are not readily available, so it might take time to complete them all.
So expect 2–4 weeks more at this stage.
6. Investment contract and shareholder agreement (SHA)
This step can be run in parallel with the previous one, although some cautious VCs will only do it once they have checked all previous boxes.
An investment will reproduce all the terms in the Term Sheet but with more detail. There should be no surprises here. But every now and then, the entrepreneur’s lawyer needs to justify his fees, so starts arguing about something. The shareholder’s agreement in particular introduced new clauses that are not part of the deal, for example, what happens if the founder leaves (Key Man clause), dies (Succession rules), or needs a bit of cash (Respiration clause), etc.
For very early-stage deals, the company needs to be incorporated at this stage, with bylaws, etc.
So expect another 1–2 weeks.
7. Getting the money
Once the investment contract and all documents are validated, we do a closing, which is a date & place where all documents are signed, between the investor (or all investors) and the entrepreneur.
VCs usually don’t have money in their accounts, so as to optimize the IRR. So now they do a capital call to their own investors (the LPs), and give them 10 days to send the money to the VCs account. There might be dozens of LPs in any given fund, so it’s a laborious process to track them all, call them back, etc.
Once all the money is received, the VC will wire the money to the company in a matter of hours/days.
So 2 weeks here for this process.
As discussed above:
- Identifying your investor: 2–4 weeks
- Confirm his interest: 2–4 weeks
- Confirm the interest of the fund / Investment committee: 1–4 weeks
- Negotiate the term sheet: 1–2 weeks
- Due Diligence: 2–4 weeks
- Investment contract & SHA: 1–2 weeks
- Getting the money: 2 weeks
The range above goes from almost 3 months to almost 6 months. It gets even more difficult if you have a large round with many investors (as in you need to identify them; then the Lead Investor takes over the rest).
In my case, I once met an entrepreneur on a Monday, ran through the whole process at my firm in 7 days, and sent a confirmation of our commitment to investing the following week (the equivalent of step 4 here). But there was no step 1 (I found the company), no step 2 (I got convinced by his presentation), no steps 4 and 6 (as it was a syndicate, it was more of a take it or leave it condition. Nevertheless, I asked for a side letter giving me information rights with access to board packs and minutes, and access to a meeting with management quarterly); I performed nevertheless my DD just after that (and I got a lot of material from 4 other syndicating investors in the round). But I only did such as short process once. So it’s an exception. And it was the largest investment in the fund…
So part of the business planning you should always consider when preparing your P&L is the equity story, and when you should start fundraising.
I consult with corporates and startups, and help them address issues like this and many more. Don’t hesitate to reach out at www.rodrigosepulveda.com.