The Unforced Error Discount

There are a lot of excellent blog posts and columns on start-up fundraising. Some of them even discuss the errors that founders make in the process of raising money. Having read a lot of them recently I think that they tend to focus on what I would call “forced errors” — mistakes that the founder had little choice but to make.

Increasingly, however, I have noticed that a lot of founders are making what I would call “unforced fundraising errors”. These are errors they could have avoided that make it more difficult for them to raise money, reducing their chances of getting investor capital or forcing them to take a lower valuation or worse terms than they could have had.

To give you a sense of the difference between forced and unforced errors, let me give you the analogy of tennis. In that sport, sometimes your opponent hits the ball in such a way — like a drop shot — that you can’t easily hit. Because you can’t quite reach the ball, you just tap it, while falling on the ground. So your shot goes into the net. That’s a forced error. Your opponent’s good shot caused you to make the error.

But other times, a tennis player makes a unforced errors, like double faulting on his or her serve. A good tennis player should not be making unforced errors, like double faulting, in a match. He or she should practice the second serve so it doesn’t happen in a game.

In start-up fundraising, you will make forced errors. For example, you might not be able to raise a round or get stuck with poor terms because the economy has gone south, investors are scared, and valuations have dropped. So you end up with no money or a term sheet that is very favorable to investors. Low valuations or investor-friendly terms that result from unfortunate timing are forced errors.

But founders also fail to get financing or get lower valuations and less friendly terms than they could have received because of unforced errors. Those can and should be avoided.

Avoid These Unforced Errors When Seeking Funding

Here are the top five unforced errors I have seen demonstrated so repeatedly that I am motivated to spend a Sunday morning writing a column about it:

1. Bad Communication: When investors indicate interest in learning more about your company, figure out if you want them on board. If you do not, decline politely and quickly. If you are interested in having them invest, then communicate with them. Failing to return emails, taking a week to respond to a simple question (e.g., are you still structured as an LLC?), asking for the investor to sign a non-disclosure agreement, refusing to send your pitch deck, cap table, historical financials, and so on, are not actions that will get the investor to put money in your company. You have to commit to spending time and sharing information with investors if you want their money.

2. Carelessness: When you send information out to potential investors, make sure it is right. I receive way too many pitch decks, spreadsheets and emails with basic errors in them. I have calculated that about ten percent of the pitch decks, emails and spreadsheets that I have receive from start-ups have multiple grammar and spelling errors and/or spreadsheets with multiple numbers that do not balance. That’s crazy. The correct count should be zero. It’s just pure sloppiness on the part of founders that any of these go out.

3. Failure to do Your Homework: Founders should never begin any kind of communication with an investor without doing his or her homework on the financier. Yet they do. I am an extreme test case of this problem. I am an academic, which means that a ton of information about what I research and teach is publicly available. I have profiles on Linked In and Angellist that show the kind of companies I have invested in and the founders and investors I know. I write regular columns (like this one) for practitioners that are all over the Internet. However, I routinely get contacted by founders who don’t seem to know anything about me. They try to pitch the kind of deals I have made clear I don’t invest in and they miss opportunities to tell me how their business is perfect for me.

4. Not Being Nice: Sam Altman has a blog post on fundraising in which he says that someone a myth has emerged that investors want entrepreneurs to be “arrogant, antagonistic, disrespectful.” I have personally interacted with several founders who are arrogant, antagonistic and disrespectful so I know exactly what Sam means. It surprises me that he had to write the following in a post: “Don’t do it. Be respectful …. Remember that investors are people too.” It surprises me more that I have to quote him. This isn’t advanced psychology here. It is common sense people.

5. Lying: Do not try to bluff investors into putting money into your business because it doesn’t work. Here are two examples that founders tried with me in the past couple of months. I asked founder A, who else is interested in investing in your start-up this round? The founder’s answer, Mr. Moneybags. So I called Mr. Moneybags, a person with whom I have co-invested with in the past to ask him if he was investing. His answer: I told Founder A, no. So I did not invest. Also I recounted this story to other investors who asked me about the company.

A founder seeking money whose start-up had about $125,000 in annual revenue wanted to convince me the company was making a lot of progress so I would go in the round. He told me they had just signed a contract with a customer worth $250,000 in annual revenue. My response was to request a pdf of the signed contract. When it didn’t come, I declined to invest under the assumption that if the statement were true, I would have received the pdf.

It is hard enough to raise money for a start-up without making unforced errors. If you make them, you will either fail to raise money or will take an unforced error discount, getting worse terms and a lower valuation than you would have otherwise received.

Tennis Photo via Shutterstock

This article, "The Unforced Error Discount" was first published on Small Business Trends