For founders, especially those starting companies for the first time, the gyrations of the stock market, the resulting correction in public market tech stocks, and the inevitable impact on private company fundraising might seem disheartening. And the past few weeks of geopolitical challenges only added to the bleak scenario.
As an entrepreneur and venture capitalist who has lived through two downturns (the post-2000 internet bubble bust and the post-2008 financial crisis), I know that entrepreneurial innovation is always alive and that company-building is a marathon, not a sprint.
If you are at the inception stage, we are primarily evaluating your team to make sure the product is a pain-killer and not a vitamin.
Here are a few of my favorite tips for founders looking to raise capital and build a strong inception-stage company.
Capital raised and valuation should match company stage
Rather than holding out for a nosebleed valuation at the inception/Series A stage, founders should remember that there will be many future rounds of funding. It is easier to go up than down, and your final value results from building a sustainable company.
Raising too much capital at the early stages can result in undisciplined spending, leading to layoffs and other painful actions when the burn rate skyrockets and future funding becomes scarce.
The list of breakout companies that raised moderate Series A rounds is long: Lyft raised $6.2 million; Airbnb raised $7.2 million; Zoom raised $9 million; Uber raised $11 million; Confluent raised $6.9 million; HashiCorp raised $10.2 million; Snowflake raised $4.95 million. The list goes on.
These founders understood the value of a long-term mindset and the importance of building startups with the right values and structure so they can grow into lasting companies.
Founder dilution and investor ownership are part of a long game
While founders are rightly sensitive to dilution, it helps to understand that investors who commit to partner with them realize the company will raise many rounds of capital that follow the one they are leading.
As stewards of capital raised from their limited partners (often pension funds, university endowments, and philanthropic institutions), investors are committed to delivering returns, and having a meaningful stake in a future liquidity event allows them to achieve that.
For example, we partnered with Armon Dadgar and Mitchell Hashimoto of HashiCorp, leading their Series A in 2014 and owning 20%. When the company went public in December 2021, our ownership stood at 18.3%.
Sequoia Capital, an early investor in Doordash, owned 18.1% at the IPO; Benchmark, an early investor in Confluent, owned 15.1% at the IPO; and Sutter Hill, an early investor in Snowflake, owned 17.2% at the IPO.
In the end, if an investor is able to play a role in helping a founder build a sustainable company, everyone benefits from the resulting value created.
The founder-investor zone of trust is key
During long company-building journeys, founders and their investors evolve, pivot, and thrive. It is critical that they share a zone of trust that goes beyond the CEO-board member relationship.
As an inception-stage investor, we take board seats in all our companies, irrespective of the size of the round, and serve as a counselor through the IPO and sometimes beyond.
It is critical that founders choose investors that go beyond financial metrics such as check size or valuation. I recommend they prioritize researching an investor’s reputation. Do they spend time understanding your business and get appropriately involved? Do they have a reputation for standing by founders through the good and bad times? Do they deliver on promises of support on strategy, fundraising, hiring, and customer intros?
Great companies are often created in tough times
Many enduring companies were founded during the financial crisis of 2007-2009, including Airbnb, Lyft, Uber, Square, Stripe, Pinterest, DataDog, Twilio, Okta, Cloudflare, and Zscaler. While it is not clear if the current market volatility will last, it is safe to say that many great companies will be created in this climate.
Founders approaching investors in March 2022 would do well to keep these historic beliefs as well as current market expectations in mind:
If you are at the inception stage, we are primarily evaluating the team and making sure the product from the company is a pain-killer and not a vitamin. It’s hard to figure out addressable market size at this stage, but we are always trying to figure out how many customers will need the company’s product and, finally, what is their claimed secret sauce and MOAT.
If you have a product in market, beyond the criteria mentioned above, we try to talk to customers to understand if the company’s product is a must-have, not a nice-to-have, and if the customer can live without the product.
We also want to be aligned on your growth and cash spend plans to ensure you are not planning to “grow at all costs” before establishing product-market fit.
Accept entry valuations that are fair for everyone, as what matters most is the value of the company at exit. Don’t raise money at very high valuations, as it can hurt you in future rounds.
I am an optimist, and while our current times may seem intimidating, the founder DNA of thinking big and aligning with societal transformation trends always wins.
For Lyft and Airbnb, it was the sharing economy; for Twilio and DataDog, it was the rise of the developer; for Okta and Zscaler, it was cybersecurity. They powered through pivots bear markets, and even a pandemic to realize their dreams.
Investors like us are lucky to have been along for the ride. So here’s to the dreamers and to thinking long-term so we can continue to change the way we work, live, and play.
Disclosure: Mayfield portfolio companies include Lyft and HashiCorp