Building An Insider (Not Bridge) Round

This is Rich Maloy with SpringTime Ventures, bringing you the VC Minute, quick advice to help startup founders fundraise better. Welcome back to another week of the VC minute. This week, we're going to be talking about that bridge round. No matter where you are in your fundraise cycle, whether you're raising for the first time, you've already raised a Seed round, or even if you've already raised a Series A, you need to be prepared for the dreaded bridge round, starting now. But first, I highly recommend you go back and listen to episode 37 when I first talked about the bridge round and why you should never call it that. For most of this week, you're going to hear me say bridge round, and every time I say bridge, I want you to think about a bridge to nowhere. There are two situations that typically lead to a startup needing to raise a Seed Extension or a bridge round. The first one is that you hit your numbers and the goalposts moved. And so now you can't raise that Series A and you need to come back to market to raise a Seed 2. That is totally acceptable in this market. The other reality, is that you didn't hit your numbers. And look, this is hard. If building a company was easy, everybody would be doing it, but it's extremely difficult. There's no shame in working hard and sometimes coming up short. When that happens, you're in a situation where you need capital to get to the next level, but you are in the worst possible position to raise it. However you can set yourself up for success for that potential future bridge round, but only if you start working on that now. The idea for this week's theme rose out of a conversation that I had with my friend, Eric Marcoullier, and I've mentioned him before, he's got a great blog called Obvious Startup Advice. I was trying to explain to him why we would not participate in a bridge round for half a million dollars. Our typical check size is about half a million dollars. Seems like a perfect fit, doesn't it? It's a terrible fit. I'm going to go into great detail about why seed funds do not do this; why we don't behave in this way. And why that half a million dollar bridge round seed extension round whatever-you-want-to-call-it round is going to be the hardest round that you raise... unless you set yourself up for success starting now. Seed investing is a team sport. When it's done right, you've got the right people around the table that can provide support to you on an ongoing basis because they have a literal invested interest in the success of your business. Great investors will help you with hiring; they'll bring you candidates. They'll help you with sales; they'll bring you potential clients and partnership opportunities. They'll be there for you when you need them. They'll be that mentor in your corner; that support structure when you're going through the hardest times. All seed funds work like this. We want to invest with other good funds around the table. We want you to have that support because you're more likely to make it to the next level. And if you wanted to dunk on VCs, you could also say that there's a herd mentality to it. This is where the pool party analogy comes in and why the pool party analogy is so strong. Everybody wants to make sure that there's somebody else in the pool. The flip side of that situation is true as well. Founders that I know with prior startup successes will not take a check from just one investor. They want that optionality of having multiple investors around the table so that they can get support from different places in different ways when they need it. And it's not just because of mentoring and connections. Different funds will be at different stages when it comes time to raise the next round. Some will be able to do their pro-rata. Some will want to double down and some may not be able to do anything at all. Those experienced founders know that if they only have one investor from their previous round and that investor doesn't want to do the next round, they're screwed. If the best founders will not even take a single check from a single investor and they want a party round, and if all of the other funds participate in the market in this way, how are you going to buck that trend? You are not going to get one investor to write one check and take your whole round. It just doesn't work like that. Don't fight the market on this. Figure out what is the right size of round that you can get done and then go find investors that will take a portion of that. If you're trying to raise half a million dollars, you need to find people that write between 100 and 250 K checks. If you're trying to raise a million dollars, then you want to look for funds that write checks somewhere between 250 to 500 K. Find the right investors for the right round. Or rightsize your round for the investors that you're targeting. Call it what you want. But seed stage investing is a team sport. The fewer team members you have around the table, the weaker position that you're in and the less likely you're going to get to the next level. Here's where seed funding as a team sport turns against you. And it's not with FOLS, fear of looking stupid. It's something even worse: the greater fool theory. According to Investopedia the greater fool theory argues that prices go up because people are able to sell overpriced securities to a greater fool. That is, of course until there are no greater fools left. Nobody wants to be the last fool left holding the bag. If you don't have other investors participating in your round, especially your current investors, that one investor you're asking to be the only one in your round, that investor feels like the greater fool. Think about it from another angle. A venture investor is buying securities. In any securities market, in any investing market, decisions are made based off of information. Information in private markets is highly asymmetrical. Having investors in your round, or not having any other investors in your round, is an important piece of market information. It's another piece of the due diligence puzzle that a fund is considering before they make an investment in you. Next, if you're raising a bridge round, it implies that you have raised a prior round. Where are those current investors? How much are they putting in? Which one of those current investors is putting in the most money and stepping up to say, we believe so deeply in this company that we're willing to double down on our investment. In a world of information asymmetry, your current investors have the most information. And if they're not willing to step up, that is a very bad sign. For an investor to be the first one to jump in the pool, or for an investor to know that they're going to be the only one in the pool, is a huge leap of faith. Uh, it takes a massive amount of conviction and confidence for a seed investor, for any investor really, to say I'll be the only one to put up money for this. Most funds understand that they do not have all of the information that they don't know everything that's going on, and they can't turn over every stone in the due diligence process. And so, there are approximations for this. One of those approximations are the number of investors, and the quality of those investors that are in the pool. If nobody else is in the pool that is a piece of information. And it's not a good one. The other element of how a bridge round is working against you, is not having enough capital to hit your milestones to get to the next stage. The very nature of raising a bridge round speaks to the fact that you did not hit the metrics that you thought you would. Things did not go according to plan, and things never go according to plan. That is understandable. Maybe you haven't found a product market fit. You made a pivot, made a bad hire or any number of things that can and do go wrong when building a startup. However, it is a negative signal if you did not see this coming far enough in advance in order to make the changes that you needed to make, to stretch your runway, and keep your business alive. When you have limited runway left, that is another piece of market information that tells me about how you run your business. To be fair, running out of money is part of the plan. It's called runway, not highway because you're expected to take flight before it ends. Which means you should know when it's ending and be planning for your next raise far enough in advance so that you don't crash at the end of it. Whatever the situation, the story of a bridge round is always the same from an investor's perspective. You raised money. It wasn't enough. And now you're coming back to raise even less money...? If you say, "I only need half a million dollars and then I can hit a million of ARR." You got it wrong before, why would I believe you're going to get it right this time? Raising less capital is an even worse position to be in. Remember last season, when I talked about the VC Treadmill: that it only gets steeper and it only gets faster. The way to structure a round is to raise enough capital to get from here to there; to reach the metrics that will enable you to raise the next round and level up on the VC treadmill. I need to believe that with this round, you are truly going to hit those metrics and you are finally going to break through to the next level. That is extremely hard to buy into as a new investor coming into this round with no historical context. This is why you need to structure an insider round and not a bridge round. And we'll talk about that tomorrow. Have I convinced you yet that raising a bridge round is going to be the hardest round you ever raise? And that you should never call it a bridge round. The number one thing you can do to be successful with your raise, is make it an insider round. Here's the thing with the inside around it has to be filled with your current investors, your insiders. So how do you get them on board? You need to start right now. First, and you need to do this long before you are in the untenable situation of needing a bridge, you ask your potential investors about their follow on allocation and strategy. Here's some questions that you can ask. What is your reserve allocation? How do you decide who you're going to follow on with? Can you give me an example of a follow on investment that you've made recently? Can you give me an example of a follow on investment that you've chosen to not make recently? What additional proof points do you need to see for a follow on investment? How does your follow-on process differ than your initial investment process? Asking these questions upfront will help you understand what sort of a firm you're working with and how they're going to behave down the line when you need them the most. If you have already taken it on investment, you can go back to your current investors and get this information. Second, keep your investors updated. There are a ton of update templates that you can find online. It's so simple and so incredibly important. Do it monthly. It doesn't have to be long. You just have to actually do it. Start now. Third, start warming up your current investors to the next round six months before you run out of money. It will take you at least three months to bring the whole round together. You can't start this process with less than three months of runway or you'll have your back against the wall as your runway ticks down into days instead of months. Talk to your investors now. All of them. As the old adage goes, ask for money, get advice. Ask for advice, get money. Go ask your investors for advice about what they think the next round should be. How is the market for a startup with your metrics in your industry? What do they need to see, to consider following on in you? It's also a great time to ask for referrals. What funds have they talked to recently that will be a good fit to come into a new round? Better yet, send them a list and ask them for introductions. Then, when they're on board, ask if you can use them as a reference for new investors. Fourth, tell the story about how this round gets you to the next round. How does this enable you to level up on the treadmill? Tell how your revenue is growing and will accelerate with this infusion of capital. Finally. If you are bringing in new investors, get all of your current investors to close and wire first. Then give the new investors 15 to 30 days, depending on how much you've got circled up. We've participated in both bridge and insider rounds with multiple close dates, with the current investors going first. SpringTime does this as a way to show its commitment to that startup to the new investors that are coming in. Ask this of your investors. You can only build conviction in new investors by having your previous investors already in the pool, splashing around and having a great time. You can have the hottest insider round, but you have to send the invites early and work that pool party magic. Whew. Another week at the VC minute in the bag. Hey, before you go. I have a huge favor to ask of you. My favorite VC podcast, the 20 Minute VC, is asking for suggestions for future guests. I'd like your help to get the VC Minute on the 20 Minute VC. Would you help me with that? Go to miro.com/20vc. That's M I R o.com/two zero VC. And add a sticky for the VC Minute. It'll just take you a few minutes and man, it would be awesome to talk pool party with Harry Stebbings. Thanks for your help. You're the best.