All entrepreneurs who have gone through the all-consuming process of raising capital have heard their fair share of “No” from investors. The rejections are usually followed with a myriad of reasons, but they include “too early,” “too far-along,” “we only do B2B (or B2C),” “we don’t invest in that geography,” and the classic “we’re really interested in your next round.” The most frustrating of all of them may be hearing something along the lines of “we think you have a great business and know you’ll be successful, but its not for us.”
The pain can be particularly acute in North Carolina, where the state has been ranked as the No. 1 “hot spot” for tech startups outside Silicon Valley, but North Carolina isn’t one of the 4 states (CA, MA, NY, TX) that are home to over 80% of VC investment dollars, and the Triangle has a hard time cracking the top 20 cities for VC investments. Guess what, entrepreneurs? The local VC feels your pain.
The truth is, North Carolina does not have the number of VC firms in the state with enough meaningful capital and diverse areas of focus to fit the needs of all entrepreneurs raising capital. Fund managers trying to raise their first or second fund struggle to meet the track record or fund-size requirements to secure investments from investment groups or endowments, and raising a sizeable fund from high-net-worth individuals is a challenge with SEC restricting the number of Limited Partners (LPs) to 99.
At Cofounders Capital, we have a very specific fund strategy that allowed us to raise capital. We focus on B2B software ventures, primarily in the Triangle; we are typically the first institutional money into a deal; and we seek companies that can become cash flow positive (on their current plan!) on our investment, rather than relying on a future funding round—which we acknowledge above is difficult to land in the Triangle—or unforeseen pivot to get there. Specific enough? Sure, we have companies that also include a B2C revenue model or are outside the Triangle, but we never stray too far from how we promised our LPs we’d invest their money.
While my partner, David Gardner, and I have been on the fundraising trail we have met with several large funds that invest primarily into venture funds (so-called “funds of funds”). They have their strategy too, and unfortunately it is not always aligned with ours. One of these funds of funds, for example, said they needed to make a minimum investment of $10M into a venture fund, but could not be more than 10% of that venture group’s committed capital. Do some quick math and you see that we would have to raise $100M to fit that groups investment criteria. And just like that we hear, “Get back to us when you are raising your next fund.”
It is frustrating, we know, but that is the strategy that they have set, and one we have to respect. It’s also why it’s important for entrepreneurs to know the strategy of the VC funds they are targeting, since that is the plan that they have sold to their own investors when fundraising. VC firms are unlikely to disregard that strategy to invest in your company, no matter how special your company may be. We’re in a very similar boat.
I’ve heard metaphors comparing venture capitalists to crabs that have to molt their hard exterior every few years. As in: “When fundraising time comes around for VC’s, they soften up and can relate to entrepreneurs!” While there is some truth there, I’d say that fund managers are more entrepreneurial than they get credit for. At the heart of the business, fund managers need to have something special about their background, skill set, or strategy that allows them to raise capital for the first time. They then need to execute on a plan to create value for shareholders, raise more capital on a plan that has been modified from their learnings, and deliver above-market realized returns to their investors. Sound familiar?
Anyone who has been involved with raising a fund has heard the same objections entrepreneurs have to deal with. At Cofounders Capital, we have raised over $25M for our second fund and $37M overall, but have still been “too big,” “too small,” “too early,” or “in the wrong geography” for many potential LPs because we did not fit their investment thesis. At least they are all interested in keeping an eye on us for our next round!