Why Money Isn't Free and Other Lessons from Early-Stage Investing

Patterns and cycles govern the natural world. Their evidence survives in physical forms and can also be traced to the ways investors and founders behave as a species. Armed with a degree in history, Brianna McDonald has spent years as an investor and mentor for young companies. She believes that recognizing patterns as they evolve, breaking free from toxic ones and revisiting the core lessons of one's craft can help us become better investors and founders. Brianna also believes returning to these better practices can help us deal with the chaotic present and nurture the next generation of entrepreneurs. It's part of her audacious goal.

In other words, understanding fundamentals is a way to control the chaos, deal with the frantic nature of the work and emerge through turmoil. And it is hard work! Brianna's Keiretsu Academy talk offered a contextual look at the fundraising market, dived into the dynamics of being an early-stage angel investor, revealed how founders could approach fundraising and, finally, untangled sticky subjects that make all the difference in a deal –– terms, capitalization plans and marketing the company. 

Back Before the Dot Com Boom

Before we understand where we're headed, Brianna believes we need to revisit where we've been. The 1990s were a time of great technological churning. For the first time, people were buying and selling through an awkward-looking box on their desks, playing video games on this powerful new machine and trusting it enough to enter sensitive information into it. 

We were in the midst of the personal computer revolution. Then, came the rise and rise of the Internet. By the end of the Millennium, there was massive expectation and speculation. And in no time, it lit the fuse for an explosion of activity and VC funding. But what went up inevitably came down. The collapse of the Dot Com Bubble left only the fittest on the battlefield as trillions of dollars went up in smoke. We know these companies –– Amazon, eBay, and more as behemoths today. 

Let's go back to the 2000s for a moment. What happened after the Dot Com Bubble? In Seattle, companies like DocuSign, MailChimp, and Redfin emerged. We saw game-changing innovation come to light. Facebook came along as well. The iPhone alone changed how we live, work, and play. But just as the party approached a climactic high, the arena changed yet again. The 2008 Subprime Mortgage Crisis dealt a death blow to the entire system as our lending institutions disintegrated. But, still, it was not all dark. 

As Brianna put it, "The financial crisis is huge because it led to the next 15 years of growth in innovation, which led us to where we are today. So Uber was born, Airbnb, Square, WhatsApp, Instagram –– all born between 2009 and 2010."

The stage was also set for over a decade of near-zero interest rates and easy money. An entire generation of founders and investors was driven by the mindset that money didn't cost anything – it was simply free-flowing fuel for infinite growth. That's not true. When the basics were ignored, the lure of VC and business tourism proved too hard to resist.

And so, after this decade of easy money, we arrived at our most recent frenzy, the stratospheric funding peak of 2021, with over $620 B invested globally — a record. Deal after deal funded at nosebleed prices and with little regard for fundamentals like disciplined growth, long-term strategic planning, or conducive deal terms. Greed was good, and recklessness trumped all. Until it didn't – yet again.

The Reckoning 

When the music stopped in 2022, it wasn't pretty. It still isn't. Companies that had taken on too much, too fast, and with zero contingency planning found themselves slashing staff and burning precious runway. Valuations imploded. Deals dried up and once free-flowing funds began dissipating. Investors had gone too far. The numbers for 2023 paint a stark portrait of just how dramatic this correction has become. The high interest rate environment, and the war environment, have all created significant challenges. 

But here's the thing: the market correction also carries with it an opportunity to invest when in quality and to go back to what works best. As Brianna says, "It's when [in] the investment cycle, when most people are out of it, that we can come in. We have the opportunity right now to build better companies. We have the opportunity right now to lean in and support the next set of the next generation of entrepreneurs."

When times are flush and capital is overflowing, it's easy to become lax. Due diligence gets handwaved, governance best practices fall by the wayside, and founders fall over themselves to chase hype rather than sustainable business models. But when we're pulled back from the precipice? That's when the real work can begin. With the excesses of the past firmly in the rearview, the path is clear to reset and get back to the fundamentals that underpin every successful journey.


The Perception Shift

So just what are those fundamentals that deserve a pragmatic relook in our new normal? What seemingly unglamorous practices and processes have been neglected by investors and founders? 

It starts with rebuilding an appreciation for that most old-fashioned of tools: The Business Plan. For too long, we've de-glamorized the work of actually reading a business plan. Strangely, it is reflective of both tedium and impatience. Because let's be honest: Ideas are a dime a dozen, but moving methodically from insight to execution? That's where the magic happens. Where fortunes are truly determined. 

The same back-to-basics approach applies to capitalization planning. Simply put, there's nothing more fatal than running out of runway. As Brianna adds, "The capitalization plan serves as a roadmap for ensuring the company or organization has enough cash and other assets on hand to manage risk and pursue opportunity."

Yet all too often in the gold rush mentality of recent boom cycles, capitalization rigor is tossed aside in favor of moving lightning-fast. No one asks tough questions. Patterns devolve into harmful ones. Founders gave away the farm before fully understanding just what they were trading ownership for. As we emerge into the new reality of high interest rates, and money no longer being free and easy, that slapdash approach is no longer tenable. Discipline and foresight around capitalization will separate the wheat from the chaff, allowing serious operators to map their future and raise money. We need new patterns to adopt. And as we shall see, these new patterns lead to better outcomes.

Seeking Partnerships

In Brianna's experience, the typical founder's fundraising playbook goes a little something like this: 

  • Assemble some cursory materials and meeting notes, scour databases, and LinkedIn for any investor even remotely related to their space.
  • Carpet bomb them with emails, messages, and hustle efforts in hopes that sheer saturation will yield.

Can you think of a more scattershot approach to securing growth capital and onboarding partners who will be true partners for years to come Especially for founders, rather than fighting uphill with the blunt-force approach, Brianna implores us to think more strategically about fundraising. To put themselves in the mindset of a professional marketer looking to identify their ideal customer profiles, understand their motivations and proclivities, and map out how to capture their attention in an authentically resonant way.

That means developing a fundraising marketing plan – a living, breathing roadmap for identifying target investor personas, studying the competitive landscape for capital, and carefully crafting positioning/messaging that will differentiate their specific opportunity. It means leaving no stone unturned in researching the market conditions, and their potential funders' backgrounds and investment theses. 

"Shift the perspective from seeking investment to seeking partnership because that's what we're looking for." 

Deal Terms: The Basics We Return To

As we come to the end of the article, let's finally look at the nitty and the gritty. Speaking of partnerships and investments, perhaps no topic looms larger for founders and investors in the deal conversation than deal terms. We cannot ignore these in our quest for returns and growth. Brianna talks about 3 routes in her Keiretsu Academy talk: SAFE notes, Convertible Notes and Equity Rounds. Here is a summary of her detailed analysis of each.

Resources like SAFE notes and convertibles help startups bring in growth capital without complex negotiations around valuation, protective provisions, and all the other thorny deal points notoriously complex for young companies to grapple with. However, each has its pros and cons. 

  • SAFE notes are great for founders on the surface level, and fairly standardized but they lack founder and investor protection and remain a promise of equity in the future. 
  • Convertibles are a cheap, fast, and great bridge but add debt to the balance sheet and the said debt harms the cap table. They score low in investor protection.
  • An equity round awards equity to the investors, ties them to the business and has all sorts of investor rights baked into it. But these rounds are expensive, negotiations may take time and in a few cases, the company may not be ready for the big time yet.

Knowing these tricky but fundamental terms and examining them early can make all the difference in raising and investing money. For a full breakdown of SAFE Notes, Convertible Debt and Equity Rounds, watch Brianna McDonald's full Keiretsu Academy talk here

But now, finally, we come to the finale. The "Why" behind it all. Brianna's BHAG or big hairy audacious goal: 

Galvanize leaders in our community to work together and support the next generation of entrepreneurs; to learn from the mistakes of the last market cycle and to build new best practices.

Let's not sugarcoat it – the funding landscape is facing a reckoning as we emerge from the excesses of the 2021 peak and chart an uncertain path forward. We're staring down the fallout of reckless investments, sloppy due diligence, and a culture that treated private funding like Monopoly money, the correction has been a wake-up call to get back to fundamentals. To reassess how we identify, diligence, and finance promising new ventures in a more disciplined and sustainable way. We have an opportunity to impart the hard-won lessons from past cycles to the visionaries with brilliant ideas but limited operational experience. Brianna closed her talk with these words:

"Entrepreneurs have dreams and goals to do big things in the world. But we [must] remind them that planning is important. Money isn't free. As we sit at the bottom of the venture market, the market is ripe for change. We can coach and work with people. We can be a mentor. We can share our time, talent, and expertise that we've learned over the years."

So, what will you do when you meet an entrepreneur looking to start a business? What will you do?


Source: Brianna McDonald, Keiretsu Academy talk

 April 09, 2024