VCs are moving fast to sign term sheets with startups to beat competition as cash floods the market.
Moving fast means investors do less due diligence and focus more on “signals,” investors said.
It also means founders have more options and opportunities to raise money on their own terms.
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One hopeful investor sent him half a dozen follow-up emails in a 24-hour period. Another begged him for a
call on the weekend so they wouldn’t have to wait a week for his next available opening.
Since presenting last week at Y Combinator’s Demo Day, Ekram Alam’s company MindPortal has been inundated with outreach from more than 120 angel investors and funds. Many have been enthusiastic and explicit about their readiness to commit capital right away.
“The other day I had six investor talks, and within 30 minutes, all six of them wanted to wire us money,” said Alam, who has spent most of the past week glued to his screen pitching investors over Zoom from his London apartment.
MindPortal is one of 319 startups from the most recent, all-digital startup class for the popular startup accelerator Y Combinator. Alam’s startup is working on a device that lets users control a virtual character using only their thoughts. Its long term plan is to build a brain-computer interface so that people can experience software directly inside their minds.
It may sound far out, but it hasn’t scared away investors.
“The funding is abundant,” Alam said.
With coffee meetings canceled in favor of COVID-19-safe Zoom calls and a flood of capital looking for a home, venture capitalists are moving fast to sign term sheets with promising companies before they lose out to other hungry investors with shorter turnaround times or less concern about valuations.
The funding frenzy is inflating already lofty valuations and prematurely accelerating business plans, as entrepreneurs and investors feel they have no choice but to cast caution aside and play along.
The pressure to close deals has meant many venture capitalists are leaning heavily on external signals, like a founder’s pedigree or big-name venture-capital firms in a round, investors told Insider. Some worry their peers are skipping out on the type of thorough founder and product vetting that could prevent the next high-profile fraud case like uBiome or save firms from painfully reneging on investments once information surfaces about a cofounder’s past, as happened last week when Spark Capital severed ties with Dispo in the wake of an Insider investigation into an allegation of rape at founder David Dobrik’s YouTube project Vlog Squad.
“It’s pretty crazy,” Sheel Mohnot, a fintech investor and general partner at Better Tomorrow Ventures, said. “I think VCs are sometimes being asked to make decisions in a very tight timeline, which doesn’t give us enough time for diligence.”
Sheel Mohnot of Better Tomorrow Ventures.
Courtesy of Sheel Mohnot
There’s no shortage of historical precedents flashing warning lights about the danger of such behavior. But in Silicon Valley’s current overheated atmosphere, bolstered by the tech industry’s resilience amid the pandemic, the fear of missing out appears much stronger than the fear of a downturn.
Taking seed funding can be a sign of weaknessSamara Gordon, a Boston investor at Hyperplane Venture Capital, is in a group chat with venture capitalists at other firms. Lately the conversation has been overtaken by a constant flow of shocking valuations and deal terms that people hear about, she said.
Though she would normally consider meeting with founders to be an important part of diligence, the East Coast winter and COVID-19 restrictions have meant she hasn’t met in person with a single company she invested in since March last year. When she does do extra diligence, Gordon said, she gets it done without letting it interfere or delay the timing of a funding commitment.
“I have heard from founders that there is a power shift,” Gordon said, adding that this year had proved a startup could “get around without doing the dog and pony show” to convince a venture capitalist to write a check. When Gordon now sees a startup she likes, she feels more pressure “to really show my excitement,” she said.
As a seed investor, she’s usually betting on companies before they have a product or revenue. She recently did a pre-seed round for a company that doesn’t even have a website, and she’s already had outreach from Series A investors asking for introductions.
“The best pre-seed companies are being preempted for A’s and skipping seed entirely,” she said.
Excessive interest from investors can be a Catch-22 for founders in a world where large funding rounds are seen as a sign of success. When a startup raises a smaller round at a lower valuation, whether it’s out of necessity or just a strategic choice, fast-moving investors can interpret that decision as a sign of weakness.
“People are questioning why a company would do that,” Gordon said. “Does that mean they’re not a hot company if they have to raise a seed in this current climate?”
So long as someone has vetted the startup, it’s OKOne of the biggest shortcuts in the funding process is the “follow-on” investment, where venture capitalists put money into a startup primarily because another respectable firm is expected to be in a round.
“When you’re not taking the time to run through a diligence process, you give a premium to any company that has been vetted,” Gordon said.
Andrew Lee, a partner at Initialized Capital, said investors from other firms would sometimes skip steps when they got wind that his firm had already prepared a term sheet to fund a startup. Suddenly, Lee said, the startup will hear from the other investor: “OK, we’re accelerating this whole thing. How much do you want? And we’re willing to give it to you.”
Lee usually advises his companies against taking money from such followers, in favor of investors that take the time to learn about the company and truly believe in its potential, he said.
“Those aren’t the types of investors that you want anyway, right? You want people who actually have high conviction,” Lee said.
That’s part of the allure of Y Combinator’s startup class. For investors looking to invest in the best companies as fast as possible, seeing that a startup has been accepted into the accelerator is a signal in itself that a company has been thoroughly vetted for success. The accelerator invests $125,000 in return for 7% of each of the startups in its program. It doesn’t hurt that its alumni include many of the most successful companies in tech, including the Airbnb, worth $108 billion, and Stripe, worth $95 billion.
Michael Seibel, a partner at the startup incubator Y Combinator.
For founders in the program, the interest can be liberating. Venkatesh Sakamuri, a cofounder of the hotel-software startup Stayflexi, said he got outreach from more than 100 investors after last week’s Demo Day event. The startup raised 60% of a $1.5 million funding round at a $15 million valuation in the 48 hours after Demo Day.
“We’re in a position where we can pick who we can partner with in the round,” Sakamuri said.
Sivo, a fintech company focused on debt that was in the latest Y Combinator class of startups, raised $5 million in seed funding at a $100 million valuation in a deal announced before Demo Day, despite being founded just eight months ago. Sivo founder Kate Hiscox told TechCrunch that she had already received outreach from investors about raising a Series A.
For Alam, the MindPortal cofounder, the most important thing now is to pick the right investors. But it hasn’t always been easy to convince venture capitalists once he and his cofounder have made a decision. One rejected firm even enlisted mutual connections to try to talk MindPortal into taking a meeting to reconsider, he said. It didn’t work.
Alam declined to share the terms of his fundraise for this story, but for him, there is no question that he will get what he wants.
“We’ve set the terms,” Alam said, “and they have all agreed.”
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