Texts with Founders: “Should I take small checks from large funds?”
Understand the benefits and avoid signaling risk.
This is the 25th weekly post from Texts with Founders — tested tactics for early-stage startups.
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“Should I take small checks from large funds?”
Sometimes, when you close a funding round, other lead investors you did not pick or who heard about the round too late will ask about putting in token amounts of money.
Why do they do this, and what should you say?
Remember that the goal of a venture fund is for any company to be able to "return the fund," — so how does a $250M venture fund expect to return $250M from a $50k investment?
The answer is they don't—they hope this tiny investment buys them an option to lead a future round — likely somewhere in the $5M to 10M range.
These token checks are a savvy move on their part. Token checks cost them nothing ($50k is just .02% of a $250M fund) but give them an information advantage over other investors.
Being on your cap table means they'll get information they would not receive otherwise—your investor updates. These updates will give them an early insight into whether or not they should try to pre-empt your round.
Pre-empting presents many of the same benefits to a lead investor and drawbacks to a founder as when investors reach out before you raise your first round of funding:
Investors doing the pre-empting have unique insight compared to the broader market.
The founder has yet to start a fundraise process, so they will not be able to get far enough along with other firms to result in multiple term sheets, which would make a round more competitive.
It's generally good practice to refrain from advertising when a multistage firm puts in a small check. Other investors will be watching to see what the fund does when you go out to raise your next round. Suppose the fund doesn't offer you a term sheet. In that case, you will face signaling risk — other investors will wonder if that fund knows something bad about your startup they are unaware of.
On the positive side, if a great fund puts in a small check and later offers to pre-empt your round at reasonable terms, there are some significant benefits. For one thing, you'll save weeks or even months of work pitching other firms. Even if, hypothetically, running a process could result in 20% better terms, the time and focus costs associated with a full-scale fundraise might not be worth it.
That’s all for this week — thanks for reading.
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“I met so many fascinating people in different stages of their entrepreneurial journey, some still full-time employed, some secretly working on their next thing, some exploring new ideas, and some already with shipped products and revenue.”
Jacob Rice (ODF19) is a former senior software engineer at Airbnb and participated in our latest cohort. ODF20 kicks off 1/26 — learn more and apply at beondeck.com.