The most common reason investment firms give for not investing in a startup is a too-small total addressable market, but this is usually a lie, Auren Hoffman, CEO of software company SafeGraph, said in a SaaStr webcast. The real reason is they don’t like your team.
“They’re just not going to tell you this,” said Hoffman, whose company helps businesses make location-specific decisions such as where to open a store or sell a product.
Team is everything to investors, because even if the total addressable market (TAM) is smaller than they’d like, they know a good team can find new opportunities, he said. This is especially true if the company is still at the seed or Series A stage.
“Venture capitalists will happily invest in businesses with small TAMs if they think the team is good enough to move to an adjacent TAM once they’re no longer growing at 100% year-over-year,” he said.
Because you can’t count on investors being candid about their concerns, you’re better off discounting their rationale for opting out.
“Getting advice from venture capitalists that pass [on your funding request] would be super helpful in theory,” he said. “In practice, the advice is not worth considering.”
Start with the lawyers
Hoffman is a serial entrepreneur who’s taken half a dozen technology startups, including Kyber Systems, Bridgepath and Rapleaf, to successful exits.
He recommended executives, if they find an investment firm that wants to give them capital and offers them a term sheet, tackle lawyer fees first.
The fees are the first thing lawyers on both sides of the transaction look at, because the amount signals how complex the deal is expected to be.
Although some transactions are complex and can lead to contentious negotiations over rights, board seats, the company valuation, the lock-up period, among other things, a plain vanilla deal shouldn’t require high legal fees, he said.
“If the number is large, they’re going to justify their fees by adding work and nit-picking on very small points,” he said. “And that’s going to result in a significantly delayed closing.”
You shouldn’t get too much pushback from the lawyers if you seek lower fees if you can show the terms are straightforward, he said.
“If the number is smaller, the nit picks are going to be less prevalent and the time to close will be much, much speedier,” he said. “It’s a real win-win, because it’s going to, one, take less time for you and the VC to close, so you both can focus on more important things, and two, the company will be able to use its treasure for more important things than covering legal nit picks.”
Hoffman listed legal fees at between $10,000 and $100,000. For capital raises that can close in 20 days, the fees should be closer to $10,000. If the close is closer to 45 days, the fees tend to be closer to $100,000.