Can, and should, advisers play a greater role in start-ups looking to raise funds, asks Nic Brisbourne?
What role do advisors play for start-ups? Advisors are typically small partnerships, or individuals, who help startups raise money from venture capitalists. They usually charge some form of retainer, and then a success fee of a percentage of funds raised and perhaps some options. Retainers normally range from £5,000 to £10,000 a month, the percentage of funds raised between three and five per cent, and options up to 0.5 per cent of the business. Larger fundraisings (£10 million to £15 million) are typically charged at the top of the retainer range and bottom of the success fee range, with smaller fundraisings the other way round. Most advisors won’t take on a fundraising of less than £2 million to £3 million because they can’t make enough money from it.
Advisors are highly geared towards the success fee. Their economics on a £5 million fundraising might be six months retainer at £5,000, totaling £30,000 and then a further £250,000 success fee if they get the deal away. Their business will be successful if they achieve a high hit rate, and the good ones turn away a lot of business. I was talking to one advisor recently whose success rate over the last three years is 100 per cent. That makes him just as picky as the VCs he is raising money from.
But my emotions are mixed when I see I have a deal from an advisor who I know and trust. On the one hand I can be sure that the deal will be at least half decent, particularly if the advisor is well known. On the other hand I know that it is likely that most every VC in London will see the same email and competition for deal will be fierce – or at least that is what we have to assume. We are often told that we are “one of only a small number of funds that have been introduced to the opportunity” but in my experience that is not always the truth. A few years ago we did quite a lot of work looking at a games company, and I had been repeatedly told that we were one of a select few VCs looking at the deal, but when the advisor inadvertently emailed me the spreadsheet he was using to track investor discussions there were over 60 investors on his list.
The challenge for VCs is that it is easy to spend a lot of time going nowhere on advised deals. Good advisors know that the way to reach the highest price is to keep investors guessing about whether they are going to win the deal. As a result there is usually at least one VC who invests a lot of resources and then loses. And when you lose a deal as a VC you are left with very little, and often precisely nothing, to show for your efforts.
I am much more excited, however, to see an email from someone I respect who is helping a company because he is on the board or board of advisors. I generally feel that my chances of success are much higher from this kind of introduction because it will be less widely shopped, and, ceteris paribus, it will get more attention than an advised deal.
Finally, when I get an email from an advisor I don’t know or don’t remember, I don’t feel anything at all. We have a process for looking at deals like this and we check them all out, but my expectations are very low and the chances of an investment happening are similar to if the email had been sent to our general company email address.
None the less, entrepreneurs need to understand when advisors can be useful. If you are going to use an advisor, then for heaven’s sake go for one who is well respected, well known, and has a wide network. Otherwise you might as well email the VCs yourself. If you are unsure check with a couple of VCs before you sign with them (I’m happy to help). Look beyond the VCs the advisor has raised money from in the past, to the live relationships they have today. Ask for names of individuals they will email about your company. Be careful. There are a lot of chancers out there who will take retainers from companies with little chance of raising venture. I even had one fairly well known adviser admit to me that was his business model.
Next, if you have a hot company that is already well known, using an advisor will probably allow you to reach a higher valuation. I think that is the best time to use an advisor, hence the title for this article.
For lesser-known companies, however, the logic for using an advisor is less clear. VCs who see an email from an advisor about a company they do not already know will most likely prioritise the opportunities they have from other sources. There, they have a better chance of closing a deal. So companies that are not super hot and which have alternative ways of putting themselves in front of VCs should consider whether an email from an advisor is the best route in – even if you still use an advisor to manage the fundraising process.
But for lesser known companies without good links to VCs, advisors can be really helpful though: they will help navigate through who does and does not have money and who is likely to be interested. They will generally take some of the misery out of engaging with investors. Additionally, good advisors have probably the widest network of potential investors and are well placed to help companies that might need to boil the ocean to secure funding. But if at all possible, you should start building relationships with VCs long before you need to raise money. You will benefit from early feedback on your company, and have a higher chance of success when you do come asking for cash.
Lastly, advisors are only really suitable for larger or later rounds. For decent advisors the economics do not work for a typical Series A fundraising, and if someone is offering to help you raise less than two or three million, you should really ask yourself why.
Good advisors can also add a lot of value in other ways. They spend a lot of time helping companies to cast their story in investor-friendly terms. This can be hugely valuable for entrepreneurs who have not worked with VCs before. They manage the investment process, which can be hugely valuable to resource-strapped start-ups. They will also advise on the complicated and lesser known aspects of raising venture capital, although that information is increasingly available on the web, not least on my blog.