Always run an Auction

Part I: Why auctions work

When selling a unique asset, auctions usually work. Your equity is a unique asset, and when you raise money, you are selling a big chunk of it. There’s no “right” price for your equity and there aren’t that many interested buyers. An auction allows you to figure out who is interested in buying your equity and what they’d be willing to pay for it. Now, keep in mind that there are similar assets and traditional ways of doing things, so you want to play off those norms instead of upending them.

The best asset auctions follow a common set of principles:

1. Full information is gated to valid participants
2. Information is distributed to relevant participants at the same time
3. Everyone starts bidding/process at the same time
4. (Ideally) bids all come in at the same time

The perfect version of a Series A auction would look like a seed Demo Day or an IPO road show. You’d put all the relevant parties in a room, pitch them, give them a due date, then field diligence requests, review all the bids at once.

There are a few reasons this doesn’t work for Series As. The largest of these reasons is that this just isn’t how it is done. Silly, sure, but you deal with the market that you have and not the market you wish you had.?

There’s another critical thing here about the auction…not all auctions are the same. Simple auctions - say for a piece of art - are primarily based on one matching criteria - what’s the price at which bid and ask match. The seller wants this to be as high as possible as they’re selling 100% of the asset. The same is mostly true for an IPO, though management in this case has some desire not to “price too high” because of the unfair expectations it might set at the initiation of trading. No CEO wants the price to fall off a cliff on the first day.

There are other complexities related to the dynamics of different types of auctions (common value, private value, affiliated value). We’re not going to dig into all of those, but it’s important to remember that not all auctions are created the same, and not all bidders approach an auction in identical manners, even for the same asset.

Series A auctions require the parties to optimize against multiple variables. Price is a major concern, but so are board structure, partner quality, fund quality/brand, options pool sizing, secondary, founder refresh, etc. Ideally, you could manage all of these in one go, which would turn the Series A process into a special class of auction called a combinatorial auction, or a smart market. This would be a fun topic to dig into for a few hours and model theoretically, but is too operationally complex to implement in the VC world. At least for now.

The way we practically deal with this consideration is to use the auction process for two main things:

1. Running an auction is the best way to create pressure on investors to act. Parallel processes simply work better in 99% of cases.
2. The second benefit of an auction is that it allows for price discovery. If you have multiple offers, the highest offer is not necessarily the best. However you need to know what the ranges are so that you can find? the best match across all the variables.

Part II: How to start an auction

Now that we’ve established the benefits of auctions, let’s look at how to actually run your Series A process as an auction. To do so, let’s compare two timelines. The first is how founders view a fundraising process. The second is how investors see the same. The dates below are all entirely fudgeable.

Nearly every investing process at every investor on the planet runs a version of this model. There is some flexibility here - some investors move faster than others - but it is surprisingly rigid. That fact is your weapon. You can actually control the pace at which your fundraise happens by forcing a simultaneous start time.

This can be operationally complicated, but isn’t hard to understand. The way to do it is by starting early and being consistent.

1-3 months ahead of your fundraise, you need to identify the full set of investors that you will want to pitch. If you’ve been doing coffee meetings, you’ll have a good chunk of this ready. Once you’ve identified the investors, you need to identify your intro paths to those investors. Again, not that hard if you give yourself the time to research those paths and to make sure that the introducer is up for it. You can send an email like this:

Paz!

Hope you saw our investor update this month (dropped it below as a reminder). Things are going well and we’re going to kick off our A on Feb 10. We’ve built out a list of investors we’d like to pitch, but there are a few to whom we’re not well connected.

I noticed that you and Magnus @ KSEF have done a number of deals together. We think he’d be a good fit for us because of his interest in novel methods of electric power generation. Do you know him well enough to introduce us? If so, we’ll send over the blurb as soon as we’re ready to kick off.

Thanks,

Simon

Once you have those introductions set to go, you get your deck ready (you can do this at the same time). And then, two weeks before the round kicks off, send out scheduling emails to the investors. Two weeks is a good timeline here because it gives you enough time to deal with scheduling back and forth and to lock in 20-30 meetings per week during your active pitching.

That scheduling email looks like this:

Aaron -

Thanks again for introducing us to SuperDuper back in November. As I’m sure you heard, we signed them up as a customer. December was another great month (+22%), which puts us up 500% last year.

As you can imagine, we've been getting a lot of inbound interest and now that we understand how to scale acquisition, we're going to raise an A to accelerate. I'd love the chance to walk you through our deck & our plan. We're kicking off on Feb 10. I have openings on Feb 11 @ 11 or Feb 13 @ 9am & 2pm. Tell me what works.

- Gail

Something funny will usually happen here. You’ll email the investor, and then immediately get passed to an EA. If the investor is interested, the EA will move quickly to schedule. You can push back quite a bit here on timing. Make sure you get 45 minutes - 1 hour for your meeting. Make sure your days have enough meetings and your meetings have enough buffer to travel or recharge.

One great hack is to schedule meetings in different geographies at the same time and to use the fact of your trip as a reason to get a meeting scheduled with someone who might be hard to reach. When possible you want these meetings in person - in person meetings are higher fidelity.

Part III: How to create and hold momentum

Once you have all your meetings set up, you hit the next test - maintaining momentum. This is hard and the truth is that fast moving rounds move on their own. The founders don’t have to do much more than kick things off and let the logic of the process take over. Founders always want to know if their rounds are moving fast or slow. Lots of founders have heard bad ideas about forcing investors into a timeline like so “Meetings start Tuesday, data room open Thursday, term sheets Friday.” This is a bad plan for reasons that would take a while to unpack and which I’ve done before. Let’s just leave it as “don’t do this for now.”

But there is a simple heuristic for knowing how your round is going:

• Very hot round: term sheets inside of 72 hours
• Hot rounds: term sheets inside 2 weeks
• Normal rounds: term sheet in 2-4 weeks
• Can still get done rounds: term sheet in 4-12 weeks
• Anything goes: 12 weeks+

There’s no magic to getting investors to move faster. When you have a clear process update, use it. Some of these are:

• We’re moving into partner meetings with a number of firms
• We have a term sheet

NOT

• We’re expecting offers tonight
• We got an offer from so and so (that hasn’t given you an offer)

The way to do this is to send an email that looks like this:

Tuve -

I’ve enjoyed getting to know you and your team over the last week. I’m writing to let you know that we received a term sheet from an investor that we know well and who we think would be great for our business.

That said, I’d hate to lose the chance to work with you because the process gets away from us. We plan on making the right decision here - not simply the fastest. What do you need from us to get to a decision?

- Bandit

If you don’t have process updates, use business updates. One of the best things you can do during a fundraising process is drop the news of a big new contract or expansion or user milestone that supports the core argument you are already making about why your company is going to be huge.

You can always bluff in these situations. Sometimes it works. Sometimes it blows up in your face. You need to be careful about it but also this is very definitely like gambling, so sometimes that’s a good idea.

Now, during the process, you’re going to have to deal with diligence requests and reference requests. The way you respond to these will be inversely related to the amount of heat you have. Fast moving processes generally require less diligence and fewer references ahead of the term sheet than slow processes. Leverage matters.

Which creates a funny problem - if you answer every diligence question in full and do so quickly, investors will be happy with the information but also will intuit that you have time on your hands which means you’re not close to a term sheet. Same thing with customer references. You may have glowing references that could tip the scale to a term sheet, but if you offer those freely then investors will realize not many people are asking - since you wouldn’t bother your customers with EVERY VC that comes knocking.

So you need to weigh these considerations and make micro decisions on which questions you answer, to what depth you answer them, and when.

It is generally a good idea to allow all investors from a cohort of meetings into the data room at the same time rather than 1 at a time. This is an example of how you can re-impose grouping on your own.

Honestly that’s a key goal - any time you have the opportunity to regroup investors back to a starting line, use it. When credible investors hit each of the milestones below, you can send an email to the rest of the investors to let them know that the process is moving and that they need to hurry up to keep pace.

1. Kickoff
2. Data room
3. Partner meetings
4. Term sheets

Part IV: Closing the auction

If you’ve run this process well, a set of investors will all approach the decision point and be ready to deliver term sheets at the same time. You still need someone to go first, and investors are often scared to be the first to offer a term sheet because they don’t want to get rejected. This is less true of more experienced and of more excited investors. Sometimes investors willt try to get you to pre-agree to terms before sending them. Don’t do this. Always hedge and use lines like “We’d love to work together. The pricing you’ve mentioned is (or is not) in line with our expectations, but we need to see all the terms in one place in order to evaluate the full offer.” Another good one is “I’ve never done this kind of fundraise (or maybe have only done it a few times) and you do it all the time. Could you send over the terms so I can review with counsel and make sure I know what we’re discussing?”

It’s important, in these dynamics, to not act as if you are only looking for the highest possible price. This is true both because it will annoy investors and also because it is a bad idea - remember that you want a deal that sets you up best for terminal value, not current value.

If you get a single term sheet, you can use that to get other term sheets using the script above. Once you do this, you will get 1 of 3 answers:

1. Thanks so much, while we love what you’re doing, we just won’t be able to get there in the time we have. Congrats.
2. We’re excited but need a bit more time to finish our work. Can you get us X, Y, Z and 48 hours?
3. That’s great, can we get on the phone and discuss? We’re excited here and want to make sure we get to build your business alongside you.

If you get to the point where you have multiple offers, you are almost running a second auction. At this point, all of the investors to whom you are speaking have expressed their willingness to bid, and you have to figure out what you want and how to get it. The leverage - at this point - is strongly in your favor. There’s quite a lot of nuance on how to handle a multi-thread negotiation of that nature, which we can’t fully unpack here. That’s the time where it’s best to have someone you trust to guide you through the process using a clear understanding of the parties involved, the unwritten rules of this business, and the right ways to think about the overall optimization.

Disclosures

This material is intended for information purposes only and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. Unless otherwise stated, all views or opinions herein are solely those of the author(s), and thus any view, comments, or outlook expressed in this communication may differ substantially from any similar material issued by other persons or entities. The information contained in this communication is based on generally available information and although obtained from sources believed to be reliable, its accuracy and completeness cannot be assured and such information may be incomplete or condensed. The information in this communication does not constitute tax, financial, or legal advice.