Lessons learned from a deal lost
I lost a deal a couple of weeks ago.
Experience is what you get when you didn't get what you wanted. As in "I lost the deal, but I got some experience". To make the most of my "experience", I wanted to recount what happened for myself.
To give some context, I responded to the founder's cold email, which I don't typically do. He was persistent though, as it wasn't his first email. Through the course of 3 months, we began diligence. We drew a map of the competitive landscape and the opportunity. We traced back previous startups in the space to understand why they may have failed.
We became excited at the prospect of working with the team to help them achieve their goals. But this was a young team, with a first time CEO and we knew there'd be lots of work ahead of us. We made a verbal offer, that was below the founder's stated valuation expectations. But it seemed we were in the ballpark. After some deliberation, the founder asked us for a written offer to understand the other terms.
We produced the written offer, with the belief that we were close on price and it would come down to the other terms. After two or three days, the founder told me the other terms were clean and he was happy with them. But he also said he couldn't stomach the valuation and wanted something 35-40% higher.
There is no doubt that I left the conversation disappointed. Why have us write an offer if you're going to come back at 40% higher? That's not in the ballpark. After holding me off for a period over the 4th of July break, we agreed that a deal was not going to happen. In my mind, the founder used my written term sheet as a way to get a deal done with a different party.
Fred Wilson has a great post on competing to win deals. His 10 rules, from back in 2010, and my interpretation of how I did:
1) Do your very best to connect with the entrepreneur. If you don't have a great personal connection, you won't win the deal. Don't even bother to try to win a deal where you don't have good personal chemistry with the founder/CEO.
I think his first rule was my biggest downfall. We almost never engage in cold emails. We want founders to find their way to us through our network, showcasing their sales skills. Another benefit is that our network will sing our praise and help show the value we bring to a deal, beyond the money.
I had some of my founders reach out to this CEO, but it was too little, too late and I had already lost. I thought I had engaged with the CEO and shown what I would bring to the table, but I realize now that I needed to do much more.
2) Bring your full partnership into the deal process early and consistently. Entrepreneurs are smart and they know they are doing a deal with a firm as well as an individual. Let them see the full picture early. Make it easy on the entrepreneur to meet the full partnership. Don't make the entrepreneur do all the work.
I would give us high marks on this one. I had the initial engagement, but brought my partner Howard in right away. Our third partner and I then met with the two co-founders. And then Tom and I did it again. Howard still hadn't met with face to face. We took the initiative and asked them to fly down to San Diego when Howard staying off of planes. When Howard got back in gear, we made it up to SF and met with the CEO. I tried to articulate the value of the partnership and each of us as individuals.
3) Encourage the entrepreneur to get feedback on you and your firm. Instead of references, I like to give a list of every entrepreneur I've ever worked with and an email address. I tell them "throw a dart at that list and talk to four or five of them randomly. you'll hear the same thing from everyone."
I'm going to start using this tactic. I had three of our CEOs reach out to share their stories, but that's a different way of sharing references. I have nothing to hide and am proud of the relationships I have with my CEOs. In the future, I'll hand out a list and judge the founder's engagement with us by their desire to reach out learn more. In this case, I don't think the founder engaged with any of our CEOs, but again, I was probably too late.
4) Don't pressure the entrepreneur to make a decision. Don't issue exploding term sheets. Don't put no shops into your term sheets. Those kinds of things are signs of insecurity. I prefer to tell people that we'll have an exclusive relationship when the deal closes and not before then. If someone wants to leave me at the altar, better it happens then than after we are married.
I'm split on this one, but I see the point. The TS didn't have an explosion date, but it did have a no shop clause. I didn't want my term sheet to be used as leverage to get a better deal which is why I stated it verbally to begin with. Once we handed a written offer, we certainly had an expectation that we were close to a deal. But perhaps the better option is to focus on the first two bullets and ignore what happens with the TS. Something for my partnership to discuss.
5) Make your offer in person and don't do it via a term sheet. Tell the entrepreneur you want to be their business partner. Tell them how much you will invest and how much ownership you want. Leave it at that. Tell them that if they are interested, you will send them a term sheet. Leading with a term sheet focuses the discussion on the wrong things. The process should be all about personal fit and very high level deal terms. Once the decision is made to try to work together, you can get into the specifics of the deal.
Again, I'd give us high marks on this one. I didn't do it in person and instead did it over a phone call given we were in separate cities. I see the point of doing it in person though and will strive to make that extra effort going forward. Re-iterating our value and commitment while seeing the reaction in the founder's eyes is likely worth it.
6) Add value during the process. Talk about the strategy issues facing the company. Talk about the hiring challenges the company faces. Try to help with these issues even before you are an investor. Show what you can do right away.
Other than introducing the company to potential customers, I believe we showed value here. We dug into the financial model. We talked about recruiting, salaries, skills and locations. We discussed and debated around the roadmap and short term priorities. We talked about naming and branding. We got deep on the discussion, but stayed away from execution.
7) Use the product or service. Ideally you should be using it well before you start chasing the deal. But use the product/service actively and smartly. The entreprener will be watching. I assure you of that.
This one isn't applicable given it's an enterprise product, but we drilled into the product, the UI/UX, the roadmap. You can always do more, but I'm not beating myself up over this one.
8) Don't feel the need to pay the highest price. Offering a crazy price to win the deal scares off most smart entrepreneurs. They will be wondering why you are so aggressive. Offering a fair price that is in the range is what you need to do. And communicate that if the entrepreneur chooses to work with you, you will be flexible on your offer. That way you put yourself in the position to win and you can work the specifics to close the deal when the opportunity presents itself.
Our biggest disconnect ended up being on price. A quote attributed to Peter Fenton here:
If you lose a deal because of price before Series B, you are too price sensitive. Use price as a litmus test for your excitement on the deal.
I should have gone in with a slightly higher price to leave room to meet in the middle. Given I was grounded on the lower price, I couldn't pivot to the higher expectation. Beyond #1, my second biggest learning to to come in with an offer where I can be flexible to make it work if I truly believe.
9) Don't team up with another firm. We've made this mistake a few times recently. Entrepreneurs want to choose their syndicate partners. By pairing up with another firm, you signal to the entrepreneur that you want to choose the syndicate and that is a mistake in a highly competitive deal.
No issue on this one. We knew one of the other firms already involved, but it was our term sheet and our deal to lose. The other firm will almost certainly continue with whomever ends up leading.
10) Be prepared to lose the deal and if you do, lose gracefully. There are plenty of good deals out there. You don't have to win them all. Lose gracefully and maintain your good relationship with the entrepreneur at all costs. They might come back to you on the next round.
I don't think I was prepared to lose the deal. We don't often lose deals when we write a term sheet. I think most of that comes back to how we engage with the founders, where the introduction comes from and more. And this was a different situation. Add to it that I moved too slowly and then not aggressively enough, and I deserved to lose it. I wished the founder luck and I have no ill will towards him, so hopefully I conceded gracefully.
Experience gained, no doubt.