Entertaining offers from VCs to preempt your next round is almost always a waste of time and sometimes dangerous. On three separate occasions at GroupMe and Fundera, I let excellent VCs that were interested in our company conduct diligence when we weren't actively fundraising. In every single instance we spent months getting excited that a top tier VC was going to make our lives easy by preempting our next round with a term sheet. And in every single instance they passed.
A preemptive financing is an extraordinarily compelling proposition for entrepreneurs: skip the formal and painstaking fundraising process and replace it with a painless gift from someone you like at a VC firm you admire. In the recent bull market when money was recklessly thrown around preemptive rounds happened aplenty. Capital allocators were incentivized to deploy their wares as quickly as possible and were increasingly diligence and valuation insensitive. That epoch is dead and now we are living in reality again, which means that it’s important for entrepreneurs to understand the motivations of a VC.
When a VC says they want to preempt your round, they are being savvy and doing their job. They are attempting to get a first look at your company and avoid competing to invest in a way that appeals to your sensibilities. It does not mean they are committed to investing. It simply means they will evaluate the company outside of your designated fundraising plan and then make an investment decision.
Frequently a lot of these processes kick off because an existing investor introduces you to one of their friends they say is a good VC and would be helpful for your company. It gets you excited because there’s social proof, you trust your existing investor, and you begin to hallucinate that there’s an easy fundraising path forward. There’s seldom an easy path.
Entrepreneurs need to be mindful of and for the most part avoid the “I want to preempt your next round!” trap for several reasons:
When you talk to one venture firm, even if you think you’re embarking on some clandestine operation, the clock starts on your fundraise whether you like it or not. Word gets around - VCs talk. They go to dinners and banter and gossip through a variety of channels. Some will say they passed even if they never got a look in the first place. Some will say the passed after issuing a term sheet you rejected. You don’t want to be tainted goods, and if there’s a cycle of “we passed” stories out there it makes any subsequent fundraise all the more difficult.
Fundraising mainly sucks for most entrepreneurs. It’s emotionally draining and almost always takes longer than you want. Engaging in a preemptive process has a real opportunity cost when it comes to focusing and executing on what matters most.
The preempting investor has no incentive to move fast, especially in this market. If they think they’re getting an exclusive look at your company, most of the time they’ll take their sweet ass time.
They will likely say No and that you should keep them updated on your progress. It will take weeks at a minimum, but likely months to get to this point. It’s the same probable ending that would happen during a more rigorous and standard go to market process.
Competition is important. Unfortunately (and fortunately for some I suppose), a lot of VCs have a herd mentality and nothing speeds up a process and gets to Yes like competition and FOMO. A preemptive process strips you of control of the narrative and dynamics of a proper fundraise.
I’ve been burned by entertaining preemptive rounds on multiple occasions. It’s like touching the hot stove repeatedly.
There are some compelling reasons to entertain the preemptive round on occasion. You get to learn why people you like and respect will say No. This is a gift when you decide to run a real process so you can get ahead of the curve. Letting an inside investor (someone who is already on your cap table) that you like and already knows the status of the business is a great reason to consider it. Especially if the Partner is someone you deeply trust. This is the ideal scenario - it saves you time and you know you’re not working with a wildcard. Same could be said for a new investor that you have a long-standing, deep, and trusting relationship with. If these things are true, then it's worth considering. Otherwise, in this market, be wary of someone trying to preempt your round.