The Ultimate Legal Guide to Seed Startup Funding Part 3: Common Mistakes Founders Make When Raising Startup Seed Funding

Raising startup seed funding often is a challenging process for startup founders.

Many startup founders, especially the “do-it-yourselfers,” will make mistakes that adversely affect their chances of securing funding or negatively impact their startup’s future. When planning how to get funding for your startup, knowing what not to do can be as important as knowing what you should do.

Part 3: Common Mistakes Founders Make When Raising Startup Seed Funding

Part 3 of this guide discusses how to avoid 10 common mistakes that founders make when raising money.

This guide is broken into three parts to provide a comprehensive playbook for startups navigating the seed fundraising process:

Part 1: How to Prepare for Startup Funding

Part 2: Key Structures, Terms and Legal Issues for Startup Seed Funding

Part 3: Common Mistakes Founders Make When Raising Startup Seed Funding

TL;DR: Raising startup seed funding is tough, and common mistakes can jeopardize your chances of receiving funding. Founders often stumble by being underprepared and neglecting key aspects of their startups that investors really care about. Avoid these errors through thorough preparation, clear communication and strategic planning, ideally with the guidance of experienced startup legal counsel, in order to improve your odds of securing the funding your startup needs.

Working with an experienced startup attorney is essential to avoiding costly mistakes while raising money.

Consult with a startup attorney today!

Top 10 Startup Business Funding Mistakes to Avoid:

1. Lack of Preparation

• Incomplete Business Plan: Failing to have a solid business plan can signal to investors that the startup founders are not serious or knowledgeable about their business and its prospects.
• Insufficient Financial Projections: Not providing appropriate projections can make it difficult for investors to assess the viability of the business. Unrealistic projections for future growth can crater credibility and confidence with investors.

2. Poor Pitch and Presentation

• Unclear Value Proposition: If startup founders cannot clearly articulate the unique value of their products or services, then investors will likely lose interest.
• Overcomplicated Pitch Deck: A pitch deck that is too long, overly detailed or poorly designed can confuse or bore investors. The pitch should be concise, engaging and visually appealing. Be sure to emphasize the most compelling investment points at the beginning of the pitch and presentation.

3. Underestimating the Importance of Market Research

• Lack of Market Validation: Not having sufficient evidence of market demand or customer interest can be a red flag for investors.
• Ignoring Competition: Failing to acknowledge competitors or having a weak competitive analysis can make it seem like the founders are not fully aware of the market landscape and their business prospects.
• Who is the Expert?: Preparation is critical and, as the startup founder, you should be more expert about your startup and its market than the investors that you are pitching. It is important to articulate your long-term vision and how the current startup funding round fits into your startup’s overall growth strategy. This transparency builds investor confidence and sets the stage for future startup funding rounds.

4. Setting Unrealistic Valuations

• Overvaluation: Setting an unrealistically high valuation can deter investors and make future fundraising rounds more difficult.
• Undervaluation: Conversely, undervaluing the company can lead to significant dilution and loss of control for the startup founders.

5. Ignoring Legal and Compliance Issues

• Neglecting Legal Documentation: Incomplete or improper legal documentation, such as incorporation papers, cap table and equity ownership, IP assignments and key contracts, can increase funding transactions expenses unnecessarily or even derail funding negotiations.
• Non-compliance with Securities Laws: Failing to comply with federal and state securities regulations when issuing equity can lead to legal complications and penalties. Among other things, you should try to seek investment only from accredited investors and avoid any general advertising for the startup funding or general solicitation of potential investors.

6. Inadequate Due Diligence Preparation

• Unorganized Records: Not having financial statements, corporate records, and other key documents organized and ready for investor due diligence can delay or jeopardize the startup funding opportunity. At a minimum, it will take more time and money to complete the seed financing, thus resulting in less operational proceeds after the funding round closes. Be sure to maintain organized and accessible records. Experienced startup legal counsel should help you get organized by coordinating the preparation of and access to an online due diligence data room for potential investors.
• Cap Table Management: It is critical to maintain a detailed and accurate equity capitalization table that tracks all equity, convertible notes, SAFEs, and options. Avoid promising any equity that is not properly issued and documented. Failure to do so can delay or derail the proposed startup funding round. Ensure the cap table is transparent and easily understandable by potential investors to demonstrate professionalism and readiness for future rounds.
• Ignoring Red Flags: Not addressing potential red flags and specific financing issues, such as unresolved legal disputes, unclear or poorly documented equity or IP ownership, incomplete corporate governance documents, financial inconsistencies or incomplete financial statements, before due diligence can raise investor concerns. Be prepared for thorough due diligence by having all corporate and business documents in order and addressing any potential financing issues and red flags in advance.

7. Mismanagement of Investor Relationships

• Poor Communication: Failing to keep investors informed, or being unresponsive, can damage trust and make investors hesitant to commit and fund.
• Not Building Relationships Early: Waiting until you are desperate for capital to start building investor relationships can be a critical mistake. Building relationships early and keeping investors updated can lead to smoother fundraising. Remember that it can take many months to raise startup funding and investors will have varying due diligence requirements and timelines. Plan for this process to take longer than you expect.

8. Misunderstanding Term Sheets and Investment Terms

• Overlooking Key Terms: The term sheet is the roadmap to the transaction and should contain all essential and material terms of the investment. Not fully understanding the terms in a term sheet can lead to unfavorable conditions, such as excessive dilution or loss of control. Even though most of the term sheet is not binding, the term sheet represents a meeting of the minds regarding the proposed financing terms.
• Failing to Engage or Ignoring Startup Legal Counsel: Companies sometimes make the consequential mistake of conflating “non-binding” with unimportant; just because the term sheet is mostly non-binding does not mean that it is not critically important. Rather, most of the deal is won (or lost) in the term sheet.

Trying to handle term sheet negotiations without involving a venture capital attorney can result in missing critical issues or agreeing to terms that are not in the startup’s best interests. Experienced startup legal counsel will provide guidance concerning how the term sheet will translate into the binding startup funding agreements, future operational and governance issues that the startup may face and the startup’s ability to obtain additional startup series funding. Experienced startup attorneys are also necessary to help draft and review all funding documents, ensuring they are favorable and protect your startup’s interests, are attractive to future investors and support the startup’s growth strategy.

9. Failing to Address Team and Operational Gaps

• Weak Founding Team: Investors often look at the strength and cohesion of the founding team (sometimes it is better to bet on the jockey and not the horse). A team lacking in necessary skills or experience, or depth, can be a significant drawback both for the startup seed funding round and the startup’s eventual success.
• Operational Weaknesses: Not addressing operational weaknesses or lacking a clear plan for scaling the business can deter investors.

10. Overlooking the Importance of Milestones

• Lack of Milestones: Not having clear, achievable milestones can make it difficult for investors to see the startup’s progress and potential for growth. Instead, establish and communicate clear milestones and key performance indicators (KPIs) that demonstrate progress and provide a roadmap for future startup funding needs.
• Unrealistic Milestones: Setting milestones that are too ambitious or unattainable can undermine credibility with investors.
• Financing Milestones: Tread carefully when using milestones as a condition for further investments. Excessive optimism or lack of bright-line clarity regarding the milestone conditions often results in milestones being missed, thus denying your startup of critical working capital.

Conclusion:

Avoiding the above mistakes requires thorough preparation, clear communication and strategic planning. Working with experienced startup legal advisors can help navigate the complexities of seed startup funding. By being well-prepared and aware of potential pitfalls, you will improve your chances of successfully raising the seed funding needed to advance and grow your startup.

Consult with a startup attorney today!

Clients also ask us:

Why do startups fail to raise funds?

Startups often fail to raise funds due to inadequate preparation, unclear value propositions and unrealistic valuations or expectations, which can lead to a lack of investor confidence.

Why is it hard for startups to get funding?

Raising startup funding is one of the most challenging aspects of running a startup because you must convince investors that your startup is viable in a competitive market while overcoming the inherent risks and uncertainties involved with early-stage businesses.

What is the best way to raise capital for my startup?

The best way to raise seed funding for your startup is to thoroughly prepare for your fundraising round. This includes preparing a compelling business plan, building strong investor relationships early and engaging experienced legal counsel to help you navigate the complex negotiations and ensure favorable terms for your startup.