Almost no investor wants to be the “first check written” for your round of funding that uses convertible securities. This makes total sense if you think about it from their perspective. If you don’t secure any other investors, they are in big trouble because you needed a certain amount of money to become viable and now their investment is already extremely risky.
For this reason, until you actually have money in the bank from a few investors you will find that most interested investors drag their heels (artificially delaying things). This article describes how you can use verbal commitments as a crucial tool to shake things loose, get some money in the bank, and trigger needed fundraising momentum.
The Investor’s Perspective
The corollary to “no investor wants to be the first check written” is “every investor wants to be the last check written“. So keep that in mind as you hear comments like these from seemingly-interested investors:
- “How much have you raised so far?”
- “Let’s meet again in a week or so”
- “I’m going to need some additional information”
- “I’m evaluating some other investment opportunities and need a little more time”
- “Can you save a slot for me?”
It’s totally possible that these statements and questions are legitimate. But they might be hints of first-check-paranoia.
If all investors in your round gets the exact same terms, they can optimize their risk by being the last check written in the round. One way to address this is to give the first investors certain economic benefits to compensate for the extra risk you’re asking them to take. You can sometimes get away with that approach when using convertible notes or SAFEs (via a higher discount or lower valuation cap), because these instruments allow for what’s referred to as “high resolution financing”. Different terms could technically be offered to each investor, although taking that to an extreme is not advised. But that doesn’t work for priced/equity rounds of funding in which the terms are locked in and also isn’t the topic of this article.
But what if favorable terms for the first investors in a round isn’t enough to get them to write a check?
Using the “Soft Close” Technique
While seeking to close your first investor(s) and also respecting the fact that none want to be the first check written, don’t always go for the hard close by asking them to write you a check. Instead, be prepared to use a softer approaching by asking them to “verbally commit” to an investment. This allows them to signal that they want to invest in your company, but without yet requiring the action of writing a check.
The way to execute this soft close is simple. Just ask something like “Can I include you on my list of committed investors?” If they say “yes”, then politely see if they are also willing to execute docs and write a check. If not, then let them know that you recognize the risk of being the “first check written” and ask if you can mention their name and intended investment amount when describing your fundraising progress to other prospective investors.
Experienced investors will understand what you are doing. And if needed, feel free to make it clear that you’ll describe their commitment as “verbal” or “soft-circled”.
The other benefit of a soft close is to gauge whether the investor has remaining concerns that prevent them from investing. By asking the specific questions, you are putting them in the best position to get specific about any concerns. Sometimes, the best thing you can get is a short list of the things you need to accomplish in order to secure their investment.
When Will They Write Their Check?
You don’t want to just leave the meeting with an ambiguous verbal commitment, but rather want to know what milestone(s) you need to reach to get them to give you their money. Often, it’s a certain amount of funding raised/committed so they aren’t the first check written. For the earliest investors, this is possibly something like 10-20% of your total fundraising target. So if you’re raising $1M, the first investors might want you to get $100-200K of firm commitments and investments before they will write their check.
It’s also possible the investor wants you to hit some other non-funding milestone. Maybe something related to your product, revenue or team. The main point is you need to ask, so that you know exactly when to come back to them for their money. And if that’s going to take more than a couple of weeks, make sure to keep them updated on any progress – otherwise they will go “cold” and you might lose the commitment.
Prove It To Me
Other investors will naturally be skeptical when you tell them you already have a certain amount of funding committed (I personally think “committed” sounds much better than “soft-circled”). Because of this, make an attempt to get more than just a verbal indication from the prior committed investor(s). Below is a list of increasingly more substantial forms of verbal commitments:
- The investor lets you mention their name
- The investor lets you mention their name and committed investment amount
- The investor agrees to an email exchange with you, demonstrating their commitment
- The investor agrees to talk with other investor prospects to confirm their commitment (and hopefully explain what they like about your company that causes them to want to invest)
- The investor agrees to sign a Letter of Intent (LOI) confirming their intention to invest – understanding an LOI isn’t legally-binding.
Note: If you’re lucky enough to get an investor to sign an LOI (#5 above) but don’t have a template for that, just download mine as a starting point. It’s on my Resources Page in the Fundraising Resources section.
Safety in Numbers
As soon as you have more than a single verbal commitment, no individual investor is the “first check written”. That doesn’t mean that having two verbal commitments will be sufficient to get those two investors to write their checks. But as you get to three, four or more, surely you can rally them to write checks together.
Here are two stories I like to tell as analogies:
- Cliff Jumping – Have you and some friends ever stood on a high cliff above a body of water with the intention of jumping off for a thrill? The higher the cliff the more nobody wants to be the first one to jump. So instead you make a commitment to jump together on the count of three. Then the discussion turns to how important it is to actually jump on the count of three and the embarrassment any non-jumping member will experience if they don’t.
- Dance Floor – How many times have you been at a reception following a wedding where the DJ is playing great dance music but nobody is dancing? Eventually, some couple that has had a few too many glasses of wine decides to jump out there and start dancing. Suddenly, the dance floor fills up with everybody else.
At the right time, get your early and committed investors to “jump off the cliff together” or “get on the dance floor” by telling them you’ve got __ (#) investors committed for a total of $__K in funding and you are doing an “initial close” with all of them in 3 days to move into your middle phase of fundraising.
Note: If you are offering special economic terms for the first investors or the first certain amount of investment, reaching that amount of verbal commitments is a perfect point to do this “initial close”.
Off to the Races
With just a little luck you’ll close the first 15-20% of your total funding round objective using this approach. The next set of investors you approach will evaluate the opportunity without the added “first check written” risk. In fact, hopefully you’ve already met with some that are perfect to approach now that you’ve got some new money in the bank.
For more on this, read my related article titled “Don’t Spend Your Fundraising Goal Until It’s in the Bank“
You will still come across investors that want to maximize their risk reduction by being the “last check written” but don’t give up on them – just put their name on a list to officially approach again when you cross the 75% mark and don’t forget to keep them “warm” by remaining in contact throughout your fundraising process.
Continued Use Throughout the Process
Even after getting through an Initial Close using this approach, you can use verbal commitments throughout the remainder of your fundraising process. Until your round is completely closed, any experienced investor will want to know how close you are to your ultimate fundraising goal. “How much have you raised so far?” will be a question you get from virtually every investor.
There are multiple ways to answer that question. And that’s because at any given point during your fundraising process you will have a combination of new money in the bank and outstanding verbal commitments that aren’t yet funded.
To continue with a specific example, let’s assume you’re raising $1M in total and have $400K in the bank plus another $150K in verbal commits. When asked how much you’ve raised so far, should you say “$400K” or “$550K”? I am usually OK recommending that you say something like “We’re currently at $550K of commitments”. But here are some important caveats and additional insights to consider:
- If any following comment or question by the investor hints at their interest in more details, you should be quick to mention how much of the $550K is in-the-bank versus verbally-committed but not yet funded.
- The total amount of verbal commits makes a difference. For example, imagine the numbers above were reversed, meaning you have $150K in-the-bank and $400K in verbal commits. In this case I strongly recommend saying something like “We’re at $550K including verbal commits“. The investor will surely ask for more details, which you should provide.
- There are different levels of “verbally committed” and you should take that into consideration when deciding how to message. The strongest type of verbal commitment involves an investor that signs an LOI. The next best is one that has performed solid due diligence, asked for a copy of your funding docs, and confirmed that you can count them as “committed”.
- What is your track record for converting verbally-committed investors to checks written? If all, or almost all, have converted for this funding round so far, then you’ve got a track record you can point to as justification for including new verbal commits in your total number.
- After interacting with many investors, you will find some that seem obviously skeptical and overly scrutinizing. For those investors, including verbal commitments in your total can easily backfire when they discover the underlying details.
A common term included with priced/equity rounds of funding is called the Initial Close. This is the minimum amount of funding the company must get committed before money actually gets transferred. If you think about it, this is a built-in protection mechanism against a form of the “first check written” issue. You will still use most of the ideas and recommendations in this article, but instead will have a specific goal you’re shooting for initially.
The inclusion of an Initial Close term and the associated amount is something you will negotiate with your lead investor. Just realize that for equity rounds of funding led by a VC, the amount will be more like 75-90% of your total target amount, rather than the 10-20% that has been described in this article.
Your integrity and reputation as an upstanding entrepreneur or business leader are critical to on-going success. Be very careful not to stretch the use of verbal commitments too far, because it could backfire. But hopefully this article has demonstrated how powerful they can be in multiple regards.