A VC in Vacationland

Being in venture capital has more than a few similarities to Diane Keaton’s 1977 classic movie Looking for Mr. Goodbar (when are they going to bring that out on DVD?).  Substitute the lonely VC for the by-day teacher of the deaf Diane played in the movie and her nightly craving for sex via the bar scene for venture conferences and you have a fairly good description of the lifestyle of at least some VC’s. 

Why is it that we attend these conferences and allow ourselves to be besieged by all sorts of inappropriate investments to waste our time and patience? I guess it comes with the territory, but is also part of the craving not to miss the next new, new thing. Perhaps we are just new, new thing junkies.

Of the one hundred or so investments I "considered"(consideration can range from 1 minute to multiple weeks) last year, well over 80% were the result of attending conferences.  The wildest one was one Diane could have used if the evening’s Mr. Goodbar had back problems–HarmonySystems.  Most of the others were forgettable, mostly because many entrepreneurs are very bad about follow up.  If a VC asks a lot of questions or requests a viable business plan (no revenue hockey sticks or third year 80% gross margins, thank you), these entrepreneurs tend to disappear.  Perhaps they are looking for easier money that I provide.

I usually end up investing in two types of companies:

• Personal Experience: start-ups where I have known the senior leadership team for many years. Most have worked for me in the past and I am glad that I spawned a crop of entrepreneurs who have good ideas and a solid plan for executing the idea.  They feel comfortable with me and vice versa.  It makes our lives a bit easier as we know each others strengths and weaknesses.

• Referential Experience: start-ups where someone I have known for many years recommends a leadership team they know very well. In this case, the source is a good friend whom I trust, who has done substantial due diligence, is investing, and thinks that the company would complement my portfolio companies.

For companies on the fund raising trail, here are a few recommendations:

1. You better have a good network before you start serious fund raising. Many entrepreneurs think the time to go after VC money is after they have an inital idea and a modest business plan.  As I said in a previous post, Step Away From The Term Sheet, this is a great way to give up a lot on control for very little money.  It is much better to modestly invest second mortgage and angel money, produce a viable product or service, and get launch customers excited than to shop a concept. This is the time to have initial conversations with a select group of friendly VC’s to make them aware of your business and then provide them with short, quarterly progress reports as you move to a true value creation point.
2. Targeted approaches are better than conference hopping. The dreaded "thirty investors in one month"  road show is still a major feature of fund raising, but hopefully one that is dying out.  The reason is that it is a waste of time for both entrepreneurs and VC’s.  If entrepreneurs spent as much time planning their capital campaigns as they do, say, new product enhancements, then both sides would be spared the inappropriate meetings, often with junior VC staff members instead of decision makers. If you have done the right preselling to the right VC’s, then the process of obtaining the necessary funding should be less painful for both parties.
3. Get the luminaries on board early. If you and your company are relative unknowns with a minimal, prior track record, your probability of receiving funding, even with an excellent idea, is about as good as winning anything substantial on Deal or No Deal. If you have not successfully competed previously in your chosen market segment, please, please get someone on your team who has done it before.  Not having market experience was the number one reason I turned down entrepreneurs last year. I had one very smart person with a successful background in software try and convince me that he was now the world’s best manufacturer of RFID chips. I politely suggested a few people who had done it before, and who may be able to help him get funding, but the person was not interested in sharing ownership.

I would be interested to hear about entrepreneur’s experiences in raising money over the last year, especially what worked and what did not in their campaigns.

When VC’s plan a trip to meet with their investments, they often refer to the event as "visiting my money".  In truth, they are visiting all their partner’s money as well, and the "my" word seems a bit high minded and out of place in the phrase.  Whatever. 

The normal drill is that the company prepares the high level overview presentation, software demo, and sales/marketing data for the visiting dignitaries to demonstrate that the money is being well spent.  I have attended numerous such events over the years, and have recently begun to tire of the usual fare.  Do they have a seminar at Stanford Business School on How to Manage Your VC?  If so, it must be popular and the entrepreneurs take it to heart, pulling out their notes on "structuring a visit for your VC" every time their investors come calling.

I have three suggestions for making these visits more productive and valuable to you and your visitors:

• Focus on Networking : If you have correctly chosen your business partners, they should be extremely well connected in your industry and target customer base.  Spend a fair amount of time working on how they can help you get the right kind on meetings with the right people, whether they are with potential customers or alliance partners. You should provide details on what you would like to discuss at these meetings and evaluate how best to approach their contacts.

• Real Live Demos :  Please, please, please don’t give me some hokey demo with made up data.  I want to see your technology in operation at a real client or pilot site.  If it is a SaaS business model, show me the how the single incidence software is performing, for example, in the multi-client environment. In an installed environment, show me a solution where the customer saved a lot of money and/or dramatically improved service using your software/technology. I want to see that your technology is really doing what you claim it is capable of doing.

• Beating the Competition : Do you as an entrepreneur really know what’s going on in the marketplace?  I usually do a Blog, Google, analyst, etc. site search for potential competitors and their market successes prior to a visit.  I often find that many of these would-be competitors are not showing up on the entrepreneur’s radar screen, or that they not fully aware of competitor activities.  I know you guys are busy making your technology work and selling new clients, but not knowing your space is inexcusable.  Be sure to prepare a competitive analysis on a regular basis to avoid embarrassing questions.

I am not saying you should do away with the overview presentation, just make it short and focused. Same for the sales and marketing pitches.  Both the entrepreneur and the investors really want to maximize the value for the time spent and the best way to ensure this outcome is to take advantage of the investor’s network and knowledge through discussions, rather than overwhelm them with PowerPoint slides.

This will also allow you to refocus preparation time on who to target/sell in the customer realm, what new people you need to add to the team and why, whether the investor has any ideas on candidates, and what competitors are doing that could trump your Beta roll out. To me, these are the critical questions that can make the difference between success and failure in any start up company.

Perhaps instead of "I am going to visit my money" ,the phrase should be "I am going out to help my entrepreneur succeed". That should be everyone’s primary goal.

About half of the entrepreneurs who approach me about investing in their ideas should not (yet,or perhaps ever) be speaking to a venture capitalist. I know, the conventional entrepreneurial wisdom is get an idea, draft a short business plan, then find a vc to fund it. And believe me, I am always pleased to see a great new concept with an experienced management team show up on my doorstep.

But is my investing in your start-up always the right answer?  I often have to resist the urge to get a great idea on the cheap, as the premoney valuation for "ideas and concepts" is pretty minimal.  But, more importantly, I hate to have young entrepreneurs realize too late that they have chosen the wrong funding path for their idea.  So, the question is: "Do you want to give up the ownership rights to 50% or so of your idea for a few hundred thousand dollars in seed money?"  Surprisingly, many savvy players have not thought this through and think that expensive vc money is the key to "validating" their proposed idea.

What really validates your idea and bolsters your premoney valuation is an enthusiastic customer or two willing to pay money for access to the technology, product or service you are proposing. I realize that many vc’s bet on the idea and the team without having any signed customers. There are also many good reasons for doing this, especially if you need to get your idea to market quickly and need the high level of funding to accelerate development.  Even in these situations, vc’s like pilot site customers for the new technology or product within the first few months of operations.  None of us likes to see our money used for development without significant market input.

So, what’s an entrepreneur to do to both fund early stage development and maintain control over ownership of their ideas?  First, hit up the friends and family for loans.  You have to be willing to live with Uncle Ralph reminding you for years about losing his money if the idea fizzles, but I personally prefer someone who has put up the first $250,000 or so in seed money from second mortgages and family loans.  Second, remember that, beyond friends and family, angels are the fastest growing source of early stage funding and your local community probably has a number of potential investors.  Check out angel associations like the New York Angels to see when they are meeting to consider new investments.  In both cases, have your lawyer structure the investments as early stage loans with conversion rights to common stock (with warrant coverage) to protect initial investors from cram downs (that’s when a vc reduces early stage investor ownership levels as a precondition for new investment) if the start-up later goes after venture money.

There is a lot of venture money chasing innovative technologies and products at the moment.  You may find that it is easy to attract a lot of venture interest.  But think about stepping away from the term sheet and increasing your valuation by using early stage loans to land some benchmark customers to use and endorse your idea before looking at venture money.  Your management team and your early stage investors will profusely thank you for your astute management of funding as your idea proves itself in the marketplace.