| The Full Series - how to avoid a "No" from a VC |
| Written by Gerry Langeler | |
| Wednesday, April 28, 2010 | |
|
It has come to our attention that in certain parts of the world, the "How to Avoid a "No" from VCs" series, originally written for Seattle 2.0, is "not accessible." Hopefully those same folks in far-off lands will not see the OVP blog as in any way subversive. So, for the record, here is the multi-part series all in one place. Where does VC money come from?
Let's start at the beginning, a very good place to start (as
Julie Andrews in The Sound of Music would say). For those
start-ups interested in raising venture capital (VC) dollars, it pays to
understand your customer. In this case, the customer is for your
stock, not your products - but the same principals apply. The better
you know your customer and their "care abouts" the more likely you are
to match your offering to their needs.
Most dollars managed by venture capital firms of any size come
from institutional sources such as pension funds, charitable trusts,
university endowments and so on. And just as you need to understand
your customer, it never hurts to understand your customer's customer.
Those major institutional sources of money have a couple of things in
common.
Now, for one thing about how we the VCs deal with our
customers. About every four to five years, we have to go back to raise a
new fund. That is because each fund we raise has both a total expected
"life" of about 10 years, and a contractually limited investing in new
companies period of about five years. So, it is at times like those
that we very literally get to find out if we get to stay in business.
If our investors (called Limited Partners) don't find the performance
and prospects of our recent prior funds compelling, their easy option is
to say "no" to the new fund. Remember, they have hundreds of other
choices, and we are small potatoes in their eyes.
So, when you wonder why VCs are both VERY selective about where
we place our funds, and VERY involved in how well those investments
perform, you now have a picture of our world.
We have to raise money just the way you do. We have
competitors just as you do (in fact we have many more). And we all
recognize that no matter how successful we may have been in the past,
"what have you done for me lately" applies to us as much as any other
industry.
Addendum..................................................................
A reader asked:
More
about fund internals e.g. How funds receive the money (all at once, or
in tranches), how the money is allocated over time, how profit is
returned to investors and what happens if there is none, what happens if
an investment (a startup) doesn't perform in the expected time-frame
but is still promising. Also how the VC firm itself profits from it's
activity and what the margins are, what happens to that margin if the
fund performs well vs badly.
Much more (6 articles) after the break.... Why do most VCs say "No" - most of the time?
We know it can be very frustrating to entrepreneurs to put
their best foot forward, make what they consider a compelling
presentation, and yet get turned away, again and again.
So, why are we so "mean"?
Well, hopefully we are not that, even if we don't choose to
invest. In fact, our internal goals are for those we turn down to go
away at least with some valuable free consulting for their time and
effort.
But we do say "No" the vast majority of the time, and owe it to
you to explain ourselves better, in general and in specific. For this
post, I'll focus on the general and on our internal dynamics. Over the
coming weeks, I'll address things that begin to reach more directly
across to your side of the table, and to those specifics. If you want
some perspective in advance, feel free to visit the OVP blog
and
check out the now 5-part series "Behind
Closed Doors". (link is to the first in the series)
We say "No" most often because, frankly, the vast majority of
start-ups simply aren't right for institutional venture capital. The
companies involved are never going to scale to a size that makes our
investment worthwhile.
To explain, here's some simple math, using our fund as an
example. OVP VII is a $250M pool of capital. Our fees and expenses
will eat up about 15%-20% of that over 10 years (let's call it $40M).
We'll make about 24 investments in OVP VII, and assume we average about
$9M invested in each company over their life. We'll usually own 20%-25%
of each of these companies. Finally, assume typical venture fund
dynamics: that 33% fail (where we lose some or all of our investment),
33% are only OK (we get our money back, or maybe a little bit of a
profit), and the final 33% are the ones we feel good about.
For the eight that failed, say we lost 50% (say $35M) out of the
$72M put in, so we're now "down" $75M from where we started ($35M, plus
the $40M expenses). On the next eight, let's say we got 1.5x our
capital paid in, or a $35M profit on top of our $72M invested, so we're
back to $40M under water.
Internalize that: we've just accounted for 2/3 of our
investments, and we're not back to break even yet!
To be a good fund (greater than 2x paid in) those last eight have
to get us at least $540M ($500M + the $40M we're down). That means
each deal has to return, on average, ~$70M. At 20% ownership, that
means each has to average a market value of $350M. But for those eight
to average that, probably two have to be well north of $500M, with one
probably close to $1B. Those are "big ideas" indeed.
Now, how many start-ups can legitimately claim that if all goes
according to plan, they will reach a market capitalization of $350M-$1B?
Yet, if we invest in a company knowing it never can - even if it
executes well - then we are stacking the odds against us ever having a
good fund for our investors.
To be fair, we actually do this periodically, because we know
that a higher hit rate of companies in the lower $100Ms can balance us
out. And we talk ourselves into believing that THIS deal is not going to
be one of those losers, hence the higher hit rate. (I'll leave it to
you to decide whether this is folly.) But, at numbers below $100M as an
optimistic exit value, the math just doesn't ever work for us. Yet,
there are many, many fine companies that can be built that end up in
this value range. They can be very rewarding to their founders and
employees, serving their customers and society well.
This is why there is a real place for investors such as friends
and family, angels, small venture funds, customer financing, the whole
panoply of financial backers to assist the whole range of companies for
whatever scale they should strive to be. For example, if you were to
divide all the numbers above by 5, and then approach a $50M venture fund
or angel group, you might see something that fits your world (and
theirs). The important thing is to match your realistic company scale to
the proper financing source. If more entrepreneurs did this before
approaching potential investors, there would be fewer disappointments on
both sides.
Of course, if you do have one of those "big ideas", we VCs most
definitely want to check it (and you) out!
How to avoid a "no" from a VC - part 1 (People)
OK - a few weeks ago I promised more details on how to avoid
the dreaded "no" from your local (or not so local) venture capitalist.
It seems the best way to organize this series is around the four major
risks all VCs think about when looking at a new potential investment:
People, Product, Market, & Financing.
The old saw in the VC biz is investors invest in three things:
people, people and people. There's more than a little truth to that.
We've seen great teams dig themselves out of some deep holes, and weak
teams dig themselves into some deep holes.
But how do you know you have a great team, at least in the eye of
the beholder (us)?
First, ask yourself this question: "What is the probability that
there is a team with more domain expertise, more horsepower, and more
high-level industry connections located somewhere along the Silicon
Valley, Boston, London, Zurich, Haifa, Mumbai, Shenzhen, Tokyo, Seoul
corridor?" Really - ask yourself that! Because we are asking ourselves
that as you speak.
We know all too well that in this global, internet-savvy world,
unique ideas are fleeting. But, unique teams are precious.
If you can't answer the question above with a solid "yes", then
ask yourself if you CAN gather such a team. We understand that
early-stage startups often start up with less than fleshed-out teams.
So, know where you are weak or missing talent. Know what you don't
know, but know you need to know. And know that if you share that level
of introspection with us, we will be much more impressed than if you try
to blow by us with a patched together personnel story - or worse a
bunch of B or C players plugged in to fill holes on an org chart. We
VCs are very used to building teams and used to working through team
transitions as companies grow. But we'd like to fully understand where
that help will be needed before we begin, not after the first key
milestones are missed. And we'll be evaluating how much heavy lifting
is reasonable and still be expected to succeed.
Next, beat me to the punch. I have a question I love to spring
on unsuspecting entrepreneurs. (I guess this post ends that
opportunity) I go around the room and ask each member of the founding
team to describe who they are, their background, and their role.
Now, I'm looking at you, "Bob, what about you?"
and you say..."I'm the CEO!"
and I say..."Why?" (this is usually the first time anyone has
asked this person that question)
and you say..."Because I'm the founder."
and I say..."So?" (long pause...)
"What do you think a start-up CEO has to be good at? Are you
good at those things?"
You'd be amazed how many times I've done this and how many Dan
Quayle moments (deer in the headlights) it has engendered. Let me be
clear, I'm not doing this to be mean. I'm doing this to make a point.
You wouldn't hire a VP of R&D unless they had proven they had the
right skills to do that job, nor a VP of Sales, nor a CFO. But founder
after founder thinks that being a founder is all it takes to be a good
CEO. We have lots of evidence to the contrary.
To be fair, being a founder actually shows you do have one key
attribute of successful startup CEO's - the ability to craft a
compelling vision of the future direction of the enterprise and then get
people to follow that vision. But, vision buys you the first couple of
months. After that, only steely-eyed execution matters for the next few
years. And the fact that I put entrepreneurs on the spot doesn't mean
they can't be CEO. It means they need to understand that from the day
they take our money it's no longer about them, or about us. It's about
the enterprise and what's good for it. If that means you are a one in a
million like a Bill Gates or a Michael Dell and can take the company
from day one to billions in sales - terrific! If it means you need to
step into another role in six months - terrific! What we all need to be
working on is building a powerful, lasting, valuable enterprise - with
whoever we need in whatever roles need filling.
My final ploy on this topic is to ask a simple question, "Do you
want to be the boss, or do you want to be rich?" There is only one right
answer (for us). Again, it doesn't mean you can't be both - but it
means if it becomes clear someone else is needed to help the company
reach its potential, you are not confused about our shared need for
economic success. By the way, there is absolutely nothing wrong with
answering that question, "the boss." It just means you are not right
for institutional venture capital - and as I said in an earlier post,
there's nothing wrong with that, either.
In the end, we look at the team and say to ourselves. "Are these
guys and gals likely to go toe to toe with those phantom start-ups
around the world that are somewhere between 6 months behind and 6 months
ahead - and win?" If we think you are, then we start thinking
seriously about the next three risk areas.
So, next time - we'll talk products/technology. How to avoid a "no" from a VC - part 2 (Product)Last time (in part 1), I talked about the People issue. This time, we’ll move on to the second of the four great risks VCs evaluate when looking at a new deal: the Product.
Because we are technology investors, at OVP this actually means
Product + Technology since in many of our investments it is not a
certainty the product envisioned by the founding team can actually be
delivered, or will work as advertised.
In any event, as you are presenting your business plan to us, we
are asking the following questions about your product and when
appropriate, your technology:
1)
If this is an area of deep technology barriers, do you have
clear rights to the intellectual property (IP) you need to have freedom
to operate? How much work has been done to validate that assumption?
Who are the competitors most likely to feel threatened by your arrival –
especially those who employ more lawyers than you will have total
employees? If this is not a patent issue but one of know-how and trade
secrets, as in most software companies, what is the evidence that you
possess proprietary advantage?
2)
How hard is it to do what you are setting out to do? This
actually cuts both ways: If what you are doing is not hard, that means
it is very likely you will deliver, but it will be much easier for
someone to come up your tailpipe. If what you are doing is very hard,
then you may not succeed in getting it done, but if you do, you’ll be in
the clear for a while.
Frankly, if we have to choose, we’ll go with the latter. We like
tough technology barriers erected for others to have to hurdle. Not all
VCs do – another reason to match yourself to your potential funding
source.
3)
Is your planned offering a “feature”, a “product line”, or a
“company platform?” Most great companies are not built around a single
product, but a set of products covering a range of needs across some
adjacent market segments.
So, we ask ourselves: Is this a capability that we might see
subsumed in the next release of some Google or Microsoft offering (a
feature)? Or is this a capability that might be stand-alone for a
while, but really needs to be part of a larger more complete offering to
succeed (a product)? Or is this a platform, with a product as its
first deliverable, but with a broad foundation that can support multiple
products and/or services over time (a company)? Companies built around
a single product can be successful, but they are inherently more risky
because a competitor can hurt you much more easily than if you are a
platform. Platforms can be harder to get launched, because they may not
address enough of a pain point immediately to get budget dollars.
We don’t ever knowingly invest in a “just a feature” deal. We
will sometimes do a "product deal" if we think its space is large
enough. Platforms are our favorite, as long as the first product from
that potential platform can penetrate the market on its own merits.
4)
However, for those who lean towards a platform play there is a
trap. Somewhere at the outer reaches of a platform you become a “boil
the ocean” project. Those companies are simply biting off more than any
rational start-up can chew – often more than any large company can chew.
(Mixed metaphors are us). Ask yourself if any reasonable team of
people can do all the things you are setting out to do in the time
allotted.
That said, the company I helped found (Mentor Graphics) was told
by knowledgeable observers that we couldn’t possibly do what we said we
were going to do. When we did, we became the
fastest
growing software company ever to $200M in sales (to this
day, in constant dollars). So, if you can boil maybe not the ocean but a
good sized bay, the rewards can be terrific!
5)
Do you have adequate control of your destiny? One of the very
first VC deals I was involved in as an outside board member was planning
to build its future success on top of Windows 1.0. (yes, I am that
old) You can guess how that one ended. This is not to say there aren’t
big rewards available for those who build into existing eco-systems.
But betting on a new external eco-system to arrive on your schedule is
multiplying your risk. Betting on an eco-system to spring up around
your little piece of the world, as a requirement for your success, is
multiplying your arrogance.
6)
Does your success require success to be successful? Huh? You’d
be amazed at the number of Internet deals we’ve seen that essentially
posit, “We’re going to do X, and then once we get to 10 million unique
visitors a month, we can monetize that with advertising.” Well, of
course you can! The problem is getting to the 10M uniques. That is damn
hard. Assuming you can make that happen by just showing up is naive.
7)
Do you have multiple revenue streams? That’s not good. What?
Doesn’t that lower risk? Not in our experience. There’s a proverb on
my wall that says, “Do not try to catch two frogs with one hand.’ As a
start-up, you barely have one hand. Some of us can remember back to the
early days of Sun when Scott McNealy was hedging his bets with both the
Sparc architecture and Intel architecture….and Sun was struggling. His
famous, “Let’s put all the wood behind one arrowhead” was a key turning
point in their ultimate success (until recent times).
Again, to be fair many angel investors love multiple revenue
streams. In their world, it does reduce risk. But, they usually don’t
have the diversification we have, and usually aren’t as ready to be
totally wrong and lose all their money in that investment in return for a
chance to be screamingly right. So, a project that has multiple
revenue streams may be better for angels than for VCs.
Final thought, if you do present multiple streams look at your
numbers. Are there some streams that you could just drop and not
materially change the top and bottom line? If so, do that!
Let me leave you with a case study of a deal OVP did that looks as if it will be a huge winner. I will not name it to protect the innocent, and to not jinx it, either. This company came to us with a revolutionary product concept that was essentially two orders of magnitude better than the competition. In fact, it was so much better it would open up potentially huge new demand. But, to succeed they had to deliver on three separate technology areas, pushing or breaking the state-of-the-art in all three. This was VERY close to a boil the ocean project, so much so that one of our more risk-averse partners at the time voted "no" on the deal. But, the rest of us thought the risk was balanced by such a large potential reward that it was worth the chance. In addition, this was (and is) a killer team, so the People risk part helped mitigate the Product risk. The company had all its IP nailed down and it would be completely self-reliant. Although it might ultimately engender a new eco-system around it, that wasn’t necessary for it to succeed. A very large company could be built around the initial product concept, but the technology (if all three legs worked) had applicability into adjacent areas. It had a single major revenue stream, albeit a very different model than its industry was used to. Time will tell whether this one delivers as it appears it will – but against the criteria above, it made our Product cut-line with ease. Next time, part 3 on the VC decision tour will cover Market. And it will contain some controversial positions, you can be sure! :-) How to avoid a "no" from a VC - part 3 (Market)
So, previously, we've talked about the first two risks VCs
evaluate when looking at a new deal (People & Product). Now, on to
risk number three: Market.
Frankly,
we put about zero weight on market research reports from the big
consulting and pundit firms. They are remarkably self-serving, are
usually overly optimistic as to timing, and can't foretell the future
any better than the rest of us. So, when it comes to market analysis we
go about this in the most basic, bottom's-up way we can. We ask the
customer!
One of the most surprising things
I've found over the years is how willing complete strangers are to take
our calls, and share in-depth insights into their businesses, their
"care-abouts" and their priorities. This goes all the way back to my
days as an entrepreneur, when we emulated vaudeville and traveled the
country asking these questions face-to face of potential customers. We
started with those not quite in the mainstream and worked our way to
"Vegas," which in our case was Motorola . By the time we got there,
we'd gotten feedback to our initial concept and adjusted accordingly,
our "act" was polished and so when we presented our product concept to
MOT they said, essentially, "If you build it, we will come." Then we
went back and asked our engineering team if they could build it.
As
potential investors, we maintain a cadre of contacts in the industries
we serve, and so when an entrepreneur gets our attention, we get on the
phone and ask those key industry players to evaluate the idea. If we
don't feel confident explaining the product ourselves, we'll put the
start-up team on the phone and play fly-on-the-wall while we listen to
the pitch, and the questions that are asked. The amazing thing is, it
doesn't take too many of these calls to pick out a pattern. Some
academics found years ago that somewhere about 20 you've hit diminishing
returns. We often seem to get there at about 10.
The
most important thing you can do is make these calls before we do.
What you never want to have happen is for us to have more customer
insight than you do. So, before you darken our doors, darken the doors
of your prospects and be prepared to share that anecdotal insight with
us. We'll still do our own, but you'll have started out on the right
foot.
Of course, sometimes if you are at the
leading edge of technology, you are explaining a product the customer
can't even fathom. These are the really tough ones. On our end, we do
hobnob with some "futurist" type folks and we'll certainly bring them
into the mix. Our key issue on these "change the world" deals: is the
product a nice-to-have or a have-to-have. The difference can be subtle,
or time driven. The initial cell phones were nice-to-have, because
they were big, bulky, expensive and not too many people had them. But
once they hit the right form factor, cost and penetration, they became
have-to-have's. The problem for VCs is we usually can't wait long
enough for a nice-to-have to become a have-to-have. And when we are
wrong (which is often) it is because we didn't evaluate properly the
fact that technology moves faster than people do.
Another
major issue besides customer readiness is market scale. I wrote some
about that in my
first
post on Seattle 2.0, so I'll just refer you to that. The key
issue is if you are successful, can your company grow to a scale
whereby our economics work? There are many fine companies that create
products customers are ready to buy, that are have-to-haves, but there
just aren't enough of those customers, or they aren't willing to pay
enough, to grow a major enterprise.
One
additional thought about markets: I've seen thousands of product feature
comparison matrices in start-up presentations. But not once have I
ever seen a company comparison matrix. Yes, your new product may be
better in certain ways, but what about your distribution channel? What
are the switching costs for customers who have solved your problem in
some way to date? What is the average evaluation cycle for new products
in this market? How important to your customer is eco-system
integration? Do those big, established competitors have relationships
with your prospects that transcend a simple product feature decision?
When they FUD you for being a small struggling start-up, how will you
counter that? (a strategic partnership, perhaps?) When they cut price
to keep you at bay, how will you respond?
Market
entry against entrenched competitors is very, very hard. Relying on
product features alone to carry the day is very, very shortsighted.
How to avoid a "no" from a VC - part 4 (Financing)
When is a lemming not a "lemming?" When it's bath time!
I'm not even sure where I was going with that, but there is a
point to be made. Many folks criticize VCs for acting like lemmings,
all blindly jumping off the same cliff into the sea, investing in the
same sectors, while ignoring interesting projects outside those
currently hot spaces. There is a lot of truth to that complaint. But
there is a rationale for it, too.
As I've said in other posts, often the hardest check to get is
not the first one but the second (or third!). When reality interjects
itself into the financing process, the sparkle and promise of a Series A
investment gives way to hard questions when initial targets have been
missed. It is in times like this that financing risk can become the
most important risk facing a start-up. And this is when being in a "hot
space" can help overcome an otherwise cold start.
Most entrepreneurs believe in at least one of two fallacies:
The reality is that those business plans are not correct, much
less conservative. As I've stated many times, we're now at over 120
companies backed, and NOT ONE has made their initial business plan
metrics. And we've seen many, many examples of companies that, having
missed their initial plan, struggled or failed to raise follow-on
capital. Not only do the entrepreneurs pay in that circumstance, we do
too.
So, when we look at a new start-up opportunity, we are asking
ourselves about the financing risk in that deal. That risk comes in at
least three forms:
So, what can you do about these issues? First, recognize they exist and
they are just as important as the previous three risks in this series
(People, Product, Market). Be ready to discuss the financing risks with
us. Next, find ways to mitigate them. For example, while most software
companies don't have to worry about capital intensity, even they can
find creative ways to use fewer dollars (cloud computing, etc.). If
your start-up is in a currently unpopular sector, find a strategic
partner who would benefit greatly from your success and get them into
the first round. Or find a customer who is desperate for your product
and get paid 50% up front as a deposit. If you are in a "cold space"
either find a way to morph the plan to get closer to warmer climes, or
belly up to the fact that you are looking at a long, tough slog to raise
capital.
Next, value your investment syndicate the same way you value
your most critical employees. When it comes time for the next check, you
absolutely need all your VCs to be telling their partners, "Yes, the
company is behind plan, but our investment thesis still holds. This
group deserves another check." rather than, "There is still an
opportunity here, but I'm less confident in this team than I was
initially." You'd be amazed how many start-ups take their VCs for
granted once that first check is in the bank.
Never say, "I can't wait to be done fund raising so I can get
back to running the business." Fund raising IS part of running a
business! In fact, you are always (or should always be) fund raising.
So, be looking for opportunities to expose your firm to investors beyond
your initial set. Those are the ones who might lead your Series B or C
round. Jump on any chance to present in the private company portions
of the investment banker beauty shows in your sector.
If you treat Financing risk with the same attention that you
treat the other three, you'll positively stand out from 90% of the
entrepreneurs who go looking for venture capital.
While this concludes the initial intent of a 4-part series, I'm going to add one more in the coming weeks. It will be titled, "Part 5 - Potpourri" and deal with a number of irritants and mistakes entrepreneurs make, that while not conclusively leading to a "no," get us leaning in the wrong direction. How to avoid a "no" from a VC - part 5 (Potpourri) So far, we've covered the "big four" risks in a start-up that are front of mind for every VC when you walk through the door (People, Product, Market, Financing). But there are some other issues, irritants and obstacles you can inadvertently toss in your path that don't fit nicely into those categories. While not as important as the big four, they can still direct an otherwise positive impression in the wrong direction. So, beware of: The ill-advised adviser: This is a tough one, because once I describe the issue, you'll ask for specifics that we're not comfortable giving out. But here's the situation....you come to visit and either bring along with you, or mention that you have a key relationship with someone who we know is either a pain in the rear, or worse a charlatan who doesn't know what they are doing. The former adds a level of friction to a process where we already have many more interesting new companies to look at than we can invest in - risking us taking a path of lesser resistance. The latter reflects badly on your process of selection of key people (and puts up a big red flag on the People risk domain). But, you say, "How do I know these advisers are going to be a negative? I'm new to the start-up scene and have no way of knowing who to trust." Well, this is one of your first tests. We can't get comfortable revealing the names of these folks (and there are only a few) who raise the hair on the back of our necks, because you never know when they'll hook up with the next killer deal and we do not want to be black-balled by those advisers. But, you can look around, ask around and see who we and others prefer to deal with. Start with the law firms who guide most start-ups around town. There are a handful of these, and they are all quite professional. Use them as your introduction source to us, if you feel you need one. This is not to say those firms can't be appropriately tough with us when they represent you. But it says they know the rules of the game, and we know they know. So everyone tends to operate in good faith, while representing their respective positions. A secondary message here, you don't need to pay anyone to introduce you to us. A quality service provider (lawyer, bank, accountant) will do so at no charge. Better yet, they tend to know what we have funded and have not, and can point you towards the most likely VC match.
Another thing you can do is ask us (or
folks like us), "We're looking for someone to advise us in area X. Can
you recommend anyone?" What may be most interesting to you are not the
folks we mention, but those we don't mention. Sometimes, that can just
be a momentary oversight. But if you ask a couple of VC firms that same
question, and there is a consistent name or two missing of someone you
were considering using, then you have your answer.
Control and dilution, not optimizing for success: One of the obvious questions we'll ask you is how much money you need. There are many possible right answers, but a couple of wrong answers, too. If you respond with, "It depends on valuation," you just told us you are optimizing for dilution rather than for success. The company needs a certain amount of money. In fact, it probably needs more than you think to allow for likely slippage somewhere in product development or customer traction. But if you skinny down the raise to optimize for dilution, you have dramatically raised the risk of running out of money at an inconvenient time. (BTW - there is no convenient time)
If you respond with, "I don't want to
give up control," you've just hit two negative points. First, as I've
said in earlier posts, when you take institutional money it is no longer
about you, or about us. It's about optimizing the value of the
enterprise for all stakeholders. So "you" and "in control" are off the
table as primary issues. Second, someone once gave me a very cogent
piece of advice. He said, "When you are running a company, there is
only one way you are in control. That is by executing. If you own 100%
of the stock, but don't execute, someone else is in control (the bank,
your customers, your suppliers...). On the other hand, if you own 20%
but execute, you have all the control you'll ever want. No one will do
anything other than sit in the back of the bus and cheer for you." It's
true.
With too many angels, you're in hell. Angel investors can be enormously helpful. Sometimes, they may invest prior to VCs being willing to. (But DO NOT accept the notion that this is always true. We have backed MANY companies that came to us with a business plan, and nothing else. Angels love to try to position VCs downstream from them, to make sure they get their bite at the apple. As with all things, the truth is fuzzier than that.) But angels, if selected carefully, can provide business and industry guidance and connections along with their cash. We often invest in rounds where angels provided the initial seed money, and have good, long standing relations with them afterward. However, there are two potential problems with angels. First, they often are good for the first check, but have trouble with follow-on financing rounds. And, if the terms include a "pay to play," which means an investor who does not participate in later rounds gets crushed, those glowing halos can turn dark in a hurry. In addition, unless you really fancy yourself as a cat-herder, the more angels you add to your cap table, the more cats will need to be herded. And some of these cats will keep you up at night with yowling if you aren't right on plan, or right on the phone when they have a question. I have a good friend who has raised an enormous sum from angels for his company (>$30M). While he must now be ranked as an expert cat-herder, he's also on the cusp of becoming a public company by default. That threshold is at 500 shareholders, and he's very, very close. When he started, you can be sure he never dreamed it would take so much money, so many investors, and so much of his time. He eschewed VCs early on, but suddenly has found religion as he approaches the 500 investor mark. One $10M check is a whole lot easier than two hundred $50,000 checks! "We're selling stock at $0.50 a share." Your price per share is meaningless to us. What matters is the implied company valuation (price per share times number of shares). In addition, I hate to be this blunt, but the price paid will be what we offer, not what you ask. Now, that's not to say there won't be some back and forth negotiations. But the surest way to scare off a VC is to put a valuation on the table that we know is crazy. Rather than try to educate you to how the world works in private equity, we're likely just to move on. When someone asks you what valuation you are expecting, answer simply, "The market will determine that." Your job is to get an offer. With an offer in hand, the games can begin. "We can't tell you what we're doing until you sign a NDA." We can make this very short. We aren't going to sign it, so you can decide before you visit whether that is really a criteria or not. Practically, we see thousands of new start-ups every year. There is no way for us to be in absolute control of or even remember everything we've seen and heard about. Now, that said, those of us who do this for a living do operate with enlightened self-interest. We know that if we EVER violated the confidence entrepreneurs place in us, the word would get out and we would no longer see the best deals. And that is a prescription for death in our industry. So, deal with an established VC firm, and your ideas should be safe. Of course, if the issue is one of disclosure for a potential patent, we'll find a way to make sure your IP is protected. Let me close with one of my favorite entrepreneur stories that trumps the NDA example. Years ago, I was approached by an entrepreneur who said he had a technology that was going to revolutionize the world. In fact, it was so powerful that the company he was starting would reach over one billion dollars in revenue in just five years. There was only one catch: he couldn't tell me what it was until AFTER we'd invested $10M. Now that's a powerful position! :-) I guess he never found that investor/sucker, because I've never heard of him again.
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