August 19, 2003 - The Maxims of
Venture Capital - Do
this, don’t do that!
by
Bill Snow
With alarming regularity, early stage entrepreneurs run into the decorum buzz
saw Bill Snow calls “the maxims of venture capital.” As bad as this is, there
is actually something worse than running into a buzz saw: It is not knowing you
just ran into a buzz saw.
A venture capital buzz saw exists. No matter
how much you rail, wail, whine, and complain, this buzz saw exists and you are
not going to make it go away. Venture capital presents the aspirant
entrepreneur with a rich array of decorum, maxims, and truths that baffle far
too many ignorant entrepreneurs. I use the term “buzz saw” for a simple reason:
Walking into a real buzz saw will result in a big mess. The same can be said
about the venture capital buzz saw.
Instead of trying to change the way things are,
entrepreneurs are advised to learn the ways of the jungle, adapt their methods,
and go after the right financing, at the right time,
in the right way.
Today’s column focuses on some the right (and wring) ways to hunt for venture
capital.
I don’t want to hear nonsense about “the way things ought to be.”
“Life is unfair, deal with it,” is a phrase I
utter so often that I run the risk of eventually plagiarizing myself. Regular
readers of VC101 will know what I think about notions of “fairness,” (join
Greenpeace and hang out at Phish concerts). VCs do not want to hear how they
should invest their money, and they do not want to be told how they should take
risks. When you have a pile of money you can decide exactly how you use it.
This is not a perfect world, and venture capital
is not a perfect system. Remove all notions of egalitarianism from your
approach and thinking. It is up the entrepreneur to mitigate as much risk as
possible, and not for the VC to take as much risk as possible.
The Truth about bad ideas
Many early stage entrepreneurs have a seemingly
inexhaustible supply of bad ideas. They often mistake
an
idea for a good idea. No amount of spit
and polish can make a bad idea compelling. If the fundamental business model
and/or underlying assumptions are faulty, a professionally prepared plan will
not cure these fatal ailments.
Further, make sure there’s a
market for your idea. The “better mousetrap” theory is fatally flawed. If your
target market does not have a pestilence problem, the world will not beat a path
to your door to buy a “better mousetrap” they don’t need.
The Truth about venture
capitalists
VCs rarely say “no.” They
don’t want to be the example a successful entrepreneur uses one day when talking
about “all those idiot VCs who passed on my deal.” To their credit, VCs tend to
be optimistic, helpful, and encouraging. The downside of this is many
entrepreneurs keep chugging on, working on bad businesses, mainly because they
haven’t heard, “no, not a chance hell.”
VCs are polite people. Most
people learn good manners at an early age. For example, it is not polite to hang
up the phone while the other person is still talking. No matter how irrational
or long-winded the caller, most people try to end a conversation politely before
hanging up the receiver. In other words, just because VCs give you a few minutes
when you call them does not mean they’re interested in your deal!
Do not
confuse good manners for interest.
VCs utilize the “One Reason” rule. During the first step of a review process,
VCs rarely read business plans: they scan them. They are not looking for reasons
to invest; they are looking for reasons not to invest. They are not looking for
the singular hidden gem in your plan. Only if the plan passes this initial
screening, will VCs dig deeper and seriously consider the investment.
The entrepreneur’s “greatest idea in the world” is the VC’s commodity. VCs see
50, 100, 1,000 “greatest” ideas a month. Entrepreneurs need VCs more than VCs
need entrepreneurs. The person who controls the money controls the situation.
While VCs know it is unlikely every investment is going to be a home run, they
perform their due diligence expecting every investment to be a homerun. Be
prepared if you choose to contact a VC.
Basic decorum for
entrepreneurs
The easiest way to explain
this one is to say: You are being graded on your behavior just as you are being
graded on your business plan. Many first time entrepreneurs are unaware that
they are being graded on they way the behave and the way they answer questions.
There’s no secret sauce here, this is all common sense, but you would be
surprised how often money seeking entrepreneurs screw up the basic decorum
test. A simple error in any of these will result in entrepreneurial doom, and
worse than that, most entrepreneurs will not even know what they did wrong.
§
Irrationality,
irritability, insanity, instability, complaining, griping, and whining.
These are not good things.
If your behavior incorporates any of these things, you are essentially telling
the potential investor that you are unstable, and therefore you are a bad risk.
You are dead.
§
Give direct answers to direct questions.
This is the number one rules violation…with a bullet! The entrepreneur is so
excited about the chance to give his spiel to a decision maker that he often
jumps 20 steps ahead, rushes through his answer, and generally fails to answer
the question. You can almost hear the gears spinning in the entrepreneur’s head
as he parses every question, looking for hidden nuance and meaning in otherwise
direct and clear-cut questions. Here’s an example:
Q: “What are your revenues?”
A: “Our technology is portable to Unix servers
and we hope to get a patent next year after we use this venture capital round to
pay back my mother.”
§
Be honest.
While you would think this is a basic business tenant, many entrepreneurs flat
out lie about the their company and its prospects. The truth will eventually
come out, don’t shortchange yourself and your dream, and make sure you are
honest in your presentation and answers. One of the biggest lies entrepreneurs
tell is that other investors are about to put money in the deal, and “you better
get in now while you can buy at a low price.”
§
Be accurate.
Entrepreneurs have a tendency
to gin up their companies, trying to portray their efforts and dreams in the
best light possible. The combining of effort and dream seems to
be the culprit here. Using the same question as posed above, here is how
honesty gets twisted:
Q: “What are your revenues?”
A: “$2 million.”
Sounds like a direct answer to a direct question,
right? The problem, not readily apparent, is the fact that this entrepreneur
doesn’t have a $2 million company. He has some trailing revenue, but his $2
million figure is what he hopes the company will produce in the coming year.
Make sure you have a very clear delineation between historical results and your
projections.
§
Understand the lingo in the venture capital world.
Educate yourself, do your homework, learn the terms and the language. There
are plenty of resources on line, start exploring.
§
Know to whom you sent your plan.
If an investor calls you back, it is a bad thing to say, “Huh, who are you?”
This makes it look like you are sending your plan willy-nilly to everyone and
anyone. Investors usually take this as a sign that the deal has been shopped,
meaning a large number of other people have passed on it.
§
Know if an investor
actually invests in your type of deal.
This is a basic issue that
many early stage entrepreneurs don’t seem to understand. Venture capitalists’
investment criteria are usually limited by their experience and/or the covenants
of the fund’s operating agreement. Let’s say a strong software company
approaches a reputable venture capital fund that invests only in medical-related
deals. The venture capitalist will likely realize this software company is a
good deal, but he will refrain from investing because software is outside his
area of expertise and/or the fund prohibits investment in anything other than
medical device and drug discovery.
Phrases (of death) - don’t
say these things
In addition to basic decorum,
there is a pretty well know list of things I call the “phrases of death.” I say
“pretty well known” because experienced entrepreneurs and investors seem to be
acquainted with all of these, while many first time entrepreneurs are befuddled
and unknowingly walk into that venture capital buzz saw. Don’t argue any of
these points, just know if you say any of the following phrases, you are dead:
§
“You don’t get it!”
This is usually a sign of
entrepreneurial exasperation, leveled after the entrepreneur has been rejected
after the nth time. The VC probably understands more about the
situation than the person leveling the charge. In fact, the exclamation is akin
to yelling, “I’m telling mom!” Stop your whining and fix your plan. Or find a
new job.
§
“Will you sign an
NDA?”
This is a sure sign the
entrepreneur is a rank amateur. There is usually an inverse relationship
between the voracity of the NDA inquiry and the quality of the deal. If your
plan is based on an idea so tenuous that merely hearing what you do (or plan to
do) will cause grievous harm to your plan, you don’t have a plan. You have a
pipe dream.
An exception to this rule is
if you are far downstream with investor negotiations (for example, you’ve
already had numerous in depth, serious, and meaningful discussions), you
actually have something proprietary, and it is time to “open the kimono” and
expose the secret sauce (for example, source code) to the fund’s technical
expert. In this case, it is probably appropriate to ask for non-disclosure
protection.
§
“These projections
are conservative”
Your rank amateur is
showing! This usually means the projections are pie in the sky, and extremely
unobtainable.
§
“We have no
competitors”
All companies have
competitors, either direct, indirect or substitutes. Movie studios directly
compete against other studios, but they also indirectly compete with every other
kind of entertainment: theater, sporting events, restaurants, nightclubs, and
so. There are always alternatives/substitutes to your product. The biggest
competitor you may face is apathy. The customer’s decision to NOT buy your
product is a possibility.
§
“All we need to do
is grab 1% of a $100 billion market and we’ll have a billion dollar company”
This statement is unique to
exactly you…and the other 6 billion people in the world! This is yet another
sign the entrepreneur is letting his rank amateur show.
§
“I’ll quit my job
upon funding.”
This means you won’t be
quitting your job because you’re not getting funding (from a venture
capitalist). You need to make the full and complete commitment to your business
long before you seek venture capital.
§
“Seasoned
management will be hired upon funding.”
Oh, yes! I can see the
venture capitalists lining up when they read this sentence…lining up to laugh at
the plan before it is condemned to the ash heap of clueless business plans.
Conclusion
As I’ve said countless times,
the world isn’t fair, and venture capital is even less fair. But I don’t think
it is unrealistic to expect entrepreneurs to learn some of the basics before the
wade into the Sea of Private Equity. You wouldn’t try to fly a plane without
possessing some knowledge about how to fly planes, so why do so many
entrepreneurs try to raise money from a group of people who have their own
unique language and culture, without understand that culture? I’m reminded of
the old joke about the American couple visiting Europe. As they walk down the
streets of Rome, the man turns to his wife and says, “Look all those
foreigners.”
Has your company been profiled by Bill Snow? Send
an email to introduce your company:
bill@billsnow.com
About the author
Bill Snow runs this site. If you haven't figured that out yet, I can't
help you.
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