Adventure Capital

This is an article (first published in 2008) that I am republishing as a brief primer to a series of forthcoming posts on leadership and the heathy stewardship of a fast growing enterprise.

My wife’s literary hackles were once again raised by my venial twisting of a quote from Hamlet “To be or not to be…” Her view is that all too often the things that are within close reach are not the things that offer us the most favorable or ultimately desirable outcomes. And so once again I will forsake the clever “To raise or not to raise…” as a title for this post and present the above title, which is in the end somewhat less pithy but perhaps more cogent.

The desire to raise capital is utterly seductive—what can be better than using OPM (Other People’s Money) to fulfill your dreams? Sounds great, right? However, like so many of life’s great temptations, raising money comes with enormous caveats, particularly for the uninitiated. But if you are aware of the implications, are well prepared, and go in with eyes wide open, it can be an extraordinary way to launch your venture into the stratosphere. Bear in mind, however, that you are almost as likely to get on American Idol as you are to get a business funded—so be prepared for rejection. It’s not personal, and your idea may really have merit and great potential, and yet still not be right for venture capital. But don’t let the odds dissuade you; just be prepared and make sure that you have thought your business out thoroughly. To do this you may need to become “that guy” for awhile, the one that talks about their business to everyone they meet in order to get the story down.

Faustian bargain?

Contrary to what you may hear, venture capitalists are not the devil. Not that there aren’t devils in their ranks, but by and large most VC are genuinely and deeply interested in the businesses and the people they invest in. The trick in business, as in romance, is finding the right match. Easily said, of course, but how do you go about the process, and how do you know when you’ve found the right match, and, even more importantly, how—even if you find the right match—do you make sure the VC you want to work with will want to work with you, the entrepreneur? Well, like any good game there are rules (in this case they are of the thumb variety).

1.) Put yourself in the VC’s shoes (they usually wear pretty nice shoes, so this part should be fun).

These people work hard. They are up early, get home late, and in their day they deal with dozens of complex relationships involving portfolio companies that are in various stages of development. Typically an individual partner champions a candidate company to their partners in the firm and it is usually this partner who takes a seat on the board of the company when it gets funded. This person has a lot to gain, but nine times out of ten has more to lose (often the champion partner, along with committing the firm’s money, has to put up some of his own personal capital into the investment). So in addition to financial risk, partners are taking a risk with their own reputation within the firm, as well as the firm’s reputation to its limited partners (these are the investors who have given their money to the firm to manage and grow), and finally, the firm’s reputation in the industry. Once a partner has decided to bring a company in for consideration (there is, as you can imagine, a fairly sophisticated vetting process to even get to this stage that involves junior associates sorting and reading through hundreds of business plans per week, then contacting the entrepreneurs of the more promising companies and speaking with them and often following up with a meeting to make sure there is real potential for a good match), they invite the entrepreneur/s in to present their business.

2.) Be on your best game.

This is where the magic happens. This meeting is about being on your best game, this is the audition, the job interview, the big moment to shine. But, again, don’t let that intimidate you. Remember that you are presumably the expert with regards to your business idea, and these people are here to listen and learn. Though you may get what seems like a lot of resistance, keep in mind that they are, in part, trying to see how you perform under pressure. If I had to give a single piece of advice, I would say that you should just be natural. Converse in your own style and think of these people as your peers. You are the expert here and they are your students, and as students, they are usually very good, so do your best to be an equally good teacher. They are not testing your ability to have the answer for everything. In fact, most VCs will tell you that one of the most common reasons they decided to work with an entrepreneur is because when the entrepreneur didn’t know something, he or she simply said so. That is a big deal because, if you’ve been around early stage ventures long enough, you know that no matter how well-considered a plan is, it will inevitably fall apart, only to come back recast and stronger as a result. That is the nature of the early-stage game, and recognizing it and honoring it is critical. Other than being natural and genuine, I would say you should be confident and receptive to dissenting opinions.

3.) Do your research.

Despite the notion that business is highly competitive, the VC world is very small and they speak with one another frequently. When you think about the fact that a typical VC firm gets thousands of business plans a year, it’s clear to see why they wouldn’t worry too much about competitors taking their deals. Couple that with the fact that they are very risk-averse, and you end up with a situation where they would prefer to share an opportunity with another strategically aligned firm rather than try to keep it to themselves. This is great, and it is how other industries should work, because in the case of the VC world this practice has given them better deal flow and a reduction in risk by spreading it around more broadly. And so it is vital that you are selective about to whom you send your plan; if you blanket the entire field, you will just end up having wasted your time. This is not a numbers game. So go to websites such as CrunchBase, or CB Insights, do some studying on who has funded what, when, and for how much, and then create a target list of a handful of firms and go after them with laser focus.

4.) Get yourself out there in the spotlight.

Nothing is more conducive to getting capital for a good idea than hanging out with VCs. Put yourself in situations where you are visible and credible. Speak at conferences, do as much PR work as you can, find ways to help other entrepreneurs. Cooperation and generosity are good, basic human traits and, particularly with entrepreneurs, what comes around goes around. Essentially it comes down to this: build your brand as an entrepreneur.

5.) Don’t hold on too tightly.

If you are going out to raise money from VC, don’t think of your company as your baby, because no investor wants to pour capital into someone else’s baby. Instead, think of your business as a mini public company, and run it like one. This is one of those compromises that feels Faustian because you are selling a part of your company and as a result, a new voice (that of the VC) is being added to management dialogue. It will likely be a quiet voice, unless something starts to go wrong, and then VC investors will clamp down quickly and very hard. If things do start to go south for any reason at all, it is likely you will be fired and replaced. You will generally get a fair severance and still own your vested equity in the company, but you will likely have little or no authority in the business you started. So be prepared for that potential reality.

6.) It is a symbiotic relationship.

A company’s relationship with a venture investor is a complex one—mostly good, but the tough times can be really taxing. Many entrepreneurs make the big mistake of assuming that sharing the economic goal of a big exit with their venture investor means everyone will always see eye-to-eye. This is simply not true. VCs base many of their decisions on their IRR (Internal Rate of Return) and so even if your business is growing, there will be many issues on which you and your VC will differ, and their IRR across their entire portfolio may affect your company in ways that have little or nothing to do with your business. They are smart people, and they want your company to succeed, but they also have a responsibility to manage the capital entrusted to them, and so they keep their eye on macro conditions that affect their entire portfolio—not just your company.

7.) Just do it.

If your company is at an early or conceptual stage, just keep going: keep running and growing the business and don’t get distracted by the potential to raise a bunch of money. It is a huge and time-consuming undertaking and will take you and a good portion of your senior management away from your business. Instead of moving the venture forward, you will be caught up in a 3-to-9-month, nearly full-time cycle of fundraising. This is one of the big contradictions in the VC-to-venture relationship. While you’re out raising money, your business will suffer, but while you’re asking people for money they want to see the business preforming. In part, the extraordinary amount of time it takes to go from first meeting to closing is built into the due diligence process by its complex nature, but it also serves to give the investors time to watch and get a more intimate reading of the company over the course of the process. So performance during that time is critical.

8.) Keep it simple.

This is my opinion and others will likely disagree, but I believe that a business plan should be between 5 to 15 pages max, without financials. If you can’t say it in 15 pages, it probably has too many moving parts to scale or you are not articulating clearly enough. Writing a business plan is an art that takes practice and experience; a cookie-cutter approach won’t do. From your plan you should be able to extract an executive summary of 3 to 5 pages, and you will also need a comprehensive set of current financials (Balance Sheet, Income Statement, P&L), and usually projections looking forward 3 to 5 years. You will also need some way to clearly present the business in a meeting. I’m not a big lover of Powerpoint, but it or Apple’s Keynote are often really great ways to get a complex or abstract idea across. Finally, you should be prepared to take a call and be able to answer deeper questions about the business.

9.) Be prepared to step aside.

Sometimes VCs love an idea, see the potential in the market, and like the team. At the same time, they may view the founder as a great visionary or guide but as not a manager who can scale a business. In these cases, they tread lightly but probe to see if you recognize the same issue and are prepared to find a CEO, President, etc., who can take the reins and drive the business forward. This is not necessarily a bad thing; stepping aside from a management role does not mean you will lose your business—it often means you will be able to focus more on what you love and let someone else do some of the heavy lifting.

10.) Relax and enjoy the ride.

Pitching can be a tedious and emotionally draining process. At the same time, it is a really exciting opportunity. I found pitching for the first time to be romantic, the second time exhilarating, and anything beyond that a comfortable opportunity to talk with smart people about something you enjoy and believe in.

In the end, my view is that venture capital has a very real and important role in our economy, and as an entrepreneur it is important to respect that. At the same time, what you’re doing is creating—while they are your patrons, you are their da Vinci. So enjoy the adventure and feel free to contact me if you have any questions or thoughts.