After a short break, Enable continues with its virtual university for startups. We continue with the excellent work of venture capitalist Scott Chou - Maxims, Morals, and Metaphors, A Philosophical Guide to Venture Capital
Today, we add a little twist. Enable turns the tables on the venture capitalists and shows entrepreneurs how to use the “primer for venture capitalists” to their own advantage. By getting into the head of the VC, entrepreneurs will be able to work with them better, and hopefully both sides will benefit.
Once again, Enable cannot say enough good things about Chou’s work and the following are only a few highlights of the entire masterpiece which must be read and reread in its entirety.
Deal Flow
On the issue of deal flow, Chou tells VCs the following:
Although a firm’s portfolio establishes its public reputation, venture community insiders will form an additional opinion based on how your firm conducts itself during deals. For example, a trigger-happy fund can establish a competitive, differentiating factor by deciding very quickly. However, it can be a dubious distinction when poorly managed. Other dubious distinctions include whether you
- Cut and run at the first sign of trouble
- Rake entrepreneurs over the coals
- Leave heel marks at the edge of the cliff
- Support companies to the very end
Enable Table Turner: Learn from this that all VCs are not created equal. Ask for the VC who sticks with you through thick and thin. Get references and see which entrepreneurs were raked over the coals. Use this to determine the VCs true insider reputation.
Deal Sourcing
Chou tells VCs the following tidbits about how to get the best deals:
To make it easy on you in the beginning, you can get deals passively through your firm’s existing reputation and marketing efforts. You can always count on the occasional bluebird to fly through the door and land on your desk. Nevertheless, there are many ways you can still contribute to these passive marketing efforts such as maximizing your firm’s utilization of the web or hiring a PR firm. You may quickly come to the wrong conclusion that generating deal flow is pretty easy. Yet, good ideas are a dime a dozen, bad ones are free.
There is a not only a great imbalance between bad ideas and good ideas but also an imbalance between good ideas and the ability to execute them. You’ll soon realize that the better deals come through the referral network and that the path to partnership means having your own.
They call them business brokers because after a business uses one, it is.
Well, going broke is an exaggeration but be aware that brokers can charge substantial fees. These fees will reduce the amount of your investment that actually goes to work on behalf of the company. It’s also common for brokers to get a significant block of stock that will further dilute the incentive pool for the employees. The only thing for sure when you see a broker is that the deal has been shopped.
Enable Table Turner: Here, Chou clearly tells VCs that the best deals are referrals and to stay away from brokers and other middlemen. Turning the table here is obvious. If you want to get the VCs attention, find a way to be referred to him/her. Also, do not use brokers, etc.
Screening Deals
According to Chou, the first and only filter of a cookbook nature will be to match your firm’s investment focus. Basic criteria such as geography, industry, transaction size, consumer orientation, stage, type of financing, and syndication should allow you to quickly set aside most of the pile. Intuition tends to be first real screen for most VCs since they immediately ponder the classic question dating back to 1703, namely: Will this business hold water?
However, there are somewhat methodical ways to answer that question. You can apply Venture Capital 101 fundamentals such as the management team, market opportunity, and competitive advantage.
- I’d rather have an A-team with a B-technology than a B-team with an A-technology.
- Bet on the jockey, not the horse.
- A rising tide lifts all boats.
- It’s like giving sight to the blind.
- God issued them the distribution rights on air.
If a plan meets the fundamentals, then you start on the less tangible issues such whether the company can grow and if there is an exit.
Products address limited markets and often have limited life spans. You’ll have a much stronger exit if you have a standalone business that is sustainable. Sustainability raises the issue of scalability and bottlenecks to growth.
Even if you have difficulty judging people, you’ll at least get a product demo. When meeting in person, you should prepare yourself for the three basic lies that entrepreneurs almost always tell VCs:
- It’s not about money. I want you for your value-add.
- We won’t need more money.
- The product is in beta.
When translated, it comes out as:
- I’ll still respect you in the morning.
- I got this sales projection from a business plan template.
- We have a nice brochure and possibly a demo.
Enable Table Turner: Enable placed a lot of information in the screening section on purpose. This is the key to getting funding and you must know how VCs decided on which companies to invest in. First of all, make sure that you send business plans to VCs that actually invest in your particular technological sector. Don’t just send out bulk emails to VCs they will be rejected in less than a second (Note: I get dozens of bulk business plans where the entrepreneur did not even take the time to add my name. These are rejected immediately – M.N.)
Second, you must stress that your business meets the necessary fundamentals listed above. VCs invest in companies – not products or technologies. The team is also crucial and is typically the first thing VCs look at, not the technology.
Third, don’t tell the three lies. If you don’t have a beta version yet, don’t say that you do. Of course you need the money, that is why you are meeting in the first place. I disagree with the statement of “It’s not about money. I want you for your value-add”. To some extent this is true, but if all things are equal, go for the VC who does provide added value. If you can’t – then take the money.
To conclude, I quote one of Chou’s best statements: If it’s too good to be true, it probably is.
In turning the tables, be realistic with the VC. Don’t exaggerate or stress the truth. Your relationship what really counts – even more than the money. Surprisingly enough, if you are frank with the VC you will get farther than if you mislead him/her. Most entrepreneurs do not out and out lie to VCs. Instead they tend to omit certain facts. Do not do this. It will come back to haunt you.
Next week, we continue the virtual university and move on to mergers and acquisitions.
Published by Israel's Business Arena on December 5, 2000.