Quantity, quality, and size of early-stage seed financing has recently given rise to speculation about a seed funding bubble.  Ex-founders, Hollywood personalities, the rich and the powerful, the smart and the cool, all seem to be foregoing or, at least, de-emphasizing the usual trappings of wealth [...]]]> Tweet

Quantity, quality, and size of early-stage seed financing has recently given rise to speculation about a seed funding bubble.  Ex-founders, Hollywood personalities, the rich and the powerful, the smart and the cool, all seem to be foregoing or, at least, de-emphasizing the usual trappings of wealth (homes, cars, planes, baubles) and taking center stage at pep rallies preaching  lean, capital-efficient startups poised to change the social fabric and consumer experiences, all for a few hundred thousand dollars invested.  Money is available, some will say, easy to get.  There are pitch sessions, pitch presentations, and a slew of incubators, accelerators, germinators that are ready to provide a cubicle and an internet connection in exchange for some equity.  The process is quick and painless.  I have witnessed angel investors flash their cash and write checks on stage.  Founders who have never raised a real VC funding round have all been made to believe that the traditional funding process of overly lengthy, way too expensive, and, in general, unnecessary.  Dropping out of college is suddenly cool, venture capital is stuffy and bad, and a big company can be built with almost no cash.

Early signs of trouble.

Many more companies that should not be funded are getting funded — micro-funded, to be exact.  Founding teams lack critical mass (witness the “find a technical co-founder” craze) because instead of three guys with an idea and a prototype looking to build a company you have three distinct embryonic ideas looking for money, pitching a promise of hiring a top notch team that is nowhere to be found.  Nowhere to be found because everyone who’s any good also has a company of his own to build.  But these thoughts have been aired before and are now part of the usual rhetoric about the seed bubble.  For me, the real danger started to manifest itself over the last couple of months as I saw some very good seed-funded companies looking to raise their Series A.  These companies could have easily been winners, but, unfortunately, drank the wrong Kool Aid.  I call these “ungerminated seeds.”

The real problem: little to show.

Ungerminated seeds are startups that raised a big seed round, often from prominent investors or VC funds, and have expectations and sense of entitlement that is completely out of proportion with what they’ve been able to accomplish using the money raised.  The ideas are often good.  The founders are often smart.  But there’s trouble.  I have spoken to a number of startups coming to the end of their $700K+ in seed funding.  ”That’s a lot of money,” I said, “… and what do you have to show for it?”  Often, the result is a beta launch, a team of hired guns, trickling early signups, some indication of traffic to the site.  Maybe a pilot in early stages if it’s an enterprise company.  To me, it feels like a Series A…  but it’s not a Series A.    The “cap” on the convertible note is often mistakenly seen as a post-money valuation (which it isn’t).  There are egos (founders’ and investors’), there are appearances to be maintained.

The company seems to feel that burning through a million dollars of someone else’s cash entitles them to more cash from another group of investors.  Founders, reality distorted, have expectations of valuations that make little sense to a professional investor because they are based on an implied seed valuation that should have been dubbed a “small Series A”.  I am talking about good companies and good ideas, companies that could have traveled the normal Series A, B, C + IPO path that startups have taken for decades.  Their  early stage financial shenanigans make them, in my mind, un-fundable.  Sad because if they had only taken less cash and not listened to the angels’ siren songs they would have been great Series A candidates.

This is not “sour grapes” from a small fund that can not afford to invest $10M in a Series A….  my fund certainly has the financial resources to do that.  But, just having capital to deploy does not make you a drunken sailor that walks into a port of call ready to blow all his money and befriend the natives.   There are responsibilities VCs have to their LPs — and one of them is not being stupid.

There’s nothing wrong with seed funding

However, there is absolutely nothing wrong with getting some early-stage money together to get a company off the ground.  But founders need to be careful and make sure they are doing it right and are planning for the long-term financial success of their business.  Some advice….

Before seed funding:

Look for professional organizations vs. individual angels.  There are several smaller funds that make seed-stage investments.   There are organized angel groups with screening committees consisting of industry experts. They are doing this because this is what they do, not because it’s some big VC fund partners’ experiment in ecosystem building or a bone thrown to a junior member of a VC team.  There are funds I support, help, and ones to which I send promising early-stage investments.  They are professional organizations managed by professional investors.  They work very much like VC funds work (sometimes earning the label of micro-VC or super-angel funds).  They manage their investments and the founders’ expectations.  They prepare them for their next round and they make sure the company stays fundable.  These funds are known.  Drop me a line and I’ll give you a list of my favorites.  Individual angels tend to be hobbyists.  I am not talking about Ron Conway or Paul Graham — they are organizations, not individuals.

Raise just enough to show results.  Avoid the piling on that is all too common these days.  Don’t “leave room in the note” for people who want to join the round after learning that Ashton Kutcher is on board.  The math that VCs do in their head is still the same.  A dollar of post-money valuation should be worth about 3x in the next round.  If you raise $1M in seed, assuming a normal 25% dilution, you are expected to have a company that is worth around $10M in about 18 months.  $10M is a lot of money despite what you may think.  Given that seed money is often used to experiment, the more money you raise the higher the expectations are for the experiments’ results.  Saying “we did all this with $250K” sounds WAY better than “we only did this much with $1M”.  Once you take big money, the meter is running.

Avoid big VCs with angel projects.  Large VCs have started participating in seed funding frenzies.  I saw one fund, on stage, talking up the advantage of taking seed money from them explaining that seed investments don’t need to go through the normal investment committee process and don’t require full partnership approval.  Isn’t there a problem there?  What happens in 18 months when a fund that typically writes $10M+ checks and requires all those approvals looks at your barely off the ground startup?  It won’t be that easy.  Signaling is an age-old problem with VCs.  What will happen when the big VC that gave you $500K refuses to participate in your Series A?  Think it will attract or repel investors?  And, needless to say, there are issues with time commitments, prioritization, caring.

Look for accelerators with real infrastructure and industry support.  There’s TechStars, there’s Y-Combinator, and a few others.  All have a brand names, VC industry support, and professionals running the program.  They do convertible notes, they do ask for a lot, they do put the companies through their paces, they are hard to get into.  But all is done for a reason… to get the companies graduated and funded.  I know that demo days sometimes feel like Hollywood productions.  But there’s method to the madness.  And those guys know what they are doing, certainly as far as financing is concerned.

After seed funding:

Pretend there’s a Board of Directors. Many seed-stage companies don’t have real boards.  Some do, but many settle for loosely formed advisory committees.  Either is fine, but there’s a real discipline that comes from being forced to give regular, structured updates on your progress to a small group of people that know what they are doing and who see these updates month after month.  Get into the habit of having regularly scheduled meetings with several investors at once.  Yes, in person.  Yes in a conference room.  Yes, with slides, reports, and financials.  It will put what you are doing into the right perspective.  Run through decks, introduce the teams, air your grievances, ask for help.  This is another argument for professional funds vs. individual angels.  These funds care enough about you and your company to devote the time and effort that’s needed.

Talk about the next round ASAP.  As soon as the seed funding is closed, start thinking about the Series A.  Immediately.  Have a good understanding of when it’s going to happen, when you need to start raising more money, and what the required milestones need to be.  Adjust and maneuver to hit dates.  Expect to be chastised for missing them.  Yes, your goal may be to find product-market fit, or to build something wonderful and exciting.  All will be for naught if you can’t get more money.  So, that’s the real goal.  Good accelerators and professional early investors know this very well.  There’s a reason TechStars companies prep for “demo day” the moment they land in the program’s city of choice.  You should be prepping for your demo days as soon as the first checks hit the bank.

Focus on one simple goal.  There’s a Russian saying:  ”if you chase two rabbits, you won’t catch either one.”  Figure out what the one KPI the company will obsess about and watch it like a hawk.  If it’s user signups, if it’s conversion, if it’s enterprise pilots, if it’s a set of features that blows everyone’s mind… decide and focus.  Don’t chase too many rabbits and experiment too much.  You need to be able to show improvements in the chose KPI over time, and time is scarce.

Going for Series A:

RTP VENTURES announced its existence on September 6, 2011 on this blog.  I did not want to do a press release, talk about nebulous market trends, or brag about our fund’s raised capital as is often done by venture firms looking to make a big splash.  I always [...]]]> Tweet

RTP VENTURES announced its existence on September 6, 2011 on this blog.  I did not want to do a press release, talk about nebulous market trends, or brag about our fund’s raised capital as is often done by venture firms looking to make a big splash.  I always wanted and will continue to insist that our actions should speak louder than our words.  I felt that theme, investment stage, geography can be understood by looking at the companies in which a fund invests.  Whenever I try to understand what a fund is all about, I usually start with the “portfolio” page and look for companies I recognize, then look at the “team” page and see what the partners are all about.  So… I wanted to wait and gather a few data points.

Sixty days passed, and I have been gathering the data instead of blogging about it.  Here are the facts.  Over the last 60 days I met with 48 companies in various parts of the country.  Some facts about them….

• 23 were in the Bay Area (which entailed two week-long trips to SF), 19 in New York, the rest elsewhere
• 15 were Seed investments, 21 were Series A, 10 were Series B, and two were Series C
• I passed on 21 of the companies, 3 were put on the “watch” list, and 18 companies are still in the running.  We “lost” 2 investments.
• I am happy to say, we made 4 investments (in chronological order):

Tinfoil Security: a security as a service solution for small businesses that enables them to monitor their web sites for ever-changing ways in which those sites can be hacked, damaged, and compromised.  The company is led by a smart and tech-savvy team, and we are joined by a group of great investors including IDG Ventures, and on of my TechStars pals, David Tisch.  Tinfoil was a seed investment.  Though without a formal board of directors, I plan to actively work with the company and intend to support them in their next financing.

  Koding: a cloud-based development environment that lets programmers create applications in PHP, Ruby, Python, and JavaScript completely in their browser.  The company has a strong 30K+ following of active users, and was started by a passionate team (two brothers) whom I have gotten to know over the past year.  Koding will change the way engineering teams work and be an invaluable tool that cloud providers will use as an on-ramp for the people actually building applications on their infrastructure.  We led this Series A investment, joined by my friends and colleagues at Greycroft Partners.  I am a member of the company’s board of directors.

CakeHealth:  I saw CakeHealth at TechCrunch in San Francisco and knew I needed to make an investment.  They should have won, vs. being runner-up.  Though I often talk down “consumer” plays, I loved this one.  You can think of CakeHealth as the mint.com + Expensify for your healthcare bills.  They ingest the bills you receive from your health provider, correlate it to the statements from an insurance company, and finally let a consumer understand the arcane nomenclature and cost structure of all those notices he gets in the mail.  Being married to a doctor and having her sister (also a doctor) as my primary care physician, I personally have an easy way of dealing with the problem — I hand the bills to them and forget.  Most consumers, most families do not have this luxury.  CakeHealth will help the consumer take steps toward taking control and optimizing their own medical plans.  CakeHealth was a seed investment in which we were joined by a number of great angel investors as well as Menlo Ventures and Charles River Ventures.  Again, without a formal board, I plan to work actively with the team and get them ready for their next financing.

GridGain:  GridGain is a company that creates software for managing high-performance, dynamically scalable compute grids.  The company’s founders are advancing the state of the art in defining the next generation of grid computing.  Their impressive list of early customers includes amazing brand names in the finance industry from New York, London, Paris, and Tokyo.  Applicable to any demanding computational tasks, they also managed to secure business from a well-known personal computer, tablet, and phone manufacturer in Cupertino.  What GridGain is doing is technical and complex.  The team is smart and focused.  We led a Series A investment in the company.  I am a member of the company’s board of directors.

“Stay hungry, stay foolish.”  In 2005, Steve Jobs gave this advice to the graduating class of my alma mater, Stanford University.  Jobs spoke about taking risks to change one’s life and change in the world.  I listened to his speech again following news of his departure from [...]]]> Tweet

Image by Esther Dyson (Flickr): Leonid Boguslavsky

“Stay hungry, stay foolish.”  In 2005, Steve Jobs gave this advice to the graduating class of my alma mater, Stanford University.  Jobs spoke about taking risks to change one’s life and change in the world.  I listened to his speech again following news of his departure from Apple.  Like the first time, his words inspired.  In my own life, I always did just what Steve suggested, even before I heard that commencement speech.  Last month,  I once again confirmed: I am still hungry, and still ready to risk and be foolish.

I  decided to keep following Steve’s advice and play the hand fortune dealt me once again.  Here’s the story:

An old friend of mine, Leonid Boguslavsky, whom I met in 1989 when helping Oracle start its Eastern European business, has since become one of the most prominent technology investors in Russia.  His investments include some of the top internet companies in both Russia and Europe.  Recently, his investment group scored a big win as early investors in Yandex.  I met with Leonid during my recent vacation in Moscow.  One of the projects he was considering was taking his investment activities overseas, specifically, to the United States.  He needed someone to run the newly formed investment fund.   We talked, traded emails, Skyped, and decided to form an investment group in the United States.  Needless to say, I was intrigued by the idea.  So, a new fund, Ru-Net Technology Partners (and our U.S. operation, RTP Ventures) will be formed and I will be running it.  Despite the seeming safety and promise of my career in venture capital, I, once again, chose to do a startup — now  a VC startup, not a VC-funded one.

We plan to start investing carefully with about $100M slated for the U.S.  My passion and my personality will make an imprint on the work we do.  Our focus will be early-stage, Series A software and internet companies that have technology and innovation at their core.  B2B, SaaS, cloud, big data, analytics, infrastructure, enterprise — these, in my opinion, are markets underserved by the current swarm of consumer internet investors.  And these are exactly the investments that we are going to do.

Our choice of investments will be driven by many of the principles I described in this blog.  We will always focus on large markets, innovative products, and smart, energetic founders — not the latest fads.  The fund will be large (~$100M backed by another $600M+ in opportunity investments that can be used for later stage portfolio companies) but small enough to be effective.  We will gladly syndicate deals with investors whom we respect and who can contribute to a company’s growth (smarts, not just money).  We will be angels where and when appropriate.  We will be growth investors if the opportunity is right.

Though I will be based in New York City, many of our investments will happen elsewhere: California, Seattle, Austin, Boulder  – anywhere smart entrepreneurs are solving tough problems.  Though on the East Coast, I come with strong Valley roots.  Make no mistake:  I will make this fund feel like a Silicon Valley VC, choosing the same caliber of people to help me and using the same rules and processes to pick future winners.

I want to thank the friends who helped me through this “soul-searching” year.  Last, but certainly not least, I want to especially thank my colleagues at Greycroft Partners who gave me a chance to see how real venture capital works.

So, I am on my own again, building something on my own instead of working for someone.  How new, yet how familiar.  Once again, I am staring at the abyss and smiling.  It will be another thrilling ride.

Entrepreneurs, dreamers, angel investors, VCs — I look forward to working with you and building great companies together.

… is coming to a startup near you.   Sign up for our mailing list and I’ll keep you posted on our upcoming launch:  http://rtp.vc

Lately, entrepreneurs reading the VC press  have been seeing investment announcements that leave their mouths agape.  Press releases featuring giddy investors justifying nosebleed valuations have sent them scrambling to the lucky company’s website to figure out what product, team, and idea could possibly be worth that much.   Tweet

Lately, entrepreneurs reading the VC press  have been seeing investment announcements that leave their mouths agape.  Press releases featuring giddy investors justifying nosebleed valuations have sent them scrambling to the lucky company’s website to figure out what product, team, and idea could possibly be worth that much.  All this leads them to an overwhelming question: “WHY would anyone want to BUY that, much less finance it?”

Let me tell you, VCs often have the same reaction.  We too ask similar questions adding “WHO would fund this?” trying to understand what our colleagues are thinking, followed by the inevitable “how will they ever make a return?”

VCs’ thinking, in many ways, is more like that of a startup than like that of our larger cousin — private equity, who focus on the hard facts and the math behind the investment.  VCs and startups both live in a world of uncertain, unverified, and mostly missing information.  We project outward confidence and seem to know, with conviction which what waits around the corner.  But, in reality, VCs know that their assumptions about markets, customer needs, and business climate are anchored on the same shaky ground that sprouts the hockey sticks startups project onto their walls.  Aside from platitudes we spout with certainty  (“Mobile is big.  Social is important.  Cloud is the way of the future”, etc.), few things are known to us well enough to warrant our conviction.  Just like the startups we fund, we, ourselves, live in an unpredictable world and often make mistakes.

Venture Capital, despite the colloquial taxonomy, is not just a “cool” branch of finance.  And things we learned in business school:  ratios, comparable analysis, revenue forecasting with Excel, are, for the most part, irrelevant.  VC is as much about art as it is about science, about things that “feel right” and betting on people you can see succeeding.

Since VC is as much about feelings as it is about logic, sometimes, we make bad bets.  When does this happen?  I have a few thoughts…

• In B2C, …when we don’t understand the consumer.
  Companies that appeal to the 20-something crowd are often created by 20-something founders.  Most VCs are not in their 20s or even in their 30s.  And all the hanging out at the Shake Shack does not compensate.  I was recently told (by a company) that I was not “a Facebook mom raising children” and that this was the reason I didn’t get their value proposition.  I thanked them for their insight and promptly moved on.
  When we are asked to believe that something is cool and that all the cool kids will be using it, the only fallback we have is “traction” — that’s why the term has become so popular.  Traction glosses over our inability to step into the shoes of the target demographic and reduces it to spreadsheet math we understand and love.  No due diligence cycle is long enough to properly survey the masses, so we rely on advice from our children (who sit in front of their iMac’s and worry about private school admissions) or dubious year-old sentiment surveys.
  We step into investments hoping the public will like it.  Sometimes it does.  Often it doesn’t (witness Color).   What’s cool with the kids at SxSW isn’t necessarily cool with the rest.
• In B2B, …when we aren’t in tune with the corporate ecosystem.
  We go to startup conferences and startup events looking for deals more often than we attend established industry trade shows which focus on the big players and their strategy.  We forget to track our potentially crushing competitors and benevolent acquisition sources.  We forget that to build companies they buy, we need to understand their roadmap, product holes,  and where our companies fit in.  Most of us have never sold anything to anyone, much less to an enterprise-sized business.  We don’t do enough of the boring homework, looking at the present while trying, bleary-eyed, to discern the future.
• …when we don’t understand the technology.
  Most VC software investments are rooted in technology.  Successes in this business, no matter how social or consumer-focused still requires technology and its competitive advantage to rule the marketplace.  Facebook, LinkedIn, Dropbox, Google all have tech at their core, even if they are not featuring it on their web site.
  Often, we let things be “over our head” and don’t dig deeply enough into what the company is actually doing.  We should never invest in anything over our head.
• …when we follow the herd.
  When the action in certain investment sectors heats up, the fear of missing out on the next big thing often gets the better of our rationality.  We see other funds, bigger funds, better funds, make large and seemingly better investments.  Whether these investments are correctly valued, whether the funds making them have more resources and can better tolerate mistakes seems unimportant.  It’s all about the game and the fear of not placing a bet.  We need to make an investment in a “space” because we think someone else validated it.  Smaller funds co-invest with famous ones on the premise that the big guys know what they are doing looking at the “earned media” instead of the financial return.
  This is a recipe for disaster.

Term sheet signed, due diligence complete, now it’s time to head into the last stage of the funding process — the closing.  I don’t mean to use the title terms “legal grind” negatively. But, for most VCs and for most entrepreneurs, getting through the legal paperwork required to [...]]]> Tweet

Term sheet signed, due diligence complete, now it’s time to head into the last stage of the funding process — the closing.  I don’t mean to use the title terms “legal grind” negatively. But, for most VCs and for most entrepreneurs, getting through the legal paperwork required to complete a round of financing tends to be much less exciting than building companies.  However, the legal process that caps the funding is important and should be taken seriously.  Often, mistakes made at this stage can cost dearly later in the company’s life.

You should…

• Get a good attorney.  You may have a family friend or someone you met on the plane who is a lawyer.  That’s great, and they may be suited for the job, but if you’re not sure, don’t take the risk.  While there is nothing overly complicated about venture financings, especially early ones, there is a cadre of legal professionals that not only know the law behind getting a deal done but also know what the expected behavior of the legal team should be.  They know what points to focus on and which ones are less relevant.  They know how to negotiate with the other side without pissing them off and potentially wrecking the deal.  They have done these deals before and plan to do many more with the same sets of investors, so they come into the game knowing what to expect and what is anomalous.  There are a handful of law firms in Silicon Valley (compared to the total number) that top tier VCs use for their representation — and they do so for a reason.  VCs maintain a continuous relationship with the same firms and the same attorneys.  If you, as a startup, get one of those firms to represent you, the deal will go smoother and move quicker.
• Don’t stress too much over the costs.  For me, seeing my first real “legal bill” was a shock.  Yes, these people charge more for sending a fax that you used to make in an hour during your first part-time job.  However, attorneys do not charge the entrepreneur for a financing until the deal is done done and, therefore, get paid with the money that goes into the company as an investment.  Your attorney will have another watchdog — the VC that’s funding you.  As I mentioned already, VCs and attorneys have a symbiotic relationship.  The last thing your attorney wants to do is to be seen as gouging his clients.  VCs talk, VCs refer, and VCs know what things should cost.  If you are dealing with an experienced firm, costs may be high, but they tend to be within a normal range.  It is much better to pay a bit more for an experienced attorney than to get bargain representation.  But…
• Always get a cap on legal fees.  You should know and be comfortable with what they lawyer will charge.  This is really important for your sanity and comfort.
• Focus on getting the deal done.  You should make this perfectly clear to your legal counsel from the very beginning.  ”Your job is not to out-lawyer the opposition.  Your job is to watch out for anomalies in the deal, explain the risks, explain the probabilities associated with the risks, but, most importantly to get the deal done. We want to do this, our VCs want to do this, so make sure it’s done.”  It is your lawyer’s job to help make the deal happen.  You will have agreed on the basic terms and they should not be the ones to torpedo the whole thing unless there’s damn good reason to do so.
• Ask your lawyer to explain things.  This may be your first financing, or you just may have never cared that much about legal terminology (like me during my first few financings).  You should have your attorney walk you through all the “interesting” parts of the document (and only the interesting parts) and explain what they mean to you and your company in plain English.  Do not permit your attorney to use terms like “pari passu” without asking him “WTF is that?” and getting a simple answer.  You shouldn’t be surfing the web for definitions when you have a professional by your side.
• Honor the no-shop.  Your term sheet will have a no-shop agreement somewhere in the text.  While there is little legal recourse that VC can take if this promise is broken (you don’t have any money, that’s why you’re getting the financing), there is a huge risk of damaging your reputation as a company and as an entrepreneur if you violate this clause.  If your promises are, indeed, like pie crusts — made to be broken, your chances of getting another round done or getting another company funded drop dramatically.  VCs talk and reputations persist.  Keep your word, even if it causes some minor discomfort, even if it means not chasing the two pretty birds in the bush.
  Talking to other VCs is OK during this period if you are trying to put together a syndicate for the investment, but you should always check with your lead investor first.  And, if you jump ship because another offer is too good, be aware of the consequences… they are not pleasant.
• Stick to the terms you negotiated prior for the term sheet.  During the legal process, some nuances may get tweaked.  Even the valuation may be adjusted for some reason (such as letting a strategically important partner into the deal), but, you should not change the terms dramatically after the deal has gone to the attorneys.  Don’t come in saying that your friend told you that the option pool should be smaller and so you want to change it.  Don’t agree to form your company in Delaware and then decide, in the eleventh hour to base it in Chihuahua, Mexico for tax reasons.  Just as with a no-shop violation, no one will take you or other agreements you make in the future seriously.
• Demand a closing schedule from your VC.  Usually, early stage deals close in four to six weeks.  You should confirm the expectations of the closing date, have a plan and a set of milestones by which you can gauge if the deal is on track.  If your VC’s attorney is planning a vacation, you should know about it and insist on a backup.  The period of closing the deal is very unproductive for your company.  You want to make that period be as short as it possibly can be.
• Always provide full and honest disclosure.  If there is anything that is material to the legal aspects of the financing, especially if it is explicitly asked for, you should be thorough and honest with your disclosures.  If your founder is not committed to moving to a new city, if your former boss feels that you stole code from his company, if you really have 5,000 and not 8,000 customers — now is the time to tell the truth if you haven’t already.  By not being honest here, you are not just irrevocably damaging your reputation, but also risk a catastrophic rift with your investors down the road (and a lawsuit to boot).
• Remember, your lawyer is your ally, but they work for you.  You call the shots and you set the schedule.  You insist on points that need to be made and you chose to ignore ones.  The attorneys are there to get the deal done and they work for you.  However…
• …trust your legal team and not get distracted.  You should have an attorney whose opinion you value and trust.  Chances are, they will have done many more of these deals that you and when they say something is important, it probably is.  Good ones are upfront about prioritization and are not there to book hours by digging into unnecessary details.  Your ears should perk up when your lawyer says: “listen, I’ve seen many of these, and this part is bullshit.”  or “trust me on this one, this part is important.”  Being your employee, your attorney should want to see your company get funded and feel like he is on your team.
  You should not be reading blog posts for legal advice during this process and brining up points that some blogger mentioned.  Not the right time.

We should….

You made it through the partner meeting, your email dings, your phone rings — good news:  the VCs liked your company enough to proceed to the next step: due diligence.  Usually, the word will come from your “inside coach”, [...]]]> Tweet

You made it through the partner meeting, your email dings, your phone rings — good news:  the VCs liked your company enough to proceed to the next step: due diligence.  Usually, the word will come from your “inside coach”, as explained in a prior post.

“Due Diligence” is a broadly defined term with explanations here:   WikiPedia, Webster’s, and elsewhere. But, basically, it means researching you and your company to ensure that investors are taking care to validate the assumptions they are making about the worthiness of the deal.  There are funds that prefer to do significant due diligence before issuing a term sheet, and some save the bulk of the detailed work for the time between the term sheet’s signing and the actual closing of financing.  However the process is split, it is pretty much inevitable and tells you a lot about how the fund likes to operate.  And entrepreneurs should be wary of guys offering to “invest on the spot” — they are either clueless or hiding something about themselves.  You want a diligence period because this is also a time for you to do your checkup of the fund and the people offering to finance his company.  Due diligence is a two-way street.  They take their time, and you should take yours.

Remember, we selected your company because of the market it is trying to address, the product it built for that market, and the team that built the product.  In our due diligence checks, we want to validate that all the conclusions we made about these important areas are, more or less, accurate.  We trusted you and your presentation, but, as the Russian saying made famous by Ronald Reagan goes: “trust but verify.”  Due diligence is all about verification.

Typically, a VC team will be using the gathered diligence materials to write some sort of “qualification memo” for internal consumption by the other members of the fund as well as their limited partners.  This memo will be a part of the investment documents that the fund will keep to remind itself and their own investors about their assumptions at the time of making an investment in your company.  This memo is an important document for your VCs, so you should try to make its writing as easy and as accurate as you possibly can.

YOU should…

• Prepare the paperwork.  You should have these documents ready, in theory, before the presentation.  You will need them if all goes well.
• a list of 3-4 customer/user references (even if it’s a B2C business, have a few “fans” ready to talk).  Don’t worry, you’ll have a chance to warn them that a call is coming, but have them ready and, obviously, make sure they have good things to say before putting their names down.
• a list of 2-3 professional references on each of the founders
• incorporation documents
• capitalization table (who owns what).  Even if there was an informal split agreement between partners, at least put it into a spreadsheet
• any patents and filings for patents you have claimed.  I, for one, place relatively little value on patents because I invest in software.  There are investment areas where validation of patent claims are critical.
• financial statements since the company’s founding.  MBA types, take it easy, but you should be able to produce basic financials.
• prior financing documents (including angel or friends and family rounds).  Obviously, these are important.

• provide a complete package of documents (described above) at the start of the diligence process,  all at once, rather than tricking emails over the course of the week.  The fund will, most likely, have a team of people doing due diligence on your deal, so it’s easier to split up the work if all the materials are available at the outset.  Send them to the one person in the fund that is coordinating the process.
• expect us to call your customers to validate market conclusions.  Warn your customer references that they will get ONE call from each VC doing due diligence on you and that you appreciate them taking 30-45 minutes to talk.
  We will be asking them the following questions of your business users:
  
• are you really experiencing the problems that the company described?
• does the company’s product help solve these problems?  how?
• what were you doing before you met the company and how much were you spending (time and money) on doing this?
• how has the company’s product changed the way you do things?
• can you quantify what the overall impact of the company’s solution is on your organization in terms of time and money?  are you saving money?  are you increasing revenues?
• how much will your company use the product and how much will it eventually spend with the company if all needed features are delivered?
• what has been your experience working with the team?  do they seem knowledgeable?  are they responsive?

We will be asking the following questions of your consumer users:

• How did you find out about the product?  Word of mouth is fine, but we also want to know what marketing programs (if any) you used and how they worked.
• How often do you use the product? If you are building a business dependent on traffic, this is important.
• Has your usage of the product increased or decreased with time? See above.
• Are all your friends using the product?  We want to determine the “viral” qualities of the product.
• Would you recommend this product to your friends? See above.
• How would your life be worse without the product?  Important.  Is this something “nice” or something addictive and needed.
• Would you ever pay for a product like this?  Will be asked gently, but it helps us understand how much you value the product.
• expect us to schedule a technical session with your product team to validate the product conclusions
• there should be an on-site visit from one or more members of the technical due diligence team (or your team will be asked to visit the VC again)
• no slides – whiteboard.  We want the presentation to be a freeform discussion using graphics and drawings to make points.   You will be explaining this to your customers and your developers — we want to see how well you can do it.
• we will want to talk understand the product architecture
•  a block diagram of the product’s components and how data and function interact
• inputs/outputs to processes in the diagram
• internal and external interfaces to the product (REST, ATOM, etc.) and formats for all
• languages, frameworks, libraries used
• we will want to understand any immediate robustness issues
• extensibility:  how does the software incorporate new technical features and extensions
• portability: how easy is it to move between platforms
• openness: how easy is it for others to integrate with the software
• standards compliance: are you paying attention
• scalability:  when and why will we see “the twitter whale” on your home page.  What if you had 1000x the traffic you have now — what would be the first thing to break?
• we will want to understand the product construction mechanics
• development infrastructure (servers, storage, machines) why?
• IDEs used (TextMate, Eclipse, IntelliJ, Visual Studio, etc.) why?
• Version control systems in place (SVN, Git,….)
• Build tools (Bamboo, Hudson, n/a …)
• Defect tracking systems (Jira, YouTrack, …) how are they used?
• Development methodology:  Scrum, Extreme, Kanban, etc
• we will want to understand the product management/engineering/QA/acceptance workflow
• how are features introduced (customer -> PM -> Engineering -> QA -> PM -> customer)
• how is QA integrated into the development process
• who has final signoff, who decides when the product “ships” or “goes live”
• how are bugs handled
• how are customer requests handled
• how is the beta program managed
• expect us to call your professional references to validate the team conclusions
  These can be your former partners, your reports, your former company’s partners.  We will ask them….
• What is it like to work with this person?  We would rather not deal with assholes.
• Is the person honest and trustworthy?  This is very important.  Sometimes being classified as a “consummate salesman” raises eyebrows.  We value honesty.
• Is the person smart?  Needless to say, we prefer genuinely smart people leading our companies.
• Does the person learn new things?  Flexibility is important when growing a new business.
• What is the person’s management style?  Depending on the company and maturity of the team, management style matters.  A person who is used to commanding an army of followers may have a difficult time running a company of five where everyone expects to be heard.  On the flip side, consensus is good within reason.  Sometimes the CEO has to be firm and make decisions.
• What things is the person strong/weak at?  Please, don’t let us hear “he needs to stop working so hard.”  Everyone has areas for improvement and it’s totally normal.
• Is this someone you would work with/for again?  This is important.  Even if companies fail, there should be a willingness to trust the person in new ventures.

But, remember that this is also a time for you to do your due diligence on us:

• research the fund’s financials. The VCs should answer these questions.  Information is also available online on various sites (crunchbase, thefunded, etc.) though it may be out of date.
• How much money is in the current fund? Understand the difference between the fund that’s investing in your company and “assets under management” that is usually a much larger figure.  Often, funds list “under management” as the sum of all the assets they have ever managed.  So, if they are on fund SIX, it means that they have been successful enough in funds 1-5 to warrant a six but, also, that the money for your company is coming from fund six which can be a much lower figure than the total.
• When was the fund raised?  This is important for understanding whether the fund is in “management mode” or “investment mode.”  Usually, VCs are actively investing new money during the first 3-6 years of a fund’s life (typically 10 years).  During the first few years, they are actively looking for new investments and then focus on managing companies, follow-on investments and raising the next fund.  You prefer to get an investment from the “new money.”
• When will the VC be raising another fund?  Remember, usually VCs don’t invest cross-fund so you’ll be stuck for follow-on investments from the fund that originally gave you money even if they raise more in a couple of years.  If the fund that backed you is in its late stages, has not had a lot of exits, and doesn’t raise the next round, you’re screwed, most likely.
• How much money is left in the current fund and how much is reserved for follow-ons already in the portfolio?  If you plan on raising significant additional capital, you should make sure the fund has enough money reserved to at least have an option of following on to this investment.  If they don’t, you’re basically left raising money from scratch again the next time around.
• research the fund’s track record to figure out where your company fits in
• Has the fund made investments in your company’s area of specialization?  If they have, and they are still hungry for more, means they have had a good experience and have built both expertise and a contact network to help your business grow.  There may be new partners in the fund that came from another fund that really know your space so don’t overlook that fact either.
• Have they had many “home runs”?  On the one hand, this is great and means the fund will probably be around for at least another iteration.  On the other hand, they are now looking for big hits to equal the prior ones and if your company is not one of those hits it will get less attention.
• Are they spread too thin?  A fund should have a reasonable number of current portfolio investment per partner.  These numbers vary, but they are usually somewhere around 5-7.  If there are more, you will get less attention.  Fewer, and there’s a chance you will get micro managed.
•  understand the fund’s operating style
• How often do they require board meetings?  Monthly is the norm, but, remember, these are emotional circuses and resource drains.  See if monthly reporting and bi-monthly meetings have been done (a much better scheme).
• Are you getting a “super star” investor?  Though having a big name VC on your board is prestigious, they are often too busy doing other things to pay attention to your company.  The big shot VCs are often shadowed by more junior members of the firm at board meetings and that, usually is a good thing.
• How responsive is the investor?  If they are hard to get a hold of during the “wooing” period prior to deal closing, they will be even harder to reach once the deal is done.  Then, it’s just money, and you don’t want that.  You want your lead partner’s phone number on your speed dial.
• do personal reference checks on the partner that will be leading the investment
• Does he understand my market?  Usually, this means having operating experience at companies like yours.  There are few other ways to really get an understanding of the players in your space.  They should have street smarts as well as book smarts about your market.
• Does he appreciate the technology?  The partner should know which things are technically difficult and which are easy.  The partner should be able to sit through a design session with your team (though it will rarely happen) and not act smug or chuckle about everything being over his head.
• Has he been in your shoes?  Empathy for the things you will experience is built over time, in personal crucibles.  Best VCs are often ex-entrepreneurs who have started companies themselves — started, not walked in and managed.  They know what it’s like to hear an echo in an empty new office and run downstairs to buy coffee for the new coffee machine, to drink it sitting on the floor.  They know what it’s like to lose a deal or get screwed over by a partner. They know how hiring mistakes feel. (Blows my mind, but there are actually VCs out there who have NEVER MANAGED PEOPLE — stay the hell away).
• Is he an asshole?  This is the biggest concern.  There are positive assholes and negative assholes.  Having someone who is tough and demanding (good asshole) is a plus on your team especially when he isn’t really there bothering you every day.  Someone who is just full of himself and commanding without rhyme or reason is a bad thing.  Whenever you hear the word “asshole” in any personal reference checks, beware and do a double take.
• Can he actually help?  Usually, VCs help with two things:  ideas and recruiting.  You should ask your reference what new ideas did the VC bring up that were not useless drivel (e.g. “It is very important to have paying customers. — I was actually told that by a VC on my board).  What people did the VC actually help recruit vs. just spew about the importance of having good people on board (e.g. “You should really hire only the best.  – ditto, heard it from a board member)?
• talk to failed companies in which the fund invested.  Funds will happily give you names of CEOs from companies that are doing well of have already succeeded.  But it’s the failures that are interesting.  CEOs of failed companies don’t usually badmouth past investors strictly for emotional reasons — they have other companies to do and are worried about their reputation as much as the VC.  However, you should talk to the companies that didn’t work out to understand how the VC responds in times of crisis.  Take these calls with a grain of salt and filter them through your own lens of understanding.  Just because a VC shut down a company does not necessarily mean he did the wrong thing.  It’s how he acted that matters.
• What was the reaction of the VC when the company started heading downhill?  Was it a knee-jerk “cut staff” call or was it more thoughtful?  Was he strong and supportive, or a baby?
• Did the VC try to pull any clever financing tricks when the company was up against the wall?  (“I will give you more money at 5x preference” — actually happened,  ”I will give you a loan that you can not repay secured by your IP that I will move over to another company if you don’t” — actually happened).  Were they courteous or assholes?
• Would you have this person on your board again?  Why or why not?

We should…

The term sheet should appear sometime during this process (by the end, definitely).  Often, a term sheet will be issued subject to completion of due diligence.  You are almost there…

NEXT POST:  Step 5 – The Legal Grind

Related articles

• Getting Funded: Step 3, The Partner Meeting (thansys.com)
• Getting Funded: Step 2, The First Meeting (thansys.com)
• Getting Funded: Step 1,  Getting VCs to notice (thansys.com)
• Getting Funded: Step 0, Prepare (thansys.com)

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

Welcome to the next step in your funding journey:  the partners’ meeting.  If you have followed this series, by now you [...]]]> Tweet

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

Welcome to the next step in your funding journey:  the partners’ meeting.  If you have followed this series, by now you will have gathered your materials, approached the right VCs (and succeeded), and made it through the first meeting with someone at the firm.  Congratulations.  You’re farther along than most companies ever get. Since you will have reached out to many investors, connected with several of them, and made it through the first meeting with a few… you should have a partner meeting or two on the calendar.

“Happy families are all alike; every unhappy family is unhappy in its own way.”  So wrote my countryman Leo Tolstoy opening his Anna Karenina.  That line always came to mind as I presented at VC partner meetings.  Most funds, as most families, seem happy.  And while some actually are, in my experience, many are somewhat unhappy —  each in its own way and to varying degrees.  Presentations to partners are more about psychology (some call it politics) than substance, about how you say things and to whom, and not what you say.  These meeting are less about substance because you should know that the fundamentals are right or you wouldn’t have been invited to present.  Still the presentation guidelines for the first meeting, but…

YOU should…

• Have a coach.  The person inviting you to the partners’ meeting who heard your presentation live should be your coach through this step.  This is very important.  You need a friendly sherpa with inside information who can guide you away from the psychological land mines and explain the characters you are about to meet.  Almost always, the person that suggested the partner meeting will be your coach.  He is, in  a way, putting his reputation on the line and has a lot at stake in making you look good.  Use this to your advantage.
• Know the audience.  You should know who will be at the meeting.  And you want the meeting to have, ideally, enough members of the fund to make a decision.  You should know their names and their titles.  Get this information from your coach.  It is now up to you to try to create a profile for the key players.  If there is a teleconference with another office, fine, but you will, inevitably, focus on the people in the room.
• Research.  You should know where the players on the other side came from and what they did in the past.  You should know what boards they serve on, what investment areas they prefer.  You should know their schools and majors.  You should read through their blogs.  Many VCs (including this one) clearly signal what they are looking for in their social media interactions.
• Identify players.  Titles and roles in a VC fund are often confusing to the non-initiated.  Here are the basics…
• Associates: usually, they are VCs “in training,” straight from (business) school.  They are there to show their investment mettle to the rest of the partnership which they hope to join or to build a reputation that will advance their career at another fund.  Smart ones also care about their reputation with the entrepreneur community and, thus, care about what you think of them, because, chances are, you will meet again in another venue.  They can be the strongest allies you have, but, occasionally, or can come off as insufferably arrogant.  You have to worry about the latter for the duration of the meeting, but, in the long run, they won’t last, so just note who they are for the future.  Good associates tend to have a “pro-entrepreneur” bias which is generally forgiven by the partnership because of their inexperience and eagerness to find a big hit.  Associates do not say “yes” but can certainly sway the decision.  They do not officially say “no” either, but, depending on the fund, get heard.  There is competition between associates on who can outsmart the other, so be ready for seemingly clever questions.  They care deeply about what the other people at the table think of them so do not put them down even if you feel you can.   In general, they are smart, energetic, and want to see deals happen.  Associates should be your friends.
• Principals/Jr. Partners/VP’s:  up and coming investors hoping for a partner role, usually at the fund where they now work.  VC funds raise money infrequently, and, thus, there are long waiting periods for an opening in the partner ranks.  They should be on a few boards — find out which ones because that indicates their specialization.  They tend to be more neutral in their approach to companies, often skewing their questions to the business side of the matter because it is the safer route.  Again, they could be very valuable allies, especially if they seem to be the heirs to the fund’s partnership roles or rising stars in the VC community.  But, stars have egos and want star treatment — treat them with care.  They can certainly influence things in a big way, though probably won’t make the final “yes” or “no” call.  They tend to be more conservative than the associates because, at this stage in their careers, they are worried about getting a “track record” of investments in which they take part in order to score a partnership role.  You should offer to discuss any of their concerns in detail and after the meeting in person — shows respect and neutralizes at the same time.  You may want to hint that you would want their involvement in the company down the road — vote for longevity.
• Partners: obviously, the most important group.  But, in general, partners have their own investments to worry about and unless the coach happens to be one of the partners, your role is to show all of them how valuable their opinion and insight may be.  Don’t be offended if a partner is silent at this meeting.  It does not necessarily mean he doesn’t like what you are saying.  Partners tend to specialize in industries/markets/technologies so it may be that what you are talking about is simply outside of their comfort zone.  That doesn’t mean they will say “no.”  Hopefully, they will be open to opinions from more deeply engaged partners in their decisions.  In most funds, no single partner can say “yes” but any one of them can certainly say “no.”  Don’t piss off any of them, and don’t argue.  The decision is usually made by consensus (though some funds have strange point-based voting rules) so it’s important to get all the partners to at least “neutral.”
• Senior/Managing Partners:  if the fund has this title, this is an important, usually more experienced person and thus, should be treated with care and respect.  Try to find if the control model is more of a “Roman republic” (which had two equal consuls), “classic Roman Empire” (which had one omnipotent emperor) or “late Roman empire” (where the East and West were split between Rome and Constantinople).  The classic empire model is simple — make sure the guy at the top agrees.  This model tends to be most dysfunctional, so, you’re really rolling the dice unless the top guy happens to be your coach.  The late empire is also simple — make sure you know which part of the realm you belong to and act accordingly.   The “consulship” is tough.  There is competition among the top ranks and you have to walk a delicate line in pleasing two or more often contradictory parties.
• Venture Partners/hired experts: usually, people who are “trying out” venture capital, on their way up, or, getting out of the business, on their way out.  They don’t have as much at stake and tend to care less about fund politics.  Can be valuable allies, but rarely make any consequential decisions.  They can certainly help make your case behind the scenes.
• EIRs / ex-CEOs:  persons using the VC fund as a stopover to doing another company.  Could a strong asset if they focused on the same business earlier in their careers.  They could actually become your CEO if you need one.  They are usually seen as “experts” and their opinion matters.  Important to have on your side.
• Understand “fund bias”.   It is important to slant your presentation correctly to protect yourself against unstated prejudices a fund may have.  If a fund has had one big hit after another, they tend to have a negative bias toward any company proposing smaller, more down to Earth businesses.  These funds tend to look for the next Google.  Ask yourself, does my business have the right outcome down the road to move the needle for these guys?  If a fund is looking for “big” you should pitch “big.”  If they are comfortable with getting you through a couple of rounds to an acquisition, pitch small(er), but, remember, everyone still secretly wishes for the next Google.  Does the fund have enough cash to get you through the four series of funding you will need as you build the next Groupon?  Are they early in their fund’s life-cycle and willing to take more risk?
• Understand “fund focus”.  Are these people comfortable investing in your sector and at your stage?  Contrary to common belief, most VCs are not daredevil risk takers.  Venture Capital is about pattern recognition, not risk.  And once the fund recognizes the routing that works, they are unlikely to step outside their comfort zone.  Strange things happen, but odds are against it.
• Formulate a meeting strategy.  Schedule a 30 minute call with the coach a week prior to the presentation.  Explain your understanding of what you are going to present.  Ask him to confirm or help with any personality interpretations you have made.  Ask for advice about people who will be in the room and what they want to hear.  Write it down.
• Bring a team and understand who does what.  You should be bringing a team to these presentations.  One of the best posts on this  subject comes from one of my favorite VC bloggers, Mark Suster, and can be found here.  Make sure everyone knows who is covering which questions during the meeting.  It’s shouldn’t be a “CEO show” with a bunch of silent cameos.  Everyone should have a chance to say something.  Make sure the CEO knows what every team member will say.  Make sure everyone on your team knows whom they are covering.
• Follow the basic presentation you gave during the first meeting, and do not change it dramatically as most people will have seen your original deck.  Do adjust the pitch based on the people dynamics you uncover and the fund bias that may have been determined.
• Take about 30 minutes.  You have an hour, but the pitch should be a little shorter than the first meetings’ one because there should be more questions and you want to answer all of them.  You also want the partners to have time for discussion after you leave.
• Give technology enough time but do not let it be the focus of the presentation.  You should answer the questions from the more technical members of the fund, but, offer to do an in-depth walk-through as a follow-on.  However, the CEO (yes, the CEO) should know how the product works and be able to cover the basics.  Don’t ever say something is “over your head” — you are the head of the company, nothing should be over it.
• Dispel fears about competition and expect the inevitable “what about?” questions that will come (usually from the more junior members of the fund).  Know your competition, especially if you see people in the fund with LinkedIn connections to competitors’ CEOs.  You should have a list of “what about…” questions they will ask and know your answers to those questions. You should ask your coach who else in your space the fund has seen.  Obviously, if they invested in one of your competitors (and it’s not public), they will not invest in you so you shouldn’t be doing this presentation at all.
• Sell your value proposition from an investment perspective.  “You give us X dollars and in X years, you will have another Y (Google, YouTube, LinkedIn…) on your hands, worth 10x the dollars, and have a hand in creating one of the major players in the industry that you can put on your “exits” web page.”  Maybe don’t make it that blatant, but that’s what you want them to think.
• Explain your valuation expectations and where the proposed funding gets you.  This is important.  You do not want to go through a few weeks of due diligence only to find you’ve set these expectations incorrectly.
• Let them know who else you’re seeing.  At this point, this should not delay the decision.  VCs should not be waiting to hear what the others say.  However, if you’re talking to a competing fund (yes, all VCs are friends, but some are better friends than others), you might want to make that known.  Talking to rivals adds fuel to the fire.
• Try to smile and make friends.  You hope to work with these people for several years and they should like you and you should like them.  Make sure everyone on your team understands that.  If there is anyone in the fund that you just don’t like, chances are, things are not going to go smoothly.
• Don’t say “it’s a great question”  (unless it really is and very few are).  If is not a good question, or an obvious one, chances are the other people at the table know it and you are not making yourself look any better.
• Leave with minimal expectations.  Understand that investments rarely “happen on the spot” (if they do, it’s very unusual and you should ask yourself “why” and “perhaps I should shop this around some more.”).  The decision should come during the following week.

WE should…

Related articles

• Getting funded: Step 0 – Prepare (thansys.com)
• Getting Funded: Step 1 – Getting VCs to notice (thansys.com)
• Getting Funded: Step 2, The First Meeting (thansys.com)
• Why I Am Ashamed Of My Early VC Years (fastcompany.com)

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

In Step 0 of this series, I have described the arsenal one should [...]]]> Tweet

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

In Step 0 of this series, I have described the arsenal one should have ready when preparing to make a funding pitch to a VC.  Assuming you have most of the materials I suggest or, at least, are in the process of gathering the bits and pieces, you now approach one of the more difficult phases of securing funding — getting VCs to listen.  If you spent most of your life on Sand Hill Road or have been funded a bunch of times before, you can skip this section.  For the rest, to be honest, the process is often unpleasant.  It doesn’t help that, in general, Venture Capitalists who have not been in your shoes don’t make it any easier.  But you shouldn’t set your expectations too high either (less disappointing that way).   Most of us working on “the other side” simply get too much email to dedicate the 15 minutes such a document would deserve.  Don’t expect just to hand over your business card, however cool, write a quick follow up, and have the doors open.  Again, bandwidth is the issue — not your fault.  Here are some suggestions on making the process smoother.

YOU should… decide if you really want a VC.

VC firms tend to invest in companies that have graduated from the “design on a napkin” stage of their development.  And going to most firms with just a dream and an idea is usually a waste of time not because the idea is bad, but, rather, because it’s too early for VCs to get involved.  Most VCs want to do a Series A investment as Preferred Stock and invest $1.5M+.  This implies that your company should be worth $3M+.  Hard to find a million dollar idea, let alone a three million dollar one.  You might want to start smaller.  I suggest…

1. Practice your pitch in public.  There are a number of events in New York City where I live that regularly select companies to do a “mock” presentation to members of the investment community.  Usually, it’s a 3-5 minute pitch followed by a 3-5 minute Q&A session.  These events are well attended.  There are real VCs sitting on the panel that reviews and critiques each presentation.  I am a regular on the panels hosted by The Hatchery and Entrepreneurs Roundtable.  Not only does your pitch get better if you are presenting, but you get to meet some of the people on the panel and in the audience.
2. Try to get into a Startup Accelerator.YCombinator is the one that gets the most buzz and hosts some great companies, but there are others.  Nation-wide, there is TechStars.  In New York, there are also NYCSeed, ER Accelerator, and a few others.  This answer on Quora gives a nice list of others for New York.  Unfortunately, it lumps “incubators” and “accelerators” together.   The two things are different — incubators “incubate” ideas to get companies to form around them.  Accelerators take the earliest stage startups and get them ready for funding using a specific process.  The reason for getting into those programs is two-fold.  First, you get to surround yourself with other companies trying to get started.  This is an invaluable source of support and expertise.  Second, VCs like to act as mentors in these programs.  I am a mentor at TechStars NYC and NYCSeed.   There are other VCs (if they are any good) milling around these places as well as locations like General Assembly and Betaworks.  Good place to get a head start on the fundraising.  They usually have specific rules for application and selection.  If you need to get going, I’d check them out.  I am only giving examples for New York where I live.  Other cities have their own.
3. Get on Angel List. I know it has “angel” in the title, but many VCs (including this one) subscribe and follow the companies listed there.  It lets VCs triage the companies that interest them and lets you read which VCs are interested in the technologies your company creates.
4. Consider bootstrapping. There is nothing wrong with financing your company with the money earned from your own work.  My first company, before Sequoia came in, was funded just that way.  Just make sure you’re in a market that can wait for your product.  Bootstrapping is great, but does slow things down.
5. Consider angels or seed investors. They tend to be easier to reach than VCs and like early stage companies more.  There are some great ones in New York and other parts of the country.  I often recommend angel investors I know to companies that are too early for our fund.  Just make sure that angel and seed investors are, indeed, “smart money” — that they actually add value to what you are doing and have a track record of getting graduates from their programs funded by larger funds.

If you’ve done these things or feel that you can skip the incubation phase, you are ready to approach an investor.  Pardon the cliché, but “you don’t get a second chance to make a good first impression,” so care should be given to the way you make your introduction…

YOU should…

1. Figure out which firms are “right.” Best way to do so is to browse companies in this space and see who invested in them in the early stages.  A good resource for finding investment histories of companies is CrunchBase.  Keep in mind that VCs don’t invest in competitors to their portfolio companies.  So, if your company is a better version of something they already have, don’t waste your time.  However, if your company is different, think about how you will differentiate yourself in the introduction.  It is important to find a VC with an appetite for “the space” in general and look for holes in their portfolios.  Now, most VCs have a play in cloud computing.  But which part of Cloud Computing?  System provisioning?  Storage?  Virtualization?  Think how you would be complimentary to the companies they already have.
2. Do your homework on the investor. If they are a modern VC, they will tweet, maybe blog.  They will have their presentations as slides or videos somewhere on the internet.  Decide if this is a person you’d enjoy meeting.  If the investor strikes you as an arrogant ass with a blackberry talking about numbers you don’t understand, skip them.  There are plenty of fish in the sea.  If it’s someone with a friendly attitude and actually says things that you find interesting, make your approach.
3. Try to get an introduction from a friend.  I know this is easier said than done, but referrals are the best way to get a VCs attention.  Make sure the referral is from a good source.  Portfolio CEOs are the best.  Other VCs are good as well.  Just make sure they actually understand what you’re all about and why you want this particular introduction.  If they decline to make the intro, don’t be upset.  I, for example, make it a point not to introduce people around simply as a favor and feel I put my professional reputation on the line every time I make an intro.  If I think your company is not right for a particular investor, I won’t make the introduction.
   DO NOT hire a firm to “shop the deal” around.  Not at this stage.  I want to hear from the founders and the founders only.  Personally, I will never take a company that hired someone to “help” with fundraising seriously.  Sorry.
4. Connect via LinkedIn. Many VCs use that network.  And you do not need to get to the most senior partner in the firm for an introduction.  Just make sure that the introduction is personalized vs. boilerplate.  Explain why you want to connect:  company, goals, space, etc.  Keep it brief.  Go for the associates, principles, and venture partners — they are more likely to respond.  Chances are you’ll get connected and will then have their email address.
   DO NOT say you are a “friend” unless you really are a friend.  Some of us pre-date Facebook and feel that the word “friend” still carries some weight.  Join a group I’m in, find a common acquaintance already connected.  Just don’t bullshit.
5. Send a brief introduction. Send your “Elevator Pitch” as part of the introductory email and attach your “Executive Summary” (see Step 0).  If you follow the guidelines in that step, the investor should be able to quickly tell you if there is further interest or not.  Title should include the words “introduction” the company name and a tagline.  Avoid spam filters and don’t say “Viagra” (or Cialis) anywhere in the text.  Check your grammar and spelling — words matter.
   DO NOT send the deck or any other megabyte attachments.  You should include a link to your website or a demo invite if you have them.  Concise, to the point, and sent from ONE individual to ONE individual.  The introductory email should be personal.  If I detect that it’s something from MailChimp, chances are it will get deleted.
6. Have some patience. VCs should respond to your intro (more on that later) but there may be a conference, an offsite, or a vacation you don’t know about.  If you haven’t heard back in two weeks, send a reminder.  If there is no response within a week, note down that investor’s name, never speak to them again (for this or any other company you start) and laugh at them all the way to your IPO.
   DO NOT be a pest.  Do not send constant reminders, twitter DMs, or blog comments.  Give the VCs time to digest.
7. Accept “NO” for an answer. Do not try to argue over email, do not try to change their mind.  If they misunderstood, it’s their fault.  If your message is unclear, make it better next time.  Just say thank you, move on, and hope to meet the next time around.

Hopefully, you’ll get an indication of interest asking you to send over the deck and the real process can start.  If not, do not give up — there are plenty of investors out there.

Meeting investors is a chore.  However, it is an important and meaningful step in your company’s early life.  Hopefully it is a start of a relationship.  And it blows my mind to see a cavalier, nonchalant attitude towards companies trying to get in the door that some investors display.  If there were no startups there would be no VCs.  It’s not chicken and egg.  Companies matter a lot more than investors.

We should…

1. Be reachable. Deal flow is what Venture Capital is all about.  We should make ourselves available and reachable to startups.  Most modern VCs, as I mentioned, are on LinkedIn, Twitter, AngelList, and other social networks.  Most attend conferences, trade shows, events, even meetups.  We should be using Hashable.  We should have an infinite supply of business cards at all times.
2. Respond. Time to get off the high horse and realize that startups are what make investors successful.  We should respond to your email, in person, within two weeks either asking for more information or giving you a succinct reason for why we are not interested.  A VCs email inbox is not a void.  If a VC decides to declare “email bankruptcy” because they are too behind on their email, they should announce that in public.
3. Delegate intelligently. There may be others at the firm who are better qualified to make a judgement on your company.  The VC should forward your intro, with comments to another member of the firm after which you should leave him alone.  There is nothing wrong with that and not a sign of rejection — it is a good thing.
4. Guarantee attention. We should guarantee that at least the elevator pitch will get read and given some thought.  This is why it is so important.  We should look at the LinkedIn profiles of the founders.  We should peruse their blogs.  There may be times when we are busier than usual, but that’s why it takes two weeks to get back to someone.
5. Show respect. These people are knocking at your door trying to have you join them in fulfilling their dreams.  There is nothing worse than a condescending VC.  That doesn’t mean you shouldn’t be harsh when necessary.  But be honest and critical, rather than just dismissive.
6. Offer to help. Sometimes, the idea is good, the founders are good, but it’s just too early.  A VC should have a network of early-stage and seed funds to which a company can be referred.  I save these referrals for companies I honestly believe in but in which I can not invest because of its stage.  I will take a meeting or a breakfast with an early stage company I like just to help.  We are part of the same community and should take care of each other.

CONTINUED:  Step 2 – The first meeting

Related articles

• Getting funded: Step 0 – Prepare (thansys.com)
• Angel Investors Outshine VCs For Entrepreneurs (fastcompany.com)
• Changes in Software & Venture Capital – Part 2 of 3 (bothsidesofthetable.com)
• VCs are now selling their ideas to entrepreneurs (observer.com)
• Investors Flock To Boston To See TechStars’ 12 Cool New Startups (Here’s A Peek) (techcrunch.com)
• Just Write Checks, Be Humble but Unstoppable, and Boston VCs Are Dinosaurs: 10 Highlights from Angel Bootcamp (xconomy.com)
• Why Every Angel Should Beg to Mentor at an Accelerator (tydanco.com)

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

This is part of a series on what it takes to get your company funded.  In this chain of posts, [...]]]> Tweet

A series of articles about getting through the VC process from a serial entrepreneur who now sitting on the other side of the table.

This is part of a series on what it takes to get your company funded.  In this chain of posts, I want to take a slightly different perspective from the usual “we want to see this” articles peppering the web.  I want to present two sides.  First, what is expected of you and second, what is expected from the VC as well.  Too often VCs focus on their expectations of what companies need to present and prepare because we are in the business of looking at dozens of potential investments every month and want to get through them quickly.

Unfortunately, I will start with a post about the work you have to do:  getting the materials together.  Not much work for the VC on this one, but you need to have these things ready to go.  It will make the rest of the process smoother and give the investor no excuse for dragging his feet asking for “additional information.”  If your presentation package is complete, the funding process can follow a familiar and acceptable pattern: some quick and understandable ”no’s” and, hopefully,  a sequential series of “yes’s” leading you to your final goal.

YOU should…

…have a few things ready before you start seeking funding.  Elevator pitch and executive summary are the minimum.  The others are nice to have and will be required soon if the first two are good, so you might as well get them ready.  Do not write a business plan unless you are doing it as a tuning exercise for your own thinking or a business school class assignment.   I have never written one.  I will never read one.  Here’s what you need:

1. Elevator Pitch:  one paragraph (150 words or so) explaining the market you are targeting, the product you are building and how it aims to address that market, a word or two about the team, and the deal you expect to get (capital required — skip the valuation, these things are usually implied by the amount).  I know it is hard to put your life’s passion into a paragraph.  But, this is what gets read first and, often, the whole idea gets rejected if this paragraph sucks.  As I was taught in my journalism classes — the editor can cut your story at any point, so make sure to say everything in the lead paragraph, before the cut.  This is your story’s lead:  Why now?  Why this?  Why us?  How much?
2. Executive Summary: one page summary that elaborates on the elevator pitch.  You can make this page dense, but still keep it to one page and keep it in a universal format like PDF (I, for one, do not like to mail around Word documents or PPTs).  This page should support all points of the elevator pitch and set yourself up for getting enough interest to get a solicitation to see the pitch deck.  In the summary, you need to have more details about the market (skip the TAM and SAM figures — good VCs should know those), but rather focus on the traction the market is getting, how fast it’s growing, where the users are.  Talk about your success in that market, mention big customers, focus on growth.  Product — don’t just describe your technology as “unique,” “innovative,” or (God forbid) “patented” — explain what you do and how.  Yes, that’s hard on a single page, but you have to do it.  Talk about the team in terms that apply specifically to the market (business side of the team) and product (technical side of the team).  Attach links to your LinkedIn profile (not your academic papers).  If you have a link to a video of you doing a presentation, even if it is on a different topic, and you sound good, attach that as well.
3. The deck: A short 10-20 slide (NO MORE!) deck (PPT, Keynote, or PDF) that can be presented in about 30-40 minutes.  You will have one hour to meet with an investor and you want to leave plenty of time for questions.  The deck should elaborate on the points brought up in the executive summary, still be short, and not have any animations, sound effects or videos.  There is a classic:  10/20/30 rule but, I think the 30-point font can be relaxed — not everyone is Steve Jobs (or Guy Kawasaki).  Just make sure it is concise and to the point, has some graphics to break up the monotony, and flows naturally.  I want to hear your voice as I flip through the deck and follow a single, coherent train of thought.  Again… the problem, the solution, why us, what will it take, and where will the company be when the money it is raising runs out.
4. A competent technologist: I will want to check out the technology behind the product.  Make sure there is someone on your team who can talk about the product with a competent technical VC or their representative, preferably using a whiteboard rather than slides.  ”Our product is developed in Romania and we have no idea how it works” is a show stopper.  Architecture diagrams, sample code, API references, RDoc/Javadoc, etc.
5. Website: In this day and age, there is no excuse for a company, even at the earliest stage, for not having some sort of a web site.  There are excellent services out there like unbounce.com that let you create a landing page for your company or your domain (if you secured one).  A “real web site” would be better, of course.
6. Demo:  If your product is a web-based consumer-facing service, you should have invites ready for your “beta” program and your VC should ask for one.  It doesn’t need to be perfect and complete, but there should be something.  There is no better way of conveying the experience a customer would bet.
7. Financial Projections: A spreadsheet (Google or Excel) that shows the modeling you did for future customer growth, revenues, and expenses.  Five years is common, three years is often OK.  Interested in two sides of the model:  revenue projections and assumptions about them as well as cash burn.
8. References: You will, inevitably get asked for these if things go well.  Might as well think about what the list would look like.  Personal references are OK, professional references are WAY better.  If the VC knows you personally, you can skip some of these things.
9. LinkedIn account: This is the way I connect to people and check them out.  Besides the work experience summaries, I will look at education, publications (if any), and who else is in your network.  Get this set up an looking good (and recommend that your co-founders do so too).  I will have another post on how to best do LinkedIn introductions to investors in a few days.
10. Email address: Gmail is fine, if you can register the domain — that’s better.  No @aol  please — it’s 2011.
11. Blog, social presence (nice to have): If you blog, and your blog is related to the market or product you are building, realize that interested investors (or at least this one) will read it.  I will also look at your Quora answers, your Klout score, your Twitter stream.  I will not look at your Facebook page.  I will want to know how you think and how smart you are.  I only invest in smart people.  How well you express your ideas in writing is one indicator of that.

I know this seems like a lot of work, but, you want to have all the tools you will need at the ready before you get started.  Some of the materials may be created during the funding process, but you should be prepared to have all of the above scrutinized.

WE should…

…always be willing to listen but set the expectations of what will be required to actually get the funding done.  If we’re into the idea, we can even help with putting together the materials.  In order for us to be “into the idea,” however, you have to get VCs to notice you.  So, stay tuned:

CONTINUED:  Step 1 – Getting VCs to notice

Related articles

• Elevator pitches and the point of your marketing [René Power] (ecademy.com)
• Why You Need A Powerful Elevator Pitch (blogs.sitepoint.com)
• Market, Product, Team (thansys.com)
• Getting Funded: Step 1 – Getting VCs to notice (thansys.com)