风险投资顾问

Reverse due diligence - Making sure your VC isn't a dolt (or worse)

by Healy Jones

The wrong investor can really traumatize a startup's growth trajectory. Stupid questions, micro-managing/backs-seat driving, pig-headed insistence on the wrong strategy, forcing bad executives on the company, halitosis - it's a pretty long list. If you are a startup founder about to take on venture capital financing you should want to know everything you can about your funding venture capitalist prior to accepting an investment. One of the most basic tests you want to conduct is to speak with some of the other founders who have worked with the VC. This isn't that hard - most VCs will expect this question.

Ask for introductions to founders who have taken capital from the venture capitalist

You'll want to have an honest, founder-a-founder conversation. Your goal is to make sure that they venture capitalist is someone who you want intimately involved with your company for the next five+ years. Are they trustworthy, do they actively try to help the business, do they listen well, are they approachable and very importantly, are they NOT jerks.

Prasad has begun this phase of the fund raising process. I'm hoping he will have some insights to share on some of the conversations that he's started to have. However, I think the basic questions that every founder should want to be able to ask other people who have taken the investor's money are:

1. How responsive is the investor
2. What help, beyond financial, do they provide
3. How involved do they get with your business - try to keep this open ended so you don't lead the other founder to the answer you want to hear. One founders "very helpful" could be another's "smothering."
4. Do they prepare for board meetings
5. Do they make helpful introductions (customers, potential members of the team, other funding sources)
6. Have they been transparent with their time frame to exit
7. If you had to do it all over again, would you accept money from this investor

I am sure that other people have had successful conversations like this in the past and I'd love to hear what was asked and what was learned!

Why VC does not line up with innovation

by Georges van Hoegaerden

The biggest complaint I hear and agree with is that Venture Capitalists (VCs) just don't get it and in the words of a VP at Apple, VCs simply don't line up with the needs of entrepreneurs.

Real innovation has no precedent and leaves many VCs, with their platitudes and an army of analytics in the dark in coming up with a reliable reason to invest. I personally had a VC become teary-eyed about the prospect of having to convince the rest of his team about an investment I presented, and I subsequently got it funded elsewhere.

With monetary assets being equal, it takes a visionary or a black swan (whichever classification floats your boat) to separate the good investor from the bad. Great investors have a strong belief that finds solace in an internal compass that is fine-tuned by years of risk-taking. Risk-taking in entrepreneurship or personal life, whichever one shaped that core competency. We have many VCs with strong beliefs, but few of those beliefs are founded on relevant experience.

So, entrepreneurs (and LPs) take note of what is the most important ingredient to look for in the bios of General Partners (GPs). With few exceptions, a GP (General Partner) that has never been a CEO at a startup, responsible for developing and executing its unique ecosystem, is not a great candidate to become a VC. Neither is the GP who has never challenged him/herself personally.

Venture Capital is government

But not only are those investors hard to find, the physical makeup and workings of the current VC construct is diametrically contradicting the decision-making for groundbreaking innovation. As long as the meritocracy at the VC level of the investment pyramid that started Venture Capital is not restored, the artificial arbitration of the current aristocratic model will continue to erode high yield returns.

Here is how VC acts like government:

1/ You (still) need to be in Silicon Valley
Just like you need to be in DC to make an impact on politics, do you need to be within 20 minutes of Sand Hill Road in Menlo Park to be on the radar of investors.

2/ You need an intro to the VC
In DC you need lobbyists to get anywhere, in Silicon Valley you need to find similar lobbyists that can introduce you to the investor you want to talk to. Most GPs simply refuse to talk with entrepreneurs they have not met before. Entrepreneurs who contact VCs directly will find themselves debating the vision with an academic white swan, dramatically improving their chance to get rejected.

3/ Investment decisions require internal consensus
Politics is based on consensus. Likewise, if the entrepreneur is lucky to convince one GP of their proposition, the next monday morning meeting at the VC firm is spent on getting other GPs to agree (except if the first GP is of John Doerr stature). In essence it means a unique invention is shoved through a democratic (government) filter to be validated with chances of a majority vote rapidly approaching zero.

4/ Deal syndication requires external consensus
Many VCs don't have the balls (excusé les mots) to make independent contributions to companies and look for syndication to mitigate the risk. Just like in DC where politicians look for peers to join their charter, before they stick their necks out.

5/ Lack of accountability
VCs can hide behind the size of the portfolio to select one or two successes to brag about. Just like politicians that hide behind a party and associate themselves with many initiatives and get credit for the few that worked. Quite opposite to the devotion of an entrepreneur.

6/ Lack of transparency
To understand politics you need a graduate degree in the subject matter, to understand VC you need to be (or have been) one. Just because the type of businesses VC invests in are private, that doesn't mean VC needs to be.

7/ Far removed from its constituents
Not only physically but spiritually many politicians are far removed from their constituents when they enter into office. So are the VCs who prefer to congregate more with each other than with entrepreneurs to develop unique support for disruptive innovation. VCs are oblivious to the many "false negatives" (as described in my previous blog) they don't even get to see, just as many politicians forget that many americans don't vote at all.

8/ Fewer real innovations are born here
DC (at least before Barack) is not the place to get anything done, and Silicon Valley choking on a vast supply of sub-prime VC is not the place to get anything really disruptive done. The real world is the market, not the current VC interpretation of it.

9/ Long incubation periods
Just like in politics, once the GP secures a fund with the LP the performance of the fund is in limbo for 5-10 years. That is a more secure job than the presidency of the United States. Many GPs stack funds or jump ship before it is about to go under, picking up new management fees under a different fund and LP structure. Another 5-10 years of GP safety lies ahead.

10/ External circumstances
Just like in politics, VCs blame their underperformance on anything else but their own decision making. The state of the economy is their welcome excuse, even though startup economics are quite resilient to macro economic aberrations.

So, the point of this blog is to emphasize that in order to get VC to create high yield returns we not only need to take a close look at the GPs that take the risk but change the mechanics of VC from a "government" based system to a meritocracy at the VC level of the investment pyramid. That is the message I will develop further (and more constructively, I've hammered on VC enough) in helping individual LPs develop new relationships with VC firms.

Saying No In Less Than 60 Seconds

by Brad Feld

I say "no" all the time.  I could start keeping track of the number of times I do it a day, but I'd guess it's a minimum of 10 and occasionally over 50 times a day.  When I type that, my first reaction is "no way, there's no possible way I say no more than 50 times a day", but when I think a little more, it definitely happens sometimes.

One of my goals is to be accessible to anyone that reaches out to me.  Another goal is to minimize the amount of time I spend on things that I either (a) don't have an investment in, (b) won't have an investment in, or (c) don't have an interest in.  Basically, I want to "optimize my accessibility".  This ebbs and flows – when I'm in balance I'm very happy; when I'm out of balance I'm still very happy, but notice that I'm out of balance.

One of the keys to this is to "say no in less than 60 seconds."  Given that my email address is easily discernable, I get a lot of random inbound "we are looking for money" and "do you want to have coffee" emails.  These are easy to say no to, but I also get a lot of not-random "we are looking for money" (e.g. sent from someone I know) and "do you want to have coffee" (e.g. sent from someone I know or recommended by someone I know) emails.  And it escalates in relevance from there (and morphs into all forms, including breakfast, lunch, dinner, meeting, run, …)

Somewhere between 1% and 10% of these fit my a/b/c criteria above.  I can figure this out from the first interaction at least 50% of the time and my first email response is (hopefully a polite) version of "no" that usually consumes a total of less than 30 seconds from beginning to end.  Another 25% of the time I need a little more information and request it via mail.  This has the side effect of eliminating another chunk of interactions since the person on the receiving end never bothers to respond.  For those that do respond, I can usually figure out from the response whether or not I want to spend more time or not; if not, I'm still probably under 60 seconds for saying "no".

The rest usually end up in more email interactions, a phone call, or a meeting. I try to limit all first meetings to 30 minutes so I don't waste either of our time if it's not going to go anywhere, although I'm not always successful at this (the wasting time part).

Now, lest you think this is "overstructured", remember my goal: minimize the amount of time I spend on things I don't care about which allows me to maximize the amount of time I spend on things I care about, while still being very accessible.  While I don't always get this right, I've gotten a lot better at it over the past 20 years.

4 Questions and 4 Pressure Tests To Decipher A VC's Interest In Your Company

by Larry Cheng

I have heard from a number of entrepreneurs over the past couple of months about how they wished VCs would give them a "quick no" more often.  I think it's a totally fair critique and have tried to improve in this area myself.  In lieu of a "quick no", I thought I'd give entrepreneurs 4 questions and 4 pressure tests to help you decipher a VC's level of interest.  These questions presume that you have already given the VC an initial pitch of your business, so they have enough information to at least be initially interested.  After thinking about this post, I have a renewed personal commitment to make my interest level clear and prompt so that there's nothing to "decipher".  A good working relationship should start before an investment is closed – so while I hope the advice is helpful in general, I hope that it's advice you don't have to take with me.  If you feel like you do, feel free to call me out on it – I'll respect you for it.  Without further ado…

4 Questions

1.  How quickly does the VC respond to your calls or emails? 

This is more of a disqualifying question than a qualifying one.  If a VC consistently takes more than one week to respond to your emails or calls in a normal work week, I'd say it's pretty safe to disqualify their interest in 98% of cases.  If they're responding consistently to you with positive sentiments in less than 12–24 hours, I'd consider that a positive sign.  Everything in between is a grey zone, but the more responsive the better. 

2.  Who is investing the time and resources in diligence – you, the VC, or both? 

For a productive process, it should be both.  If the nature of the diligence process is the VC asks you for information, you scramble to pull it together, and that's it – it's not necessarily a buying signal.  You want to see an investment of time and energy from a team of folks at the VC firm including a partner.  Such an investment could include: on site visits (especially if air travel is required), spending money on diligence (e.g. legal, technical, financial, etc.), clear commitment of time on diligence calls, or a partnership presentation (which is an investment of other people's time).

3.  Is the VC making progress "reportable" to a partnership every week?

Most VC firms manage a deal pipeline the same way any company might manage a sales pipeline.  When an investment opportunity progresses to a stage of real interest and opportunity, they raise it to a level internally which presumes some level of weekly reporting to the team.  Once it reaches that stage, the VC has every incentive to make "reportable" progress each week so that they don't lose momentum internally with their partners.  If you feel like a process is dragging and is slow, then you're probably not at that level or you have come down from that level and serious interest may not be present.

4.  At the end of the day, do you feel like you're chasing the VC or is the VC chasing you?

Any VC worth his/her salt knows how to go 110% after a company they want to invest in.  We all know we need to be aggressive in a competitive environment to win the best opportunities.  So, VCs know how to chase great companies.  If you feel chased, consider that the best buying signal.  If you don't feel chased, then consider a pressure test…

4 Pressure Tests

1.  Ask the VC to sign an NDA. 

I'd say this is the easiest test.  There's a widely held belief that VCs don't sign NDAs.  I haven't found that to be true.  Imagine if a VC said to their LP, "We didn't invest in Google because Larry and Sergey wanted an NDA and we declined out of firm policy."  That wouldn't fly.  The reason VCs generally don't sign NDAs is that it creates too much complexity if you're meeting with thousands of companies a year to sign NDA's for all of them.  But, VCs will sign NDA's if they're seriously interested in a company and it's important to you.  As a ballpark measure, I sign about 1–2 NDAs per month and invest in 1–2 companies per year. 

2.  Schedule a partnership presentation, or specifically outline the process to get there. 

No investment will close without you pitching the partnership.  Many VCs won't allow term sheets to be issued without a partnership presentation.  Either way, ask the VC you're engaged with to outline the specific steps and timeframe to a partnership presentation.  If they outline something very clear or even schedule a date, that's great.  If their answer is hazy or unclear, then they're not ready to put you in front of the partnership which is where they invest some of their credibility. 

3.  Ask to call references on the partner.

This is a qualifying test rather than a disqualifying test.  If a VC partner lets you call their references, then it's a clear buying signal because that's an investment of time from their references (usually their CEO's).  They won't use their CEO's time unless they have very serious interest.  If they're not ready to give you references, I wouldn't say it's disqualifying but it's a sign that there's still work to be done before the finish line. 

4.  Reject the VC (nicely).

This is probably the ultimate pressure test.  If you've asked the questions, done the pressure tests and your gut doubts the level of the VC's interest – in as kind and as humble a way as possible, let the VC go.  Just tell them that while you would have liked to work with them, it doesn't seem like they're interested, and there are no hard feelings.  Perhaps the stars didn't align this time, and you'll keep them in the loop for any future financings.  While I wouldn't recommend this as a negotiation ploy, I think it's fair game if that's how you genuinely feel.  If somehow you have misjudged the situation, and they are really interested – this should kick them into gear.  But, more likely, it will lead to a clear no which is still helpful.

VC's Mathematical Challenge

by Matt McCall

There is no doubt that the venture industry is going through a major house cleaning right now. Much of the pruning that should have been done post Bubble is finally going on now as LP's start to wake up and pull back a bit from the asset class. One of the main challenges has been the mismatch between LP demand in the category and the declining liquidity of it. The main question people as is what is the right amount of capital that should flow into the business annually to keep it healthy. Let's look at the mathematics from the exit perspective:  

Average annual number of acquisitions: 250

Average sales price: $80 million

Average annual number of IPO's: 100

Average value of IPO: $150 million

Total annual value of venture backed exits: $35 billion

(IPO's have been down below 10 recently and above 200 in healthy times but below 60 for the past 8 years)

(sale & IPO values have fluctuated but these are swags)  

Assumed VC ownership at exit: 70%

Exit Value going to VC's: $24.5 billion

Target Fund multiple: 2.5-3x

Capital Deployed to hit: $8-10 billion

This means that for the industry to continue (a la 1990's) generating IRR's north of 20% net in this exit environment, no more than $10 billion should be flowing into it during any given year. If the IPO market wakes up, this number goes up. If it stays asleep, it goes even lower. In a strong year (250 IPO's & 300 acquisitions at $200 million & $120 million avg values respectively), total annual exit value jumps to nearly $90 billion. Filter this through and the industry could handle roughly $25 billion in new capital.

Well, until just the first quarter of this year, industry fundraising has been north of $30 billion for several years and the exit markets have been significantly below even the initial levels above. Our industry stays healthy if no more than $10-15 billion per year is raised. So, we've been at 2x that rate. The LP's have hopefully figured this out and we'll see smaller brand funds and fewer total funds. 

How many funds can survive in this kind of market? Let's do the math again:

Couple of mega-mega funds like NEA, Oak, TCV & Menlo: say 5 x $2 billion each = $10 billion

Number of brand funds: say 25 x $500 million each = $13 billion

Number of next tier funds:  say 40 x $200 million each = $8 billion

Fundraising cycle: every 3 years

So, just these initial 70 funds results in $10 billion+ per year raised.  

Assuming that there will be around 300 funds around in total, this leaves about $5 billion/yr for the remaining 230 groups. Using the 3 year cycle, this results in each of these funds being under $65 million in size. If the exit environment remains moribund, then all of these number have to discounted even more to get to $10 billion in total industry dollars annually.

So, the industry has to drop from 500-600 groups to 300 groups and the LP's need to pair everyone back. No more $4 billion Mega-mega funds, no more $700-800 million brand funds, no more $300-400 million next tier funds and no more $100-150 million remaining funds. If the LP's don't do this, we end up north of $25 billion per year again and terrible returns.

Can LP's contain themselves? We'll see once conditions start to improve in the economy. In the interim, it will be ugly times for VC fundraising...