Being “too early”

创业投资或风险投资的“创业”、“风险”不再，硅谷的风险投资也倾向于做后期项目。

by STU PHILLIPS

The hardest money you will ever raise is the money you need to get going.

Sadly, the "venture" in venture capital has gone – at least for now. I've written in the past about the growing trend among Silicon Valley VCs to want to fund later stage companies. These later stage companies offer the perception that risk has been taken off the table and so make for "better" investments.

If you are a true startup – a founder or two, a good business idea and the guts to start a company from the ground up, you face a huge challenge to get money to start the company.

I've seen this first hand over the last couple of months as two of my friends have struggled to raise money despite being multiple-repeat entrepreneurs with great track records. Time after time, from VCs and Angel investors alike, they've heard the same comment:

    "You are too early!"

Perhaps it's a reaction to a looming recession, a largely closed exit market (both significant M&A and IPO) or the overhang of a portfolio of later stage companies, but there's precious little appetite for early-stage risk.

The pressure of deploying larger venture funds coupled with the longer time to reach a liquidity event (now between 6-7 years for a new company) has driven a lot of investors away from early stage companies. Why take all the early stage risk when you can generate a (smaller) return by investing in a later stage company?

These dynamics place a premium on establishing proof points for your business BEFORE setting out to raise money. Build a prototype, get really detailed customer and market feedback, and earmark the people who are going to be the critical hires. If you can, bootstrap the business until you get growth and traction – then if you need money for expansion it will be easier to raise.

Above all, stay the course. This week, after almost a year of bootstrapping his business and getting endless "you are too early" comments, one of my friends got a great term sheet for a very significant financing. What had changed? In terms of the strategy, not much… But there were a ton of proof points on the table for all to see.

Venture Capital Due Diligence

by  c worrall

You have presented your plan to the venture capital partners. It was well received and they have offer you a term-sheet. You have negotiated your major deal points and are ready for the investment. Now the VC wants to commence with due diligence.

Wait a minute… what was all that presenting and talking to partners and scientific specialists? Wasn’t that due diligence? Well, yes, sort of. That was due diligence to make sure that the business model and technology were worthy of investment. Now they want to make sure your company is.

Post term-sheet due diligence reviews your corporation at a detailed level to make sure that you do not have any skeletons in the corporate closet. The venture capital firm wants to make sure that they are not opening themselves up to patent infringement litigation, employee disputes, or tax scandals.

The VC will usually want some form of the following information:

Corporate organization and history — basically your minute book plus any partnership agreements or joint ventures.

Management and employee relations – resumes of management, descriptions of key personnel, organizational charts, any changes or planned changes in management

Intellectual property — lists of any patents, pending patents, trademarks, copyrights, etc. as well as all claims and litigation by or against the Company regarding patents and patent infringement.

Financial and accounting matters – Financial statements, preferably audited, over the past three to five years, and copies of all documents from previous financings, stock purchase agreements, shareholders agreements, etc.

Legal and tax matters - all claims and litigation by or against the Company including any issues with income or employment taxes.

Acquisition, divestiture, or reorganization - any documentation surrounding any acquisition, divestiture, or reorganization in recent years.

Each venture capital firm will have its own list of due diligence needs. Even early in the process, you might ask the firm for its due diligence list so you can get a jump on what the firm might want. Often the list will include additional sections on product and sales plans, competitions, public relations, and R&D.

From the date you receive the term-sheet to the funding date will be six to eight weeks, possibly more. Once you have committed to receiving funding from a VC, you do not want to get held up because you are trying to locate documents or make copies.

Business Plan - What is Your Market?

by cworrall

If I see one more plan without a DOLLAR based market size, I’m going to go nuts.

The Small Business Dictionary has a good (and short) definition of market size:  “The total dollar amount of potential sales to all customers within a given market.”

If you are selling a biology textbook, the market size is not “14 million post-secondary students.”

The market size is the dollars spent today per year on textbooks, plus any annual growth in the market. You are allowed to derive this number. For instance:

• One in two hundred students takes biology once in the four years they are at college.
• Biology textbooks cost on average $100.
• The total enrollment in four year college is 8.8 million.
• The market size for biology textbooks is $4.4 million (8.8M/200*100).

Now, if you think you have a really special textbook that can sell for $250, guess what, the market size is still $4.4 million. You may grow the market a little if your book is that wonderful, but in general people are going to spend what they are going to spend. If you sell your book for more, students may just check it out of the library or share or buy used copies. Your dreams and aspirations do not change the market size.

As part of my consulting practice, I have to derive a market size for many different products. In almost every case, it can be done. Even if you invent something new, those dollars that you want are being spent on something else. What you are replacing is your market size.

Generating a market size is useful for more than just putting a big number in your business plan. By forcing yourself to consider where the dollars are coming from, you will have to also consider how you will get those dollars to come to you, which should also be part of your business plan.

Nasdaq Wants SPACs. Should Investors?

by Heidi Moore

Nasdaq Stock Market wants to start listing special purpose acquisition companies. Should investors buy the shares?

These vehicles, which are really just small, publicly traded shell companies devoted to only one or two investments, have been largely a niche market since 2005, when they began a renaissance after a scandal-plagued history in the 1990s. And until now, largely every market except the American Stock Exchange avoided accepting SPAC listings.

On one hand, it isn’t difficult to understand why Nasdaq — and even NYSE Euronext would want to list SPACs: they represent a rich and expanding market. Last year, these vehicles constituted nearly 25% of the number of initial public offerings, and Amex executives told The Wall Street Journal that SPACs helped drive the exchange’s equity listings up 60% and its total number of listed IPOs to more than double in 2006. About 50 SPACs raised $10 billion last year on the Amex.

And the pipeline is rich, with around 143 SPACs looking to list or buy companies in the first quarter of this year, according to Dealogic. Liberty Acquisition raised $1 billion in December, making it one of the largest of these M&A vehicles, and such names as Greenhill and Lazard also have gotten into the game.

But while these IPOs may be good for the sponsor, investors may not have been as well served. Dealogic data show that the great majority of SPACs that went public in 2007 are trading either flat or below their offer prices. In fact, only 11 of last year’s 66 SPACs are trading more than 3% above the offering price, the data show. And of the 28 SPACs priced within the past six months, only six are trading above the offer price; all the rest are trading below.

Besides the stock-price performance, there is the issue of the sell-by dates. Most SPACs must decide on their first investments within 24 months of the initial public offering or return the funds to shareholders.

Consider Marathon Acquisition Corp., which is widely seen as the leading edge of that SPAC renaissance. It went public in 2006 at $8 a share and now is trading about 8% above the offer price. It faced a Feb. 29 deadline to invest its funds (as you can see on page 8 of its 10-Q here) . On Feb. 20, Marathon said it had picked a target, which it didn’t disclose, and could take up to Aug. 31 to close a deal.

Marathon has risen about 8% to investors since its initial public offering in August 2006. Investors have to weigh that against the performance of small stocks in the Russell 2000 Index, which returned -1.46% over the last two years and a dismal -15% over the past year.

No one gets hurt when SPACs do fail to invest and have to return money to investors, but it does raise one concern: if you raise money just to return it all, unused, later–why bother? We put that question to one prominent backer of a SPAC. The answer: “That’s a good question.”

Advice to anyone lucky enough to get a referral. . .

by Alexander Muse

This advice applies to anyone who is the recipient of a referral for a job, an investment or a service. If someone takes the time to make a referral and you accept the referral you have several responsibilities:

1. Only accept referrals you intend to follow-up on.
2. Promptly follow up on the referral (returning the call, sending the information, scheduling the meeting, whatever).
3. Let the referrer know (usually via email) that you made the connection, or request help making the connection.
4. Close the loop (usually via email) by explaining how it turned out.
5. Return the favor. Take a minute to think about how you might be able help the referrer (regardless of how the referral turned out).

More than a week ago a friend of mine who is raising money was in a tight spot. I offered to help connect him to a potential investor. Within a day I had scheduled a meeting over drinks with the investor and my friend. I moderated the meeting over sushi and drinks and by the end the investor was interested enough to request an investment book and my friend seemed appreciative. For some reason I got stuck with the tab (responsibility No. 6: don’t make the referrer pick up the tab). Anyway, I followed up with my friend several days later only to learn he hadn’t sent an investor package to my investor friend. I begged the investor to do the meeting for me as a personal favor. I felt let down and somewhat burned.

However, over the weekend (I was at Ethan’s soccer game) a headhunter told me about a CEO job for a pre-IPO company and I mentioned that I might have the perfect candidate for him. I made a quick call and gave the candidate the headhunter’s contact information. He agreed to contact the headhunter today after sending me a thank you email. This morning I got an email from the candidate indicating that he had connected with the headhunter. He is keeping me in the loop because he realizes that I am extending my relationship to him ~ he is showing me that he respects my relationship and is taking it seriously. Guess who I will refer a second time?

Thoughts On Choosing Board Members

by Fred Wilson

I am a professional board member. I've been sitting on boards for almost 20 years and I've seen a lot. I've seen some of the best board members in action and have tried to copy them. I've seen some of the worst board members in action and have tried hard to forget them.

Here are some thoughts on choosing board members. This advice is for everyone, but it's of particular use when you are a bigger company, maybe public, and need to fill your board with good people.

• Avoid "big names".  For the most part, they are useless.
• Select people who will attend each and every meeting, who will pay close attention to the business
• Select people who have an affinity for your business, who understand your challenges and your opportunities
• Avoid putting someone you can control on your board. In tough situations they will have a fiduciary duty to do what's right and you won't be able to control them when it matters most to you.
• Don't let conflicts get in the way of selecting the ideal board member. Conflicts will be disclosed and can be managed. Many times the people who will understand your business best are conflicted in some way. There are ways to deal with this problem.
• Make sure to have an experienced accountant/auditor on your board and have them run the audit committee. That is no place for amateurs.
• Make sure to have at least two or three CEOs of comparable companies on your board. Make sure they are on the comp committee. Compensation issues are best handled by people who understand the talent market.
• Select people who have the time to do the job right. Being a board member is a job. It's not a retirement perk. If someone cannot commit to attend each and every meeting and to spend at least several hours a week on your company, they are not the right choice.
• Select people who will get along with each other. The very best boards I am on are friendly social active groups. Serious business doesn't have to be stilted and formal. It can and should be fun.
• Above all else, look for great judgment and ethics.

Dating...er...Fundraising Etiquette

by Furqan Nazeeri

I've always been surprised (and somewhat dismayed) at how unpredictable the fundraising / investing process is.  I have been party to many conversations with entrepreneurs along the lines of:

Me:  What happened with XYZ Capital?

Entrepreneur:  Dunno.  They said they were really interested, but it's been a week and I haven't heard anything.

Me:  So are you going to call them?

Entrepreneur:  Ya, but I'm going to wait a few days...don't want to seem desperate.

The funny thing is that I've also had many conversations w/ VCs (present company excluded) with the following gist:

Me:  How'd your meeting w/ NewCo Inc. go?

VC:  It was interesting, but I think they're too [early/late/big/small/whatever].

Me:  So are you going to follow up with them?

VC:  Ya, but I'm going to wait a couple of weeks to let them down so it looks like we did some diligence.

It reminds me of that scene from the movie Swingers!  The more I think about it, the more fundraising sounds like dating.  So with that in mind, I will proffer my "dating...er...fundraising etiquette tips" (which I shamelessly plagiarized and modified from some website on dating):

• [Fundraising] is about two [firms] coming together to see whether they are compatible and then enjoying each other's company so that they may move towards forming a close bond. In doing so there are things that you should remember. [Fundraising] should always be fun and it is as much your responsibility to ensure it is. When you are [fundraising] ensure that you do everything you can to make the meeting enjoyable.
• You will always turn up for a [meeting] unless you have given enough time for it to be canceled. Standing someone up is not acceptable adult behavior, and shows contempt for your prospective [investor] by wasting their time. This kind of arrogance is detestable.
• You will not be opinionated or arrogant on a [pitch] and you will try to avoid discussions on politics and religion in the early stages. You may be very opinionated on certain topics and maybe for good reason but that does not mean you are right. You will come across badly if you act like this. Arrogance makes most people feel uncomfortable so avoid at all costs.
• You will be a listener and not talk your [prospect] to death, particularly if you are [the entrepreneur]. Listening shows interest and the ability to compromise. If your idea of a [pitch] is talking about yourself and your opinions all [day] then do the world a favor and stay at home alone.
• If you don't like your [prospect] then don't be quick to give them a hard time. They are human beings like you and they deserve always to be treated with respect. You can and will have a good time with someone you are not attracted to, so treating someone badly because they are not your type is not acceptable behavior. Rudeness is not allowed.
• You will never tell lies on a pitch to promote yourself because you WILL get found out. Maybe not now but probably when it is too late. Tell the truth or avoid a subject if necessary.
• You will call when you promise to call and not keep someone hanging on. If you don't like your [prospect] then don't falsely promise anything or leave the door open. Again this shows a great disrespect for your [prospect] if you do.

Inside the (messy and spooky) VC Mind

by Rick Segal

Keith writes:

"If one exists, I would love to see the "secret" checklist of criteria VCs use to decide if they even want to pursue talks with companies, or is every business / idea always evaluated with a fresh set of eyes? In other words how do you get in the door and make your company stand out among the hundreds of proposals?"

There are two ways to answer this. First, is the obvious answer: All things coming in the door are evaluated on their own merits.  The second is really an expanded answer to the first one so here goes.

Tons of VCs will tell you that getting a referral is the fastest/easiest way to get into a VC's office to make that first pitch.  I suspect with the massively large players, this is probably true. They see 1000s of deals every day, field 100s of calls, 100s of emails, etc, so getting to the top of that list will not be a cake walk.

For me and the spooky place called my mind/space/time, there is somewhat of an unofficial process that I use.

First, I try really really hard to talk to everybody at least once.  I'm just not that important/famous/arrogant/successful/egotistical that I can afford to be any other way.  I believe I have the greatest gig in the world and I love talking to smart people.  So, my no harm/no foul meetings usually cover most people trying to get in the door of a VC.

Getting to the top of my pile is another matter entirely.

Generally, I'll work on nine active files at any one time.  Active is defined as a deal that has a)passed the sniff test and b) has a possibility of being funded.  I probably have 20 'deals' on my desk at any one time.  So, I'm constantly rolling through deals, process, etc.  Yes, I'll get to it, as they say, but it might take time.

If you are a Microsoft Alumni, you go to the top of the pile/head of the line. To the Microsoft haters out there, sorry, the company was very very good to me and an Alumni calling card gets you in first available slot.  If you a Veteran, same thing, top of the pile/head of the line.  I know, corny, but I was in the U.S. Air Force for 9 years and, well, there you go.

If you are a Canadian investment opportunity, you are up there.  I am first and foremost a Canadian Venture Capitalist who truly believes this country has some amazing people and brilliant ideas.  Canada is an excellent country to do business in and I want to be as active as I can in promoting and helping the Canadian entrepreneurial environment prosper.

Get to know what we invest in.

You have to be in our general sweet spot of what our firm does in order the most out of NHNF meeting.  While I'm happy to spend 30 minutes with a Photon Torpedo inventor, weapons are not something we would ever invest in. Ever.  A great new medical widget? Excellent for you, never for me.  Drug trials? I might take em but I will never fund you.  

Solve a problem.

I know it sounds corny, but it is really true.  Show me the problem, show me the pain, show me the solution and let's talk about the money.  Now, you might think the problem has to be something I experience.  Not necessarily. Sure, in the case of Tungle, it goes after a major pain for me and I'll pay 3x what Marc will charge but there are other problems we are looking at where the problem isn't mine but it is a big problem.

There is an article on yours truly which talks a bit about what I mean.  No ego plug intended.  

Play to my strengths.

I'm a geek, wonk, tech guy. I barely can dress myself (I hang out with Mark McQueen when I need to be seen with better dressed money people).  So, it will be harder for you to get me excited about things that are outside my world.  For example: I had a brilliant women spend a NHNF meeting on business venture that centered around technology/systems within the dry cleaning business.  I've never been in a dry cleaning business and have only heard rumors about what they do.  More seriously, retail was outside my space plus I'm jeans and polo shirts.  So it was a brilliant women who probably didn't get as much as she would have liked, certainly not a source of funding, but nevertheless, we talked.  If you want general social talk with some feedback on an idea or some sanity check on what you've heard, excellent; but for that first step toward being funded by my firm, solve a problem in our space. For bonus points, get to know me a bit so you can tune to my strengths.

Understand the odds.

At one deal a quarter, some people would tell you we are insane.  Others would tell you we are slow.  Regardless, it is not one deal a day which means your odds of getting a check are not great on paper to start with.  This applies to any VC firm.  Just understand this and the rejection pain is a bit less.  Just a bit.

Ask for the No.

One of my portfolio companies was courted by a west coast (northwest) firm which played games for months and months.  To this day, they are still doing the "Let's continue the dialog" nonsense.  I hate that and you should as well.  Feel free to come in here, give me an elevator pitch and ask me right on the spot if would be something you have a shot at getting through the JLA process.  I'll try to get you the no within the first 10 minutes, so the next 20 minutes can be spent talking about your business, ideas, etc, and me getting to know you.  I LinkedIn is a great (check that; amazing) tool.  I think a face to face dialog is even better. So let's get the no out of the way and see if we can find some other things to talk about that will have value to you.

I hope this rather weird list of things helps answer Keith's general question as well as giving a bit of some insight in to what goes on over here at JLA.  It really is like the making of sausage; now that you know, being a VEGAN looks pretty good.

Leading VC firm Kleiner Perkins loses partner in China

By Matt Marshall

Joe Zhou, the partner who led the Beijing office of big-name venture capital firm Kleiner Perkins, has left to set up his own venture capital firm.

Zhou had long wanted to start his own venture firm, so the move is not that much of a surprise, according to Asia Venture Capital Journal, which first reported the news (sorry, no link).

The move comes at a time when investments in China are booming, and at all-time highs (see details on financings below). It’s not the first time U.S. venture firms have seen defections in frothy China. DFJ was hit hard when two of its best partners defected to join Sequoia Capital and Granite Global Ventures two years ago. It’s also a sign that the venture capital model can be difficult to scale outside of one’s home territory. Benchmark Capital, for example, had to cut ties with its European partnership last year when that operation became successful enough to declare independence.

Zhou’s departure comes less than a year after KP opened its operations in China and announced a $360 million fund for the country, including teams in Beijing and Shanghai. Zhou, who had previously scored a hit by backing Chinese company Shanda while he was at venture firm SAIF Partners, was alone in KP’s office in Beijing and was considered a “maverick,” according to the Asian Venture Capital Journal. The Shanghai office of Kleiner has three partners, led by Tina Ju (middle in image above), who helped back Alibaba and Baidu. That team will stay put. So it’s not like Kleiner is falling apart over there.

The story was reported by Rebecca Fannin, who has followed the Chinese venture scene closely. She recently wrote a book called Silicon Dragon about the Chinese technology scene, which argues that China has moved from copy-cat to true innovator mode. (By the way, the book also has some good color about how Robin Li of Baidu and his co-founder almost failed with Baidu, the Chinese search engine that now is No.1 in that country.)

We tried to reach Kleiner for comment this evening, to no avail.

Meanwhile, according to the latest survey by Dow Jones, venture capitalists invested $2.49 billion in 241 deals in China last year, a five percent increase in investment over the previous year — although this comes with one caveat: the number of deals actually fell, despite the overall increase in the value of investments. The data shows increased investment into non-tech. Here’s a spreadsheet (downloads Excel file) listing China investments by sector, stage and round over the past six years.

More from the release here:

“As has been the trend for several years, venture capitalists continue to diversify their investments in China,” said Jessica Canning, Global Research Director for Dow Jones VentureSource. “While prior years saw big gains in energy and Web-related investment, 2007 saw much of that interest shift to the non-technology focused business, consumer and retail area. This industry really picked up in the second half of the year with more than $831 million invested in the third and fourth quarter.”

In total, the report found that China’s business/consumer/retail industry saw a record $1.25 billion invested in 94 deals in 2007, up 83% over the $682 million invested in 2006. The most popular segment within this industry was consumer/business services, which accounted for 48 deals and $761 million in 2007—61% of the industry’s investment total.

Elsewhere, 110 information technology (IT) companies in China received $992 million in venture funding in 2007, a nearly 9% drop in capital compared to 2006. For the third year in a row, the most popular IT segment was the Internet-dominated information services area, which attracted $562 million in 55 deals. However, the number of information services deals was down from the 86 completed in 2006 and investment dipped 1% compared to the prior year.

While healthcare is a relatively small investment industry in China, particularly in comparison to the U.S. and Europe, it did post record gains in 2007 with 21 deals and $175 million invested, more than double the $86 million invested in 15 deals in 2006.

The data also found that China’s energy segment, which enjoyed record investment and deal flow in 2006, cooled in 2007. The area saw six deals completed and some $31 million invested in 2007, a big drop-off from the $421 million invested in 14 deals in 2006.

“In addition to branching out into new investment areas, venture capitalists continue to help their companies grow quickly by providing larger sums of capital—a trend also seen in the U.S. and Europe,” said Ms. Canning. “The median deal size in China is now $8 million, up from $6.1 million in 2006, and the highest median in at least seven years. In addition, the amount of investment activity going toward mature companies—those that are already profitable or generating revenues—points to the rapid development of the venture capital market in China.”

As expected, given the youth of the Chinese venture capital market, the report found that seed and first round deals make up the majority of deal flow in China with about 61%, but second and later rounds now make up 50% of total venture investment. Specifically, second rounds saw 15% more capital invested in 2007 than in 2006.

As for round sizes, the report found the median size of a first round deal was $6.2 million in 2007, up from $5 million in 2006. For second rounds, the median was $9.5 million, down slightly from 10 million in 2006. However, the median round size for a later-stage deal jumped from $20 million in 2006 to $25 million in 2007—illustrating that investors are willing to provide more capital to mature companies in China.

When Does a VC Mean NO

By Jacob Ner-David

Besides my never ending Inbox overload, from time to time also "suffer" from deal flow overload --and the real problem sets in, which is failing to get back to entrepreneurs to say thanks, but no thanks. In other words, No.

My partner Lior Lifshitz  and I often discuss the difference between an American (read polite) and Israeli reaction to a company presentation. My American background has failed me over and over when trying to decipher the responses that some of our portfolio companies receive from VC funds all over the world. "Very interesting" could mean very interesting, but also could mean "I can't think of any questions, don't want to sit here and not say anything..."

The perennial "we will get back to you" could actually mean that, or it could mean "please never ever call us again."

And when does a VC actually just mean No? And does No mean No,or does it mean keep me in the loop and try and convince me.

What I can do is give you our take on this whole issue, and offer a recommendation that is limited to dealings with Jerusalem Capital, I do not deign to think I can speak for an industry.

We receive, on average, 10-20 new "deals" a week. Some are cold calls, some referrals. We will meet with five companies a week, both new ones and ongoing discussions (most of our time we reserve for existing portfolio). That's at least 60 yes/no decisions a month.

Now many of those are quite easy...not in the range of investments we make (above $1 million), not in areas we invest in (we do not do bio-tech, chip development, hardware development, classic enterprise software).

Then we get to the deals which are potential deal flow for us...first we take quick look at material to gauge whether we have any interest... if so we schedule a meeting. But already there many fall through the cracks--lost in aforementioned Inbox overload. So feel free to send again, as of now email is free. I receive hundreds of emails a day (after cleaning out spam). Sometimes I forget to respond. Even to the deals that I am interested in!

Then we meet...and we try to determine is these are people we can work with -- if not, no reflection on them or the business, just our belief whether we will mesh well. In our business we need to work quite closely with our partners -- and not everybody can be partners.

After the "people" test comes our analysis of the business itself...and sometimes we are not sure. Usually breaks down that 1/3 of the time we say, we like the people, but don't agree with the business vision. 1/3 we are not sure, 1/3 we say, hey, maybe we can do this.

Then comes the difficult part--can we agree on partnership terms. Some in the venture/start-up world call this "valuation," I say partnership terms...at the stage we get involved in a company, it's silly to talk about inherent value. It's all blue sky.

So why do I mean with the question "When Does a VC Mean NO?"

Because anywhere in our process we could mean NO, but not quite get around to saying it. And then there are times when it may feel like we are saying no (e.g. emails not answered) but we really are just overwhelmed, or perhaps never even saw the email (that happens, email is NOT foolproof).

And when we say No, but keep in touch..it means just that. It means maybe we will do something down the line together, maybe the IDEA will change over time, or we will realize that there is a there there.

If we say a straight no, accept it. Probably means no. But we wish you the best.

Why Isn't There A Network or Hub Connection Venture Capitalists With Startups?

by  Jason Mendelson

One of the questions we get often is whether or not there is a central clearinghouse or hub (social network?) where VCs and entrepreneurs can connect.  The idea is that VCs would find good deals and entrepreneurs would find funding.  The answer is "no."  Lately, on top of the questions, I've gotten several business plans that seek to create such a network.  So why aren't there any?  And if not, should there be?

I've always been pretty negative about the idea.  In general, I think there would be a natural adverse selection to those who would populate the network.  Here's why:

1.  Great VCs already have more great deal flow than they can fund.  Therefore, they will not be interested in such a clearinghouse and will "opt out" from participating.  Also, keep in mind that there is always a higher hurdle to fund a deal that hasn't been started by someone whom the VC doesn't have some previous experience with.  If the best VCs opt out, then likely, so will the best entrepreneurs.

2.  Repeat entrepreneurs (who have had success in the past) already have a VC network.  They'll likely opt out because they already know VCs from their prior successes.  In fact, most of these types of deals are done quietly without a lot of shopping around.  This assumes that the entrepreneur liked his/her VCs at his last company.  If not, it will still be very easy to find backers for a previously-successful team.  Successful founders are always hot properties. 

3.  First-time entrepreneurs who have executive-level experience are at most one degree separated from a VC network.  Even first-time folks who have been part of a successful startup probably got enough "air time" at board meetings to get to know the investor syndicate and thus have their own network.  If not, they can usually gain access through their former CEOs and other management executives. 

4.  It's not really that hard to find VCs.  Unlike 10 years ago, there are many more VCs out there and many of us have our email address on our web site.  It's not that hard to just email and ask!

So, who is left to be a part of a community like this?  It looks like first-time founders / unsuccessful repeat entrepreneurs who don't know how to find email address on the web.  Yes, I'm being a bit glib, but the bottom line is that I've never thought that the "best of the best" would end up a part of such a community and is the reason why there isn't one today and probably not one tomorrow.

Of venture capital and bubbles

by Nic Brisbourne

Following OpenCoffee this morning I met with Harry Holmwood for lunch.  Harry is a serial entrepreneur from the games industry and a veteran of the last bubble.  Amongst the topics we talked about was whether we are in another bubble today, what that might mean for the availability of financing now and in the future, and what that in turn implies for companies that are thinking of raising money.

In the last bubble a lot of companies raised large amounts of venture capital and built up big cost bases on the assumption that they would be able to raise more money in the future.  That assumption collapsed when the bubble burst and some of these companies either went under or had to endure painful restructurings and down rounds.

That is something that any company would want to avoid, yet at the same time raising venture capital to aggressively pursue a market opportunity can often be the right strategy.  This post is aimed at better understanding the trade-offs between the risk and reward of these options.

Most companies have a choice between a slow growth strategy which requires little or no investment (let’s call this the organic strategy) and a high growth strategy which requires significant third party investment (let’s call this the venture capital strategy).

The organic and venture capital strategies are equally good, they just have a different risk-reward trade off.  Organic is lower risk and lower reward, venture capital is higher risk and higher reward.  Which you choose will depend both on the circumstances of your company and your personal disposition and situation.  I repeat, neither one is inherently better than the other, they are just different.

The rest of this post is about understanding the impact of a changing financial climate on the venture capital strategy.  Specifically, the risk that you start on a VC track because you can, but then the financing climate becomes more difficult and you end up in trouble.

The first point to make is that great companies always get financed.  Valuations may move, but good companies always get money.  And if you don’t believe with all your soul that your company will be great then you should probably be careful about how much money you raise.

The second point is that good VCs are here for the long term and will stay with their companies irrespective of the economic cycle and wider macro-economic condition, provided always that the company retains its potential.

The third and final point is that with prudent management you can limit your exposure to downside even if the first two points don’t apply.  The key things here are knowing how much time you have left before your cash runs out, starting third party fundraising at least six to nine months before your drop dead date, getting firm statements from existing investors about the conditions under which they would or wouldn’t re-invest and if possible having a ‘cut back to profitability’ plan.

One of the more bubble-ish characteristics of the current financing climate in consumer internet is that I and others have been saying focus on building an audience first and monetisation second.  At first blush this seems to increase exposure to changes in the financing climate, but when you get into it things are not as bad as they might seem.  In the consumer internet sector once you strip out marketing expenses the operating costs of a company are often very low and as a result the ‘cut back to profitability’ plan may not be that painful.  Clearly Plan A is to have a large and fast growing community, but there are worse things than taking a period of time to consolidate an existing position before pushing on again.

Should Entrepreneurs go to Venture Conferences?

by ventureexplorer

Greg Costikyan (game designer, entrepreneur, blogger) writes a tongue-in-cheek look at the entrepreneur's experience at Venture Conferences.  You know, the ones which promise you a moment in the sun pitching to a legendary pantheon of VCs ...
Here's an excerpt which had me nodding my head  ...

From an entrepreneur's perspective, the supposed appeal to the venture conference is this: I'm pitching to a room containing maybe 200 people, all interested in venture investing, and even though there's a fee attached (and maybe travel and a hotel room), and even though it's a couple of days out of my (and maybe my senior staff's) life, it's a more efficient way to reach a lot of potential investors at once!

Right?

Well--no. That room of 200 people is maybe 25% other entrepreneurs waiting their turn or listening to other pitches to get a better sense of how to polish their own, and maybe 50% service folks who actually want to sell you stuff, and maybe the other 25% are investors of one kind or another. Of whom the vast majority would never invest in whatever it is you're pitching. And of the handful who remain, almost all are so junior that unless they go back foaming at the mouth with excitement, it doesn't really help.

I've been wondering how long entrepreneurs will keep paying up to be one of a crowd pitching when they could far more easily research relevant investors online (that's one of the many benefits of LinkedIn and, now, Facebook!) and wangle a one-on-one meeting instead.

This bit had me ROTFLMAO (Rolling On The Floor Laughing My Ass Off)...

The basic problem with the venture conference panel is that the conditions under which they are created mitigate against anything of the slightest interest ever being said. They exist to motivate the attendance of VCs, who may be flattered to participate; to reward service firms for contributing money (by allowing them to provide the moderators); and to attract the interest of entrepreneurs, who may reasonably be expected to find what potential investors say of interest. But the choice of topic is inevitably anodyne ("Emerging Trends" -- can't pass that one up!), and since the moderator is from a service firm, which has an interest in sucking up to both investors and entreprenuers, he is extremely unlikely to ask challenging questions, and is likely to stick to the equally anodyne. E.g., "Which is more important when you're looking at a company--the finances or the team?" -- a question at this actual conference, to which the only honest response is "Which are you, a moron or an idiot?"

That's why my first conference this year is GDC in mid-Feb ... conferences of, for and by practitioners tend to be far more rewarding than those catering to investors.

How to Select, Screen and Hire a Business Plan Writer or Business Plan Professional

by Greg Balanko-Dickson

I am not a proponent of hiring someone to write a business plan to obtain financing for your business. I used to write business plans for clients and made money doing it. Today, I no longer provide services of a business plan writer. Why? Because it is most often not in the business owners best interest, for example:

Do not delegate your leadership role. It is your business and if you cannot explain your business, goals and strengths to the person writing your plan they will have to use their imagination and then suddenly your business plan becomes a work of fiction.

You know the business best. No matter how much experience the person helping you has with your business or industry they do not have your knowledge, experience, and your vision.

Ability to answer questions. When it comes time to sit in front of your banker or investor you will be peppered with questions. A lot of weight will be given to your ability to answer their questions because it demonstrates your knowledge of the business and ability to manage it to meet the goals outlined in your business plan.

Being able to articulate, explain, and sell your business plan. You can read and study the business plan written by someone else but you do not have an intimate understanding of inter-relationship between your goals, marketing, and financial statements. There is nothing quite as powerful to absorbing the intricacies of a business plan as writing it personally. If your schedule dictates that you outsource your business plan make sure you are the project manager and the 'senior editor' responsible for the final document that is simply drafted by the business plan writer or professional you hire.

Writing a Business Plan is Requires Effort
Hiring someone to write your business plan should not be viewed as an opportunity to delegate or download a difficult job. As I have said, you need to view your role as a project manager, senior editor, and sales manager. A business plan is a highly structured document designed to sell the financial institution or investor to accept your 'financing proposal'. It is structured to provide them with information in a familiar format so they information they need to make a decision to loan you the money you need to start or expand your business.

Selecting & Screening a Business Plan Writer or Professional (checking qualifications & experience)

Here is a list of questions you can use to screen a business plan writer:

• What qualifies them to write a business plan for your business?
• Do they have direct experience in your industry?
• How many business plans have they written?
• What is their background? Do they consider themselves a business plan writer or a professional?
• Ask for the names and phone numbers of the last three customers.
• How long have they been in business? How long have they been writing business plans?

Types of Business Planning Advisers

Business plan professional is someone who has either the training (CPA etc.), practical experience (retired entrepreneur or other professional), has the financial expertise to create good pro forma financial projections. Their weakness will likely be in the area of marketing and sales. If that is your strength you are in good shape. If not, you will need to find a marketing professional to provide support and expertise to round out your plan.
When you the phrase 'Business Plan Writer' in search engine you will get search results that can range from software, to people selling their writing services. For my money Business Plan Pro is the best software package on the market to help you accelerate the process of transferring your thoughts to paper. Whereas, someone who markets himself or herself as a 'business plan writer' is likely a 'technical writer' that should have a business background. They have strong writing and organizational skills. If they have a weakness it will likely be on the preparation of financial statements. They can do a good job of helping you to extract your knowledge, plans and goals down on paper.

Business Planning Books: consider the author. Is he/she an academic, professional or business owner? What qualifies them to write a book on writing a business plan? Is the book practical? Does it provide you with the background and information you need to understand the importance of each section of the plan or is it filled with generalizations?

Coach or Consultants: this is what I think is the best option because an experienced business plan coach will have the experience, expertise, and coaching skills to help you write your business plan. Use the questions above to screen a coach as you would any other business plan professional.
If you follow these guidelines and work hard you can write a business plan yourself. You will be rewarded with a in-depth knowledge of your business, plan, and the ability to speak of it with confidence.

To VC or Not to VC – That is the question???

by Ramneek Gupta

Every entrepreneur will face this pivotal question and needs to carefully evaluate raising PE/VC money as he/she thinks about scaling their ventures. The barriers to entry and capital requirement to start a new business have come down dramatically due to a number of innovations in hardware (eg: storage and processing power available as utilities in a pay as you go model) and software (eg: SAAS). As a result it does not take a whole lot for entrepreneurs to code a new idea and let it loose on the netizens to see what sticks. This has led to a tremendous spurt in formation and growth of new ventures that fall all along the feature/product/company continuum. Each of these opportunities can represent a good business provided the capital usage and the capitalization table (% ownership of the various stakeholders) has been carefully matched with the scope of the venture. Let us discuss this point in greater detail:

Feature/Product Ventures….
Feature/Product type ventures are generally limited in their ability to be standalone companies for various reasons: their monetization models may not be suited to support costs like G&A overhead, direct sales, marketing; they might be add-ons on an existing platform, etc.….especially in the Web 2.0 area, these types of ventures are well suited to being acquired by a larger company that already has the ability to monetize the feature across its existing traffic, can acquire and retain new users/traffic as a result of the product and can continue future development efforts. This does not mean that these “built to flip” businesses, as they are sometimes referred to, are less exciting intellectually or any less enriching financially for the entrepreneurs. As long as these types of businesses are built with little or no venture capital they can still translate into significant paydays for the entrepreneurs.

This might be an over simplification of the math but at a high level, a $15-30MM exit for a business that is majority owned by the founders (which often means that there is no venture or private equity involved) can result in just as significant a return for the entrepreneur as a $300M+ exit where the entrepreneur owns only a small piece of the company. Additionally, if we factor in the probability of success by using the number of acquisitions with considerations <$40MM as a proxy, the risk reward ratio becomes even more attractive.

To give you some examples, there have been a number of ventures that were acquired very early in their lifecycle and tended to be products rather than companies including Flickr (acquired by Yahoo), Blogger (acquired by Google) and Bloglines (acquired by Ask.com). If one is to take a closer look at say Flickr one would find that the founders made the decision to join forces with Yahoo early on rather than go down the path of a Snapfish or Ofoto (not that they ever intended to) which would have required greater investment and consequently outside capital. Similarly, Blogger (a service that enables consumers to easily create web logs on the Internet) is a perfect example of a product that may not have supported a standalone company on its own but made perfect sense in being scaled under the Google umbrella.

Large standalone company type ventures….
This is not to say that there is no home for venture capital (there better be otherwise I am going to have a serious existential crisis ). There are businesses that require tremendous upfront investments in technology, operations, distribution, fulfillment, sales, marketing, etc., before their business models can be tested and they can demonstrate the hockey stick exponential growth that we as VCs look for. These businesses are perfect candidates for VC/PE investment. Readers can take their pick out of any number of companies like eBay, Expedia, Amazon, Akamai, Google, Yahoo, etc., that would help illustrate this point.

Then there are the rest….
In between these two ends of the spectrum, are a host of businesses that do require some outside sources of capital and are well suited to angel investment and/or investments from smaller to mid-sized VC firms that have much smaller terminal value hurdles (not to be confused with return multiple hurdles). These are companies that have terminal values in the $100-$200M range that take anywhere from $10-$30M to build to cash flow break even.

A little about what drives your friendly neighborhood Venture Capitalist….
VCs represent a very specialized source of capital which is inherently high cost. Their investors which tend to be large pension funds, university and other endowments, sovereign funds, large family offices, etc., have a much higher return expectation from the asset class in line with the inherently higher risks involved. Additionally most funds are structured on 80/20 split of the profits (meaning that the VCs get to keep 20% of the profits only after they have returned the entire corpus of the fund). So most VCs are driven to make investments that would help them get to a point where they have returned their corpus and are able to share in the profits. This is where the fund size comes in. If we assume that out of a portfolio of 30 investments somewhere between 5-10 can have return multiples of 5-10 times the original capital invested, then a VC needs to be able to return his corpus from their 5-10 investments and also make profits on top of that so that he/she can get paid. For a $100M fund a return of $20M from a single investment would be considered a very good outcome as 5-6 of those would return the entire fund whereas for a firm with a fund size of $1B the same return hurlde would need to be $100M before it can be considered a good outcome.

As an entrepreneur one needs to make sure that they understand the return expectations and hurdles of their potential investors and should carefully match that with the potential of the opportunity before partnering in order to avoid disagreements and acrimony later on in the lifecycle of the venture.

In summary….
A solution based on a good idea that serves a real need in the target market will always have the potential of being a good outcome for all the stakeholders as long as the expectations are well matched with the opportunity. This is one of the key assessment exercises that entrepreneurs and VCs alike should go through in order to increase the probability of a good, successful and enriching outcome.

Follow-On Financings: Act Like a Pro, Raise the Dough

by Jeff Bussgang

With the capital market turmoil raging, many argue that 2008 is going to be a tough year for start-ups to raise money, particularly follow-on capital in the form of a Series B financing (not surprisingly to any veteran viewers of Sesame Street, Series "B" follows Series "A" rounds of financing).

Series B financing processes are all about credibility.  Does this management team have its act together to build a great, valuable company?  As such, behaving like a pro during the fundraising process is critical.  If the management team demonstrates they can run a great fundraising process, they can run a great company.  If they look like this is their first time through the process and they are scrambling to react to questions and requests for materials, their ability to successfully execute on the business plan will be heavily discounted.

For VCs, the Series A is a “hopes and dreams” investment thesis.  Do I believe the vision and this management team's ability to bring the vision to life from nothing?  The Series B investment thesis is all about “metrics and momentum”.  The management team needs to provide a compelling case that their company and their category has tremendous momentum, in fact accelerating momentum, and that the Series B money is going to be used to cement their leadership position in a valuable market.  It is not a speculative bet.

In a first meeting with a management team, typically lasting 60-90 minutes, a VC firm’s job is to decide whether to have a second meeting.  If so, the VC firm will typically articulate to the management team the key issues or concerns there have with respect to the business that they'd like to understand better and see addressed.

If a VC firm is interested in continuing the process after the first meeting, they’ll typically invite the team back for a second meeting with a broader group of the partnership and try to understand the business at a deeper level in the context of the key issues.  If there is interest in doing “real work”, the due diligence process begins and it is "game on".  Note to entrepreneurs:  if a VC keeps meeting with you and isn't doing "real work", it's a yellow flag that you are on the back-burner of their "top new projects" list, of which there are typically no more than one or two.  Typical materials that are asked for to assist in due diligence in a Series B process include:

• Capitalization table
• Management team bios
• 3-5 year Financial plan and model – the CFO should be prepared to walk through; which should include a 10-15 page PowerPoint presentation on the business model, key metrics and assumptions and how those metrics and assumptions impact the financial model
• Historical financials, audited and unaudited
• Note that the financial model should be packaged in an Excel file in such a way that can be send to VC firm associate/principal to tear through and tweak assumptions and run sensitivity analyses
• Sales pipeline – VP Sales should be prepared to walk through
• Management team references
• Customer references
• Partner references
• Technology review – VP Eng should be prepared to walk through, ideally with PowerPoint presentation as guide and architecture document as back-up
• Major contracts
• Product roadmap – VP Marketing should be prepared to walk through; ideally with PowerPoint presentation as guide
• Exit valuation comparables and scenarios – CFO should have matrix of public company and private exit comparables that show typical revenue and EBITDA multiples

A thorough but efficient diligence process typically takes 4-8 weeks from first meeting if everyone is focused on it.  A few pieces of good news should be sprinkled in during the process to underscore the momentum story (e.g., “By the way, we signed X” or “By the way, we were 50% ahead of plan last month”).

At the end of the day, the fundamental VC math a firm will need to be sold on for the Series B goes as follows:

• What is the post money valuation on this round?
• How much additional capital will be required, if any, and what’s my blended post money going to be across the two rounds
• Multiply that number by 5-10x. 
• Can I convince myself and my partners that I can generate that exit valuation based on the industry comparables during a rational market period over the next 3-5 years?

If the answer is "yes", you get the term sheet.  If no, rinse and repeat with next the VC firm!

Thinking of taking venture capital? Don't!

by Seth Levine

Here’s a thought for those of you considering taking venture capital – don’t do it.  Seriously. It’s not worth it.

Ok – so I’m not 100% serious. I’m trying to make a living investing in companies and would therefore be out of business if everyone followed this advice, however I think that for the majority (50%? . . . 80%?) of entrepreneurs taking venture capital money is a mistake. As I explain why this is the case, please read from the perspective of someone who is actually trying to encourage people to go into the process with their eyes open more so than I’m truly trying to scare people off from raising venture money. The worst thing you can do when you take venture capital is to go into the relationship with a misunderstanding of what each party expects – an example of that in a minute.

While I obviously believe that venture capitalists add real value to the businesses they invest in (perhaps the subject of another post), there are two things that come along almost by definition with venture capital that not every entrepreneur probably really wants:

1) VCs have opinions and they are not want to share them. This should be obvious, but rare is the early stage VC that gives a company money, asks for quarterly updates and then pretty much lets them alone. For starters, we have a fiduciary obligation to our investors (known as limited partners or LPs in VC parlance) to be good stewards of their money and part of this obligation is to keep regular tabs on the companies in which we’ve invested.  Mostly though, VCs believe that they have something to add to the mix.  We see lots of different business situations, experience similar challenges across businesses and believe we can offer the benefit of both our own operating experience (since most VCs have some type of operating background) as well as the experiences of the rest of our portfolio. 

2) The goal of a venture investment is to make money – i.e., sell the business or go public. This as well should be a pretty obvious thing, but I’m not entirely sure that it’s always understood.  In the VC business we take a box of money from our LPs and attempt to give them back that box with more money in it.  This requires us to ultimately get out of every investment – either through a sale of the business or an IPO (there are rare cases where companies redeem investors’ shares at a specified premium, but this almost never happens).  Since most venture funds have a 10 year life this means that there will be pressure on you and your business to grow quickly and sell (or go public) within this period (which shrinks if your investment is made in subsequent years of the fund).

Rather than belabor the point (or come up with the 10 item list rather than a 2 item one) I’ll tell a quick story of a very good friend of mine who should not have taken venture capital.  He did, of course, and after the bubble burst and with his business in a poor investment sector (telecom IT) his investors (both very large and well respected VC firms) were ready to call it quits.  He retrenched and came up with a new plan that leveraged the existing infrastructure and tried to convince his investors to stick it out. Ultimately they decided to pull their money (about ½ of their investment was remaining). 

My friend went around for a bit trying to drum up capital for his business.  I remember talking with him during this time and trying to convince him not to take any more venture capital.  He had a great team assembled, had equipment from the business that he was allowed to keep when his original venture firms pulled out, and had a vision for how he wanted to run his business that frankly was not necessarily compatible with taking venture money (really because of #2 above rather than #1). He wanted to run a business for a while, grow, but at a measured pace and experiment with some ideas he had on how to build a solid culture and a lasting business. Ultimately he came to the same conclusion and together with some of the other management team came up with enough money to finance the business. 

Fast forward 3 or 4 years now and he has built a solid business.  He’s cash flow positive, growing at a reasonable pace and he has created the type of company that he always wanted to work in.  He’s clearly benefited from having to figure this out on his own and while he has a board, he answers to himself (and a few friends) as investors.  He was telling me a few weeks ago that he really wants to keep running this business for a while – he wouldn’t sell it now even if he could. 

So think before you take the venture capital leap – and do so with your eyes wide open.

Do Venture Capitalists Demand Audited Financials?

by Chris Wand

We have a requirement that all of the companies that we’ve invested in get full year-end audits from an audit firm we’re comfortable with.  It doesn’t necessarily have to be one of the big national firms (such as PwC, Ernst & Young or KPMG); in many cases we’re comfortable with a reputable regional firm with strong capabilities and resources.  However, a small shop with a handful of people or a solo practitioner isn’t like to make the cut from our perspective.

Most entrepreneurs who have grown their business beyond a basic startup stage (i.e. they’re generating more than nominal revenues and have more complex or significant operating expenses) will find it helpful to have audited financials when talking with venture capitalists, since that just takes the entire issue off the table.  However, not all venture capitalists will require audited financials before investing in a company (even though virtually all venture capitalists will require their companies to be audited after the investment).

Ultimately it’s a judgment call as to whether we (or any other venture firm) would require audited financials before making an investment.  If it’s a small, early stage company with a handful of employees, a relatively low expense base and nominal revenues, we’re probably not really valuing the business (and hence our investment in the business) based heavily on the company’s historical financial metrics, so audited financials aren’t that important to us.

On the other hand, if a meaningful part of the valuation dynamic of the business is the company’s historical financial metrics (i.e. the company is arguing for a certain valuation based on market multiples and the company’s revenues), then we need to make sure that the financials are properly presented in order to get comfortable making the investment.  The same could probably be said if a company had weird expenses (i.e. issues of capitalizing vs. expensing certain expenses, etc.) but that’s less of a specific concern for us given the types of businesses we invest in and the fact that we view cash outflows as more indicative/important than expenses (using the accounting meaning of that term) for early-stage companies.

As for being prepared for an acquisition, you definitely want to have audited financials before you embark on an M&A process.  We find that very few acquirers (and certainly not large public acquirers) are eager to acquire a company without seeing audited financials before signing the deal.  While I’m sure there are exceptions, it’s generally too significant of a diligence item for an acquirer to overlook.  So it becomes a question of whether you want to get your financials audited now or whether you want to be under the gun getting an audit when you’re in the midst of an M&A process.

If you think an M&A process is likely at some point in the near-to mid-term, then you should get audited financials rather than reviewed financials, since again that keeps it from becoming a distraction (at best) or a barrier (at worst) to a deal.

How do I find a lead investor?

by Venture Hacks

Summary: Financings happen when you find a lead investor, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it. Alternatively, if you have a group of seed investors who aren’t asking you to find a lead, you can mass syndicate the round without a lead. Finally, ‘find a lead’ often means ‘no’.

So Bill the Cat writes in:

“We’re out on the warpath, with the aim of raising a Series A round in the $1M range. We’ve had a number of people say they are interested in participating, but nobody wants to lead because they know little/nothing about our market. Is there anything we can do about that, other than just keep searching for a lead? I’m pretty confident that at this point if we found one, we’d be set.”

What’s a lead investor?

From Fred Wilson’s The “Lead Investor”:

“I got an email from a friend yesterday who… said that he’s got indications of interest from a number of investors but they are all waiting for a “lead investor”.

“I told him that what he has is a bunch of followers who have no real conviction about his business because if they did, they’d step up, negotiate a deal, and get their money into his company. But instead they are going to sit on the sidelines, wait until someone with conviction shows up, and then try to get in alongside the investor with conviction.

“Those kind of “sit on the sideline” investors are worthless to you if you want to get a financing done. They don’t impress the kind of investors who have conviction because investors with conviction are going to want all of the deal for themselves (or their friends they will bring in alongside of them).

“If you are raising a financing of any kind, spend all of your time looking for a lead investor.”

Lead investors want at least half the round—and they often want the entire thing. If they don’t want the entire round, they will help you find followers (and some leads will even close before you find followers). They believe your stock is worth more than they’re paying. They don’t need social proof or scarcity to make an investment decision. Like great entrepreneurs, they are mavericks.

Financings happen when you find a lead, negotiate a term sheet, and if there’s room, politely tell followers that they can take it or leave it.

Lead investors who bet on unproven markets, products, or teams (or all of the above) are rare. If you’re unproven, don’t be surprised if fund-raising takes time.

“Find a lead” might mean “no”.

“Investors saying that they are waiting for a lead are also saying ‘no’ without saying no… They don’t want to miss out if this thing takes off (e.g., “Hey, we told you we were in, I hope you saved 10 percent for us!”), but they have no conviction and don’t want to say no in case they’re wrong.”

— Dick Costolo, Founder of FeedBurner

Instead of saying “no”, an investor might ask you to “find a lead”. Why? He wants to maintain an option to invest. If you find a great lead or the company starts kicking ass, the follower will say he intended to invest all along.

By telling you to find a lead, the follower is trying to extract a subtle commitment from you and manipulate your psychological desire to follow through on your commitments. Negotiators call this a consistency trap. We’ll show you how to avoid this trap in Part 2.

Professional investors (VCs) have two legitimate reasons to not lead:

1. Your business is too far away and they want you to find a local lead, e.g. you’re in Shanghai and your investors are in Boston.
2. The investor’s typical investment is less than half of your round.

In either case, the follower should partner with you to find a lead. His level of effort will tell you if he really wants to find a lead or he just doesn’t want to say ‘no’.

You can mass syndicate seed rounds without a lead.

Small seed funds that are investing their personal money and non-professional investors like angels may have other good reasons to not lead: they don’t want to deal with negotiating terms and hiring a lawyer, their portion of the financing is too small to lead, they like you but they don’t know the market, et cetera.

If this is the case, you might not need a lead. If you have a group of seed investors who are not explicitly asking you to find a lead, you should:

1. Generate a term sheet. Your advisers and lawyers can help with the terms.
2. Get feedback on the terms from prospective investors at the end of the first meeting. They will ask about the terms if they’re at all interested.
3. Incorporate the feedback into the term sheet.
4. Once enough prospective investors have said ‘yes’, circulate the term sheet with a list of investors who have committed to the financing.
5. Incorporate any additional feedback and send the closing documents to everyone. Set the closing date two weeks out.

How do you find a lead?

If you’re doing a seed round, you may be able to mass syndicate the financing without a lead. Otherwise, here are three microhacks for finding a lead, in rough order of importance—but you should probably try them all.

1. Ask the followers for introductions.

If the followers have good reasons to not lead, ask them for introductions to potential leads:

“Can you suggest any firms who would be interested in leading this investment? Why do you think they would be interested in leading? Would you make an introduction?”

This simple test will tell you whether the follower has good reasons to not lead. If a follower won’t make introductions, he doesn’t have a good reason to not lead. If the introduction doesn’t respond aggressively, the follower probably made a half-hearted introduction—he doesn’t have a good reason to not lead. The follower’s level of effort indicates if he really wants to find a lead or he just doesn’t want to say ‘no’. (Caveat: This logic mostly applies to VCs, not angels.)

If a follower doesn’t have a good reason a priori, don’t ask him for introductions at all. Skip this microhack altogether. An introduction by someone who can and should lead, but would rather follow, is a useless and harmful introduction. It’s a strong negative signal. Go get your own introductions.

Finally, if a follower introduces you to the eventual leader, the leader will rarely cut out the follower. (Investors who don’t accommodate the middleman who gives them introductions stop getting introductions.) You’ll end up with two investors and more dilution. But that’s better than the alternative: zero investors and no dilution.

2. Find seed stage investors.

Every professional investor’s fantasy investment is a sure thing: zero risk and infinite reward. If you’re early stage, you can circumvent this fun fact by doing a seed round:

1. Focus on investors who go out of their way to invest in seed stage companies with lots of risk, not investors who say they invest in seed stage companies:

   “What seed stage companies have you backed in the last 2 years? What exactly did the company (team, product, traction) look like when you invested?”

   Does your company look similar?

2. Find non-professional angels whose primary motivation is working with great entrepreneurs, not profit. In particular, talk to folks who already know you well and are willing to to bet on you.

Seed investors increase the probability of raising money from VCs. High-quality seed investors raise your valuation, provide social proof, and obviate the need for extensive due diligence in the VC round. Many companies close a small seed round and do a larger VC round in a few months.

If you want to skip the seed round, mere commitments from high-quality seed investors have a similar effect. And these commitments provide a strong alternative as you negotiate with VCs. Obviously, if you do the VC round, don’t cut out any seed investors you have committed to.

3. Find investors who know your market.

If every prospective investor says “we don’t know your market,” find investors who have backed companies in your market or similar markets.

Educate investors about your market. It’s your job to convince them the market is great. Find successful companies in your market and figure out how they got there, how long it took them to get there, how much money they raised, how much money they’re making, how much money they would be making if they were as smart as you are, et cetera.

Talk to the management at these companies and see if they will personally invest in your business or advise you. Ask if their company wants to be a strategic investor.

4. Incent a follower to lead.

Whenever someone says “find a lead”, you should say,

“We’re happy you’re interested. We’re interested in working with you too.

“We’re looking for a lead and a lead is going to want the entire round. Or he will bring in his own co-investors. Or we’ll build a syndicate out of investors who want to lead. So we may be back but we probably won’t.

“Most likely, the investors who get to participate in this round are those who want to lead. If you’re interested, you can secure a spot in the round by leading and we’ll work with you to set the terms and decide who gets to invest.”

Note: Make an exception for (1) angels you are trying to mass syndicate and (2) investors who have good reasons to follow and are partnering with you to find a lead.

This polite diatribe combines positive leverage (“you can secure a spot in the round by leading and we’ll work with you to set the terms and decide who gets to invest”) and negative leverage (“the only people who get to participate in this round are those who want to lead”, i.e. you may lose the option to invest if you don’t act now.) Their reaction to this message will tell you whether they have good reasons to follow or they just don’t want to say no.

If you have existing seed investors, you can also use them as the bad cop:

“We really like you but my existing investors are pushing me to find a lead and not spend time building a syndicate. Are you willing to lead the round?”

5. Get past no.

“If you’ve got a good idea, market, and team, raising money won’t be your problem.”

— Sam Altman, Founder of Loopt

“Nobody said this would be easy.”

— Marc Andreessen

Your company may not be good enough to raise money. So how do you get good enough? Read Marc Andreessen’s When the VCs say “no”:

“If you’re an investor, you look at the risk around an investment as if it’s an onion. Just like you peel an onion and remove each layer in turn, risk in a startup investment comes in layers that get peeled away—reduced—one by one.

Your challenge as an entrepreneur trying to raise venture capital is to keep peeling layers of risk off of your particular onion until the VCs say “yes”—until the risk in your startup is reduced to the point where investing in your startup doesn’t look terrifying and merely looks risky.”

Marc’s goes on to describe the various layers of risk and, even better, he tells you how to peel the layers away. This is the most useful article on improving the effectiveness of startups that we have ever seen—read it.

Founder risk is the number one reason startups don’t get funded: the team simply does not appear up to the task. If you have a good product in a good market and you can’t figure out why you keep getting rejected, look in the mirror and remove/add people until the team inspires money to fly out of investor’s pockets.

This is the fifth microhack but it should really be the first, second, third, fourth, and fifth. The best way to find a lead is to build something that attracts a lead.

“No one ever got anywhere by lavishing calls on Oprah. The only time I’ve succeeded in my career with Oprah was [when] Oprah called us.”

— Barry Krause, in Made to Stick