Don't Lose VC Money - Get to Cruising Altitude

People often ask me:

"Paul, when does an early stage VC start to feel comfortable with an investment?"

Early stage VCs regularly evaluate the companies in their portfolio. They do this to decide if they should continue pouring time and money into a particular company, or if they should shut it down and swallow a loss.

This type of evaluation often starts with a rough measurement of the risk involved with the company. For a VC, a huge amount of risk is eliminated when you've achieved what I call "cruising altitude". Cruising altitude is the point at which a VC is confident that at least he won't lose all of his money. In other words, at that stage, the VC believes that your company could be sold to someone (often just for the technology).

When you've hit that point, the scariest part (takeoff) is behind you. So don't put the VCs money at serious risk and you're halfway there. But the flight definitely isn't over, and your focus needs to shift to executing a safe landing (read: exit).

Cash Is More Important Than Your Mother - Mo' Money, Mo' Problems?

People often ask me:

"Paul, how much money should I take from VCs?"

This is a difficult question, but a good problem to have. If you're at the stage where VCs are offering to fund your company, that's a very good sign. At that point, you have to figure out how much money you actually want to raise. To understand this problem better, I will paint the scenario from each side of the table. First, from the VC side:

• More. A VC might want you to take more money because they are looking to take a larger position in your company. For example, you may have asked for $2M, but that small of an investment may not be worthwhile for a lot of VCs. VCs also want to make sure they aren't underfunding businesses. Every VC wants to give their portfolio companies the opportunity to succeed. VCs are quite savvy about how much money it takes to build a great company (we see it a lot). Entrepreneurs often underestimate how much money it will take and how long the process is.
  
• Less. A VC might want you to take less money because they want to minimize their exposure. Their is always a high risk that a startup goes south and all the money is lost. You may have asked for $10M, but the VC might only want to put $2M at risk in your particular industry/space/company.
  

Now let's look at it from the entrepreneur side of the table:

• More. You might want to take more money for a few reasons. First, it's a big weight that is lifted off of your shoulders. Fundraising is an arduous process, that takes an inordinate amount of the CEO's time. The less often that you have to fundraise, the better. Second, more money provides more speed. Speed and the ability to throw resources at a problem immediately are very significant competitive advantages. Finally, taking more money provides stability to the business. You are more likely to hire a superstar if he is confident that your startup will be around for a few years, instead of being unsure if it will last the week.
  
• Less. You might want to take less money from VCs to keep a larger share of your company. The idea here is that you take less money in the present, and then raise more later when you can demand a higher valuation.

The VC Whisperer's opinion on this? Take as much money as you can get when it is offered to you. The golden rule should be all the reason you need: companies always need twice as much time, and three times as much cash (relative to their initial expectation).

Follow the golden rule, and take every penny that's on the table. When there is lots of money in the bank, you increase your chances of success, and you eliminate a whole set of potential problems. Cash is like oxygen for a startup. Without it, you're dead. Thus, there is no point protecting ownership in something that you don't have enough money to build.

If you remember just one thing when you're running a startup, remember this: CIMITYM - Cash Is More Important Than Your Mother.

Your Payday Is Closer Than You Think - The 3 S's of Exits

People often ask me:

"Paul, how do companies and VCs manufacture exits?"

The life of a venture backed startup is centered around 3 major events:

1. The Founding
   
2. The Funding
   
3. The Exit
   

The key for entrepreneurs and VCs is to get from funding to exit. The exit can be an acquisition or an IPO, and at that point, everyone involved generally makes a lot of money. However, significant value needs to be created to manufacture an exit, and that value can be generated in one of 3 ways. I have listed these ways to generate value, in order from least effective to most effective, and I call them the 3 S's of exits:

• Strategic. Strategic value is created when you've designed your product or company to be invaluable to a single acquirer or small group of potential acquirers. Building strategic value to get to an exit is a great way to focus your company, but at the end, you are left with a relatively small number of outs. 
  
• Sales. This is self-explanatory. If a company can generate sales, then that might lead to an IPO where people are willing to pay for future growth. It might also lead to an acquisition by a company looking to capture those customers and capture that additional revenue.
  
• Self-Selection. This is the holy grail of value creation. At this level, your company has created something so special, or has marketed it in such a way, that no selling is required to bring in new customers. Customers come to you out of their own volition.

The most effective way to get to a big exit is to reach the point of customer self-selection. When customers are walking through the door, without having to spend a dime to get them in, then you know you're close to that big payday. Focus on transforming your business - from one where you have to sell to create new customers, to a business where the new customers are creating themselves. Remember the 3 S's and don't be shy to push your financial partner (your VC) for help in manufacturing the exit you're looking for.

Is Your Company Right For Venture Money? 4 Questions VCs Ask Themselves

People often ask me:

"Paul, what type of projects are suited to venture capital funding? For example, is venture capital a viable source of funding for film and other entertainment projects?"

To answer this, let's put business issues aside for the moment. When I say business issues, I mean things like management, business model, customers, etc... Attracting venture capital depends partly on the business issues, but also on how well your business fits with the type of investment a VC wants to make.

When considering a project, VCs always ask themselves 4 questions (among others, but these are always considered):

Question #1 - How much money will this business need and over what period of time?

• VCs are limited by the size, structure and focus of their funds. Those factors determine a VCs sweet spot. For example, many VCs can't make investments representing more than 10% of the total size of their fund. Also, many VCs identify themselves as "stage" investors: seed stage investors, early stage investors, or late stage investors. Others, on the other hand, like to participate in various rounds of funding throughout the life of the company. Each has a sweet spot. 
  

Question #2 - What is the expected risk?

• This is difficult to quantify without getting into discussions about business issues. However, it is important to know that different VCs have different appetite for risk, which is (once again) often dependent on the nature/size/structure of their fund. There is no absolute right answer to this question. Stay tuned for more about risk in a future post. 
  

Question #3 - What is the expected return?

• For most VCs, the expected return is a homerun, sometimes referred to as a "10-bagger". In other words, a VC has to believe that there is a chance this investment will return 10x his money. If a VC knows ahead of time that an investment could "only" return 3x his money, then that's usually not an attractive investment.
  

Question #4 - Can I add value?

• For most VCs, the answer to this question has to be yes. If a VC doesn't believe he can add value through his own network or domain expertise, then he is relegated to being just a passive investor. VCs get paid to actively manage money, not be passive investors.
  

Now let's look at film and entertainment projects using the same 4 questions as an initial screen:

1. Money/Time Required: Major motion pictures require tens of millions of dollars, invested over a very short period of time. Thus, that type of project is outside the mandate/capabilities of most venture capital funds. Independent films require less cash, and therefore are more amenable to venture capital investment. --> A film project might pass.
   
2. Risk: Film projects are very high risk. Having said that, the level of risk is similar to the risk assumed in an early stage technology investment. --> A film project might pass.
   
3. Return: Successful movies can be tremendously profitable, and those big wins occur with roughly the same frequency as traditional venture capital investments. However, for most VCs, the biggest exits are generated by IPOs. A movie isn't a business, and therefore the potential for an IPO is ruled out from day 1. That's not an attractive prospect for a VC. Additionally, a VC would likely have to take a huge ownership stake in a movie to make it worthwhile - an arrangement that might be difficult to swallow for most filmmakers. --> A film project would likely not pass here. 
   
4. Ability to Add Value: Very few VCs could add value to a film project. Filmmakers aren't building businesses. A VC's network and experience could very rarely affect the outcome of a movie. This is where a film project wouldn't make the cut. VCs don't want to be passive investors. --> A film project would not pass here. 

The 4 question screen explains why few VCs (if any) invest in film projects.

It is important to be aware of the fact that VCs always ask themselves these 4 questions. You don't have to answer them explicitly in a pitch deck, but you should know ahead of time if you're a good fit for venture money. Not every idea or business can attract venture capital. Fit matters.

Think of these 4 questions as the first screen that a VC will use. But don't be discouraged. All venture money is not created equal, and different VCs will have different criteria. Just make sure you understand the baseline, and the expectations. Venture money can be your ticket to explosive growth and the creation of a great business.

Pucker Up And Kiss Some Ass - Flattery Will Get You Everywhere

People often ask me:

"Paul, do I need to do a lot of VC ass kissing to get their attention?"

Yes. You will need to kiss a lot of VC ass to get your company funded, and to get the attention that you deserve.

If you thought you were becoming an entrepreneur so that you would never have to kiss ass again, then you were doing it for the wrong reason. Everyone has a boss, no matter what you're doing, and no matter how successful you've been. If you're an entrepreneur or CEO, your bosses are often your VCs, your board of directors or maybe even your shareholders.

When you're kissing ass, here are a few tips:

• Be Sincere. If you're lying through your teeth, and can't find anything nice to say about a VC (or any other person for that matter) and also mean it, then don't say it at all. 
  
• Don't Overdo It. It's important to do this in moderation. Too much flattery can come off as insincere. 
  
• Swallow Your Pride. If you're sucking up, but doing it grudgingly and hating every minute of it, then that will shine through. Fix your attitude first before you try doing any ass kissing.
  
• Make It Personal. Take note of the small things that a VC or customer might be doing right, and run with that. Show them that you noticed and that you appreciate it. Try to avoid very general and impersonal flattery. 
  

There is absolutely no reason to see any of this as a negative. Use flattery and ego to your advantage. VCs, like virtually everyone else on this planet, are frail, emotional human beings with egos that need stroking every once in a while. If you manage to kiss ass effectively, they will be far more tuned in to what you're saying. Keep in mind that VCs like to invest in companies where they think they can add value. Show them how great of a partner they would be, and why - don't be afraid to point why you would love to work with them.

But take solace in the fact that you're not alone. VCs have to suck up as well, to their limited partners (LPs) - the people whose money they are managing. In that case, VCs have to kiss ass over the length of a 10+ year relationship. Now that's ominous, so be thankful that, as an entrepreneur, you only have to worry about a single transaction. 

The reality is that flattery and ass kissing work not only for getting VC funding, but apply to your relationships with customers as well. Everything is a sale in life, whether you're selling your product, selling your company, or selling yourself. Everything is a sale. Flattery is a very effective tool in your sales arsenal, to be used carefully and methodically. So pucker up, kiss some ass, and the rewards will follow.

Always Be Looking Over Your Shoulder Or Your Startup Will Get Mugged

People often ask me:

"Paul, why don't VCs seem to understand that I have no competition?"

VCs hear this from entrepreneurs on a very regular basis. Claiming that your company has absolutely no competition is another sure way of shooting yourself in the foot when you talk to VCs. They don't understand it because they know it to be untrue, no matter how convinced you may be. Even if you don't have any competition right now, you most definitely will in the near future. 

Thus, making this claim hurts your credibility. VCs know that you have competition. Furthermore, VCs know that the probability of competition emerging is very high. Claiming that none exists signals to the VC that you just haven't done your homework thoroughly enough. If you haven't taken the time to fully understand the space you want to do business in, then why should a VC trust you with his money? A VC would much rather fund someone who has identified where the competition will come from, and what the plan is to beat them.

If, at first glance, it seems like your idea or business has absolutely no threat of competition, dig deeper. Here are some good places to look for potential competition:

• Behind You: The incumbent is your most obvious competitor, and virtually all entrepreneurs fail to identify it. In fact, many don't even think about it. But changing the way people do things is very difficult. Incumbents are also dangerous because they could potentially evolve their product to match yours, with the added benefit of more established customer relationships. 
  
• Above or Below You: These are vertical competitors. They are operating in the same industry, and likely have the same customers. However, their product or service addresses a different part of the value chain. It might make sense for them to branch out into a complementary product, one that competes directly with your own offering. For example, say you've developed a great new operating system for cell phones. Samsung builds cell phones (the hardware). Tomorrow, they might decide that they want to create an operating system for the phones they build. This would then directly compete with your own new product. 
• Next to You: These are horizontal competitors. They are operating in a different industry, but likely have a very similar product (in terms of functionality and purpose). It might make sense for them to modify their product to serve the customers in your target industry. For example, say you produce high power transistors for the telecom industry. A company building high power transistors for electric cars might decide that it would require minor modifications to start selling and marketing their product to the telecom industry, thus becoming a direct competitor.

It is important to assume that not only will you have competition from day 1, but that it will be fierce. It's not enough just to be there first anymore. You have to show a VC that you've anticipated and thought about who your potential competitors are. Of course, it is impossible to predict every competitive move, but thinking about it makes you far better prepared to deal with competitive threats when they do emerge.

If you were walking home at night in an area full of muggers, alone, with your pockets full of money, and a bright future ahead of you, wouldn't you be looking over your shoulder?

Romance Isn't Dead - The Passion of The Entrepreneur

People often ask me:

"Paul, what is the first thing a VC like you looks for in an entrepreneur?"

So much can go wrong in a startup - problems with technology, customer, market, execution etc... And in adherence with Murphy's Law, if something can go wrong, it will go wrong. Successful entrepreneurs are able to navigate those issues, often with different backgrounds and skillsets. The common thread is always the passion that they bring to the table, to get through the hard times, and supercharge a company's growth when times are good.

Thus, when a first-time entrepreneur walks through the door, VCs are looking for a little romance. They are looking for someone who loves what they do, who is passionate about their business. VCs are actively judging you on this. Be respectful and polite, but if a VC doesn't feel like you even care, then why should he? The passion for your business should ooze out of every pore, and affect not only what you say, but how you say it. If you are passionate about your business, there is a much greater chance the VC will become passionate about it as well. 

To hammer the point home, let's look at this from an economic perspective. The reality is that VCs can't be satisfied with returning 5 or 6 percent to their limited partners. Venture capital funds must produce returns (IRR) of 30% or more over their lifetime. The consequence of that is that the average exit needs to be very big. A 10M-20M exit on a 4M investment just doesn't cut it unless the VC is holding 95% of the company. The reality is that VCs make their living on the homeruns. Therefore, we look for entrepreneurs who have the passion, drive and vision required to swing for the fences.

Be realistic in your assumptions and projections, but don't be afraid to think big. Passion will get you everywhere, and most importantly, it is contagious. Passionate CEOs create a culture that not only attracts the best people, but imbues them with a passion of their own. Prove to the VCs you meet that romance isn't dead.

No One Understands What You're Saying - Keep It Simple Stupid

People often ask me:

"Paul, why don't VCs or customers understand my pitch?"

I will let you in on a little secret. VCs see lots of entrepreneurs, with lots of complex ideas. The way to stand out from the crowd, is to keep things simple - simple to communicate, and simple to understand. In other words, get...to...the...point.

I can't emphasize the "keep it simple stupid" (KISS) mantra enough. Too many entrepreneurs walk through the door with good ideas, but if you can't clearly communicate the value of your product, then VCs won't bite, and customers definitely won't bite. In the same vein, it should be crystal clear to anyone listening exactly what pain you're solving and how you're solving it. It's not good enough to just list features. VCs see hundreds or thousands of deals each year, and simply don't have the time to translate cryptic, convoluted and long-winded messages.

Most books talk about refining your elevator pitch. While I think that's a critically important tool in communicating the value of your product, I strongly believe that it has to be even simpler than that. I should be able to see how you're going to solve someone's pain in 3 sentences or less:

1. The pain is _____.
   
2. My product/service does _____, thus solving the pain.
3. You should care/buy because ______. 

I challenge my readers to drastically simplify all of the messages they create around their new business. And if you're not the type who can connect with people based on a simple message, told succinctly, then hire someone who can. They are worth their weight in gold.

Get to the point. Show VCs the pain. Show them how you solve it. Show them why they should care. Keep it simple, so they can understand. If you can get it down to 3 sentences, VC money and customer money will follow.