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).

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.

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.