матрациWhen I was all of 19 I purchased my first home. I got it for a pretty decent price, but it was definitely what one would call a handyman’s special. I spent the next few years cleaning, repairing what I could, cleaning some more, hiring contractors to repair what I couldn’t, landscaping and cleaning some more. One day I was scrubbing the heck out of the beautiful giant mantel (which I believed was charcoal colored when I bought the house, but was learning that it was actually painted a light blue…) when I heard a loud crash from the garage. I had left the garage door open so I couldn’t imagine what had just happened. I went out to the garage and lo and behold there was my garage door, off of its left side tracks, precariously dangling over my car. If someone had driven up that day and offered me $1.25 for that house, I swear I would have sold it to them.
But I didn’t try to sell it until the house was in the shape it ought to have been in for such a nice neighborhood. At that point I was a pretty mature 22 year old (for as mature as we can be at 22 anyway) and was smart enough to know what I didn’t know. So, I hired a real estate agent and let him dictate the asking price. The first day – the very first day – the house went on the market, the rabbi for the synagogue that was just a few acres away from my property offered me the asking price for the house. Seriously? How lucky could I get?
Except my trusted real estate agent saw dollar signs, got greedy and actually advised me not to take the offer. He took the house off the market, increased the price of the home, and put it back on the market. And there the house stood, with its lovely For Sale sign out front, for another 10 months. When it finally did sell (after I fired him and hired a new agent) it sold for much less than the original asking price.
So here’s the moral of the story for all of you wondering where the hell I’m going with this: This was a very entrepreneurial moment for me. I had a pretty good opportunity in buying this fixer-upper (like conceiving an idea or concept for a new business) and poured my own money (no friends or family money in my case, but it cleaned out my personal savings) and tons of sweat and time and effort into making it into something saleable (like getting a company to the level to pitch to a VC). I slept little and worried a ton. I had contractors and inspectors out to evaluate what I had and how to improve it (think consultants) and even with their expertise, had an unexpected and incredibly costly set back with the garage door falling (just like product taking too long to build or having a key man quit at an inopportune time). Finally, I put my hard work out there for others to judge and make bids on or not (much like in the VC circuit) and I made a huge rookie error. I believed what I had was so smoking hot that I could turn down a perfectly sound offer. I was lead to believe it to be true by an outside ‘expert’ I’ll admit, but I didn’t do research nor ask others who’d been there, done that and so I suffered the consequences.
Yet the biggest lesson I learned at my young age was that sometimes we just get lucky. It doesn’t mean we’re really that good, or what we’ve got is so great, but just that we’re in the right place at the right time. My advice to entrepreneurs? 1) make sure you get a mentor that has already been through the trenches and back and check with him/her often and 2) be confident and trust that your hard work has created something valuable, but never turn your back on a reasonable offer. Lucky doesn’t often happen twice.
I see a lot of cold email pitches. A whole lot of them. And I have to assume each and every one of them is legitimate. Even if they sound like a Nigerian cash scam, it is my job to believe these are real entrepreneurs reaching out in the hopes that someone will believe in their company as much as they do.
I read that VCs invest in only one out of every 300 companies they review. The odds go down to 50,000 to 1 when it comes to receiving funding from a cold email pitch.1 Well, after reading my share of them I can tell you part of the problem.
You’re doing it wrong.2
While the following may seem obvious and, perhaps, rudimentary to many of you I assure you I would not be sharing the list if I haven’t seen each instance at least twice. So, with no further ado:
DON’T sound like spam, or worse, just ridiculous. This could include such statements as “will end famine and poverty” or “Hurry! We’re currently in talks with 3-4 top VC firms and should receive term sheets any day.”
DON’T USE ALL CAPS!!!!!
(Didn’t you just get the sense I was yelling at you?) Honestly, beyond invoking teenage memories of coming home past curfew, it looks unprofessional when you tout “it’s going to be BIGGER THAN GOOGLE.”
Speaking of….
DON’T compare yourself to a giant. Even if you are going to be the next Google, or Microsoft, or eBay, you sound ridiculous saying so. It’s an instant credibility loss.
DO read the criteria on the investor’s web page. If they’ve taken the time to particularly list something, that’s probably a requirement. If you feel compelled to reach out regardless, be sure to acknowledge your awareness of the ill fit and suggest remedies to that. For instance, if the investor only takes on deals in Simi Valley but your company is from North Carolina,you need to make the point that you are planning to relocate in Simi Valley. (Note: it’s much less credible if you suggest that you will meet the requirement later should they fund you.)
DO read the criteria on the investor’s web page. If they’ve taken the time to particularly list something, that’s probably a requirement. (No, this isn’t déjà vu) So take the time to affirm the fit. Go blow-by-blow over each of the ways that your company is exactly what their deal criteria requires.
DO tell the investor how you ‘know’ them. For instance, did you read an article about them or see them speak; did you find them using a database, TheFunded.com, etc? Even if you just searched the web, ‘fessing up looks much less like spam and lends you a bit of credibility.
DON’T tell the investor when it’s good for you to meet them. “We would like to schedule a formal meeting at the end of March.” Would you now? Well, as long as it works for you. It’s both presumptuous and disrespectful.
DON’T be too brief. I received a short “Please accept my business plan for review and funding.” with her name, phone number and attachment. Now, that may be succinct, but it’s also boring and unenthusiastic. If you aren’t compelled enough to take any time, here again, why are you assuming I am? The best intro I’ve ever read had bullets as follows:
where he found us (TheFunded.com)
an introduction to him (the CEO/Founder) and to his company and what they do
the current stage of the company with specifics (“…just out of stealth mode to explore funding options as we head into our launch in July”)
the amount of intended raise and its intended use
a few key notes on their business
and he attached an overview deck (which is much more interesting than a business plan) and gave complete contact information.
DO proofread. Twice. Maybe even three times. Mispellings, typo’s and gramatical errers’ make you look real amature and maybe notso smart. Get it?
1Why Venture Capitalists Don’t Like To Be Rushed Into Deals, WSJ Blog, May 3, 2010, by Scott Austin
2Mr. Mom, 1983, by John Hughes
This is a very interesting article about the pending transformation of venture capital. I very much agree with the primary messages. Too large of funds and lousy returns combined with lack of liquidity will continue to drive LP’s to put their dollars elsewhere which will accelerate the massive contraction of VC funds/dollars. The good news is that more companies than ever can follow the lean start-up route where greatly reduced capital is required which may fall into the realm of the ever-evoling angel world (unless congress screws that up as part of its financial services reform efforts).
I have to imagine most of the readers of our blog are pretty up to speed on what we like to accelerate: technology-based company, SoCal-based, strong CTO type, good market dynamics, capital efficient, and maybe most important, a working product with some proof of customer demand. We have generally tried to be true to these criteria. Frankly the few times we have not, we have gotten ourselves into trouble. So one may ask why Momentum would consider co-founding a new venture, still in early R&D, with a young entrepreneur. I thought it would be helpful to write about our thought process to let people challenge our thinking. In particular given the stage of our fund (just a couple of deals left) and the current nature of the venture market, one might think that we should be doing absolutely the opposite and focus on later stage opportunities.
The truth be told, a couple of years ago we decided that we would consider a seed stage/incubation deal. What we have discovered with our typical deals is that we end up creating a lot value but have a tough time extracting enough ownership between the capital we invest (typically $300k – $700k) and the sweat equity that we earn for the time we spend (typically a partner and possibly an associate for 6 – 12 months half or even full time). Given the fact that we commit so much personal effort to a deal and put in high risk capital, I believe that we are typically entitled to own more of the upside. However, what we found out was that founders who already have spent $100k – $500k of friends and family funds and dedicated 12 – 24 months of their time building a working beta have been generally reluctant to give up as much of their company as we believe we deserve – we hit a so called “glass ceiling.”
The first and most important criteria for us to consider when co-founding a company is that one of the Momentum partners is very passionate about the business concept. While we always have required a partner to be excited in order to sponsor a deal, they are usually doing so in conjunction with a CTO/founder type who has already made the leap. In the incubation model, we need to belly up to the table essentially at the same time as the co-founder. When I say passionate, I mean a business/product that connects with a partner’s personal interest and not just on an intellectual basis – the partner must connect in a similar manner as any entrepreneur would to their start up concept (one should note that this can be tricky given the portfolio responsibility that general partners have to their funds, so it will be incumbent upon the other partners to bring a level of objectivity to the project).
The second critical component is the background and character of the co-founder. Though we are incredibly hands-on in our traditional model, the incubation model will be on a different level. The concept of founding a company with a virtual stranger is a bit daunting. We believe, through a combination of extensive reference checking and early collaboration (trial runs), that we should be able to get some key insights into the co-founder. As in traditional Momentum deals, the founder and Momentum need to have complementary skill sets and quickly develop a framework of trust.
The third component is the economics of the deal. If we are going to jump in and commit both significant time and the earliest/highest risk capital we will need to control meaningful economics. I am not talking about a Y Combinator model where they own 10 – 15% for $20k. I am talking about purchased equity of 33% – 50% for the first $250k – $500k of capital and earned equity more or less on par with the technology founder. While this may sound somewhat greedy to some, the practical reality is that we are faced both with high opportunity costs (especially in today’s market) and potentially greater downside risk from LP’s for taking a gamble on such a nascent opportunity.
Finally, there needs to be a viable transition plan for the partner. While it is exciting to be involved in such a venture, our model necessitates a serial relationship with opportunities. This is where the timing with the current lifecycle of our fund may actually work in the favor of such a project. While in the early/mid-stages of our fund the quick exit was key, the fact that we are finishing up our final investments actually provides a more flexible window of involvement. Perhaps the deals become so exciting that a transition may not be necessary.
While the possibility of incubating a deal is quite exciting, we recognize that we have several more hurdles to overcome before it becomes a reality. We also realize that the decision is only partially ours and it is incumbent upon us to do our own diligence while also helping the co-founder/entrepreneur through his/her own evaluation process . . . and hopefully achieve a mutually satisfactory outcome. I will be sharing these and other thoughts with our network in coming weeks as we refine our thought on an incubation deal. I welcome any comments you may have. Stay tuned!
I am often asked about business plans (whether to write them, what format, how to know if a business idea is legitimate, etc).
There are lots of right answers (and wrong answers) to this question. For purposes of this short note, I’d like to recommend a tool that is in use at top consulting firms and which can help you quickly organize yourself or a team around the key issues you need to understand in a business. Please step through the PowerPoint below and let me know if you have any questions!
In product development, conventional wisdom tells us that we need to constantly ask our customers, “What do you want?” We listen carefully to the answers, prioritize those that get the most requests, and we turn around and build them. Within a few months, we have a killer product. Product development could not be simpler.
However, if you’ve ever participated in a “What do you want?” product development effort for a startup, you’ve seen the actual results. Instead of killer new applications, you will likely have a me-too product, a poor-man’s version of the market leaders in your space. Your customers are not visionaries or industry thought-leaders. Instead of projecting into the future to imagine radical new solutions, they will recall what they liked about other products they have seen. Or they will think of minor tweaks to the existing product that will make the experience slightly better for themselves, but possibly worse for your other customers.
Even Google has been criticized for pursuing a data-driven approach to the “What do you want?” question. The New York Times wrote on the subject earlier this year, when top designer and ex-Googler Douglas Bowman openly criticized Google’s approach:
Mr. Bowman’s main complaint is that in Google’s engineering-driven culture, data trumps everything else. When he would come up with a design decision, no matter how minute, he was asked to back it up with data. Before he could decide whether a line on a Web page should be three, four or five pixels wide, for example, he had to put up test versions of all three pages on the Web. Different groups of users would see different versions, and their clicking behavior, or the amount of time they spent on a page, would help pick a winner.
“Data eventually becomes a crutch for every decision, paralyzing the company and preventing it from making any daring design decisions,” Mr. Bowman wrote.
That is not to say that that this type of customer feedback is not valuable, Google has leveraged it well. But, used alone, it can create a process that leads to middling innovation instead of big leaps forward, especially for a startup when big leaps forward are critical.
The real problem is that you may be asking the wrong question. You are relying on the customer to take on your job as innovator and to tell you what your product should be.
Two better questions are, “What do you do now?” and “What problems do you face when you are doing it?” These questions move customer feedback further up the innovation process to problem identification rather than product definition, which then puts the responsibility on you to be the innovator and design the product.
“What do you do now?” is a question that gets to the heart of how your customers are trying to solve the underlying problem today. By engaging a customer in this discussion, you should learn more about the fundamental problem they are trying to solve, and how they currently think about solving it. You should begin to understand how they spend their time, their willingness to spend money on the problem, the roles that friends and family play, and their level of need, all of which will help you design a product that fits into their current lifestyle.
The answers to “What problems do you face when you are doing it?” should give you insight into their pain points with current solutions, their frustrations, and areas of satisfaction. By the end of several of these conversations, you should be able to see clear opportunities where a new, differentiated solution would make their lives much easier.
One of our portfolio companies, iChange, is developing an online service to help people lose weight. We worked hard to get customers to be part of the product development process, but early on found that if we simply followed the “what we want” comments, we would have quickly ended up with a second rate version of Weight Watchers. When we finally stated asking “What do you do now?” and “What problems do you face when doing it?” we started to get a different picture of our customers and began to generate ideas on how we could truly help. We learned that if a spouse or best friend was dieting with them, losing weight became much easier. Without a supporter it was nearly impossible. We learned that a scorekeeping system of points or calorie counting was intimidating to many people and didn’t address some of the underlying personal issues that ultimately led to weight issues. We learned that fitting into an old pair of jeans was an immensely satisfying experience, even more so than seeing a five-pound drop on the scale. The responses gave the team a much clearer view on the customer, shortcomings of existing solutions, and opportunities to create an innovative and unique solution. It resulted in a very non-Weight Watchers product where customers consult with nutrition experts and online support groups for guidance and accountability. So far, the customer response has been overwhelmingly strong.
In truth, the most common error for early-stage companies is not listening to customers at all, so any feedback into the development process is helpful. “What do you want?” certainly has a place, especially further down the innovation process when you are testing and refining, rather than creating. But as an early-stage company, where great leaps forward are going to be what make you a success, make sure you are asking the right questions.
After 20 years of building entrepreneurial ventures I have had no choice but to be a devout optimist. The challenges are overwhelming, the naysayers abound but we as entrepreneurs persist. Over this period I have personally been involved in over a dozen start-up ventures with two-thirds of those under the umbrella of Momentum Venture Management (www.mvmpartners.com), the early stage venture fund/accelerator I started 6 years ago with Matt Ridenour.
The Undeniable Reality
However, we as entrepreneurs most acknowledge the nature of the challenges we face. Not so that we can become discouraged but so that we can be prepared and thoughtful about how to overcome them. I think right now it is undeniable that we are facing an extraordinary pull back across the venture spectrum. I strongly disagree with Wil Schroter’s recent post on SoCalTech (SoCalTech.com) that people are“eager to write checks.” The rule today is that raising venture financing is extraordinarily difficult. The exception is that a few sharp, experienced entrepreneurs like Wil can still quickly pull in modest amounts of capital from the personal wallets of a few name investors who under “normal” conditions would typically be writing much larger checks from their funds. Furthermore I anticipate only a gradual thawing which I don’t expect will begin in any material manner until the first half of 2010. The evidence of this broader reality is overwhelming and is directly contrary to Wil’s personal experience:
• Venture capitalists invested 48% less capital in Southern California during the third quarter with $458 million put into 66 deals (Dow Jones Q309)
• Dramatic move away from first time/early investments – 60% decline year over year in first time financing dollars (PWC MoneyTree)
• 13 year low in technology investing (Dow Jones09)
• Massive drop off on new deals from groups like TCA and Pasadena Angels – now primarily focused on supporting existing deals (just ask a TCA or PA member)
• Recent showing of investors (or lack there of) at VentureNet (which I believe is one of the best early stage gatherings in SoCal)
• Personal experience at Momentum where we historically could work with a portfolio company and secure the next round of financing in 3 months; now we are looking at 9 – 12 months if at all
• Massive drop off in valuations and dominance of down rounds (as they say, flat is the new up . . . if you are lucky!)
OK – I think you get the point. It is ugly . . . .really ugly!
Getting the Cash Flowing Again
So what is the basis of this massive slow down and what has to change to get investors to start writing checks again? First, I believe that it is unlikely we’ll see a return to pre-crash levels (it will be similar to unemployment – a much more gradual up-tick). Many of the issues are structural and may never go away.
For institutional funds:
• Reallocation of institutional investors to more liquid asset classes (embarrassing that Harvard had to issue $1.5Bn to pay its bills)
• Reallocation of institutional assets due to the denominator effect (essentially rebalancing of their portfolios to reflect the depreciation of other more liquid asset classes)
• It is widely known that many institutions have instructed their funds to limit additional capital calls even though the capital is “committed” – the implication is that there are now funds that can no longer count on having “dry powder”.
• Lack of liquidity in current funds and unrealized returns make it difficult to raise new funds
• The recession has depressed growth rates and extended timelines to reach cash flow break-even, thus increasing the need to invest additional capital in current portfolio companies rather than new companies.
The common wisdom is that we are at the beginning of a massive contraction in the asset class both in terms of dollars under management and number of firms. The National Venture Capital Association has publicly commented on this: Washington Post
I think the angel story is marginally more positive:
• Clearly the massive depreciation of individual balance sheets has forced many angels to take a more conservative approach to riskier investments
• The lack of investment by down stream capital has required they put most of their dollars toward protecting current portfolio
However:
• Recent stock market rebound and bottoming out of real estate has provided some level of stability in their balance sheets – though the scars are still fresh at this point
• Investing is usually a “hobby” that they enjoy so there is generally a passion to return as soon as it seems somewhat sensible
• Decision making is concentrated in the individual and not tied to investment committees or LP’s; if they start to feel good they will start to write checks (witness Wil’s previously referenced experience with affordit.com)
We are already seeing some early indications that angels want to take advantage of current market conditions and do deals that historically they could not access at valuations that are often 50% less than what they were at 12 months ago. Part of the success Wil experienced was probably associated with these factors.
So What Does it All Mean?
Entrepreneurs need to accept that capital will be much scarcer for quite some time. There are particular implications depending on where one is in the company building process.
• Just starting out: Find businesses that are highly capital efficient where you can build a company with your own capital or friends and family without relying on traditional VC; possibly consider consortium models or strategic partners instead. With the abundance of free or inexpensive technologies available to entrepreneurs, the cost to start many businesses is a small fraction of what it was a few years ago.
• Ship has left the dock: If you have started a company that is heavily reliant on VC be prepared to work closely with your current investors as they most likely are the ones who will have to support you for the duration; look at revising your business plan to reduce capital needs. If you need to access VC then allow plenty of time and do everything possible to show traction.
• Later Stage: Reset your expectation around potential partial take-outs through mezzanine rounds and time to IPO or exits. Consider yourself lucky if you have achieved sustainability but be prepared to be “pulling an oar” longer than you had expected.
In this changing environment, even perpetually optimistic entrepreneurs need to adapt their strategies and expectations for fundraising. There will always be money out there for great businesses led by passionate entrepreneurs. But the amount, the time to raise, the types of investors, and their expectations on traction will likely make the fundraising experience a much greater challenge than in years past. My hope is that rather than denying today’s reality, entrepreneurs will do what entrepreneurs do so well – look at the situation and use their creativity and enthusiasm to turn a challenge into an opportunity. Go build that business, solve that problem, change the world. But be careful about counting on VC backing to be the primary fuel to power your dream. The cash simply may not be there for you. Like Wil, seek out angel investors and other pockets of capital who believe in what you are doing. Good luck!
Will it and it will be so. Sounds crazy – but then again what isn’t in the world of entrepreneurship? I have been accused of being a naïve optimist, seeing the world through rose colored glasses, drinking the Kool-Aid and various other clichés for someone who always is looking for upside. Does this mean I am disconnected from reality or losing my mind? Perhaps. Then again, perhaps not.
I have been giving some serious thought about what keeps entrepreneurs going. There are so many things working against a start-up: no resources, no brand, no cash, naysayers, etc. It is all about the dream. It is the pursuit of the dream that motivates entrepreneurs to do what it takes to succeed; things like staying up all night several nights in a row to get a release completed, tapping into home equity to buy servers (probably less so now) and begging first customers to give your product a test drive. Does this mean that entrepreneurs are disconnected from reality? In some ways, yes They see a better future based on their vision of the possible – potentially something beyond today’s current reality. I think this type of thinking is foundational to successful entrepreneurs. It is a crazy/maniacal commitment to making this dream a reality that provides entrepreneurs with more energy than a tractor trailer full of Red Bull.
However, entrepreneurs MUST acknowledge the risks and pitfalls and be open to counsel about how to mitigate unnecessary peril while pursuing the dream. The goal is to climb Everest, which by its very definition is insane, but with proper planning and good mountain guides the odds of reaching the summit go up and the risk of death go down. Clearly the entrepreneurial journey is full of pitfalls and littered with corpses. So what is my point? I think it is valuable for friends/advisers/VC’s to assist entrepreneurs in their pursuit of the dream by offering short cuts, pointing out unforeseen perils or sprinkling magic fairy dust. I do not think it is helpful for advisors to challenge the fundamental premise of the entrepreneur’s dream (they are climbing Everest with or without your support) – you may not agree with their dream so don’t get involved or don’t invest. In my years of dealing with true entrepreneurs, I have never seen a debate between a third party and a founder that has had a positive outcome when the topic is about the fundamental nature of the dream. To be clear, debate is good around the execution and realization of the dream but not around the core assumption. I’d argue for true entrepreneurs their dreams must be irrefutable otherwise they won’t have any chance of making it to the summit.
Yesterday’s VentureBeat had an article suggesting that the old “2 and 20″ method of compensation should be changed. Unfortunately, they suggest that perhaps fees should be reset across the board. It seems that while the larger investment community is finally focused on the problem of mega-funds that they are missing what is perhaps the bigger problem — the lack of early stage funding. If fees for all funds were reduced it is even less practical to run a small fund!
Following is my comment on that blog:
First, I completely agree that the venture model is broken. I also agree that large funds cause most of the problem and huge fees are the big incentive to raise large funds. HOWEVER, wholesale implementation of lower fees as “standard” would actually make part of the VC problem even worse.
One of the biggest challenges facing start-ups today is a lack of seed and early stage funding. Part of the reason for this is that institutional investors no longer back early stage funds (which is strange since they’ve always had the best returns – but that is different story). Part of the reason is that it is not economically practical to operate a small fund on 2% fees. Let’s assume that the perfect size fund for first round investments is $20mm. The annual fees for this fund would be $400,000. Many would argue that it actually takes more staff in a small fund than a large one (because early stage companies generally have more challenges). So, running this size fund with 2-3 partners, a few associates and an office is simply not possible.
My view (which is extremely unpopular in VC world) is that compensation should actually be tied to PERFORMANCE. Institutional investors should negotiate a maximum base salary with GPs (like investors do with CEOs!) and the carried interest should represent the upside (like a CEO’s stock options). I think this change would go a long way to resetting the industry as the best GPs might start migrating back to early stage deals where the upside has always been much greater, rather than getting fat and happy with management fees.
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