Having been in entrepreneurial world for almost two decades, I frequently think about what it means to be an entrepreneur. The critical role of fundraising seems to be a persistent theme. I personally have been directly involved in raising capital as a CEO or interim CEO for a Momentum portfolio company more than a dozen times. Fundraising is clearly the bane of an entrepreneur’s existence (especially in today’s market).

I find myself frequently complaining about the frustration, rejection and time sink associated with the fundraising effort. It is not uncommon for us to spend 50% of our time as interim CEOs associated with a portfolio company in some aspect of fundraising. I know from talking to others that their experiences are very similar.

Fortunately at Momentum we have >90% success rate in securing institutional backing for our companies. That being said, as folks who do this as a living we must acknowledge the fundraising is grueling. While I may frequently feel frustrated I realize that fundraising is in integral part of the Darwinian process of building a successful venture. Obviously accessing capital is (typically) critical to achieving rapid growth (though not every company should access venture capital which has been covered in previous blog posts). The number one job of an early stage CEO is evangelizing the company to key constituents; capital sources are probably the most critical in this group.

So if you want to be an entrepreneur, either prepare yourself to jump on the hamster wheel of on-going fundraising or pull in a business partner who is good at fundraising and enjoys it. I challenge entrepreneurs to rethink their attitudes about fundraising; I often hear that fundraising is a distraction to building a business. Unfortunately it is foundational to building a high growth business. It is critical that entrepreneurs acknowledge this reality and adequately tool themselves to be successful on this front.

While recession data could not be looking worse, new startups in southern California keep looking more impressive.  Maybe it’s the contraction of demand for talent that’s causing talented folks to start their own businesses.  Maybe it’s the lack of capital that’s making entrepreneurs more aggressive in looking for funding.  Perhaps it’s because the threshold for raising capital has pushed entrepreneurs to raise their standards.  Either way, I’ve been more impressed with deals we’ve seen in Q1, 2009 than I have in a long time.  Pre-funded startups in digital media, social media monetization, enterprise IT,  and many other spaces are coming at us with solid teams attacking big problems.

If you’re thinking about starting a business or have started one and are considering whether or not it’s worth the effort, don’t let the economy hold you back.  Keep up the hard work and don’t hesistate to ping us for advice.  We’re as interested as ever in helping entrepreneurs build successful businesses.

The LA Times did a short piece on their blog about raising money in this environment - the take-away is that you’ll need to find it from friends and family (not institutions).

Matt Ridenour is presenting the following presentation at TCVN tonight.  If you don’t check it out live, be sure to view the following (preferably in fullscreen mode).

A guide for entrepreneurs trying to raise angel and venture capital - Get more Business Plans

Yesterday, in VentureBeat, there was a great article, discussion and related Powerpoint on why VC is broken.  I agree with most of it, but disagree with The Funded’s founder, Adeo Ressi, that part of the answer is fewer, better VCs.    Below is my comment on this article.

******

I agree very much with the overall theme of this presentation and commentary, VC is “broken”. However, I strongly disagree with the conclusion that we actually need fewer, “better” VCs. In my view, part of the reason that VC performance has become so stale is that the compensation system for venture capitalists drives them ever upward in terms of fund size. If they have success with a “small” fund they will raise a larger one.

A friend just recently closed a $250mm fund after being part of several smaller funds. Over dinner his comments to me were essentially that the partnership did not actually expect they would make returns in this new, larger fund. But, on the other hand, the 3 partners would be splitting over $8mm per year in fees between the various funds. He is activity investing in real estate on the side. Have any of you ever met a VC partner that wasn’t “rich”? The data would indicate that the majority of these people are not making money for their investors?

In general, I believe it is much harder to make good returns with larger funds. If a company is raising $50mm there will be intense competition by investors trying to get money to work. On the other hand, in today’s environment, if a company needs $3mm they are dead in the water no matter how good the company and deal. So few investors are doing those deals. For a fund group with $500mm under management a 10X return on a $3mm investment just doesn’t “move the needle” and it isn’t worth the hassle.

So, I think the right answer is that the groups that invest in funds need to think hard about sponsoring the next generation of fund managers. We need to create 10 $50mm funds for every one $500mm fund. I know this will be difficult because pension funds are massive and it is tough to deploy into small funds. But, if we don’t somehow restart the “farm team” system I fear the end of venture capital is not far off.

Entrepreneurs spend a lot of time researching their market and customers.  But, when it comes to raising money, they tend to approach anyone with a heartbeat!   The problem with this approach is that a large majority of the investors you pitch are simply not appropriate for what you are doing or where you are as a company.  So, any time you spend on them is wasted.  On the other hand, while you might be wasting time with certain investors, you might also be missing out on pitching more appropriate investors. 

I started playing around with a high level questionnaire to help entrepreneurs get a quick sense of who to pitch.   It is attached in Excel form.   It still needs some work.   Try it out and give me your thoughts!

Who should I pitch for money?

I’ve had a lot of questions and comments on the VC market blog from the other day.  I addition, Ben Quo posted a note about the topic on his blog today.   Below is a link to a .pdf with excerpts from our study on the topic:

Excerpts from Momentum’s VC Study: Summer ‘08

A few comments:

• Many will point to the fact that a lot of deals are happening and a lot of money is coming into Southern California.   However, look at the ratio of seed and early stage deals to later stage deals in Southern California.   Assuming that not all A round companies make it to round B… shouldn’t the number of early funding events be much larger than the number of later rounds?   In fact, early stage deals are a fraction of later deals.   So, while the big guys from out of town might like to come hunting in Southern California for deals at this point, it is not clear that there will be ripe hunting grounds a few years from now.
• Despite what the large VCs might say, it really doesn’t appear that they are placing small bets in order to seed the market.  Especially if they are from out of town.   It is too much work to make these investments and investors need to be close to keep a tight watch on things.    Ironically, a first round deal usually needs more care and feeding than a larger deal.  Take a hard look at the actual number of these experimental investments from the big funds.   There really aren’t very many.
• Perhaps most troubling, look at new capital formation in Southern California.  We still have money being deployed from funds raised over the past several years — but, it is not clear who will be investing in early stage deals a few years from now.   (e.g. there are not many new sub-$50mm funds with a clear strategy to do early deals).

As I’ve said before, it is an important problem for the region to address.

If you follow the venture market, or if you have recently tried to raise money for an early stage company, you know that there is a serious “funding gap” in the early stage market across the US.   By way of background, we believe that raising early rounds of capital has become extremely difficult for a number of reasons.   The short story is that the number of funds who are willing (or able) to profitably invest in “Series A” is shrinking.   This is happening despite the fact that historically, early stage funds are the best performing funds.   The dynamics behind this phenomenon will be the topic for another post.

This summer, we set out to study how this national trend plays out in Southern California.   The bad news is that the “funding gap” in our area is even worse than we expected.   Consider:

• Southern California has less than 3% of venture capital dollars raised since 2002;  amounts raised in Silicon Valley, Boston and New York at 10X, 6X and 5X more respectively.
• One measure of how hard it is to raise money locally is how many venture dollars are available for every  start-up that gets funded within a region.  In this regard, the story is even worse.   Southern California is at the bottom of the barrel with other major markets having at least 2X and as much as 7X more capital ready to deploy into start-ups.

One might argue that there aren’t deals to be done… however, this is not the case.   From June 2007 to June 2008 the Southern California region was second only to Silicon Valley in terms of the number of deals done. The issue is that the deals are not being done by local investors!   In Southern California in Q1 of 2008:

• 3 out of every 4 dollars invested in venture backed companies came from VCs outside of Southern California.
• Worse yet, almost 9 out of every 10 dollars invested in seed or early stage deals came from outside Southern California.

Some might pose the question, “if the deals get done anyway, why does it matter where the money comes from?”    From the perspective of a start-up that actually receives funding, it might not matter.   However, consider the following:

• Ask any CEO who has raised funds from outside his own region about his or her experiences.  If the company wasn’t required to relocate nearer the investor, they likely faced significant overhead associated with travel and did not benefit from local connections and advice nearly as much as locally funded companies do.
• More important, there is no way to measure who never got funding and gave up.  What we do know is that the earlier the round of capital the less likely that outside groups will travel to invest in our region.   One can infer from the data that raising money for a start-up in Southern California essentially means that you must look elsewhere for capital.   From direct experience, I can tell you that this dramatically reduces the number of start-ups that are likely to get funded.

In this market climate, it is unlikely that this problem will improve.   However, it is something that everyone in Southern California should care about whether or not they are an entrepreneur.   Entrepreneurs and their companies are the growth engine for our economy and without access to capital they will wither and die;  or move elsewhere.   Further, given that early stage investing has historically produced very high returns, we are essentially exporting our investment gains to other regions.
Stay tuned for more on the topic and feel free to drop a line for more details on our market study.

The Angelsoft blog referred to our ongoing advice not to write a business plan. It generated quite a debate on that site - I encourage you to read through the comments if you are interested in the topic. They also shared a link to a one page pdf executive summary that they believe is very useful in fund raising.

Entrepreneurs are generally frustrated with how difficult it is to raise funds. Much of this frustration is directed toward Venture Capitalists; they seem to fund so few opportunities, their criteria for investment is somewhat mysterious, they have a reputation for tough negotiation and low valuations, etc.The purpose of this note is to give you insight into how a venture capital company works, how its partners are compensated and why they operate the way they do. Continue Reading »