Having three kids causes one to read alot of Dr. Seuss. Over time, I have come to the conclusion that Dr. Seuss would have had great fun describing the world of Venture Capital. From the vantage point of most entrepreneurs, the VC world is the "Land of No". At my small firm of three (now four) general parters, we see thousands of deals every year to invest in a handful or two. That means we say no 400-500 times for every time we say yes to a prospective investment. Other firms have similar ratios. Entrepreneurs are typically the optimists who figure out how to turn anything into gold. VCs are the pessimists who figure out all the ways a piece of gold could become worthless.
Back to Dr. Seuss. Imagine a conveyor belt with packages of all different shapes and sizes in front of a row of fresh-faced, horn-rimmed glasses-toting, 30-something MBAs with khakis and blue buttoned-down shirts ("VC weenies"). The VC weenies peer into every package as it goes by and simply intone, "No". Invest in a blue-horned Skreet? "No". A buck-toothed Blahrg? "No". A callow, MIT PhD with a wireless start-up? "No".
Suddenly, something in one of the packages catches the eye of one of the VC weenies and they grab the package and shout "Yes" and run out the door with all the other VCs chasing after them. After all, once one VC decides something is worth investing in, it seems as if the rest follow.
So what are the things that make a new-fangled start-up appealing enough to appeal to the VC weenies in the Land of No? The five that I hear about the most are as follows:
1. Know who to back, back who you know
VCs like to invest in people they know. That’s why they’re always out networking at events or (so I hear) on the tennis court or golf course. They like to get to know the entrepreneurs and feel comfortable with them before they invest behind them. Investing in strangers is bad business. Investing in entrepreneurs that the partnership has designated as "money-makers" or "backable" is the preferred approach. A close friend of mine was an unknown start-up CEO a few years ago who couldn’t get funding and had to scratch and claw his way to a positive exit. Now, as a proven money-maker who everyone got to know during the previous fundraising process (when they dinged him), he’s running a hot company that every VC in town is kicking and screaming to get into – he’s suddenly been declared "backable" by the community.
2. VCs invest in movies, not snapshots
When you see a deal as a VC, you see it at a point in time. If the entrepreneur tells you that you have only three weeks to make a decision, the decision is almost always an easy, "no". No VC nowadays likes to be rushed into a decision, and people prefer to see the company and team evolve over time (like a movie) as opposed to at a discrete point in time (like a photo snapshot). If a team walks into the first meeting and outlines what they plan on achieving in the next two months, and then walks in two months later having achieved each of the milestones plus two others, it’s very impressive and gives the VC confidence that the milestones they’ve laid out for the next two years will be achieved as easily.
3. Run experiments
Start-ups are like giant experiments. You make a few assumptions, add a few ingredients and see what happens over time. VCs prefer to invest in start-ups where the assumptions are clear, the experiment being run is discrete and not too costly, and where the outcomes can be easily measured over a reasonably brief period of time. A new company that requires $20M and four years to prove out whether the key technical or market assumptions are correct isn’t very fashionable nowadays. Companies that require $4M and twelve months to prove out the three key assumptions, and then a well-defined set of milestones that will be achieved during the first phase of the experiment, are obviously far more appealing.
4. Show up with some orders
Entrepreneur: "This is the greatest widget since sliced bread!" VC: "Really? Who’s paid what for it?". An entrepreneur can claim whatever they want about how great their new invention is, but nothing impresses a VC more than showing up with some orders. Even a company that hasn’t shipped its product yet can show up with orders or letters of intent simply based on the "hope and buzz" of what they’re building. When a ten-person start-up shows up with six-figure contracts from mainstream customers, VCs sit up and pay notice no matter what they’re doing.
5. Have an unfair advantage
The final item that is important to help break through the Land of No is having an unfair advantage. Every VC asks themselves at some point in the meeting, what happens if a "fast follower" comes up with the same idea, raises more money and recruits a better team? Does this team and this idea have in some way an unfair advantage so that no one could really replicate what they’re doing to the same extent – for example, the world’s best technical expert in this field, or the world’s most relevantly connected senior executive? If the answer is no, then the project is likely to be allowed to continue along the conveyor belt and out the door.
Those are at least my observations. Dr. Seuss might have had a few others if he’d spent much time observing the VC business. But then again, he was in a far more noble profession – helping entertain and educate our children!