While attending this week’s CMO Perspectives conference, I was reminded of Tracy Kidder’s famous 1981 book, The Soul Of A New Machine. Why did a conference of Chief Marketing Officers, showcasing brand reinvigoration efforts at McDonalds and Dove (whose "Real Beauty" campaign I absolutely love, by the way), remind me of a geeky cult hit about the development of Data General’s latest big iron machine?

Simply put, all the talk about brand attributes and personality reminded me of the importance of "soul" in a start-up.

Keynote speaker Charlotte Beers (who had great stories about her experience in Washington when she was tapped by Colin Powell in October 2001 to run the US PR campaign in Arab countries after a long Madison Avenue career running Oglivy & Mather and J. Walter Thompson) talked about the importance of company executives, particularly CMOs, personifying the brands of their companies. Although the CMOs of Pepsi and WalMart, who were in the room, took her advice as very relevant to their global branding efforts, it struck me as even more critical to the little start-ups we VCs deal with every day in a very different way.

VCs tend to approach start-ups with cool, analytical rigor to get to the bottom line answer: "Will this make me and my limited partners money?". Entrepreneurs tend to approach start-ups with extreme emotional attachment beyond any rational borders, seeking the answer to the question: "Will anyone love and appreciate my [professional] baby (which, by the way, I hope makes me money so I can retire and get back to spending time with my family)?" Anyone who’s been involved in starting a company knows what an incredibly emotional adventure it can be.  The ups and downs are incredibly exhilirating yet terrifying.  One moment you’re king of the world, the next you’re afraid you’re going to run out of money, and then it flips again.  The tension between that emotional roller-coaster that the founders/insiders are feelings as compared to the cool, analytical perspective of the rational VC/outsiders is an extremely healthy one – over-weighting one side or the other will result in a sub-optimal company-creation process.

And it is that tension that gets to heart of the concept of the soul of a company. You don’t have to be a religious person to appreciate that every start-up has a soul. Webster defines the word as "the immaterial part of a person". The soul of a start-up is thus the immaterial part of the company that personifies its unique character and culture. The soul of a company typically comes from the founding team, although I have also seen it come from mid-level hires, often young, who so completely embrace the company’s mission that they begin to deeply eminate it in all of their activities.

The importance of nuturing the soul of a new company can’t be under-estimated, but can be very difficult as the start-up grows and evolves. Too often, that soul can erode when VCs come in to start-ups and begin to engineer the process of bringing in the "grown ups" (by the way, how old do you think you have to be to be considered a grown up at a start-up?). If the board and management team aren’t careful about preserving the soul of the company during growth, "grown-ups" and founder transitions, the company can easily lose its way. Perhaps not on a rational level (strategy, finance, products), but on an emotional one (culture, passion, commitment).

Think of a start-up. Now picture who represents the "soul" of that start-up. It’s probably a pretty easy exercise. Now imagine that person missing from the start-up. Ouch.

Nurturing and evolving the sould of the start-up is as critical a part of the stewardship of the company as nurturing the product strategy.  Boards and founders shouldn’t be afraid to use this emotional language when describing what they are creating.  After all, it is how they are feeling.

It’s the end of summer, so I’m trying to get some last-minute summer reading done.  Like many people, I try to pick a few books that take me away from my day-to-day job.  Unfortunately, I just read a book that had the opposite effect:  Blink by Malcolm Gladwell (author of The Tipping Point).  This book kept bringing my mind back to the VC business.

First, a quick summary of the book.  Blink’s thesis is that human beings make intuitive decisions very quickly, often without consciously thinking or knowing why analytically.  Many times, these decisions are dead on as the brain subconsciously, rapidly absorbs and processes vast amount of observed data.  One amusing example the book provides is a psychologist who can observe a married couple for 15 minutes and with a 90% success rate, predict whether they will still be married in 15 years (begging the question of who would be crazy enough to run a 15-year longitudinal study!  You can imagine the phone call:  “Hello?  Is this Susan?  Hi Susan, Dr. Gottman here.  Yes, yes, we spent time together at my lab 15 years ago?  I just wanted to know if you’re still married to Bob.  Oh you’re divorced?  Wonderful!  Just as I predicted…uh…I mean, I’m so sorry for both of you.  Thank you very much.  Goodbye”).

To be fair, Gladwell also points out that at times these unconscious decisions can be very wrong.  As another psychologist notes:  “When we make split-second decisions, we are really vulnerable to being guided by our stereotypes and prejudices.”

Now why did this make me think of the world of VC?

Simply put, VCs blink all the time.  Ask your VC friends how long it takes them to decide whether a deal will be a good one in a first meeting or call.  Typical answer:  15 minutes.  How long does it take them to decide whether an interview candidate is an “A” player worthy of an executive position in their portfolio companies?  15 minutes.  Everything else is just to fill the time.

You see, although many VCs are typically fairly analytical, particularly those with private equity backgrounds, by and large the VC investment business is an intuitive one.  When analyzing companies without a historical track record pursuing nascent, emerging markets, VCs must heavily rely on their intuition.  When assessing executives without long track records as successful CEOs or department VPs (i.e., young, up and coming and therefore, typically unproven executives), VCs again must heavily rely on intuition.

Test it out.  If you’re pitching a VC or interviewing with them, challenge yourself to get through your opening pitch in 15 minutes and then pause.  Sit back, look them in the eye, and say:  “Let’s hit the pause button.  Based on what you’ve heard so far, what do you think?  I don’t want to waste anyone’s time if you think this would not be interesting.”  I bet you very few VCs will say, “tell me more – I haven’t formed an opinion yet.”  The honest ones will say:  “This is really interesting” or “I’m sorry, this isn’t a good fit – I can tell already”.

And what about the bias issue?  What to make of the insightful comment that intuitive, unconscious opinions and decisions play to stereotypes and biases?  Unfortunately, that’s another factor in the VC business that entrepreneurs need to take into account.  If they wish to break out of the bias, entrepreneurs need a break out approach to their pitch.  Imagine a prospective CEO with a spotty track record starting off an interview by saying:  “Look, I know I’ve worked for three failed start-ups in a row, but let me tell you what I’ve learned from that experience and why I would make an outstanding CEO.”  That would be a refreshing way to start an interview!

Finally, entrepreneurs should know that there are no hard feelings if their 60 minute pitch slot ends after only 15 minutes.  The VC will respect them all the more for being efficient and straightforward rather than dragging out the inevitable.

When friends ask me what the biggest change has been in transitioning from sitting in the entrepreneur’s seat to the VC’s seat, I often think of the profound difference in the way entrepreneurs and VCs look at that all important dimension of time.

When you’re an entrepreneur, time is your enemy.  You need to solve the problem of “simultaneity” – hire the team, build the product, raise money and close deals – all in parallel.  If you have only 80% of the data surrounding a decision, you simply make the call and move on.  When I was an executive at a public company (Open Market), we used to think about every quarter like an hourglass, with the sand running out every 90 days and a mad scramble to close as many deals as possible before time ran out.  At an earlier stage company, that hourglass metaphor is similar, but the sand running out is the cash on your balance sheet!  In short, entrepreneurs learn to fight hard against the passage of time.

When you’re a VC, you have a very different relationship with time.  VCs seem to love the passage of time.  When you’re evaluating a deal, more time means more information.  When making investment decisions, VCs prefer to watch movies rather than look at snapshot pictures – in other words, they like to see a project evolve over time, not evaluate it at a discrete point in time.  They like to see teams gel together.  They like to see entrepreneurs actually achieve the milestones they claim they’ll achieve with time.  The more a VC can delay a decision, watch something progress over time, “turn another card” (a new expression for me when I joined the VC business!), the happier they are.  In short, VCs are trained to embrace the passage of time.

And so there’s the conundrum:  what’s an entrepreneur to do in the context of a fundraising process when time is their enemy, but the VC’s friend?  One piece of advice is to simply recognize this difference in this attitude towards time and try not to fight against it. One wizened general partner at a top firm once remarked to me about a particular deal:  “They told me I had to make a decision in the next few days, so I told them I’d save them a few days and simply pass.  It’s VC 101 – anytime an entrepreneur puts a gun to my head, I pass.  There’s always another deal.”  If you can create a sense of urgency in the fundraising process, you’re running an unusually charmed process.  More typically, you can expect to run a fundraising process where you simply have to give VCs the time they need to “soak in” the deal, live with it for a few months and then, at the right moment, try to call their interest to question.  Rushing the process only gets the VC alarm bells ringing.  For the entrepreneur, this start-up is their life’s work and on their mind every moment of every day.  For the VC, there’s always another deal.

"I’m the founder of Foobar, we’re a VC-backed start-up," you hear someone declare proudly at a cocktail party.  Being a VC-backed founder can have great cache and everyone around them thinks they’re so cool, but deep down, many founders know that being a VC-backed founder can sometimes simply suck.

The primary issue is that you’re always afraid your VC is going to fire you.  It’s the unspoken thing that founders live in fear of.  They work like hell to create something from nothing, take this great VC’s money, get invited to all their great parties, get told how much everyone loves them, but live in fear that after each board meeting, they’re going to get the call.  "Hi Joe – it’s your VC.  Listen, we need to get together for breakfast."  Uh oh.

Let’s put it right out on the table – VC board members are always evaluating the performance of the CEO.  That’s the fundamental job of the board of directors:  hire, fire and compensate the CEO.  When you’re a "hired gun", professional manager, you know the drill.  You’re only as good as your last quarter, goes the old board room yarn.  But founders are typically less glib about it all, because a founder can’t just bounce from one CEO gig to another – they’ve put their blood, sweat and tears into this start-up and it may be their only ticket to the big time.  And they’re damned if they let some pencil-pushing VC who simply doesn’t "get it" ruin it for them.

On the VC side of the table, watching a founder run out of steam and lose their ability to manage and build the company is incredibly frustrating.  Great company, great technology, great market position and a huge opportunity, but the founder just won’t let go and let the best people in the world come in and take the company forward.  It’s like watching a train wreck – you know exactly how it will end and it’s impossible to stop.  Founders love to cite Bill Gates, Larry Ellison and Michael Dell as young, founding CEOs who run their companies from the garage through multi-billion dollars in revenue.  Why can’t they do the same?  If it were that easy, there would be far more than a mere handful of Fortune 1000 companies still run by their founders.  A friend of mine used to talk about the three stages of a company’s life:  the jungle, the dirt road and the highway.  The right CEO and executive team in the jungle tends to be very different from who you need when you’re on the highway.  Founders very rarely can be effective leaders during through all these complex transitions.

So what are founders and VCs supposed to do?  Honest, open, direct dialog is probably best.  Founders should be clear with their boards about what they are trying to achieve professionally and solicit feedback as to how they’re perceived and what they need to work on to be more effective CEOs as the company’s needs evolve.  And VCs should discuss clear expectations, parameters and milestones to remove any lingering ambiguity so that the founders aren’t wondering whether they’re going to get the call after every board meeting.

It can really be a ton of fun to found a VC-backed company, but if you’re not communicating clearly about mutual expectations and goal, succession plans, milestones, etc…it can sometimes suck.

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!

One of the most popular things for VCs to do when describing their funds is to brag about how much capital they have under management.  "We have $XXX gazillion dollars under management" sniffs one VC at a recent cocktail party looking down at his poor brethren, "and they only have $YYY."

But does VC fund size really matter to the ultimate "customer", the entrepreneur? Is bigger actually better?  I would argue size does matter, but perhaps not in the way that you might think.  To explain my perspective on this, let me first give a bit of history.

Kleiner Perkins, arguably the best of the best, had a consistency to their fund sizes in the 1980s and early 1990s.  In 1982, they raised a $150 million fund (their 3rd).  In 1986, another $150 million.  In 1989, you guess it, another $150 million.  And then in 1992, $173 million.  Then, something odd happens to the pattern.  The Kleiner fund sizes jump in size beginning in the mid-90s, all the way up to $625 million in 2000.  Other funds were even more aggressive during that brief, five year period.  With the rush to raise bigger and bigger funds in the midst of the bubble, there was even a ludicrous moment in time where VC partnerships argued with their LPs that they needed to have a $1 BILLION fund in order to stay competitive as a top-tier firm.  What happened?  In sum, the NASDAQ bubble.  VCs began to see exit valuations with billion-dollar potential, not just hundred million dollar potential.  And so rather than deploy $100-200M over 3-4 years into start-ups at a clip of $5-10M at a time, VCs tried to invest $1-2 billion over the same period by forcing $50-100M at a time into companies.  And we all know how that movie played out.

But with the return to normalcy in the capital markets (there’s an oxymoron), things obviously have changed.  Or have they?  After all, the more capital under management a VC has, the more money they make in fees.  So, the natural incentive is to keep fund sizes large, and therefore fees large, even if the fundamentals behind new investment opportunities is more similar to the 1980s and early 1990s than to the bubble.

Let’s look at Kleiner.  They cut their next fund, raised in 2004, to $400 million.  Smaller than their 2000 fund, but still nearly 3x what they used to raise.  Is the 2005 exit potential for a start-up 3x what it was in the early/mid-90s?

So why should an entrepreneur care about any of this?  Well, a critical thing for an entrepreneur when fundraising is to find a firm that’s going to fit their capital profile.  After all, if a VC is trying to force too much money down the entrepreneur’s throats, it will mean more dilution than they’d like.  And not having deep pockets means there’s a risk of getting caught short just at the moment when a few extra million might be needed to get to the next level.  Thus, the Goldilocks Rule applies to VCs and fund size:  not too big, and not too small, but just right.

How much capital does fund X really want to put in behind each company?  The marketing materials may say one thing (I once saw a VC claim they would do deals from $50K to $50M!), but the reality is there’s a sweet spot that every firm has and if you are in their sweet spot, you’re better off than if you’re not.  The nature of that sweet spot comes down to the size of their current fund, not their total capital under management, for all the reasons discussed above.  Thus, always ask a firm what their current fund size is, not what they have under historical management.

Some early stage VCs use a short-hand calculation that there should be $50 million deployed per partner in each fund.  This figure comes from the equation that each partner can effectively make 1-2 investments per year over a four year fund deployment period and early stage deals are typically $5-10 million over the life of the company.  Thus, 1.5x deals/year x four years x $8 million per deal = $48 million per partner.  Later stage VCs prefer more capital under management because they look to deploy $10-20M per company.

Thus, the size of a VC fund really does matter.  And if you don’t find that "just right" fit, you might be sorry in the long run.

Last post, I shared my observations from the recent Microsoft VC conference hosted by Steve Ballmer in Silicon Valley (BTW:  what an amazing young entrepreneur turned mega-executive and company-builder; he has my vote for CEO of the century so far – and I’m not just trying to suck up so that I can sell any of our companies to Microsoft!).  I included in that post an observation that the enterprise software business model is dead and VCs are really shying away from these deals.

The corollary is that consumer is hot again in the VC community.  E-commerce version 2, the digital home, online advetising, social networking and finding the next Google — all are themes that VCs up and down Route 128 and Silicon Valley are chasing.  As a result, experienced enterprise software investors are trying to convert themselves into consumer VCs.  Literally every VC I talk to in Boston is asking themselves:  "How do I reinvent myself as an enterprise IT guy/gal into a consumer VC?"

And so the obvious contrarian thing to ask is:  is there a consumer VC bubble coming?  Just as Gary Rivlin of the NY Times observes the phenomenon of "VC Tourists" in his recent Sunday Business Section Article So You Want To Be A Venture Capitalist, I might argue there are "Consumer VC Tourists" now jumping into areas where they have little to no background and are therefore bound to lose lots of money.  Fast.  I confess to being personally biased on this one.  At Upromise (college savings loyalty program I co-founded in early 2000), we raised over $100M and spent much of it on marketing to acquire the now 6+ million member households.  I saw first-hand how quickly money can fly out the door in a VC-backed consumer play and I’m worried that it’s happening again.  And, yes, I still worry that we in Boston still have a thin talent pool for successfully executing such businesses.

There’s some emerging data to support the "consumer bubble" theory.  VentureOne recently reported that in 2003, there were 183 consumer deals and $1.2 billion invested.  In 2004, it jumped to 246 deals and $2.1 billion invested.  I would be surprised if 2005 didn’t continue the trend.  Most worrying, this month’s featured event at Harvard Business School Club of Boston is, you guessed it, "Emerging Trends in Consumer Technologies".  Uh oh.  Anytime HBS jumps on a bandwagon, you know it’s the top of the curve.  Maybe the contrarian thing to do is plow back into enterprise IT!

I’m in Mountain View, CA today attending Microsoft’s annual VC Conference.  Every year, Steve Ballmer and crew come down from Redmond and expose 100 VCs to their upcoming plans.  The buzz points in the audience this year include:

• The enterprise software business model is dead.  This is refrain many VCs are mumbling to each other lately.  Price pressure is incredibly intense between open source, Microsoft moving up the stack, vendor consolidation, IT buying wariness, the ASP model, overfunding in interesting sectors and many other factors.  It used to be that you could build a profitable enterprise software company at the $15-20M threshold.  But with today’s pricing pressures and high cost of sale, it seems to have jumped to $40M, and it’s harder to reach that threshold quickly.  VC appetite for standard enterprise software appears to be dwindling to nothing.
• LAMP cost of ownership vs. Microsoft is a myth.  This is a new acronymn that I learned today.  It stands for Linux, Apache, MySQL and PHP – all open source components that are eating away at Microsoft’s value chain.  Microsoft firmly believes that they are right on the facts and losing a perception battle with their core developer community – and need to fix this, fast.
• Microsoft is no longer the Big Bad Wolf.  Believe it or not, Microsoft feels downright warm and fuzzy lately to a VC.  It used to be that VCs would complain that investing is software is dumb because Microsoft will simply build it and give it away for free.  Nowadays, you hear much less of that.  The law of large numbers has settled into Redmond’s decisions.  If a business is less than $1 billion in platform revenue potential, it’s not interesting enough to warrant Microsoft’s attention.  Therefore, there are plenty of multi-hundred million dollar software segments that Microsoft is thrilled to help young companies build (on top of their platform, of course).  Also, Microsoft’s IP strategy is now all about aggressive cross-licensing rather than offensive litigation.  This company has really grown up over the years.

Ballmer’s keynote over breakfast is today, so we’ll see if anything new comes out of that.  Last year, he spent much time trying to convince us (and himself!) that Microsoft would catch up with and crush Google.  One year later, they seem to have slipped farther behind!

How do VCs make investment decisions, personnel decisions and work through other critical issues?  Well, first you need to understand VC economics before the murky decision-making process can be teased out.

So what’s the VC business model?  Raise a fund, get paid 2.0-2.5% annually in fees to manage that fund, and make investments that you hope will generate capital gains.  When those returns are generated, the VC funds typically get 20-25% of "carried interest" or "carry" in the capital gains.

Let’s walk through a simple example.  Let’s say there’s a $150 million fund and the VCs are getting 2% in annual fees and 20% in carried interest.  Then, the firm takes in $3.0 million in annual revenue.  If the fund returns 2x the capital, or $300 million, over the 10-year life of the fund, then $150 million is considered capital gains and the VCs get 20% of that amount, or $30 million, to be divided up between the partners according to who has how much of the carried interest.  If the fund doesn’t generate any capital gains, the VCs get nothing beyond their salaries paid out of the annual revenue.  Once the VC is finished investing their fund, they need to raise another fund from Limited Partners (LPs), typically universitiy endowments, pension funds, fund of funds, wealthy families or corporations.

Why does this help shed light on VC decision-making?

Because decisions within a firm typically get made depending on who has the most carry, not based on title, as you would assume coming from a real company (VP Sales – oh, I guess they sell…).  Partner or General Partner titles can be misleading.  A 29 year-old, green General Partner may have a tiny sliver of carry as compared to the 50 year-old General Partner who’s been a successful investor for 20 years.  Guess whose opinion matters more?

In VC firms where the carry is divided unevenly, decision-making is typically unevenly made.  VC firms where cary is divided evenly are more consensus-driven.

So, if you find yourself pitching a VC firm and wondering how they’ll make their decision, there are a few important questions to get answers to while you’re fundraising:

1) Who is the partner who would serve as the deal champion?  Associates and Principals don’t typically have carry, so they can’t make investment decisions without a partner’s support.  Junior partners with small slivers of carry may need senior partners to closely oversee the diligence and decision-making process.

2) How long has that partner been with the VC firm?  Are they on an equal footing in terms of carried interest (i.e., ownership) to the other partners?  If not, they may not be able to "speak for the firm" when it’s time to make tough decisions about follow-on rounds and M&A transactions.  If so, they will still need to get to consensus, but it’s a very different dynamic when your "deal champion" isn’t a subordinate within the VC firm.

3) When is the last time that partner made an investment and what other deals are they working on?  If a partner is out of capacity, conventional wisdow nowadays suggests sitting on 8-10 boards at any given time is the max, then they are far less likely to take on a new project than if they have recently sold off or shut down a bunch of their portfolio.

4) Where is the VC fund in their fundraising cycle?  If they are at the tail end of a fund, they may be more selective in their investments…or more rash.  If their current fund is strong, they may be more willing to roll the dice with the final few investments in terms of risk/reward profile.  If their current fund is weak, they may need a few short-term, safer hits to make up for poor historical performance.

VCs are great at asking entrepreneurs dozens of probing questions about their state of affairs – so in theory turnabout should be fair play!

"And the best part of all," says the entrepreneur with a big smile, "is that our unique process is patent-pending, which will provide us with tremendous upside and great defensability".

Right.

The sad truth is that when it comes to the VC process, patents don’t really matter.  There is simply so much more to the company-building process – management team, market dynamics, competition, just to name a few.  Maybe, if all else fails, you can recoup some of the investment by selling off your IP.  But patents are so tertiary to the VC decision process, that it’s really a bit silly to spend more than a nanosecond on them when pitching VCs.

How could this be, earnest entrepreneurs will cry!  Aren’t patents at the core of creating value through innovation and invention?  First of all, having a patent pending is like kissing your cousin – it simply doesn’t count.  Anyone can file.  Getting a patent issued is what really matters.  But even when you have an issued patent, 95% of the time it is too narrow to be relevant as a blocker, and so typically a competitor can find a way to design around you or have other patents in the same field that will cause a standstill to occur.  That other 5% of the time, a start-up will simply not have the legal resources to properly prosecute a patent strategy that could yield the investors any return.

Let me give you a case study I’ve lived through.  At Open Market, the founding technical team came up with incredibly fundamental inventions in 1993-94 that were filed and then granted in the form of three seemingly powerful patents in 1998.  These patents essentially covered secure credit card transactions over the Internet and the use of shopping carts.  On the day of our announcement, we made A-1 of the Wall Street Journal and and our stock jumped 2x that day (we did our IPO in 1996).  But after 3 years and a fairly focused effort, the company failed to extract any tangible value from those patents and the stock went back to being valued on more important metrics, such as revenue, growth, etc.  When Open Market was acquired in 2001 and its acquirer later went bankrupt, the patents were purchased out of bankrupcy court by an entity that then sued Amazon.com (see article).  So far, nothing has come of it.  Thus, despite nearly 12 years since these fundamental e-commerce inventions were made and filed, investors have nothing to show for it.

Call me jaded.  But ask your other VC friends and they’ll most likely agree.  Patents just don’t matter.