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Raising money from VCs – some insights

By April 17, 2007 4 Comments

Venture Capital 

Today I came across the Onstartups blog (via the web2.0 entrepreneurs group on Facebook).  Great blog, and when I come across a jewel like this it always makes me wonder how many more are out there.

There are loads of great posts (I have spent well over an hour reading the blog) and I’m going to borrow extensively from 9 Pithy Insights On Venture Capital in this post.  One of my goals in writing this blog is to increase understanding of how venture capital works, but one way or another that is something I haven’t done as much of as I would have liked or expected.  Hopefully these points will help re-dress the balance:

Pithy Insights On Venture Capital1.  Remember that VCs have a diversified portfolio of investments and can spread their risk.  You can’t.  Don’t try to compensate by pursuing a bunch of different ideas simultaneously with the hopes of diversifying your risk.  It doesn’t work that way.

2.  VCs negotiate term sheets and financing deals for a living.  You don’t.  Accept this imbalance early and find great advisors and counsel.  VC negotiation, even in early-stage deals is highly nuanced and reasonably complex.  

3.  Partners at VC firms have one big constraint, and it’s usually not capital, it’s time.  The time it takes to find new deals, explore them and continue to oversee their existing portfolio companies.  Understand where the partner is in terms of their deal flow.  If they have already closed a couple of deals this year, it will impact your chances of getting funding from that partner.  This is not a reflection on you or your idea, but is often purely a function of timing.

4.  Remember that you are being measured on a relative scale.  It’s not good enough that you have a great idea and team, it has to be *better* than the other opportunities a VC is considering.  If you’re talking to a top-tier, successful firm, they’re seeing a lot of great ideas and teams.  Most partners in venture firms will do only a few new investments a year, regardless of how many “great idea and great team” opportunities they see.

5.  You raise money from a VC firm, but you work with a specific partner.  Know your partner.  This is the individual that will either bring immense value to your startup or make your life miserable (or both).  Next to your choice of co-founders, this will likely be one of the most significant people decisions you will make.  Don’t take it lightly. 

6..  Transparency is crucial.  Don’t try to hide facts about the startup you know are important.  They will come out eventually, and later is rarely better for you.  From a VC’s perspective, the act of hiding unpleasant facts is in many cases a worse signal than the fact itself.  It goes to the integrity and behavior of the founders.  

7.  Time is usually working against you.  You’re better off getting a deal done quickly (as long as it’s reasonable) than dragging things out for the best possible deal.  If you’re looking to raise money, focus on the critical factors and get a deal done.  You are generally better off getting a fair deal done quickly and efficiently vs. seeking the “optimal” deal.  

8. Between the time initial terms are agreed to and when money shows up in your bank, a lot of things can go wrong.  Plan accordingly.  No deal is “done” until the money is in the bank.

9. Never underestimate the intelligence of a general partner at a successful VC firm.  It is a highly competitive industry and though impacted by a “who you know” phenomenon, they don’t suffer fools for very long.  Chances are very high that a partner at a VC firm is highly intelligent.  They have to be.  It’s a tough business.  If you think the VC you are talking to is stupid, you’re talking to the wrong person or the wrong firm (or both).

Bonus Insight (and my favorite one):  Remember that VCs are looking to optimize their “risk/reward” ratio.  As such, it is often to their advantage to get a “costless option” on an investment opportunity.  Said differently, let’s assume they sort of like you and your company.  The deal terms they need to give you today (i.e. the “price”) may not be that different than the deal-terms they’d have to give you 4-6 months from now.  During that time, the risk in your opportunity gets disproportionately lower compared to the “higher price” they’d have to pay later.  The only reason for them to do the deal now is if there is competition for your deal and they may miss out on the opportunity (i.e., a “costless option” is not available).  If, on the other hand, there is no competition, they’re often better off waiting.  If they’ve maintained a good relationship with you in the early days, chances are you’re going to go back to them in a few months anyway (once the business is further along).  Effectively, what they have is an “option to invest later” which didn’t really cost them anything.  At that point, they will have much better insight into you and your idea (and how you deal with the inevitable fact that the business you thought you were building is likely not what you end up building anyways).  All of this is a long-winded way of saying:  “The word maybe is one of the most powerful tools in the VC tool-chest”.

These are all great points.

Another resource worth checking out is Smarter Ventures by Katherine Campbell.  It is getting a little old now but gives a great peek inside the mind of the VC.

Other VC blogs are also worth checking out – Fred has written some interesting posts on this topic recently.

I am serious about improving transparency into the VC process.  If there are things you would like me to write about, let me know.