At $16.2bn funds in the US raised 5.1 times as much money as funds in Europe. That was spread across 135 funds and as you can see from the chart below was more or less the same as 2009 and 2010.

From these year on year charts it is also looks like the US market has stabilised at roughly half of the 2008 levels whilst Europe is still in decline. 2008 was a peak year for venture capital exits before the financial crisis slowed things down.

Looking at the types of funds that raised money last year it is clear that the trend towards both early stage and late stage funds and away from multi-stage funds is in full swing. One surprise for me in this data is that in a declining overall market capital committed to European early stage funds rose by 23%. Support from governments investing directly into funds or providing tax incentives for high net worths to do so may well have been a significant factor in this increase – largely government backed early stage High-Tech Grunderfonds accounted for circa 20% of the early stage funds raised.

In this situation it is imperative that there is a proper debate and everyone takes the time to properly understand everyone else’s position (and I stress properly), and that everyone feels that they have and respected.  However, if there is still disagreement, then the CEO must do what he or she thinks is right, even if the investor board members disagree.  In a recent post on his Information Arbitrage blog Roger Ehrenberg put it like this:

the buck ultimately has to stop with the CEO, and if the CEO cedes effective leadership to the Board it will create both an unhealthy dynamic and an untenable situation as more real-time decisions need to be made

This can be tough for investors who have some real skin in the game and care passionately about the success of the company.  They don’t want to see it go wrong and they are being asked to stand by and let the company take a decision that they don’t agree with that might make it go wrong.  However, none of us became investors because we want an easy life, and tough as it may be we should learn to live with it, as the alternative is worse.  I say that as an investor who in the past has definitely found it tough to stand by as companies take what I thought were the wrong decisions.

However, if there are too many disagreements and the board and CEO lose faith in each other then the situation becomes untenable.  Brad Feld wrote about this back in July, saying:

the board – and individual board members – are often involved in many operational decisions, but the ultimate decision is (and should be) the CEO’s. If the CEO is not in a position to be the ultimate decision maker, he shouldn’t be the CEO. And if board members don’t trust the CEO to make the decision, they should take one of two actions available to them – leave the board or replace the CEO.

This last sentence is the rub.  Ultimately if there isn’t a meeting of minds most of the time on most issues between any two people then they shouldn’t be on the same board together.  That said, it can be difficult for some investors to resign as directors, particularly in situations where the number of VCs is limited.  In that situation if the CEO is going to stay then the investor director should, whilst still being helpful where possible, take a back seat and not let their disagreement with the CEO get in the way of the functioning of the company.

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1. Have a great company!  I almost put this point as a footnote rather than a member of the list because it is so obvious, but when I thought it through I figured that a lot of people go out to raise money when they are still working out for themselves whether they have a great company or not.  That is ok, up to a point, but only up to a point.  Most VCs understand that the product will iterate and the plan will change over time, and like to back entrepreneurs who will absorb and act on market feedback.  But, they also want a Plan A which is exciting, and raising money before Plan A has been worked on enough to be compelling is always going to be tough.  It is still possible (and I would say advisable if you can) to have discussions with VCs before Plan A is baked, but they should be couched as ‘getting to know you’, or ‘advice’ meetings as opposed to fundraising meetings.
2. Make sure a large pool of investors are familiar with your company before you start the process.  VCs find it much easier to invest in companies and people they have known for a while, Mark Suster explained why in his post Invest in lines, not dots “The first time I meet you, you are a single data point.  A dot.  I have no reference point from which to judge whether you were higher on the y-axis 3 months ago or lower.  Because I have no observation points from the past, I have no sense for where you will be in the future.  Thus, it is very hard to make a commitment to fund you.”
3. Have a clear plan.  It is almost impossible to spend too much time honing and clarifying key messages.  Make them simple, easy to remember, and easy to pass on.  Use stories and soundbites.  Try them out on friends and colleagues, including non-techies.  The VC partner proposing a deal has to explain it to their partners, so make it easy for them!  This advice holds for all aspects of the business plan, including the financial model.
4. Create a sense of competition.  Making a decision to invest in a startup is a big deal for the VC partner proposing the deal.  We typically make 1-2 investments each year and we bet a piece of our career on each one.  On top of that we are busy people.  Without competition in a deal it can be difficult to create the urgency needed to overcome the natural desire to do more due diligence, and to get to the top of the priority list so a decision is made.  Plus the fact that other VCs are looking at the deal provides some validation.
5. Be prepared, organised, and courteous to investors.  Fundraising should be treated in many ways as a sales process, where the product is equity in the company and the investor is the customer.  Companies who prepare well with the information that investors will need, are organised with meeting times and follow-ups, and are generally courteous to investors have a much higher chance of success.

I have picked out five individual factors here, but in reality they are all highly interdependent – getting to know investors before fundraising helps improve the quality of the business and clarity of the plan and will also help create a sense of competition, and having a clear plan and being organised is the best way to pique the interest of a number of investors simultaneously.  Similarly, whilst these are the top five there are many other elements that are critical for a successful fundraising.  Unfortunately for most people there are no tricks that will short circuit the fundraising process.  I say ‘most people’ because the one exception to all of this is entrepreneurs who have previously had a lot of success.  They are often able to raise money based solely on their reputation and a good idea – i.e. without (yet having) a great company, clear plan, sense of competition or a lot of preparation.

I’m returning to it today after reading Roger Ehrenberg’s post on his excellent Information Arbitrage blog about how some companies make the mistake of committing themselves to having to raise venture capital when they think and believe they have the potential to get the big exit, but when in reality it is too early to be sure:

I think one of the hardest parts of being an entrepreneur is trying to honestly assess the magnitude of the opportunity being addressed and to finance the opportunity properly. For instance, there is absolutely nothing wrong with building a business that in all likelihood is a “small” outcome (let’s say an exit in the low tens of millions of dollars). …  But to be clear, the investment math of these kinds of businesses generally don’t work for venture firms and as such, should be capitalized and operated in such a way that they don’t require venture backing. …..

I frequently see disconnects between founders (“This business is going to change the world”) and venture investors (“Really? You are super smart and I love your enthusiasm but I respectfully disagree”) after a business has already been angel financed. The company has financed itself and calibrated its burn rate on the assumption that venture investment will invariably follow, and when it appears that this assumption was incorrect – doh! Unless you’ve got the right angels, it may be very hard to get additional financing out of your original syndicate. And if you’ve set up the business such that your structural burn rate leaves you between a rock and a hard place, there is generally only one answer left: fire sale/acqui-hire. And this is not what anyone was looking for going into this exciting, “world-changing” investment. This could have been prevented by spending less aggressively, getting to revenues earlier and selecting investors who have the mind-set and resources to support the company during its ugly teenage years (read: Years 2-3). And if, by chance, it really does appear that the company has the chance to be truly disruptive, smart and patient venture capital is always there to support a scale opportunity.

That’s a long quote from Roger’s post, and it’s pretty dense reading (not least because I cut some bits out) but to repeat/summarise his point is that

• it is hard to know how big your opportunity is until you get into it
• if you build a cost base that assumes the opportunity is big and you turn out to be wrong you will be in trouble
• whereas if you keep your cost base down you retain the ability to generate a good outcome for everyone with a relatively small exit and you will always be able to raise venture later
• therefore you should wait until you *know* your opportunity is big before you scale expenditure

This raises the question of when do you *know*? or more accurately how sure is sure enough?  As Roger says this is one of the hardest things an entrepreneur has to assess. 

One good test is when VCs start believing you.  Another good test is when you have talked to enough people that you know all the counter arguments and have good answers for them.  One pitfall to avoid is not trying hard enough to seek out counter arguments.  Another is to acknowledge a potential powerful counter argument, but not consider it properly, usually with a variant of “yes that might be a problem, but if it is we will fix it down the line, and if you worry about it now then you are focusing on the wrong thing, or simply don’t get what we are about”.

Exits are what make the venture world go round and whilst they are still happening the market will stay buoyant.  There has been a lot of talk this week about whether appetite is drying up for Series A deals, but whilst the exits keep coming I wouldn’t expect to see any radical shifts.  Sure, investors will get smarter (learning again that eyeballs and growth aren’t always lead indicators of value) and the macro environment might make them more cautious, but it will take a collapse in the exit market to really change behaviour.

After the panel session one of my co-panelists, Chinwag’s Sam Michel, repeated something I had said back to me, and that something has been running round my head ever since.  Last week was supposed to be a holiday, although I ended up going to the US for two days, and for us holiday time is family time, and I try to keep the work to a minimum, which means no blogging.  Hence this is my first chance to share the thought.

Hopefully by now you are almost overcome with a desperate eagerness to know what it was that Sam chose to repeat back to me.  The sharp eyed amongst you will have deduced from the title to this blog post that it relates to a common misconception about venture capital.  In fact, ‘misunderstanding’ might have been a better word, and I toyed with the idea of using ‘Why venture capitalists are misunderstood’ as a headline….. (that’s a joke ).  The words were (more or less):

Venture capital is for accelerating the development of existing companies rather than funding them at the true startup stage

Sam’s point was that too many people in the UK and Europe think that VCs should fund, or do fund, the true startup stage.  The unfortunate consequence of this misconception is that time is wasted trying to get meetings and investment from VCs, and all to often this turns to dislike of, or even contempt for, the VC industry.  A common perception is that the VC industry is flawed because it doesn’t take enough risk.

That’s unfortunate.

I work as a VC because I believe that for the right companies a timely investment of say £5-20m can accelerate growth and make the difference between being a highly valuable market leader and a much less valuable smaller player.  The caveat ‘for the right companies’ is crucially important though – only a very small subset of companies are in the right place at the right time with the right product and the right team to have a shot at owning a market.  For the rest it is a mistake to raise venture.

Also unfortunate is that VCs are responsible for this misconception.  Not in any deliberate way, but rather because as an industry we haven’t traditionally felt the need to be clear about what we do and don’t do.  One of the challenges is that presenting a clear picture requires getting across a complex message – some VCs do fund the true startup stage, or at least they do so occasionally, whilst most others, including my fund DFJ Esprit, do a small number of seed deals each year.  These are not true startup companies, they usually have at least an early product we can look at, but they are not that far along either.

The fact that sections of the entrepreneurial community believe the VC industry is doing a bad job isn’t good news for anybody.  It can only lead to fewer people starting companies and fewer companies capitalising themselves properly.  It probably also has negative consequences for government policy.

Hopefully this post has made things a little clearer.

Despite this backdrop VCs have been enjoying some good success recently, most notably of course with Facebook, but there are many other examples on both sides of the pond, including our own run of exits.  This success has fed through to VCs paying higher valuations to invest in startups, and many of us have been wondering how long that will continue given the poor macro-economic picture. 

The most obvious catalyst for change is a decline in exit markets, in the first instance driven by weakening appetite for IPOs.  The other catalyst is a decline in the amount of money VCs have available to invest.  However, the volume of new funds raised in any given quarter will on average represent around 10% of the funds in the market, so there won’t be an effect on valuations unless this trend continues for a couple of quarters.