How to avoid a “no” from a VC – part 5 (Potpourri)

So far, we’ve covered the “big four” risks in a start-up that are front of mind for every VC when you walk through the door (People, Product, Market, Financing).  But there are some other issues, irritants and obstacles you can inadvertently toss in your path that don’t fit nicely into those categories.  While not as important as the big four, they can still direct an otherwise positive impression in the wrong direction.  So, beware of:

The ill-advised adviser:   This is a tough one, because once I describe the issue, you’ll ask for specifics that we’re not comfortable giving out. But here’s the situation….you come to visit and either bring along with you, or mention that you have a key relationship with someone who we know is either a pain in the rear, or worse a charlatan who doesn’t know what they are doing.  The former adds a level of friction to a process where we already have many more interesting new companies to look at than we can invest in – risking us taking a path of lesser resistance.  The latter reflects badly on your process of selection of key people (and puts up a big red flag on the People risk domain). 

But, you say, “How do I know these advisers are going to be a negative?  I’m new to the start-up scene and have no way of knowing who to trust.”  Well, this is one of your first tests.  We can’t get comfortable revealing the names of these folks (and there are only a few) who raise the hair on the back of our necks, because you never know when they’ll hook up with the next killer deal and we do not want to be black-balled by those advisers.  But, you can look around, ask around and see who we and others prefer to deal with. 

Start with the law firms who guide most start-ups around town.  There are a handful of these, and they are all quite professional.  Use them as your introduction source to us, if you feel you need one.  This is not to say those firms can’t be appropriately tough with us when they represent you.  But it says they know the rules of the game, and we know they know.  So everyone tends to operate in good faith, while representing their respective positions.  A secondary message here, you don’t need to pay anyone to introduce you to us.  A quality service provider (lawyer, bank, accountant) will do so at no charge.  Better yet, they tend to know what we have funded and have not, and can point you towards the most likely VC match.

Another thing you can do is ask us (or folks like us), “We’re looking for someone to advise us in area X. Can you recommend anyone?”  What may be most interesting to you are not the folks we mention, but those we don’t mention.  Sometimes, that can just be a momentary oversight.  But if you ask a couple of VC firms that same question, and there is a consistent name or two missing of someone you were considering using, then you have your answer.

Control and dilution, not optimizing for success: One of the obvious questions we’ll ask you is how much money you need.  There are many possible right answers, but a couple of wrong answers, too. 

If you respond with, “It depends on valuation,” you just told us you are optimizing for dilution rather than for success.  The company needs a certain amount of money.  In fact, it probably needs more than you think to allow for likely slippage somewhere in product development or customer traction.  But if you skinny down the raise to optimize for dilution, you have dramatically raised the risk of running out of money at an inconvenient time.  (BTW – there is no convenient time) 

If you respond with, “I don’t want to give up control,” you’ve just hit two negative points.  First, as I’ve said in earlier posts, when you take institutional money it is no longer about you, or about us.  It’s about optimizing the value of the enterprise for all stakeholders.  So “you” and “in control” are off the table as primary issues.  Second, someone once gave me a very cogent piece of advice.  He said, “When you are running a company, there is only one way you are in control.  That is by executing.  If you own 100% of the stock, but don’t execute, someone else is in control (the bank, your customers, your suppliers…).  On the other hand, if you own 20% but execute, you have all the control you’ll ever want.  No one will do anything other than sit in the back of the bus and cheer for you.”  It’s true.

With too many angels, you’re in hell. Angel investors can be enormously helpful.  Sometimes, they may invest prior to VCs being willing to. (But DO NOT accept the notion that this is always true.  We have backed MANY companies that came to us with a business plan, and nothing else.  Angels love to try to position VCs downstream from them, to make sure they get their bite at the apple.  As with all things, the truth is fuzzier than that.)  But angels, if selected carefully, can provide business and industry guidance and connections along with their cash.   We often invest in rounds where angels provided the initial seed money, and have good, long standing relations with them afterward.

However, there are two potential problems with angels.  First, they often are good for the first check, but have trouble with follow-on financing rounds.  And, if the terms include a “pay to play,” which means an investor who does not participate in later rounds gets crushed, those glowing halos can turn dark in a hurry.

In addition, unless you really fancy yourself as a cat-herder, the more angels you add to your cap table, the more cats will need to be herded.  And some of these cats will keep you up at night with yowling if you aren’t right on plan, or right on the phone when they have a question.

I have a good friend who has raised an enormous sum from angels for his company (>$30M).  While he must now be ranked as an expert cat-herder, he’s also on the cusp of becoming a public company by default.  That threshold is at 500 shareholders, and he’s very, very close.  When he started, you can be sure he never dreamed it would take so much money, so many investors, and so much of his time.  He eschewed VCs early on, but suddenly has found religion as he approaches the 500 investor mark.  One $10M check is a whole lot easier than two hundred $50,000 checks!

“We’re selling stock at $0.50 a share.”  Your price per share is meaningless to us.  What matters is the implied company valuation (price per share times number of shares).  In addition, I hate to be this blunt, but the price paid will be what we offer, not what you ask.  Now, that’s not to say there won’t be some back and forth negotiations.  But the surest way to scare off a VC is to put a valuation on the table that we know is crazy.  Rather than try to educate you to how the world works in private equity, we’re likely just to move on.  When someone asks you what valuation you are expecting, answer simply, “The market will determine that.”  Your job is to get an offer.  With an offer in hand, the games can begin.

“We can’t tell you what we’re doing until you sign a NDA.”  We can make this very short. We aren’t going to sign it, so you can decide before you visit whether that is really a criteria or not.  Practically, we see thousands of new start-ups every year.  There is no way for us to be in absolute control of or even remember everything we’ve seen and heard about.

Now, that said, those of us who do this for a living do operate with enlightened self-interest.  We know that if we EVER violated the confidence entrepreneurs place in us, the word would get out and we would no longer see the best deals.  And that is a prescription for death in our industry.  So, deal with an established VC firm, and your ideas should be safe.  Of course, if the issue is one of disclosure for a potential patent, we’ll find a way to make sure your IP is protected.

Let me close with one of my favorite entrepreneur stories that trumps the NDA example.  Years ago, I was approached by an entrepreneur who said he had a technology that was going to revolutionize the world.  In fact, it was so powerful that the company he was starting would reach over one billion dollars in revenue in five years.  There was only one catch:  he couldn’t tell me what it was until AFTER we’d invested $10M.  Now that’s a powerful position!  :-)  I guess he never found that investor/sucker, because I’ve never heard of him again.