Technology Funding Venture Capital

TEN THINGS THAT CAN MAKE OR BREAK A DEAL

An entrepreneur's guide to venture capital financing for early-stage high-tech startups

Why do only a small fraction of the business plans that are sent to venture capitalists get funded? Most would simply answer that there are too many deals chasing too few investment dollars. Venture capitalists will tell you that the real reason is that there are not enough "quality" deals.

The entrepreneur and venture capitalist often view the "quality" of a deal very differently. The inexperienced entrepreneur often makes the mistake of not realizing that the venture capitalist will judge the "quality" of his or her deal relative to other deals that the venture firm is considering. So the entrepreneur must be cognizant of the fact that raising money is not simply an exercise in selling yourself and your deal to win a scarce amount of venture capital. Rather, it is truly a business plan competition against other startups to win the most "mind-share" of the venture capital investor. Entrepreneurs who are the most successful at raising venture capital financing understand this fundamental point and strategically market their deals based on this knowledge.

This guide describes some of the things that a high-tech entrepreneur should consider when raising early-stage venture capital financing - the "ten things that can make or break a deal.

1.  Referrals - will you be on top of the pile or the bottom?

In any given year, a partner or associate in a venture capital firm receives as many as 750 business plans - that's 62.5 plans per month or 15.6 plans per week. In addition to working on due diligence for new deals, the venture investor is often actively participating in the firm's existing portfolio companies - attending board meetings, recruiting and working with management. Given these other obligations, the venture investor is left with little time to thoroughly review business plans for new deals. However, a new deal that is accompanied by a referral from someone who has a relationship with the venture investor, such as a CEO or senior executive of an existing portfolio company, an attorney or even another venture capitalist, will get attention and will rise to the top.

2.  Management, Management, Management - do you have the athletes?

Management is to startups as location is to real estate. If you don't have the right management team, you'll never maximize the opportunity. Venture capitalists want to make sure that the team has the relevant experience and innate ability to execute on the plan and "turn-on-a-dime" if necessary to make changes or hard decisions in order to get the business on course. The team must consist of people with the skill-sets necessary to execute the plan in order to achieve the milestones that will be needed to justify a step-up in valuation at the next round of financing.

3.  Portfolio Fit - Babe Ruth, Ted Williams or both?

Some venture firms, like Babe Ruth, only want to hit home runs - create billion dollar companies - and will accept a lot of big strike-outs - high risk ventures and bankruptcies - to take that chance. Others, like Ted Williams, prefer to hit lots of triples, doubles and even singles - create lots of solid $100 million companies - with a higher batting average and on-base percentage. An entrepreneur has to figure out the partners' philosophy in this regard and determine if the deal is the right fit for the firm. The same analysis should apply to the type of deals a firm does. For example, don't send a biotech deal to a firm that only does information technology investments.

4.  Partner Politics - are you dealing with a democracy or dictatorship?

Getting approval from one partner may or may not make the deal happen. Most venture firms have a prescribed formula for how deals are approved by the partnership. Some require unanimous consent by all partners, while others only require majority consent. On occasion, a partner may have funds available to invest under his or her sole discretion. When it comes to Associates, some have the power to vote and advocate a deal, while others don't. Whatever the case, an entrepreneur should understand how an investment decision is made and play the politics accordingly.

5.  Reversing the supply/demand imbalance - are you creating a sense of urgency?

This is an art form, but the basic idea is to get multiple investors interested in your deal at the same time. Venture investors don't want to see "their" deal get funded by someone else.

6.  Momentum - are you giving them more reasons to say "yes"? Don't stop executing while you're raising money. New customers/sales, partnership deals, reports by analysts on the Company, etc. help validate the opportunity and build confidence in the management team. If you can make progress and good things happen during the fundraising process, you'll have a higher probability of closing a deal and closing it faster.

7.  Executive Summary - your first and often only impression!

Of the partners making a decision on your deal, only one, your sponsor, usually reads the entire business plan. However, all of them will read the executive summary. The executive summary should be the entrepreneur's main sales document, while the rest of the business plan should only serve to support the material in the executive summary. A voluminous business plan is a sign to a venture investor that the entrepreneur is spending far too much time analyzing and not enough time executing.

8.  Recruiting - a measure of quality!

If really good people commit to joining a startup once it's funded, that's a good sign. If really good people join a startup before it's funded, that's a great sign. Anything short of that and the investor will have doubts about the quality of the deal and will be less inclined to invest. It is the entrepreneur's responsibility to build or convince the venture investor that he or she can build a team that can execute on the plan.

9.  Proprietary Competitive Advantage - what about the 800-pound gorilla?

Surprisingly too many entrepreneurs focus their competitive focus solely on new entrants and not enough on the "old-economy" behemoths. But these companies usually have the cash, and existing distribution networks and relationships that can easily kill off any entrepreneurial dream. The days of "first-mover" as the sole competitive advantage are over - entrepreneurs need to build defensible competitive barriers into their business strategy.

10.  Location - if it takes me more than an hour to get there, I'm not interested!

One well-known venture capitalist actually has this down to 30 minutes. In either case, there is good reason for this. In early-stage companies, where there's a lot of "company building" to be done, the venture investor is actively working with the management team and does not want to spend valuable time commuting. So, if you're an early-stage high-tech entrepreneur, heed the words of Willy Sutton and start your company in the Bay Area, Boston or Austin - because "that's where the money is."

© Peter N. Loukianoff, September 2000.
All rights reserved. The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete, and its accuracy cannot be guaranteed. Any opinions, facts and figures expressed herein are subject to change without notice and should not be relied upon for financial or other material business decisions. This guide can be found on http://www.technologyfunding.com/resources.html. The author was a venture partner of Technology Funding, Inc., a venture capital firm in San Mateo, California.