Venture Capital Without Illusions

It's common--particularly in Silicon Valley--to hear entrepreneurs complain about Venture Capitalists. They use the unflattering nickname "vulture capitalists". This attitude seems to have its roots in a misunderstanding of the role of the VCs and their relationship with the company.



Lord Palmerston has said that, "Nations have no permanent friends and no permanent enemies. Only permanent interests." Similarly venture capitalists and other investors have neither friends nor enemies--only an interest in making money. That's partly due to their nature and significantly due to their legal and ethical responsibilities to their investors. It's important to note that most venture firms are not investing their own money. They have large number of limited partners who are typically pension funds, institutions and wealthy individuals. Venture firms invest on behalf of those partners and are accountable to them. As a result, VCs can not have any more emotional attachment to the companies in their portfolio than a poker player does to the cards in his hand. They keep them and put more money in when they see the opportunity to make "venture returns" and cut their losses when they don't. This isn't right or wrong, it's just the cold, hard truth of accepting venture investment.

Successful investing is based on that old axiom, "buy low, sell high". VCs would like to invest a fairly small amount of money early at a low valuation and sell their stake four or five years later for hundreds of millions of dollars. That's the dream scenario. When you raise money as an entrepreneur, you wan to create an auction environment witih multiple bidders by convincing several firms that your company offers them a piece of this dream scenario.

In my experience there are four statements that an entrepreneur needs to make to attract the attention of venture captialists:

1. We've identified a significant and underserved segment. Dollars make markets not bodies. It's a lot more plausible to show that you'll get a small percentage of a huge market than 100% of a small one. It also gives you a little more room to make a mistake in your planning.

2. We have a strategy for serving this segment that is unique and compelling. Why will you succeed? People? Technology? Strategy? It needs to be simple and believable. Hope is not a strategy. Bankable business plans are not based on a pile of "Ifs".

3. We've already got some traction that provides proof that we can really do this. It's preferable to seek funding after you've started to put some numbers up on the board. The only exception is if you are a proven venture CEO in which case you probably aren't reading this entry. Otherwise, your plan is more credible when you've started to build the product, acquire some customers, make some sales.

4. There is a reasonable oppportunity for a significant exit through IPO or acquisition in a reasonable period of time. VCs invest to sell not to own. Their interest in your company begins when they can see a successful sale or IPO. It's important to show other transactions that demonstrate that when you are successful they can take their money off the table at a high valuation.

That's it. The guts of the venture business plan. After the investment is made in your company, the agenda for all subsequent board meetings is tracking your progress in keeping these promises.