Speical Report

VC Primer 2002

by Steve Z. Szirom

The venture-capital landscape has changed dramatically from several years ago, when a cool idea and a few key founders were all that was required for a startup to receive funding. This year has been difficult for entrepreneurs, who were having a hard time even before September 11 and now must take additional action to ride out the storm. The reality founders are facing is one that requires them to revise their attitudes and mindsets about the valuations of their companies-which is not easy, given that they were witnesses to the big-money glory days of the recent boom. The bottom line is this: Be ready to accept tougher terms. Liquidation preferences, anti-dilution protection, VCs demanding bigger percentages of companies, bridge discounts/covenants, and negative covenants (terms based on performance) are now par for the course. Founders should look for added value, be visionary rather than arrogant, and be prepared to restructure compensation if it is out of balance.

InsideChips attended a recent Garage Technology Ventures Bootcamp for Startups™ , and we observed the ambitious entrepreneurs present at the two-day event receive a dose of "tough love." After a startup team receives its 3F (friends, fools and family) funding, the next round will be much tougher to close. The bootcamp stressed that, to be attractive to venture-capital companies, startups need the 3 'T's—experienced teams, technology, and traction. Traction refers to signing up one or more key customers for the product, thus generating some market momentum; startups that have received customer validation for their technologies stand a much better chance of getting funded. Concept companies are dead in the water, as far as funding goes.

VC Primer 2002 Continued…

Some ground rules still apply. When a new venture is ready to pitch to a VC, a third party should make the initial introduction. This could be an industry associate of the VC, an attorney, CPA, or consultant who has ties to the venture-capital community. Garage, which is profiled in this issue (page 9), provides clients with introductions to its VC network as part of its services.

To avoid wasting the precious time of both VCs and founders, it is a good idea to contact only those VCs that have an interest in investing in your sector. Blanket mailings do not work.

The first pitch should be short and to the point: a one- to two-page executive summary sent via e-mail and, later, a 10- to 15-page Powerpoint presentation (VCs are notorious for having attention deficit disorder). The initial e-mail contact should simply include the summary in the body of the e-mail. Rule of thumb: Polish your pitch so you can state your company's "raison d'jtre" in one insightful sentence.

Based on my experience, I believe an additional caveat is not to make the pitch unless it is to a senior partner at the VC. Only senior partners can decide to do a deal. A meeting with a "junior" partner may seem constructive, but it will likely waste valuable time and result in no action. My advice: Move on to other VCs when senior partners are unwilling or unavailable to meet with you. Deals can take a long time these days, often five months or more, and time is scarce for entrepreneurs who must juggle building their ventures and hitting the road to seek funding.

One emerging trend is for startups to obtain funding for more than one round; i.e., they are "fully funded." Founders should consider skipping the seed round, which typically brings in only about $500,000-just enough to cover setting up an office, working on the business plan, getting incorporated, and hiring a few engineers.

A balancing act many presidents of startups must perform is keeping the VC happy with the ongoing due diligence process while simultaneously maintaining good relations and establishing credibility with customers. One strategy is to be cautious about releasing customer names and data too early in the process; you want to first be sure the VC has genuine interest and confidence in your company. VC firms often leave reference checking to junior employees who pummel the companies listed as references with questions in an effort to uncover weakness in the startup or its technology. Customers often resent that type of cross-examination.

Finally, bear in mind that while there is still a big pool of venture capital looking for hot prospects, senior partners are devoting large amounts of time to fixing the problems of their current portfolio companies—thus, they have less time to work on new deals.

Today, funding takes much longer, and entrepreneurs should learn to bootstrap and conserve their cash. Above all, persevere and never give up. It is not that unusual for founders to make several hundred pitches before securing initial funding. Investors are looking for CEOs who are very passionate about their ventures, and whose significant personal investment reveals a devotion to ensuring the ventures succeed.

Steve Szirom is executive editor of InsideChips.com and he may reached at szirom@insidechips.com