Raising venture capital: the ‘Art’ behind the Science

I am sitting at Mesh, Oslo’s new technology center for startups.  If you ever want to see an awesome startup place, come to Mesh (www.meshnorway.com).  It’s a coffee shop + accelerator + co-working space + night club all in one, right in the heart of downtown Oslo.  Startups and investors alike come to Mesh to work, network, negotiate over coffee, brainstorm new ideas and wind down at the nightclub.

The Mesh Founders built a place that is fun, productive, well located and destined to accelerate Norway’s startup community.  And the best part: Mesh itself is a startup, conceived by tech entrepreneurs with seed capital and sweat equity.  A place built by Founders, for Founders.  Neat.

But why talk about Oslo when this blog title is ‘Fundraising’?  Because being here is like deja vu:  I see the same struggles in Oslo as I see in other high tech cities around the world.  The most frequently discussed topic? ‘It’s really (really) difficult to raise capital’.

Hm.  Capital is difficult to find in Norway?

Norway is a very wealthy country with one of the highest GDPs and largest budget surpluses (per capita) in the world.  It has an energy-driven economy that is on fire, unemployment around 3%, GDP projected to stay strong for the next several years and a ‘national pension fund’ that has saved ~$150,000 for every citizen in the country.

Yet even in wealthy Norway it is difficult to find venture capital.  Startups voice the same complaints I hear in Finland, Argentina, Singapore, Brussels and Barcelona:  It is not easy to meet investors.  We are uncertain what to say.   It’s difficult to get them to fund our idea.

So I thought it might be helpful to write a blog that helps Founders get into the heads of investors.  A ‘view from the other side of the table’, so to speak.  I dusted off my own list of insights that I regularly share with Founders.  I also checked with some of the smartest VCs and angels I know and asked three questions:

1.  How can entrepreneurs most efficiently meet an investor?

2.  What is most important to hear from a Founder in his/her first pitch?

3.  What are the most common mistakes you see Founders make when raising capital?

They were generous in providing their thoughts.  So in no particular order, here are our collective, top insights on the ‘art’ of raising capital:

1.  Know your VC.  Be sure to know the VC to whom you are pitching.  What categories do they invest in?  What stage?  Where have they created successful exits?  Make sure you fit their filter because this is where the investor can offer you maximum value.  Few things frustrate VCs more than blind business plans that have no alignment with the firm’s focus.  Don’t waste their time or yours with a request to pitch an idea that is not in their area of interest.

2.  Arrive by introduction.  A great way to get a meeting with a VC is by introduction from someone the VC knows and trusts.  This includes investors, Founders, advisors, attorneys, limited partners and portfolio companies.  One particularly smart investment is to create an Advisory board and make sure it has members with good ties to VCs.  One of the most powerful things an Advisor/Board member can do is open a door to a source of funding.  The investment world thrives on trust and if someone can make that trusted introduction, you are that many more steps ahead.

One of the smartest, most successful VCs I know offered this advice:  “Find another Founder with whom I (the VC) am already working, and who has some experience in your space.  That Founder will likely be more than willing to set up an introduction.  Why?  In my experience, Founders really go out of their way to help other Founders.  For me (as a VC), this type of introduction really ‘cuts through the noise’ and I will go out of my way to meet you, if a Founder I know recommends you”.

3.  A 10 minute pitch.  The best pitches last 10, maybe 15 minutes.  Tell the VC up front that your pitch will be short, and you hope to leave 50% of the time for questions.  In this way, there are three possible outcomes:  Pitching on time and getting no questions means they did not like it (the good news:  you know this and won’t spend any more time chasing this investor).  Pitching on time and getting lots of questions means you are getting great, free advice at worst case and strong investment interest at best.  Both are good outcomes.

Pitching too long and leaving no time for questions means you screwed it up.

4.  Problems & Markets; not Products & Solutions.

It is really important to hit on the problem you are solving early in the pitch.  If the VC doesn’t understand what the target problem is, as well as who cares about that problem, all the terrific product and solution details are for naught.

Founders often spend their entire pitch talking about their product.  Yes, it is ‘your baby’ but the solution is secondary to the problem and your insights into the nature, size and urgency of that problem.

Start your pitch talking about the problem you are solving, followed by a detailed description of the markets that have that problem.  Right down to an actual ‘day in the life of your customer’ story if possible.  Once you’ve established clarity on problem and market, move on to your unique approach, product or solution.

Although this sounds very rational, you would be surprised how few Founders actually present in this sequence.

5.  Talk about risk.  Don’t downplay risk.  It is a given in venture capital and a negative if you don’t understand and explain yours.  Moreover, some risks are more acceptable than others.  VCs want companies and teams that accept higher technology, product and team risk; but where sales/market risk is as low as possible.  Think about this: you generally have more control over technology, product and team risk, yet little ability to control market risk (short of massive marketing budget to create market pull).  Don’t downplay market risk, but be aware this is one of the most difficult to manage.

6.  Money for Milestones.  Few things are more frustrating than hearing an entrepreneur ask for capital ‘so their company can execute for ‘x’ more months’  Do you realize how uninteresting that sounds?  Investors provide capital in exchange for accomplishing meaningful, measurable milestones that increase valuation.  They generally do not care how long you will spend their capital, they care more about how will you use that capital to achieve results.

I advise Founders to talk about fundraising in three stages.  First, look back:  what did you accomplish with the capital you raised so far?  Next, look around: what meaningful things will you accomplish with the new capital you are asking for?  3-5 key milestones is enough. And finally, look ahead: what additional capital do you expect you will need and what future milestones will you accomplish with that?

Think:  money for milestones (not time).

7.  The Market matters.  Investors want to understand your markets; those who use, pay for, resell or otherwise benefit from your solution.  The most relevant source of market validation is customers.  It is less important from research reports, analyst reports, other VCs active in the space or your own intuition.

If you believe there is a strong market for your product/service, go get evidence.  Find clear indicators of demand for the features, functions, price points and business model.  Create assumptions and test them, ideally before fundraising.  Share your assumptions and test results with the investors.

8.  It’s all about the percent.  As you get closer to a funding event, understand that investors generally care more about the percent of ownership than size of investment.  This can lead to some interesting, if not amusing, opportunities for Founders.  Consider one team of Founders I worked with some years ago.  A VC was showing considerable interest.  The Founders’ initial ask was for $2M at a pre-money of $8M, giving the VC 20% of the company.  The VC agreed to give $2M, but only at a $4M pre-money valuation, resulting in 33% post-valuation ownership.  They would not back down.

Now, this was a top tier, Sand Hill Road VC with a deep network and a solid track record of exits.  Thus the Founders were motivated to close the deal, but did not want to give up 33% of their business.  So they sharpened their pencils and concluded they could accomplish most of their original objectives for $1M.  They went back to the VC and asked for just $1M at the $4M valuation.  The VC countered they would be happy to offer $1M, but at $2M pre-money valuation – resulting in the identical, 33% post-investment ownership.

Do you see what is happening?  The VC wanted a certain percent ownership; the size of check was much less important.  The end of the story was that once the Founders understood the percent game, they went back to the VC and asked for $3M in exchange for 33%.  The VC agreed.  Everyone was satisfied.

As an aside, A-round dilution between 20-35% is ‘about right’.  Owning 40%+ can really muck up your cap table.  Owning less than 20% is often too little to be interesting to a VC.  If they believe in you, they want you to make it big.  And when you do, they want to be sure their fund has a meaningful share of that big exit.

It’s a fair deal.

9.  Get an outside Board.  Many Founders resist adding outside Board members in their first round (or two).  I see this particularly in countries where Founding teams are used to receiving Government grants up through (and beyond) their first million in funding.  I think this is a mistake.

Founders often view an outside Board member as a sign of losing control.  They worry they will have to be more accountable for their point of view or having someone push them to work harder and produce more results.  I agree these things happen, but I also think they are good.

Worried about losing control?  Get used to it.  As your company grows (and I know you expect this, right?), this is going to happen anyway.  So look at losing control as a positive sign that you are indeed growing.  And fast growth can be easier when an experienced Board member helps you through those early stages.  Worried about being accountable for your decisions?  Few things strengthen execution better than a well- defended decision.  Open, direct and honest feedback makes ideas stronger.

An outside Board is a good idea and a sign of a confident Founder.

10.  Some of the most common mistakes Founders make during their pitch

* Too much pitching product.  When pitching the idea, don’t spend too much on the solution and not enough on the problem and market opportunity.

* Having a poorly defined (or not defined at all) Minimum Viable Product.  Note:  if you didn’t fully catch what I meant by MVP, I recommend you read “The Lean Startup”.

* Being overly optimistic on development milestones

* Being overly optimistic on projecting the rate of market adoption.  The market adoption rate is the speed that customers will pull product out of your hands, and it is a vitally important metric.  Be brutally honest with yourself and your investors: How fast will your market really adopt your solution?  What evidence do you have that supports your thesis?

* Trying to maximize valuation in the early rounds.  This may feel good – for a little while.  But an overly aggressive valuation ultimately decreases your company’s attractiveness for the next round.  Think ahead.

* Not being willing to take critical feedback from investors.

*  Forgetting to sell their stock.  At the end of the day, you are building a business case that your company will eventually be worth $X and your investors will do their own math based on the probability of you reaching that value.  But to put it simply, you are selling the future value of your company’s stock.  Don’t lose sight of this.

Back to my visit to Mesh…  On my last day in Oslo, the Mesh Founders asked if I could meet a number of startups at their coffee shop.  I was happy to do so and had the pleasure of meeting four startup teams.  We sat for 30-45 minutes each, discussing their ideas, brainstorming ways to de-risk their business and just getting to know each other.

During those four hours, I also noticed a great thing happening at Mesh.  I saw a constant stream of young, energetic entrepreneurs coming in and out of the coffee shop.  Continuous meetings of small groups.  Lots of networking and socializing.  People introducing themselves, Facebook checks, Java programming.  Laughter, concentration, casual banter and intense discussions.

I couldn’t put a finger on it, but I had a growing sensation of being somewhere very familiar.  Then it hit me:  Mesh felt almost exactly like Coupa Cafe in Palo Alto.  Despite being halfway around the world, it felt like I was back home in Silicon Valley.

I hope every startup city can create their own Mesh, Coupa Cafes, or Cafe Torrefaziones.  Every startup city needs these kinds of places.  Nice work, Mesh team.  And great success to you!

In closing, an investor’s decision is part science and part art – yet ultimately guided by well-honed intuition.  I hope these insights help you to see what your idea looks like to an investor, and puts you that much closer to reaching your fundraising goals.

Good luck.

Chris Vargas

Helsinki, Finland / Los Altos Hills, California

May 9th, 2013


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