ETech: VC Funding for Geeks
This session was given by O'Reilly's entrepreneur-in-residence, Marc Hedlund. In it, he described how the process of securing venture capital for a startup is supposed to work, and how it really works.
How it's supposed to work.
Once you're incorporated, you pitch to a VC. Many VCs competing for your attention gives you leverage. You sign a term sheet (a non-binding document), then spend a month getting to a contract. After you sign the contract, you get the cash and it's all good.
Here's how it really works.
1. VC's don't start new companies. Your job is to create something from nothing. If you can find a way to start without a VC round in your pocket, you'll be a lot better off. How?
Get customers. You'll get a much better valuation with customers, and sometimes you won't get one without customers.
Angel investors. Find early stage investors who are willing to assume more risk.
Bank loans. These rarely work with software startups, but are worth exploring if you have few options.
Government grants. Ludicorp (makers of Flickr) started with a grant from the Canadian government.
Yourself. If you've got the cash, there's likely no better bet you can place than on yourself.
2. Focus on the business, not funding. You need a contingency plan if you don't get VC funding. But before VC funding, you should be focused on these things: building a product, getting users, making money, not spending money, and getting to break-even. Then, and only then, should you think about VC money.
What problems will VC money solve? Money, for a while. Credibility, maybe. Guidance and review (maybe good). Some introductions (maybe). Advocates for the company.
The best way to get VC is not to need it!
You likely need VC money when: you have millions in development costs, or your competitors are VC-backed (sometimes), or you need big partners.
3. No means maybe. Yes means maybe.
They'll give you a boolean answer, but it's really an int. Update them every month, because they will be wrong about many things about your idea (they know this). Keep feeding them information that will show them that you will be successful, so they can make the right decision.
Marc's company, Popular Power, had 3 of 5 VCs who offered them a term sheet say no to the initial idea.
If the reaction is positive, that does not mean they'll fund you. Marc claims there is an inverse relationship between enthusiasm and the likelihood of funding. The people he hated at first were people he liked most in the end. The critiqued his idea, which is good. You should work with people who will critique your ideas.
Pursue anybody interested in funding. Marc made the mistake of waiting for two "A-list" firms to come through in the future when a "B-list" firm had money on the table. The A-listers never came through, and the B-lister took the money off the table. Good enough is good enough. Always be closing on your VCS; if the great VC guys won't close, assume they won't ever close. "Charge headlong at anyone who will work with you."
If they say, "if only you'd support x, i'll support you," RUN IN THE OPPOSITE DIRECTION. Your answer should be, "convince me that supporting x is in the best interest of my business."
4. Funding is more than a full-time job. If you say "I'm going to handle [any job] and fundraising," you're kidding yourself.
Talk to as many VCs as possible, listen hard to everything they say, and look for patterns and think about what it means for your business.
The numbers, on average:
10 face to face pitches = 1 term sheet. It's not even flow though, he did 30 pitches and got 0 term sheets, stopped and re-thought his ideas based on feedback, then did 20 more pitches and got 5 term sheets.
3 term sheets = 1 financing
From pitch to term sheet: 2 months (may be 10 or more meetings). After about 2 months, you should be able to gauge if they're interested.
From term sheet to money: 1 month
Total time: 6-12 months
Funders are not founders, so don't expect them to help with the day-to-day minutiae.
Investors are not inventors, so they're usually not right about what they're going to invest in 6 months from now (so don't bother asking.)
August and December are vacation months. Venture capital is a consensus business; they can't agree when half of them aren't around. The best time to get funded is in September.
What you need to pitch a VC:
- powerpoint, 10-15 slides
- executive summary, 2-3 slide
- introduction to a VC (makes your pitch more credible if you are referred)
The rest should talk about the business that will be opened by the product, and should help the VC answer questions like:
- will customers care about this product
- do i want to work with these people for 5 years
- are there enough customers willing to pay
- are they high-margin customers
- what has changed to allow a startup to grow
- is there a sales channel that will be profitable
- are the numbers believable
- how much to get to profitability
Also, Marc recommends reading The Ten Day MBA.