Tuesday, March 2, 2010

4 Thoughts on How to Get Funded by VCs

Last week at the Southeastern Venture Conference, I listened to a panel called "2010: State of the Venture Market." The panelists (Jack Biddle from Novak Biddle, Bob Hower from ATV, Dan Marriott from Stripes Group, and Lou Volpe from Kodiak) ranged pretty widely across the venture capital landscape and touched on some great insights for emerging growth entrepreneurs. Below in bold are 4 quotes that I found particularly interesting with my thoughts following.

1. "You need a big idea." -- Bob Hower.

This may seem obvious. Why start an emerging growth company if it is not based on a big idea? But it seems that almost every day I am approached by an entrepreneur with an idea that is just obviously not big. Maybe it is a great feature for another product? Maybe it is a neat app that few would actually pay for? Maybe it is a niche product that people would pay for, but there aren't that many people in the niche? Nevertheless, what these concepts have in common is that they do not have BIG potential. By big potential, I mean they do not have a chance to achieve massive scale or massive profitability. The thing about early stage venture capital is that for the VCs business model to work, they need to see returns of not 3x or 10x but 20x or 50x. That is because out of 20 portfolio investments, VCs anticipate that only 2 to 5 will be successful. (YMMV depending on the VC.) The typical VC is not interested in a 3x exit with a high likelihood of success. He is really looking for the homerun and the 50x exit. Consequently, every company he backs must have that home run potential. If you are really just a feature or a niche product, my guess is your TAM is not going to get a VC that excited.

2. "I need to know that you're not just making it up -- you need a single objective data point." -- Jack Biddle

In a word -- you need TRACTION. Your big idea is all fine and dandy, but can you prove that it works? VCs in 2010 are just not investing in two guys with an idea sketched out on a cocktail napkin (likely over cocktails). They need data points. Now, this doesn't mean that they need to see profitability or even revenues. But it does mean that they want to see that you have something that people are interested in using. Can you show adoption? Can you show a nice upward trend in hits? New users? Retention rate? Or some other metric that accurately captures why your idea is great? In a technical field, do you have your patent? Have you successfully completed Phase I clinical trials? Etc. The point is, you need to give your VC a hook to hang your idea upon. Just one single objective data point ...

3. "You have to be able to sell for a valuation that has no rational relationship to your earnings power." -- Jack Biddle

This is similar to the "big idea" requirement, but is more nuanced. What this is really getting at is "what is your secret sauce"? Is it a hot new technology? Is it a rock star team? Is it a revolutionary now business model? How can you justify to a buyer that they should pay a 12 or 18x multiple on EBITDA when competitors are selling for 7x? How do you justify a $3B pre-money valuation when you have not earned a single cent but you have traction that is through the roof? These mysteries are what make working with emerging growth companies such an exciting opportunity. And the perceived presence or lack of a "secret sauce" will often prove the difference between finding VC funding and not.

4. "Immediately out of the chute [an early stage company] will have international operations, whether in India or China, etc." -- Lou Volpe

A great reminder of the globalization of all things. Not only should you be looking overseas for crowdsourcing, coding and design assistance, but you should be watching your space overseas to see what competitors are up to. For many, it is no longer possible to say "we'll build market share in the US for 3 years, then head to Europe, and then maybe Asia later this decade." By later this decade, Asia will already have lapped you if you are not paying attention.

One last bonus thought that I think brings the VC capital raising process home:

"This is all about money and the money chases returns." -- Jack Biddle

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Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.