The Confused VC Rule part II

In a previous post I walked through a bunch of generic questions VC’s ask that can alert the entrepreneur that the VC has no idea what you are talking about. Here’s a hilarious video that illustrates the point even further —

http://techcrunch.com/2010/10/05/stupid-questions-vcs-ask/

The Rule of 2

–> Take a startup’s business projections and multiply by 2, multiply by 2, and divide by 2. Successful businesses often require 2x projected capital needs, take 2x as long to reach the investment goal, and attain 1/2x of projected revenue.

This is my back of the envelope calculation whenever considering an investment in a startup. Let’s look at Company X:

COMPANY X

• Funding Request = $1,000,000
• Goal = Cash flow neutral in 18 months
• Annual Revenue 3 Years from Today = $16,000,000

Here’s what I do:

Apply the Rule of 2

• Money Company X will actually need = $2,000,000
• Goal = Cash flow neutral in 3 years
• Annual Revenue 3 Years from Today = $8,000,000

Keep in mind that this is often the result of a successful business and not every business. Successful means you are some small % of the 1% of business ideas that get to a point where there is a paying customer and real revenue. This is obviously not an exact science. The Rule of 2 is a good starting point, a good sketch. Given the Rule of 2, does the business still get to a point where a venture capital investment return is realistic?

Death by PowerPoint Rule

–> Refrain from sending PowerPoint presentations that have more slides than the number of minutes you have been given to present your business.

You may laugh, but this happens a lot. We typically give entrepreneurs 30 minutes on a 1st call to discuss the business and demo the product. This leaves plenty of time to ask a bunch of initial questions. Before the call we have received slides decks with 50+ slides that the entrepreneur suggests we “discuss in depth” during the call… oh boy

I recently realized that younger entrepreneurs that have been coached through leading business incubators like AlphaLab or TechStars get this right every time. Through these programs, entrepreneurs are trained to present their business in a concise, time efficient manner. These entrepreneurs continue to use this format when approaching angels and VC. A practiced and tight business pitch will go a long way towards getting a 2nd meeting and, more importantly, getting funded.

There are tons of “rules” out there regarding PowerPoint but most rules focus on overall, message headings, font size, etc. We all love to hate PowerPoint, but it is here to stay….this doesn’t mean that we have to overuse it!

The Dangling Carrot Rule

–> Refrain from sending introductory e-mails to investors that reveal little or nothing about your business…with the hope that the investor will reply with a “can you send some company info?”.

Our VC firm receives dozens of cold business plans a month. “Cold” means we have no prior connection to the entrepreneur and have no prior knowledge of the business. These types of opportunities tend to be of lesser quality, but we approach them all with an open mind.

Implement the dangling carrot if you want to lessen your chances of getting funded.

Dear Investor,

I have spent 3 years and $1M developing this breakthrough technology!!! The market for this product is HUGE, and I am looking for capital to expand my sales and technology team. Would you be interested in funding my company? I look forward to hearing back. My business plan is available upon request.

Regards,

______

Most VCs claim that you must network your way into a VC firm – in other words, find someone who can personally introduce you to a Partner in an investment firm. I find this to be extremely arrogant and do not adhere to this rule. BUT, when approaching a VC in a “cold” manner, be sure you do your homework on the firm, prepare a nice email with a succinct description of your business, and refrain from using the dangling carrot.

The Confused VC Rule

–> The harder a business is to understand, the lower its ultimate valuation will be.

Does an investor fully comprehend your business after reading a brief summary or after a brief conversation or is the idea mired behind technology jargon and acronyms? Is this business and value proposition easy enough for a 9^th grader to understand?

Hi Mr. VC, nice to meet you. Here’s how our technology works:

Here’s the truth: whenever you (the entrepreneur) talk about your business to a VC, the VC will always act as if he understands the business….we are very good at this. There are a bunch of canned questions that investors ask an entrepreneur to make it seem as if he fully understands the concept. Some of the more popular questions:

“How do you make money / What’s your revenue model?”

“Is the technology protected?”

“How many employees do you have?”

“How much money have you raised to date?”

“How much money are you looking to raise?”

If any of these are a lead-off question from a potential investor, more often than not he/she is having difficulty understanding the business. If you say enough to spark some initial interest there will be plenty of time downstream to dig into the details of the technology. Work hard on developing a verbal snapshot of the business that is concise, compelling, and super-simple because a confused VC = not your VC.

The “Smells Like What” Rule

–> Do not send a business plan via snail mail and smells like cigarettes or has a distinct coffee stain on the title page.

True Story — A few years ago I received a business plan via postal mail. I opened it, and it had the distinct smell of a stale cigarette. The smell began to overwhelm my desk so I had to throw it out. I’ve also received business plans with coffee stains, missing pages, corrupt CDs (videos), etc.

It should go without saying, but make sure you send a professional looking (and smelling) executive summary to investors. Actually, with very few exceptions, you should never send a hard copy business plan to investors – email is preferred.

Furthermore, you should never send a full business plan when first approaching a VC. I will touch on all the points in future posts.

Venture Capital Rules of Thumb

Over the past 5 years I’ve read a ton of business plans of companies looking for investment – some good, most not so good. A few years ago I started collecting a list of pointers or “venture rules” that I planned to one day share with everyone. About half of these rules are important tips that entrepreneurs should consider before trying to raise venture capital and VCs should consider while considering an investment. A majority of these rules touch on what “not to do” (these tends to be the more humorous pointers). ALL of these rules have resulted from real interactions with entrepreneurs and people in the VC community.

In respect to the companies, I will not disclose the names of the startups in any future posts. I will use fake names (Company X, Acme Corporation). An aside, Company X and Acme Corp are names that I have seen attached to some business plans that wish to remain so secretive about their product or technology that they will not even provide a potential investor with the name of the startup! This is an example of a venture rule:

–> “Be transparent when approaching an investor. A VC is not in the business of sharing ideas with people outside the firm”.