The following is a guest post from Karl Treier. Karl is a serial entrepreneur, currently with ProspectStream and SaaS Capital. He currently blogs at The Alien Entrepreneur.
Be Better Prepared for Technical Due Diligence
I have been on the receiving end of several technical due diligence assessments instigated by VCs (pre-investment) or acquirers (pre-purchase). I have also been the inquisitor on a few occasions. So I thought it might worthwhile to write this post to share my thoughts on this process and hopefully help companies better prepare for this event.
The first thing to recognize is that the assessor is not there to catch you out, trip you, up or somehow prove you are incompetent, nor is it likely that he's there to try steal your job, so first and foremost don't be threatened or intimidated (it's not the Spanish Inquisition, after all "Nobody Expects the Spanish Inquisition"). It is however extremely likely that he or she is, or has been an entrepreneur and empathizes with you, so be cooperative and cordial (maybe even down right friendly). They will understand the challenges and the realities of startup, rampup and speedup life and are not expecting perfection. I personally would love it if every entrepreneur could get funded, or exit with an acquisition that gets them the rewards they have worked so hard to attain, but the reality is different. Remember however the assessor is contractually obligated to do a thorough evaluation and report honestly any deficiencies, to not do so would risk a lawsuit for negligence. Also keep in mind that the purpose of an individual doing this, rather than have the investor or buyer just deliver a survey to you for you to complete, is that they are evaluating you and your team, how well you think on your feet, how you engage, and your thought processes. So expect it to be an interactive conversation, more than an outright quiz or exam, which would be painful and boring for both parties.
In my opinion the primary purpose of the assessment is to evaluate four facets of your business from a technical standpoint, Vitality, Scalability, Maintainability and Continuity. Vitality, really? I'll admit no one has asked me to go assess the vitality of an organization, but I'll explain in the next paragraph why I use that word because I think it fits perfectly with what I'm looking for. I'll precede each section with the dictionary.com (edited) definition of each of the four words so you see just how well they fit the goals of the assessment, a narrative of the objective of assessing that characteristic of the business, and a list of questions you just might get asked.
noun, plural -ties.
1. exuberant physical strength or mental vigor: a person of great vitality.
2. capacity for survival or for the continuation of a meaningful or purposeful existence: the vitality of an institution
3. power to live or grow.
So what am I looking for when I assess the technical vitality of an organization? Really I'm looking to see first and foremost if the technical lead or founder is still excited about the business. Does he or she have a real vision of where to take the product next, are they a fountain of ideas. Sometimes the original technical founder(s) may have left, so is the replacement a caretaker, or do they have their own ideas of where to take the technology and business. In my opinion this is a very important thing to assess. The best and fastest growing software companies in the world have great technology leadership. You can't build great software companies with only MBA's at the top. Yes you need the MBA types, but you also need the engineer types that can see emerging technologies and see how they can be applied to the product to further the business. The truth is that great technical leadership also attracts great technical talent, which is essential to the vitality of the company, and essential to ensuring all the other bases we will discuss below are covered. Here are some questions you might get asked which really assess the vitality of the organization.
- Do you have a clear vision for where you want the product to be in one month, six months?
- When you advertise a programmer vacancy how many applications do you get?
- How many people have left, and how many have joined in the last year?
- Do you have people working for you now, who worked for you elsewhere in the past?
- How do you capture user feedback about the product, who sees it?
- How many releases have you had in the last year?
- What keeps you awake at night?
- Do you make interviewee's write code?
1. the ability of something, esp a computer system, to adapt to increased demands.
This one is pretty obvious though any assessment of scalability extends beyond the system itself to include the technical organization, and the answers to the first two questions below will indicate how the respondent thinks about scalability, not just from a technical perspective, but an organizational one also.
- What would you have to change to accommodate 10, 100, 1000 times more users?
- What would you have to change to accommodate a million users?
- What do you monitor?
- What metrics do you use to determine if you are not scaled appropriately?
- What aspects of the system do think might not scale well?
- Where are you hosted, and why?
- Do you use any third party services, what happens if they go down?
- Can you show me a network diagram?
- What single points of failure exist?
- What keeps you awake at night?
- How many open features/user stories are there, and how old is the oldest?
verb (used with object)
1. to keep in existence or continuance; preserve; retain.
2. to keep in an appropriate condition, operation, or force; keep unimpaired.
3. to keep in a specified state, position, etc.
Maintainability is a favorite assessment topic of investors and buyers alike. They usually are either paranoid that existing staff will head for the hills post acquisition, or incoming staff will discover a plate of spaghetti code, or they want to turn a non-profitable company into a profitable one by eliminating "engineering" or they worry that a potential future investor might discover a huge plate of spaghetti code during their due diligence and not buy. In all the above scenarios there is all too often distrust of the engineering types by the MBA types and so they want to know if the code maintainable? Usually it is. You might notice many of these questions below originate from Joel Spolsky's 12 point test, which I think it's OK to plagiarize because they are just common sense.
- Do you use source/version control?
- Do you build on check-in, daily, weekly, whenever?
- Do you require comments on check-in?
- Do you create unit tests?
- Do you have code reviews?
- What development methodology do you use?
- Can you deploy a build to staging or production with one click?
- Do you have dedicated testers?
- When do you deploy?
- Does the software automatically notify you of errors?
- Do you have a bug tracking system?
- Could you walk me through some code?
- How many defects did you close last month?
- How many open defects are there?
continuity [kon-tn-oo-i-tee, -tn-yoo]
noun, plural -ties.
1. the state or quality of being continuous.
2. a continuous or connected whole.
This is typically the area where often the greatest weaknesses appear in the assessment, particularly with younger companies. There is an assumption that the Data Center will always be there, and that nothing can go wrong, that the world will always stay the same. Even everyday occurrences like a few inches of snow (or feet depending upon where you live) can cause serious disruption that should be planned for. So many of the questions below are aimed at ascertaining if the technical lead lives in a utopian world where nothing goes wrong or if they allow their utopia to be tainted by a touch of realism.
- Do you have a Disaster Recovery plan?
- Do you have a Business Continuity Plan?
- Is there any part of the system that is understood by only one person?
- Is your Version Control system backed up, where, how often?
- If the Database Server exploded how much client data would be unrecoverable?
- If a 747 crashed into the Data Center how much client data would be unrecoverable?
- Does your staff have laptops?
Please don't take this as an exhaustive list of questions. Quite frankly the role of the assessor is to think on their feet and open up the questioning to explore avenues of weakness and strength. But what I do hope is that this post gets you thinking about how you would answer these questions, and what questions might get triggered based upon your answers.
Have you been on either side of the technical due diligence process before? What were the lessons you learned?
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The following is a guest post from Jeff Bussgang. Jeff is a serial entrepreneur and currently a general partner at Flybridge Capital Partners, a Boston-area early-stage venture capital firm. Jeff is also the author of “Mastering The VC Game”.
There is an old parable about the concept of commitment when it comes to breakfast. The story goes that when looking at a plate of the traditional fare of ham and eggs, it's obvious that the chicken is an interested party, but the pig is truly committed.
When I tell this story to entrepreneurs, my point is usually to contrast the approach VCs have to start-ups as compared to entrepreneurs. The VC is an interested party, but at the end of the day, if their start-ups live or die, they typically still have their job, their office and their portfolio of other investments. The entrepreneur, on the other hand, is the pig - truly committed to the outcome, with no fallback.
But lately I've been thinking about the parable of the pig and the chicken in the context of the characteristics that make a great entrepreneur - and the kind of entrepreneur that we VCs in general, and my firm Flybridge Capital in particular, like to back. In short, we like to back pigs - entrepreneurs who are truly and completely committed to the outcome of their venture, have a lot of stake, and no fallback.
How do we discern the difference between the two entrepreneurial archetypes? It's usually relatively easy, but sometimes subtle. Here are a few of the top characteristics we see in entrepreneurs who appear to be exhibiting behavior that suggests they're more like "chickens" when it comes to their start-up:
1) Prefer to wait to start their venture only after they receive funding ("We are ready to go, as soon as you give us your money." ...um, does that mean you won't start the company if I don't give you my money?).
2) Don't quit their day jobs before receiving funding. ("This has been a side project for a year, and I can't wait to focus on it full-time" ... um, if you can't wait - why are you waiting?)
3) Don't physically move themselves or their teammates to be in the same geography when starting their venture (think Eduardo Severin in the Social Network spending his summer in NYC).
4) Prefer to play a hands-off chairman role or look to quickly hire a COO/president in the early days rather than operate as the hands-on CEO/president. (I'll leave out the numerous examples to protect the innocent, but as a rule of thumb, companies with fewer than 40 employees don't typically need a COO).
5) Are unwilling to fully leverage their own personal and professional networks to drive recruiting, fundraising and business development.
On the other hand, the top five characteristics we see in "pig" entrepreneurs include:
1) Commit to the new company everything they have - even if that means moving their families, quitting their jobs, or even dropping our of their schools (as much as I don't want to condone or encourage this!).
2) Put themselves "out there" publicly and visibly with the industry, their relationships, family and friends. If the company is a failure, it will not be a quiet one.
3) Have not yet achieved a mega-success already and/or yet achieved wealth beyond the point of needing to work again. (I remember my mentor and boss at Open Market, CEO Gary Eichhorn, congratulating me when I became a first-time homeowner in the mid-1990s and observed: "I hope you got a large mortgage so that you are locked in and highly motivated to create wealth!").
4) Participate in a minimal set of outside interests and hobbies that aren't directly related to their business. Starting a company is a consuming, obsessive, 7x24 endeavor. Raising a family and remaining healthy is enough of a battle. When we see entrepreneurs with long lists of hobbies and outside interests, it's a red flag. One of my partners went so far as to look up the number of times an entrepreneur played golf one summer (which apparently is public information somehow, although I'm not a golfer so still don't know how he figured this out) as a barometer for how hard they were applying themselves to their new venture.
5) There exists a rare breed of entrepreneurs that have already had mega-success are so special and driven that they remain obviously hungry and scrappy. For these entrepreneurs, the key is to watch and see if they're still as hands on as they ever were (e.g., obsessed with the product, knee-deep in the financial model, out in front of the organization in selling). Again, these entrepreneurs are very special.
So what are you - the chicken or the pig? Investors clearly prefer one model over the other, not just in the founder, but in the entire team. As a result, as you are assembling your start-up team, be careful not to hire chickens. In the eyes of prospective investors, you may find it's even less kosher than hiring pigs.
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The following is the result of a collaboration between Ty Danco and Dharmesh Shah. Ty is an angel investor and startup mentor (you should be reading his blog). Dharmesh is founder and CTO of HubSpot, runs OnStartups.com and is an advisor to AngelList. [Note: All the smart useful stuff in the article is Ty, all the feeble attempts at humor are Dharmesh]
AngelList (AL) connects promising startups to a sterling network of early stage investors. AL has been getting a blizzard of well-deserved press of late after Venture Hacks released the networks 18 month statistics. But not a lot has been written for startups on how to best use the service. Here's our take in small, bite-sized pieces.
1. The Fundamentals Still Apply As Time Goes By
AngelList may be a game-changer, but most of the same rules are still in place. Angels still look for the same elements in a startup as always: a strong team; meaningful milestones; a differentiated product in a big potential market; capital efficiency and so on. Therefore, the excellent advice listed in OnStartups, Venture Hacks, AVC, Ask the VC, Both Sides of the Table, and the like still applies. What for now is unique to AngelList is the speed and efficiency with which they can harness an all-star network of active investors in front of a breathtakingly large, qualified stream of startups. Whereas B.A.L. (Before AngelList) you could mess up a presentation in front of an investor group and not worry too much (there's always another potential investor around the corner if you look,) putting in a half-baked effort on AngelList is a cardinal sin. First impressions count, so make sure you crush it!
2. There's a great primer already
"How to Hustle with AngelList", by Brendan Baker is the definitive how-to guide discussing how to make it onto AngelList, how to set up profiles, etc. It covers all the basic mechanics and throws in a few proven tactics. If you have time to read only one article on AngeList, that's the one.
3. Talk to People Who Have Had Success
With over 400 companies having raised money on AngelList in its first 18 months, this is easy. As Alex Cook of Rentabilities mentioned in this Boston Globe article, there's a learning curve involved, so make a point of talking to entrepreneurs who have previously used the site before you list. Who has been successful? Here are a few notable companies.
Quora has many dozens of questions on AngelList, as does OnStartups Answers and of course Venture Hacks, whose founders run AL. By the way, there is a high overlap between people who are active on Quora and the community of investors you want to attract.
4. Get a champion first
The first anchor investor is the hardest. Always has been, always will be. And for Angel List, it is important enough to be ranked #1 in Nathan Beckfords excellent post entitled Hacking Angel List. For instance, Rentabilities already was a winner of the 2010 MassChallenge, but they waited until they had won over Dharmesh as an investor/endorser before tackling Angel List. Nivi of AngelList will argue that it is not necessary to have a champion if one has a great team and traction, and he has several examples of this. But we respectfully disagree: just as your odds of success drop dramatically if you pitch to an angel group without already having a champion in the room, the same applies here. So don't launch prematurely. And, even if Nivi is right that you don't absolutely need a champion if you have enough traction and an awesome team, it can't hurt.
5. Don't wait too late in your rounds fund raise before you apply
Localmind is a company I invested in which had no trouble raising money, but they wanted to attract a few more angels with domain expertise and geographical diversity. Within days of listing on AngelList, they had identified 8 strong, deep-pocketed angels, all of whom could have strengthened the company. With only limited $dollars left in the round space left, they could only squeeze in 2. When I asked Lenny Rachitsky, the CEO about what he learned from the experience, he said he had wished he had started working with AngelList earlier.
Whens the best time? Others may disagree, but Id suggest getting your application in when your round is anywhere from 20% to 40% subscribed. With that head start, it should attract interest pretty quickly. If you get oversubscribed, thats a good problem to have.
6. Before launching on AL, mentally assemble your dream team of investors
If you cant dream it, you cant build it. Your ideal team may be 100% angels, you may wish to have some local micro-VC or it might be as simple as a pair of massive VCs and an industry insider. But rRegardless, the majority of investors should already have complementary holdings in your sector.
More importantly, assess what elements you need besides money, because the AL membership has their tentacles everywhere. Knowing what you need but dont yet have not only helps you get it, but it also sends a strong positive signal to angels that you understand your needs. Approaching investors who clearly dont invest in your sector is the telltale sign of a rookie.
7. Research the network, and target your angels
You can use filters to look for angels who have invested in your sector or in complementary companies. I invested in HealthRally because its CEO did just that and found me. While I don't always monitor the AngelList feed (just as you might not stay current with Facebook traffic or a Twitter stream), I got a very targeted letter from Zach Lynch, the CEO of HealthRally. He noted my investment in GreenGoose and other health tech firms, and then made the connection that one of the other GreenGoose co-investors, Esther Dyson, also had committed to HealthRally. Besides showing excellent progress to date on a shoestring budget, Zach demonstrated to me the type of targeted, "rifle not shotgun" marketing discipline that his company will need to land a few strategic partners and megaclients.
8. Get Personalized Intros
Ask all of the angels who are backing you to endorse you to their own followers. If they are not already on AngelList, ask them to sign on and do so. Helping syndicate a round is what angels do, and AL has found that personalized intros from an AL investor get opened far more than a generic profile. This is the original angel skill, (after all, Howard Lindzon calls his fund "Social Leverage" for a reason,) but now it's so simple it can be done to all of an investors AL followers with one mouse click. Using the Rentabilities example, Dharmesh has many people watching his recommendations, and when he gave the company a thumbs up, more than 100 people followed the company, and over 30 asked for introductions. Clout (and Klout) matters.
9. Spend a few calories (and maybe dollars) a good name.
For many of you, AngelList might be one of the biggest initial exposures your startup will have. And, theyre some very powerful people. Its worth spending a little bit of time and energy getting it right (it gets harder to change it later). This is particularly true if you have a consumer (B2C) startup. I guarantee you that folks like Jason Calacanis care a lot about your brand and domain name. I do too. Here are some quick tips on naming a startup. Dont obsess over the name, but its worth investing a little time on this.
10. A video is worth 1,000 slides
No one can tell your story better than you. Make a short killer, video and include it in your profile. I made my first AngelList investment in UpNext after I saw the link to the companys interview on Untethered.tv. If you can, include one. Especially if it can showcase a quick demo.
11. Get your website right first
This should be obvious. Even if you just have a well-done landing page with a good design and a good URL name, it's a plus. Every angel is going to click through, and most won't go further if your website sucks.
12. Remember Inbound Marketing, baby!
Yeah, I know that going through AngelList qualifies as traditional outbound marketing, but sophisticated angels will check on their own to assess your knowledge of the basics. Do you show up in Google search results at all? Do you have mentions in social media? Do you own the company name on twitter and have you tweeted recently? Do you have followers? Do you have an engaging blog that tells your story and has a point of view? Have you checked out your traffic graph on Compete.com and made sure its pointing in the right direction? Face it: AngelList exists because of the Net. You may be able to get away with a sloppy web presence and strategy at a traditional angel group presentation, but that won't fly with the AngelList crowd.
13. Advisors are huge.
Social proof is hugely important in Angel List. I invested through AngelList in Saygent. Why? Not only did I like the schtick, I really liked that they had sought out and won Sid Viswanathan (co-founder of CardMunch and a master at using Mechanical Turk) as an advisor. Currently Im doing due diligence on a company which landed Jason Calacanis as an advisor. Having an advisor like Jason, who is an indefatigable promoter of his portfolio companies (via his interests in the Launch Conference, Open Angel Forum, and This Week in Startups, he sees a TON of companies), shows instant credibility and is a harbinger of future success.
14. Clearly list your price
If you haven't figured out what you want to raise at what valuation, do so now. If you're going to raise convertible debt (although I'm personally not a fan,) say what your cap is going to be. There's no upside in wasting both your time and that of the investor if you're asking a price where the investor is unwilling to go. If you're unsure and you haven't already figured this out with the anchor investor, the AL team can help point to some comparables. Speaking of comparables, if this is your first startup and you're a rookie, try not to over-reach with respect to terms. Just because everyone you talked to so far thinks you are brilliant and your idea is spectacular, don't push for a really high cap on your convertible note. Going from a $4 million cap to a $8 million cap might seem like a 100% increase in valuation, but the math doesn't work that way. Such a move might decrease the number of investors interested in your deal.
15. Use a standard termsheet
Resist the temptation to introduce clever, non-standard terms into the termsheet — even if you think you can get away with them. Two reasons for this: 1) You'll come off as naive or greedy. 2) Even if you somehow manage to sneak these in now, you'll have issues when you need to do your next round. Save your creativity for your product and keep your termsheet clean. If you need an example, you could do worse than the standard financing docs that Y Combinator provides. But, there are others. Ask around.
16. Be ready to pitch on short notice via videoconferencing
This could be via Skype, Gmail video chat, Go2meeting, etc. But you should have perfected all of the logistics and have accounts and slide share materials ready on quick notice. With investors no longer being local, you need to find ways to let them see you and your pitch. Insider secret: Some investors have found a strong pattern that suggests entrepreneurs that respond to late night emails quickly have an edge over those that don't. Lets save the “but work-life balance is important” debate for another article. Meanwhile, you better be working your butt off.
16. Think one round ahead.
Listing on AL now will give you a giant head-start on your next round, as investors who aren't ready for this round may step up for next round. As Mark Suster says, VCs invest in lines, not in dots. Establish the connection for the next round now, and rethink if there are others you may wish to add to your initial target list.
17. Use the AngelList team
Who is more wired in than Nivi and Naval? Who's seen more pitches and knows what works? Once they accept you, get their advice and give it great weight.
18. Know how investors will use AngelList
Here's a similar list of techniques investors use that work especially well via AngelList.
19. Get your backers to register on AL
You want them to comment on you and endorse you. Any angel should volunteer to do this for the good of the company, and they get to build their brand too.
20. Don't game the system
You're smart and love to hustle. We get that. You should do all manner of hustling to make sure your startup gets the visibility it needs. But, don't abuse the community or take advantage of it. It's a shared resource. Just like you, there are many other entrepreneurs looking to connect with great investors on AngelList. Many of them are just as deserving. It's fine to stand-out, but make sure you are adding value to the group, not taking away from it.
21. The best thing you can do is get traction
You should invest time in your fundraising process — it's important. The basics don't take that long. But, don't get too obsessed. Your primary goal is to build a business not build this phenomenal profile and network on Angel List. The most helpful thing you can do to get the right angels on board is to make measurable, meaningful progress with your business.
I'm sure a few of you that are already in the Angel List process are likely reading this. What other tips would you like to share with the community? What questions do you have that haven't quite been answered yet?
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The following is a guest post from Brian Halligan, CEO of HubSpot.
When we were first starting HubSpot, we identified the perfect candidate for an outside board member: Gail Goodman, CEO of Constant Contact. We got a meeting with her through a colleague of mine, and that meeting only reinforced our opinion. At the end of the meeting, I asked her if shed join our board and she politely declined. Crap!
About a year later, we raised our Series A round of venture capital from General Catalyst. It turns out that Gail knew and trusted one of the partners at General Catalyst who set up another meeting with her at GC's offices. During that meeting, we talked about the progress we made, answered a bunch of her questions, and at the end of the meeting, I closed so hard that even Alec Baldwin (GlenGarry Glen Ross) would have been proud. To our surprise, she agreed!
It turns out a perfect outside board member is even more valuable than we thought. Here are the big categories of help she gave us in addition to a ton of little things along the way:
1. Pushed back on our VCs when she thought they were getting too far deep into the weeds.
2. Taught us the economics of SaaS.
3. Approximately quarterly 1-on-1s with me where she'd give me management advice and gentle nudges when she thought I was wrong-headed about something.
4. Monster credibility when it came to fundraising. I never heard anyone say it explicitly, but I know that her being on the HubSpot board sent a positive signal to the folks at Sequoia, Salesforce.com (Marc Benioff specifically asked about her during our pitch to him), Matrix Partners, etc.
The only bad news in this story is that over time, HubSpot's agenda and Constant Contact's agenda have overlapped a bit. HubSpot started as a TOFU (top of the funnel) company and we have recently expanded into the MOFU (middle of the funnel) business where Constant Contact has its core business in email marketing. At the same time, Constant Contact is adding social media features. It is a minor overlap, but rather than have it be awkward at all, we decided to part ways very amicably.
We are going to replace Gail with Michael Simon, the CEO of LogMeIn. I have been following LogMeIn for several years now and admired Michaels work from afar. He was kind enough to agree to a meeting where I told him the HubSpot story and asked for his help. After a couple of months of dancing back and forth, he agreed to join. I'm not good at much, but I think I'm going to end up two for two on the outside perfect board member thing.
Having a perfect outside board member is worth spending real cycles on. My advice would be to make yourself a list of the perfect candidates, network to them, tell the story, and ask for the order. If you get the Heisman, then circle back down the road.
Recruiting a perfect board member is one of those cases where you have to sell. The perfect person is ridiculously busy and has a million reasons to say "no". Think a bit about why the perfect person might want to join your mission, try to find out which reason will resonate, and pound on it during your meeting. Some non-obvious reasons the perfect person might want to join your board:
1. They are working for a bigger company and they think joining a startup board will energize them and give them new ideas (i.e. learn about continuous deployment, learn about the learn startup movement, learn about inbound marketing, learn about mobile apps, etc.)
2. They are interested in working with another of your existing board members (i.e. one of the VCs) for professional reasons that might pay off for them much later.
3. They are interested in working with another board member for personal reasons, like they used to work together and it will be fun.
4. They just like you or your co-founder and think youll be fun to work with.
5. Your stock options [I suspect this is the lowest on the list as oftentimes the perfect outside board member is all set in this department]
6. They are on the other coast, but have a relative in your city that they'd like an excuse to visit more often.
Try to anticipate some of the perfect board members objections that will come up in your meeting and proactively handle them:
Objection 1: I'm on the other coast and I don't want to fly to your coast for board meetings.
Answer 1: If you join, we could have two board meetings a year on your coast, you can come to two on our coast, and you can do two via telephone. Thats 2 trips per year!
Objection 2: Im way too busy.
Answer 2: You can skip one board meeting a year without worry or care. I promise I wont bother you with more than 1 email between board meetings.
One of the many nice things about being venture-funded is that it sends a positive signal to the prospective candidate that the company has something going for it. In addition, the VCs are good sources of introductions. My advice would be to ask your investor to introduce you to people on your list and, if possible, try to penetrate the entire partnership's rolodex on this effort versus just your partner's network. Another tip Id give you is if you are at any stage of discussions with VCs about a prospective investment, ask them to introduce you to a perfect outside board member -- this is an easy way for them to prove their worth to you and is very valuable.
How about you? Have you got a perfect board member that you want to crow about a bit? Any tips on recruiting that perfect board member?
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There are over a hundred seed accelerators in the world and many more are popping up every year. In New York City, there are going to be 6 more this summer on top of TechStars NYC. The common thread amongst all of these programs is what is now known as "Demo Day", which is a single day (sometimes days) where a number of investors are put in to a room to watch all of the participating companies present for 6-8 minutes. Recently, my company OnSwipe was a part of the inaugural Demo Day in NYC for TechStars. Everyone has been asking me how we prepared and put together our demo day presentation. Without further adieu, here's how. You may want to watch the recording of my presentation below first: Actual Presentation
Put together slides with very few words
You should not have the audience focused on your slides, but your words during the presentation. Bullets are an absolute no-no throughout the presentation. My presentation had one sentence at most per slide with an accent color highlighting what was a really important word for the audience to understand. The slides should set the tone for what you are currently talking about to keep everyone on track. Stay away from transitions or overly flashy slides. They were cool when you were in junior high, but don't add a lot when talking to a large crowd.
Slide Deck (some things might be out of place due to 2 animations)
Make Sure There Is A Screen In Front Of You On Stage
The worst thing you will ever do is look back at the screen. This makes you seem unprepared, especially during demos. It also makes everyone think you didn't prepare with the person, usually your cofounder, that is controlling the slides. You don't want to look down at it too much, but it's there in case shit happens. In a split second you could be on the wrong slide or miss a beat. Instead of turning around to look back confused at the screen, you can properly pause and guide the presentation back to order while looking ahead. It's a small subtle, yet useful prop. Make sure it's there.
Practice, Practice, Practice
I practiced religiously before going on stage. Dave Tisch and Dave Cohen probably wanted to murder me when I skipped the public pitch practices with all the teams, but I was secretly practicing at home or late at night. I look at a presentation a lot like product. It just needs to be broken and tweaked a lot. It isnt' ready for public consumption or scrutiny until you've fine tuned it enough. Make sure you practice until no end. It's what makes you comfortable and confident.
This might just be my style, but you need to be bold...very bold. You are going to be presenting with 10+ other companies or even more that day. Investors and press get antsy very fast. When was the last time you could sit through 5 hours of pitches easily? By being bold, you can give a great refreshing jolt to the crowd and pique their interest. It's also great to stand out with a ton of press in the crowd as they will want to do an interview with you afterwards. "Be so good they cannot ignore you."
Speak in tweetable soundbites
People love to tweet live events and demo days are no different. Inside of the room, you will have a great group of influential people that can send your message out to the right people. The thing is, they can't send out the entire presentation, they can only send out 140 characters at a time. In our case, we had 3 tweetable soundbites that became well known afterwards. These weren't by happenstance, but planned well in advance:
- "Apps Are Bullshit"- opening slide that set the tone for presentation.
- "Tap the rocketship"- @fakedavetisch caused this to become some form of sexual inneuendo :)
- "Series Awesome"- We didn't announce that we were raising a Series A, but a Series Awesome.
The "Three Acts"
The best way to do a demo day type presentation is to put the entire delivery into three different acts. Entrepreneurship and delivering a presentation is absolutely no different than theater. You should look at your delivery as a spectacle that enlightens those in the audience, not a typical slide deck pitch.
Act I - The Setup Setup the enemy for the entire presentation, the elevator pitch, and the big vision business. It should be under 90 seconds and even that is something I found difficulty with. The goal here is to give context, hook the audience in, and get to a killer demo.
Act II- The Demo This is what really matters. Too many companies approach demo day as investor day, instead of showing what they've built off in-depth. Screenshots are a no-no and sadly, pre-recorded videos seem to be the way to go due to Wifi. Show off a logical progression of what your product does. Nothing gets someone ready to write a check like a great demo.
Act III- The Execution This is where you talk about what you have accomplished and where you are going. I usually like to talk about a few things: Press, current investors, business development deals, and the team you have been able to attract. This shows where you have been and how you are able to execute as a team. You should also make sure that you talk about what's next. When are you launching? are you raising money? what is the big credo and philosophy behind the company? Tell the world why you exist and why you are going to take over the world.
Get to the demo as fast as possible
This was the biggest lesson we learned through practice. The first version of the presentation took 2:30 to get to the demo. That was an absolute eternity. Even now, I could have shortened things by a good 30 seconds or so. Make sure you get to the demo as fast as you can. The other side of it is, making sure that you give enough context to the audience.
Have an "enemy"
We set out to say app store apps for content publications like the Wall Street Journal and Wired were just complete bullshit. We were very bold in this statement, but we backed it up with undeniable fact. If you are going to make an enemy, make sure you have the weapons to combat them. You have to seem sure when declaring ane enemy and have a logical argument.
Make sure the big long term vision is known
Too many investors and potential partners will think about the present since that is mostly what you are showing. Spend time talking about the big vision in terms of product and in terms of business model. Your product is often different than your business model. ie- Google's product is search, but it really makes money through advertising. Sometimes you may not know what this big vision is, but if you do, make sure that is known. Most people thought our big vision was: be a WordPress plugin that makes things pretty. We made it clear that our goal is to power the advertising in a world where content is consumed with tablets, not point+click devices.
I'm an outlier here, but the pink shirt went over well. It made me hard to ignore and ended up color coordinating the presentation. Trivia: The onswipe pink colors come from that shirt, not the other way around. Make yourself memorable with appearance. People will remember your ability to command an audience and that can often be done through how you dress. Once again, demos and presentations are not pitches, but theater.
Have an "ask"
Most companies go into a demo day with an intention of raising money. It might be something direct with an exact dollar amount or it might just be an announcement that you're playing around in the waters. Either way, make sure you have an ask that lets the world know your fundraising plans. The biggest problem in entrepreneurship is the fact, that most entrepreneurs just don't ask. If you have existing fundraising commits, let the world know who is in and for how much if possible. My buddies at thinknear
did this by letting the world know IA Ventures was in for 400k of a 1.2 million round.
Show Off Social Proof
Social proof is one of the best things that you can portray during a presentation. Do not be arrogant or cocky, but certainly be confident. Show the world who is behind you and what you have accomplished. Nothing gets an investor more excited than tangible traction, social proof from their peers, and the ability to execute.
Things that didn't work along the way
- We spent a lot of time getting to the demo. We originally had a lot of social proof and big vision talk before the demo. That got people antsy. Let the demo be your proving ground and then
- Don't try to practice in full run throughs at first. Go act by act, screwing up along the way.
- Do not use anything from your investor slide deck. Even though we have never used a slide deck to raise money, we still sort of have one. I dusted it off from the Series Seed and tried to insert some slides. It just doesn't work for demo day. Demo day pitches should be looked at a lot differently than your traditional investor pitch at the end of the day. Demo day pitches really appeal to three broad crowds, with some companies focusing in on one more than the other: press, investors, and potential partners.
In short, this was the most important day of my life and a huge success. The only downside, is that it meant TechStars is officially over. You should apply to the program , and if you get in, hopefully this post will be of use.
Have you presented at a "Demo Day" before? Any tips of your own that you'd like to share?
You Should Follow me on Twitter: http://www.twitter.com/jasonlbaptiste, Friend me on Facebook: http://www.facebook.com/jasonlbaptiste, Email Me: firstname.lastname@example.org, or even call: 212.361.9743
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The following is a guest post by Brian Halligan, my co-founder at HubSpot. It's not usually his style to lavish such gushing praise.
As many of you know by now, HubSpot just closed our Series D round led by Sequoia Capital with participation from Google Ventures and Salesforce.com. I got a chance to work closely with Sequoia over the last two months and have thought a bit about how and why they are the top dog in the venture business and came up with 9 reasons. At least a couple of them might surprise you.
1. Brand: Since they funded companies like Apple, Cisco, Google and Yahoo, they have the best “brand” in the business. Because of this, nearly every aspiring entrepreneur pitches Sequoia (or would like to) in hopes of having some of that brand rub off on them. This gives Sequoia a first crack at many of the best deals.
2. Know-how: Since they funded all those great companies and sat on their boards, they have learned a ton about how to build great businesses and they are not shy about passing those lessons on to their current portfolio. No doubt, other venture firms have made great investments, but Sequoia’s portfolio is particularly remarkable.
3. Talent pool: Since they funded all those great companies for so many years, many of their key employees have gone on to do other new startups and Sequoia is in the front seat for when those deals happen. In addition, that network of talent is highly valuable for them in seeding their new companies with talented employees and board members.
4. Hard work: Yes, it sounds corny, but it’s true. The lead on our deal was Jim Goetz – we spoke almost every day and usually had a call or two on weekends. The second was Pat Grady. My favorite Pat story was about halfway through the due diligence when we were trying to find a time to connect him with some of our folks and he suggested 7am EST. Our team was concerned that one or two of our folks wouldn’t be available at 7 am. The interesting part was that Pat lives in San Francisco and we are in Boston, so it was 4am his time. The 4am slot wasn’t an issue at all for him as he was up at that time working every day anyway.
5. Aggressive: They are more aggressive than other VCs. When I first met Jim Goetz, the second sentence he said to me after “nice to meet you” was “what’s it going to take for Sequoia to own a piece of HubSpot?” That’s how you make a first impression on an entrepreneur! At the time, we were planning on raising debt, but the advantages Sequoia has around network, brand, and talent lured me in.
6. Reasonable: As you might imagine with a complicated deal like the one we did with 3 new investors and 3 existing investors, there was a lot to talk about as part of the deal. Sequoia was tough, but reasonable to deal with.
7. Agile: Sequoia’s deal process felt a bit like our agile product development process. Everything was pretty late-binding, but came together nicely at the last minute. For example, for their visit to Boston, we didn’t really nail down the schedule until the night before. I’m not sure why they did it this way, but I suspect they are gathering lots of due diligence and want to make sure they have as much information in place before they nail things down. They trade off the false comfort of being organized early for relative discomfort of being organized late.
8. Paranoid: In talking with them, it is near impossible to get any of them to brag about any of their high profile investments/exits. Rather, they seem to be constantly hand-wringing about the ones that got away and the ones that might be going on right now that they could miss. Its almost like the firm is more motivated by fear of failure than of success itself.
9. Chinese Firewalls: They had looked at a few other deals in the marketing space, but were closed-lipped about anything they had learned. This demonstrates respect for the entrepreneurs they work with – even the ones they don’t fund.
I found the whole process to be fascinating. I’ve always admired Sequoia’s success, but it was great to experience first-hand why they’ve been successful.
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Today’s big news is that my company HubSpot announced a major new round of venture financing. Details can be found in the non-clever, but descriptively titled “Sequoia, Google Ventures and Salesforce.com Invest $32 Million in HubSpot”. We could not hope for a better set of investors for this round, and we’re thrilled with the further marketing validation that this group of investors brings.
My co-founder, Brian Halligan and I have been thinking about the Software-as-aService (SaaS) industry for many years now. It started when we were classmates in grad school back at MIT. We consider ourselves eager students on the subject. As part of this most recent funding round, we dug into more details and want to share some of our insights, lessons learned and data with you. We’ll also share some of the same arguments we made to our new investors.
Lets start things off with a few fun data points.
* At the end of 2010, the median valuation of publicly traded SaaS companies was approximately 4.2x their revenue. (This median was 3.2x in 2009).
* The highest multiples were awarded to Salesforce.com (9.5x) and SuccessFactors (9.6x).
* Size matters. The market seems to value the larger revenue SaaS players more. The companies with revenue above the median had a 5.2x multiple vs. 3.3x for the companies with revenues below the median.
Lesson #1: Winners win big.
We’re going to argue that in the age of the Internet, winners win big. 10–15 years ago, in most technology categories, oligopolies formed. [To save you the Wikipedia lookup on oligopoly, it’s a market where a small number of sellers dominate an industry.] The #1 player in a category would get a decent chunk of the market-cap of the industry, but #2, #3 would have respectable portions too. Basically, the top 3–4 companies would have most of the market power. That seems to have changed. In modern technology-driven industries, over time, the #1 player ends up capturing a very large portion of the mindshare and marketshare.
To demonstrate this, try this short mental exercise. For the following leading companies, see if you can name the #2 player and #3 in their category. You have 30 seconds, I’ll wait:
Difficult, isn’t it? Chances are you struggled a bit with coming up with the #2 and failed completely to come up with #3. The point here is, as these tech categories evolved, the #1 player became so dominant that we often don’t even know who #2 and #3 are.
This is the main reason that HubSpot has been aggressively investing in growing our marketing platform and growing our marketshare and mindshare. Similar to how Salesforce.com dominates the CRM industry, we think there will be one emergent leader in the marketing software industry. We’re working hard to be that company.
Question: Doesn’t this reek of the late 1990s craziness when startups were spending heavily to acquire “mindshare”?
Yes, back in the dot-com days, many startups raised millions of dollars of capital to try and “get big fast” (and be first-mover). But, there’s a big difference today. In the dot-com bubble, companies were investing heavily to acquire “eyeballs” (or some other proxy for value). In our case (and in the case of many SaaS companies), we’re investing in growing revenue (not a proxy for revenue). Like Salesforce.com did in its early years, we understand the economics of our business. We understand how much it costs to acquire a customer, and the lifetime value of that customer. And, for us, Lifetime Value >> Customer Acquisition Cost. So, we don’t think it’s like the dot-com bubble at all. We’re investing capital into building a real business. At HubSpot, we not only have gross margins (gasp!) but they’re trending upwards month after month.
Question: OK, that’s great. But do you really need $50+ million in capital? It’s a SOFTWARE company!
That’s an excellent point. 3–4 years ago, when I was just starting, I thought it was somewhat crazy to even be raising $5 million for a software company (my prior two software startups were self-funded). I never would have believed we’d end up raising $50 million. But, I’ve since learned that it’s not only not crazy to raise this kind of capital, it’s quite possibly necessary. I’ve written about this (and other fun SaaS topics) before in the super-popular article “SaaS 101: 7 Simple Lessons From Inside HubSpot” (it’s been retweeted over 3,000 times!) But, the point bears repeating: SaaS companies often charge on a subscription basis — so cash comes in over time (often monthly). However, the acquisition cost is paid up front. The result is, even if you’re making margin on each sale, the faster a SaaS company is growing, the more cash it will need to fuel that growth.
Lets dig into this a bit deeper. Below is a chart that HubSpot created a while ago. It does something interesting — it looks at some prominent, publicly-held SaaS companies and then time-shifts them. The reason we did this analysis was we wanted to understand how our growth, cash burn and fund-raising matched up against other SaaS companies for which there was public data available.
The median (not mean) capital raised prior to the IPO for these companies was $47 million. Of course, going public is not the only measure of success, but it’s interesting that those that did break-out and remained independent consumed significant capital getting there. There are no “bootstrapped all the way through” kind of companies. Don’t get me wrong, there’s absolutely nothing wrong with bootstrapping software companies (I’m at my core a bootstrapping kind of guy) — but I’m going to argue that to create a SaaS market leader in a large segment takes capital. [Side note: Our peers in the industry have also raised tens of millions, presumably for this very reason].
Disclaimer: We’re not investment bankers, and this is not investment advice. This project was done as an interesting side project. Data was taken from available public sources. Don’t rely on our analysis for anything serious.
Question: So, you’re going to spend all the money on sales and marketing?
Actually, no. Last year (before we had even considered raising another venture round), we made a deliberate decision and formed a strategy that we labeled “HubSpot Inc 2.0” (a convenient label for the second-generation of the company — not the product). The primary goal of this new strategy was to shift most of our dollars away from sales and marketing and into product development. The company had been doing exceptionally well acquiring customers, and we felt that the best use of our cash was to make the product even better and produce happier customers. We have a cool measure at HubSpot for customer happiness call the “Customer Happiness Index” (CHI). It’s a regression-analysis based quantitative metric that uses available data about customers and their interactions with the company/product. In any case, when we decided to shift to “HubSpot Inc 2.0” we set very specific goals for ourselves around things like CHI. We’re in the middle of executing on that strategy now (and hiring aggressively in our R&D team).
Big Insight: System dynamics and the sales, marketing, service conundrum.
Here’s a big lesson learned from our HubSpot experience. Think of the four primary areas of a SaaS company as being marketing, sales, product and customer service. (You might call them different things, but that’s roughly right). Now, lets temporarily take product out of the mix and look at just marketing, sales and customer service. Across these three groups, an interesting thing happens. If you try to improve the metrics of one of these groups, one or both of the other groups often suffer. For example, if you’re looking at just decreasing the cost-per-lead (marketing metric), you can easily do that by allowing a higher percentage of leads into your funnel. The result is less “quality” customers — and so the customer service group suffers and your cancellation rates go up. If you try to improve just your retention rate numbers (customer service), you can do that by putting stronger “filters” in your sales group (perhaps reducing commissions on customers that are not ideal”). Of course, that means your sales team is working harder for every deal, and your cost of acquisition/sale goes up. Generally, you can take any of the key metrics for these three groups, and you can improve one metric at the expense of one or more of the others.
The way to break out of that “robbing Peter to pay Paul” conundrum is to invest in the product. If you invest in R&D and make the product better everybody wins. Marketing has an easier job (because you get more referral customeres). Sales has an easier time closing deals, because the product demo sings. Customer service has an easier job because customers are happier with the product (and cancel less). So, economically, investing in the product has the most leverage. That’s why we’re taking so much of our available dollars and pouring them into the product.
Of course, now that we have so much cash we can invest in both. We’ll resume investing in sales and marketing too. The economics of our business makes fundamental sense. No reason not to get even more customers. We have a dominant position in the marketing automation industry today (with 4,000 customers, we have more than all of our competitors combined) and it makes sense to extend our lead. We also have customers in over 30 countries today — and we’d like to deepen that footprint.
One of the core values at HubSpot is transparency (we have others too, but that’s a topic for another article). So, within reason, I’m happy to answer questions and share things we’ve learned. We don’t have alll the answers, but we usually have opinions. What would you like to know about our take on SaaS?
* Some of the data in this article was based on the Software Equity Group annual report, 2010.
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This infographic was created by our friends at CreditLoan.
Thanks also to our friends at TechCrunch for creating the fantastic resource CrunchBase. It's one of those ideas I'd wish I had done myself.
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The following is a guest post from Healy Jones. Healy is the Head of Marketing for OfficeDrop, a company that offers small businesses in paper intensive industries cloud scanning software and cloud filing. Previously he was a venture capitalist with Atlas Venture and Summit Partners.
Taking a cold call from a venture capitalist
So you are busy running your startup and suddenly the phone rings and it’s a venture capitalist. What do you do?
VCs of various stages are borrowing a page in the playbook from some of the most successful buyout/growth investor groups and taking an active, outbound approach to finding new investments. In other words, you are more likely than ever to get a cold call from a VC.
This can feel pretty flattering if you are the little startup trying to take on the world. But it can also be a waste of time. Most of these cold callers do not invest in really early-stage startups – they are looking for larger companies.
Growth Funds vs. Early-Stage Venture Capital Firms
I realize that the difference between a venture capital fund and a growth equity fund may not be readily apparent. Today there are seed funds, micro-VCs, traditional venture capitalists, later-stage VCs, growth funds, etc. It’s a little confusing.
Traditionally, investing in pre-revenue startups was the purview of venture capital funds. Growth investors focused on companies further along in their lifecycle – companies with substantial revenue and a history of profitable growth. Today, in addition to the whole seed funding movement, the lines between traditional venture firms and growth funds has blurred. However, most cold callers are from growth equity funds that still do not invest in pre-revenue, or even moderate (i.e. sub $10 million) revenue companies.
This is why I recommend that if you are running an early-stage startup that you do not spend a lot of time on the phone with growth fund investors. They are looking for businesses with certain levels of revenue and cash flow, and if you don’t fit the bill they will want to get off the phone too. But if you’ve just gotten some great press, you might not only find yourself deluged with cold calls from growth funds, but might also get a ring from a legitimate early-stage investor whose curiosity was piqued.
Taking the Venture Capitalist’s Cold Call
If you are actually raising capital then I suggest you approach these calls in the same way you would a sales lead: qualify the lead, move the worthless leads out of the funnel ASAP, get the info you need to appeal to the few leads that are actually a potential fit and set yourself up to make a legitimate/strong pitch to those few.
You need to quickly sort through the growth investors who are not a fit for your business. This approach is based on my former experience as a buyout investor, growth stage VC and early-stage venture capitalist, and now as an executive at a startup that has successfully raised a modest amount of venture funding. And oh yeah, I’ve made a lot of cold calls into private companies as an investor and have received them at my startup as well.
Steps for dealing with a cold call from a venture capitalist:
1) Quickly figure out if your company even fits the financial profile of the investor’s fund. Politely ask “what is the financial profile of your firm’s investments?” The good growth funds will unabashedly let you know what financial statistics they look for in an investment – say $5 million in cash flow and 15% year over year growth rate, or $10 million or more in revenue. If you are a pre-revenue startup then you are wasting your time speaking with these people. I understand that your projections might say you are going to go from zero to $50 million in revenue in the next 18 months, but trust me, you are not a fit for the growth fund today. These groups are usually very strict on investing only in companies that meet specific financial criteria (cash flow breakeven, particular revenue levels, etc) so you don’t want to spend time with them if you are a startup.
2) Ask how much money the fund invests at a time. If the group typically invests $25 million at a time, and you are only looking for a seed investment then you are not a good fit. Be wary of the investor whose fund invests in a ridiculous range of dollar values, say from $1 million to half a billion dollars – the individual you are speaking with is probably on the growth investment side of the fund. You only want to have an in-depth conversation with someone who could potentially meet your startup’s funding needs.
Note that these first two questions were all about financial issues. The goal of these questions is to weed out the growth and buyout investment funds. The majority of investors who cold call are these types of firms, and they make initial investment decisions based on financial metrics. Your pre-revenue startup is not going to get financing from one of these groups. It’s time to get off the phone. Let the cold caller know that you are so far outside of their financial criteria that a conversation does not make sense at this time. You don’t need to share any other information or spend any additional minutes on the phone! You’ve just qualified the investor off of your list and should get back to running your business. Go ahead and give them your email and let them know they can ping you that way in six months/a year to see if anything has changed. Quick note: if you are a growth stage company that meets the investment fund’s financial criteria then keep reading.
If the fund actually invests in your stage of startups, then your next goal should be to figure out how to give a solid pitch to the right person at the fund.
3) Make sure you know who you are talking to. Make sure you know which fund is calling. Learn a little bit about the fund; if it doesn’t sound like the type of fund that would invest in your startup then ask. Figure out who the person is and what their role is. Of course, you want to talk to a partner at the fund, but the person calling may be a more junior associate. A few years ago I wrote a post on talking with a junior VC; this advice may be helpful if you find yourself on the phone with one.
4) Ask what prompted the call. Was it a piece of press? Did they hear about you from someone? Or are they doing research in the industry? Which leads to the next question:
5) It is fair to ask if the fund has any investments in the same industry or any that may be considered competitive. You also want to know if the fund is actively doing diligence in the space for a different investment. I’d expect most VCs to be quite honest in this area! Thesis driven investors will often try to speak with every company and executive in that space. I know I did this in a few specific areas – I called everyone I could. But I also let the startups know I was serious about their industry and expected to find and make an investment. Most executives still were open to having a conversation. In general, I believe that this isn’t a bad move if you are actively looking for capital because:
a. A number of VCs will make more than one investment in a space.
b. If a VC is truly looking across an industry you should be able to get helpful market data out of them.
c. Good VCs will make introductions to potential partners, employees, etc for companies that they like, so getting to know a VC who is spending time in an industry could be valuable.
Be smart about this. Remember that you don’t have to give away every piece of tactical information to have a good first conversation. And do a little research on the thefunded.com – see if they have a good reputation, ask people in your network who know the partner and the fund, etc. This leads to my next point:
6) Now that you know who this investor is, do you want to speak with him/her at this moment? Do you want to do a little research on him/her and the fund first, or are you comfortable speaking right now? Are you ready to deliver a pitch on the phone? Do you have a presentation ready (even if you don’t share the presentation, I’d suggest you use it as a means to structure your conversation. You’ll be much more organized if you use the table of contents to talk about your company than if you talk off the cuff.) Do you actually have the time, or do you have a scrum meeting scheduled in five minutes (and make sure the VC has at least half an hour to devote to you)? If you aren’t ready then you should schedule a call in the future when you have more time. Don’t feel bad, just do it. If you are going to push off the conversation then I’d schedule it right then and there on the phone. Another option, if the VC is in your area, is to ask to meet in person. But again, try to ask for the meeting right then and there and get something on the schedule.
7) If you are ready to pitch, treat it like a pitch. Run through your fund raising presentation. Be organized and efficient. I’d suggest using your “ten minute pitch.” Even thought they called you, you are being judged so take the pitch seriously.
8) Don’t forget to ask questions. If the VC called you, they likely have some opinions on your industry. What other companies are doing well? Which customer verticals are buying? Who has cool new features? A good VC will have legitimate answers to these questions. I’m not suggesting you “test” the venture capitalist – rather you try to take advantage of the conversation and learn something.
9) Finally, end the conversation with an agreement on next steps. An in person meeting should be your goal. If you can’t get that, then get the VC to agree to follow up at a specific date. You don’t want to be in fund raising purgatory, so get their contact info so you can follow up if they don’t.
Remember, most of the investors who cold call are growth investors who really can’t help your startup. Qualify them out of your funnel ASAP. Next, figure out who you are talking to. Make sure you are ready to pitch, then give it your best shot. End with an agreement on next steps.
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The following is a guest post from Jeff Bussgang. Jeff is a serial entrepreneur and currently a general partner at Flybridge Capital Partners, a Boston-area early-stage venture capital firm. Jeff is also the author of the recently released book “Mastering The VC Game”.
One of the hardest things about venture-backed start-ups is achieving alignment. When there is alignment between entrepreneurs and VCs, all collective energies are directed towards the magic of building an amazing, world-beating start-up from scratch. When the entrepreneur and VC are out of alignment, the likelihood of success plummets and self-inflicting wounds, rather than market- or competition-related issues, tend to dominate the agenda.
In researching my book on entrepreneurship and VC, Mastering the VC Game, the issue of alignment came up again and again from both sides of the table. Here are some of the best practices I heard from the entrepreneurs and VCs I interviewed:
1. Be explicit from the start. Naturally, there will be pockets of misalignment – VCs and entrepreneurs answer to different masters and sometimes have different structural objectives. Making explicit these pockets of misalignment and talking them through openly is often even more critical than the particulars of, say, the deal terms in a financing. One useful technique for clarifying the various scenarios of misalignment in financings and M&A outcomes is to maintain a simple spreadsheet with the entrepreneur-VC split laid out under different exit outcomes. This distribution of proceeds in the event of a sale is often called the “waterfall,” evoking an image of sale proceeds cascading like a river to various shareholders. I recommend entrepreneurs be clear at all times and at every financing about what the waterfall calculations look like for each of the preferred and common shareholders.
2. Seek first to understand, then be understood. I borrowed this one from Steven Covey. It’s important that entrepreneurs understand the VC’s perspective in all situation and through what lens they are looking at things. For example, if everything goes well, most of the control-oriented provisions in a term sheet never come into play—it’s all discussion, earnest debate, and aligned decisions. But when things go poorly and there are the inevitable disagreements, the VC is often in the driver’s seat to make major decisions. Only in rare circumstances can the entrepreneur retain full control of major decisions after they take VC financing. Therefore, entrepreneurs need to invest the time and energy to understand how VCs are compensated, motivated and what the particular interpersonal dynamics of their board member are within their partnership. For example, how much carried interest does their VC board member have in their respective partnership compared to the other partners? VCs always want to know how the equity is split amongst founders. Turnabout is fair play.
3. Don’t take it personally. Zynga founder and CEO Mark Pincus put it very well to me when he said, “I tell entrepreneurs: don't be a victim. It doesn't matter whether you like the venture capitalists or don’t like them, really. Structurally, they have areas of conflict and areas of overlap with you. Depending on the way things go, there's a high likelihood that you're going to run into conflict with them at some point, whether they're your friends or not. And what defines great companies and what defines great venture capitalists and great entrepreneurs is not whether or not you run into those conflicts, but it's how you navigate around them.” The key is to de-personalize this and simply understand what is the job of a venture capitalist and what are their levers. Mark voiced every entrepreneurs fear, “All that we feel as an entrepreneur is, ‘They're trying to get control of my company. They want to mettle. They want to second-guess me when things go bad and ultimately fire and replace me.’” It’s natural for those issues to come up. So talk about them, as dispassionately as you can.
4. Discuss the exit before you enter. Before you accept a VC’s money, make sure you are on the same page about your financial objectives and what defines success in terms of ultimate outcomes. If you don’t see eye to eye on the exit criteria and framework in advance, don’t bother entering into business together. Some VCs, particularly those with smaller funds, like you to raise less money and operate in a more capital-efficient fashion. Others, particularly those with larger funds, will push you to go for the bigger outcome. The nightmare scenario arises when an entrepreneur may be thrilled with a $100 million exit, but the VC doesn’t feel it’s “good enough” and blocks the transaction to play for a bigger win. The VC is swinging for the fences and has many chances in their portfolio to generate enough returns to ensure success for their fund, while the entrepreneur may feel this is their one shot and being a multimillionaire is good enough. Fred Wilson tells a great story I include in the book about a team of entrepreneurs getting pressure from their spouses to take the $100 million offer and cash out. Hard to argue with your spouse that it’s worth doubling down on your start-up when paying down the mortgage and putting enough money to pay for college is priority #1!
5. Communicate, communicate, communicate – no surprises. In trying to ensure VC-entrepreneur alignment, nothing helps like clear, transparent, high frequency communication. And nothing hurts like a lack of transparency. “No secrets. No surprises,” Dave Balter CEO/founder of BzzAgent explained. “I heard that early as a CEO. If something new is going to come up in a board meeting that’s not good, put the calls out early to the directors. ‘Here’s what’s going on, here’s why. I want you to think about it. Help me.’ So when we get in the board meeting, they don’t say, ‘What are you talking about?’” I had one situation where a CEO revealed to me that his technical co-founder was moving to Spain for personal reasons right in the final stages of a new funding process. He was nervous about telling me, but did it in an honest and open way as soon as he found out. His candor was compelling to me, and his plan for recovery was pragmatic and thoughtful, so we still funded the company.
To be successful partners in business-building, entrepreneurs and VCs have to trust each other to be open about their motivations. In the case of the entrepreneur, they may be trying to protect their position of power at the expense of shareholder value. In the case of the VCs, they may be trying to achieve gains on behalf of their limited partners at the expense of the other company shareholders. If entrepreneurs and VCs suspect that the hidden motivations of the other are dominating their behavior and their decision making, they will lose trust in their advice and counsel. That’s when the soap opera stories begin.
In the end, entrepreneurs need to raise the right amount of capital for their business, under terms they can live with (and can achieve under the circumstances) from VCs with whom they have great chemistry and who they believe will be good business partners for the long, hard journey. It’s difficult enough to build a large, valuable company from scratch. Imagine if you get some key decisions wrong and start off with the wind in your face.
But the right decisions and the right VCs put you in a position with the wind at your back, allowing you to focus on all the tough challenges of building a business and creating value in your start-up.
Learn more about Mastering the VC Game at www.jeffbussgang.com. You can follow Jeff on Twitter @bussgang.
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