An entrepreneur's guide to pitching early-stage venture-capital firms
Why do only a small fraction of the business plans that are sent to venture capitalists get funded? Most would simply answer that there are too many deals chasing too few investment dollars. Venture capitalists will tell you the real reason is that there are too few "quality" deals.
The entrepreneur and venture capitalist often view the quality of a deal very differently. The inexperienced entrepreneur often makes the mistake of not realizing that the venture capitalist will judge the quality of his or her deal relative to other deals the venture firm is considering. Entrepreneurs should be cognizant of the fact that raising money is not simply an exercise in selling yourself and your deal to win a scarce amount of venture capital. Rather, it is truly a competition against other startups to win the "mind-share" of the venture capital investor. Entrepreneurs who are the most successful at raising venture capital understand this fundamental point, and strategically market their deals based on this knowledge.
Taking a large and growing market opportunity as a given, this guide describes some of the other factors an entrepreneur should consider when pitching an idea or early-stage company to a venture capital firm. We call it "the ten things that can make or break a deal."
In any given year, a venture capitalist receives as many as 500 business plans; that's 42 plans per month or 10 plans per week. In addition to working on due diligence for new deals, the venture investor is actively participating in the firm's existing portfolio companies: attending board meetings, recruiting, and working with management. Given these other obligations, many venture investors are left with little time to thoroughly review business plans for new deals. However, a new deal that is accompanied by a referral from someone who has a relationship with the venture investor, such as a CEO or senior executive of an existing portfolio company, an attorney, or even another venture capitalist, will get more attention and will rise to the top of the pile.
"Location" is to real estate as "management" is to startups. If you don't have, or can’t attract, the right management team, you'll never maximize the opportunity. Venture capitalists want to make sure the team has the relevant experience and innate ability to execute on the plan, and "turn-on-a-dime" if necessary to make changes or hard decisions to get the business on course. The startup must have, or be able to recruit, the skill-sets necessary to achieve key milestones over the long term. If you can’t meet your milestones, you won’t be able to justify a crucial step-up in valuation at the next round of financing.
Surprisingly too many, entrepreneurs direct their competitive focus solely at new entrants and not enough on the "old-economy" behemoths. But these companies usually have the cash, patent portfolios, research programs, distribution networks, and relationships to easily kill off any entrepreneurial dream. The days of "first-mover" as the sole competitive advantage are over; entrepreneurs need to build defensible and sustainable competitive barriers into their business strategy.
So you have a great idea and a big market opportunity. Now the question is: "how do you make money?" In order to make your financial plan "believable" in the eyes of a venture investor, you can do one of two things: compare your financials to a comparable public company in its early years (information that is readily available from SEC filings); or, prove your pricing structure by demonstrating what end-users will pay and what distributors will charge (to do this, you have to thoroughly understand the value-chain and conduct research by talking with real customers.)
Don't stop executing while you're raising money. New customers/sales, partnership deals, reports by analysts on the company, etc. help validate the business opportunity and build confidence in the management team. If you can make progress and good things happen during the fundraising process, you'll have a higher probability of closing a deal and closing it faster.
If really good people commit to joining a startup once it's funded, that's a good sign. If really good people join a startup before it's funded, that's a great sign. Anything short of that, and the investor will have doubts about the quality of the deal and will be less inclined to invest. It is the entrepreneur's responsibility to convince the venture investor that he or she can build a team that can execute on the plan.
Of the partners making a decision on your deal, only one, your sponsor, usually reads the entire business plan. However, all of them will typically read the executive summary. The executive summary should be the entrepreneur's main sales document, while the rest of the business plan should only serve to support the material in the executive summary. A voluminous business plan is a sign to a venture investor that the entrepreneur is spending far too much time analyzing and not enough time executing.
Some venture firms, like Babe Ruth, only want to hit homeruns – creating billion-dollar companies. These firms will accept a lot of big strike-outs in a high risk game in order to achieving a higher "slugging" percentage. Others, like Ted Williams, don’t mind hitting lots of doubles and triples – creating lots of solid $100+ million companies – and achieving a higher batting average and on-base percentage. An entrepreneur has to figure out the firm’s philosophy in this regard, and then determine if the deal is the right fit for the firm. The same analysis should apply to the type of deals a firm does. For example, don't send a biotech deal to a firm that only does information technology investments!
Getting approval from one partner may or may not make the deal happen. Most venture firms have a prescribed formula for how deals are approved by the partnership. Some require unanimous consent by all partners, while others only require majority consent. On occasion, a partner may have funds available to invest under his or her sole discretion. Whatever the case, an entrepreneur should understand how an investment decision is made and play the politics accordingly.
One well-known venture capitalist has publicly stated he will only invest in companies within 30 minutes of his office. And there is good reason for this. In early-stage companies, where there is a lot of "company building" to be done, venture investors actively work with the management team and can’t afford to spend valuable time commuting. So, if you're an early-stage technology entrepreneur, heed the words of Willy Sutton and start your company in the Bay Area, Boston, Seattle, or Austin – because "that's where the money is."