VC speak: What Innovative Startups should do to get funded

I am glad to announce that Sanjay Anandaram, founding partner of Jumpstartup Venture Fund has agreed to share his articles (on entrepreneurship/startups/VC funding etc) with the readers of I…

I am glad to announce that Sanjay Anandaram, founding partner of Jumpstartup Venture Fund has agreed to share his articles (on entrepreneurship/startups/VC funding etc) with the readers of I will be posting Sanjay’s articles and I strongly recommend you all to share your comments/questions and make this an enriching discussion for all of us.

About Sanjay (in his own words)
I’ve been a corp exec, an entrepreneur in Silicon Valley during the go-go days of Web 1.0 by co-founding a VC backed internet startup (acquired by Infoseek/Disney), then founded in 1999 India’s first e-zine aimed at entrepreneurs called VentureKatalyst, then co-founded JumpStartUp one of India’s first early stage cross-border VC funds, and am today an advisor-angel to startups & advisor to a few funds. I also teach a business plan workshop at INSEAD B-school and am associated with IIMB-TiE-Nasscom in driving entrepreneurship. I’m also on the board of a social entrepreneurship venture in Bangalore.

Here is the first article:

“VCs don’t want to take risks”! “Hey, you claim to be in the risk capital business, so why can’t you take a risk and fund my young company?” “I’ve been trying to get funding for my startup but no VC gets it, they don’t understand what I’m saying!” “Gosh, they want me to make more progress but how do I show progress if I don’t have money?” “They want to take a significant stake in my company when all I want is some money!”

And the litany from entrepreneurs frustrated with their fund-raising experiences goes on and on. Having been on both sides of the table, first as an entrepreneur and then as a VC, I’ve presented some ideas here that I hope will be of value:

The Context

a) Understand what a VC does: A VC is a not a bank or a financial institution that lends some money against collateral. In India, the distinction between a VC and private equity (PE) investor isn’t very clear. An early stage VC typically invests small amounts in young, fast growing companies that have the potential for delivering 10X+ returns on the money invested – usually within in a 5 year period. There’s no collateral and the investments are in the form of equity with no financial engineering involved. It is a high risk investment and so the involvement of the VC is high. Empirical data of VC investments suggests that about 50% of the companies lose all the money invested, about 30% deliver marginal returns, while the balance 20% deliver the super-normal returns thereby ensuring that the portfolio delivers an attractive return in the aggregate. Now, you can see why VCs look for the possibility of very high returns. PE investments, on the other hand, are of larger sizes, into slower growing but established companies (and less risky), are more passive investments. Since PE investments usually involve some financial engineering, the investments are typically made into companies where there are physical and financial assets that can be leveraged. Given the lower risk, the expected return multiples are lower than the expected return multiples for VC investments.

b) There are different types of VCs: There are different kinds of VCs. They can be largely segmented based on their preferred investment stages (e.g. seed, early, expansion), sectors (e.g. technology, services, healthcare, medical devices, clean-tech), geographic focus, minimum investment sizes (e.g. some VCs will not invest less than a certain size). Pitching a technology startup therefore to a VC who largely invests in services isn’t likely to generate much `interest. Do your research on the VC!

The 5 key Specifics

a) Team: This is the most important aspect of a VCs decision making. Given the high risks of the venture and the minimal downside protection, the only real collateral the VC has is the team. Integrity, academic background, work experience, ability to deal with high pressure and challenges, ability to attract and retain customers, employees, and partners, are some of the qualitative criteria that VCs use for evaluation.

What is the team’s reputation – what do ex-colleagues, subordinates and supervisors think of the team members? Do they want to work with them again? How did the team members behave during moments of crisis? Are they trustworthy?

Is the team focused on ownership control and protection of their stakes or is the team focused on enhancing the size of the total pie? Is what is good for you also good for your startup? Remember that what is good for your startup is almost always good for you. However, what is good for you does not mean it is good for your startup. Whatever your final role, you will always be known as the founder/CEO/VP of a successful startup. No VC wants to back someone who wants to continue to remain CEO of a small startup at any cost. And it is your startup that is the focus – not you as an individual. It is important to be able to de-link your startup from your individual self. This is a hard thing to do but necessary to be able to take dispassionate decisions.

Will the team hire people based on loyalty or competence? Remember, loyalty and competence are not substitutes.

Does the team think of the VC as a partner or as an unavoidable evil? Are you willing to be transparent and share all information with the VC? Maintain the highest standards of governance? Is family involved in the company as key employees, as suppliers, partners, customers? Have these been disclosed?

Is the CEO the number #1 sales person? The CEO has to sell to key hires, customers, partners, investors and the press. All too often, Indian CEOs are inhibited and diffident about their company and its offerings as it is not considered polite to be talking about oneself. But then, if you don’t talk about your company, who else will? Why should anyone else? If you are modest about your own company, the world will assume that there’s indeed much to be modest about! I’m not advocating ruthless self-promotion or making incorrect and tall claims. I’m suggesting that the leadership needs to be able to demonstrate the ability to relentlessly keep pushing the value proposition of their companies in all forums and with all stakeholders. Participation in trade shows, speaking at conferences, networking, getting the press excited, and following up with potential customers, partners, hires, industry leaders and experts are all therefore part of the process of communication. Is the leadership team up to it?

Does the team demonstrate confidence or are they arrogant and over-confident? Will they be humble enough to learn from experiences including those of others?

The young company needs to create advocates – has the company created a credibility cover for itself by having credible people associated with the company as Directors on the board, as Advisors, as Mentors?

All of this is possible only if the leadership team is passionate about their startup. A startup is not yet another job. It is not a “get rich quick” scheme. The passion to create, to deliver something unique with your name on it, to do whatever it takes to make the company successful, and to have fun while doing so is important. Getting rich is a by-product. It cannot be the sole reason to do a startup.

b) Market: What is the problem you are trying to solve? Is it a real customer issue or is it a “nice to have” thing? Is there a market for your startup’s offerings? Is it large? Is it growing? What is the competitive landscape like? How many potential customers have been spoken to?

All too often entrepreneurs say: “According to various market research analysts, the market size will be over US$5 billion in 2010. I’ve made a very conservative estimate of a market share of just 1%, so I’ll be a US$50million business”. Well, its like saying there are 6 billion people in the world and all I have to do is sell my Rs 50 T-shirt to just 1% of them to be a Rs 3 billion company! Easier said than done, don’t you think? Remember, VCs read the same research reports! On the other hand, you can dramatically enhance credibility were you to present a bottom-up approach that worked out the number of customers you could realistically acquire each year keeping in mind such things as the sales and marketing strategy (direct, channel, OEM etc), the hiring cycle times, sales cycle times, the price customers will realistically pay, the partnership discounts, a named pipeline that can support this growth, customer support and so on. Clearly, all this information cannot be obtained from reading research reports on the Net. This information has to be painstakingly gleaned from customer meetings, discussions with industry experts, with experienced sales and marketing people and the like.

It is mathematically impossible for any one market to support more than 6 companies each with 15% market share. It is also a truism that most markets tend to consolidate over time with the top 3 or so players commanding over 60% share. Can the market therefore support the creation of a large company, say $50m to $100m inside 5 years?

c) Offering: What exactly is your offering? Why is it different from those in the market? How can the uniqueness be sustained and defended?

The ability to clearly define what your offering is and the articulation of the benefits (not features) of the offering are critical. The sharp focus on the offering, the customer, and the benefits have to be clearly and unambiguously communicated. Is there defensible intellectual property in the offering? Why cannot someone else do the same thing? How will the innovation be protected? Is the competitive advantage in the business model, in the supply chain, or in the partnership arrangements? Again, how defensible are these? Is there a road map for the maintenance of the competitive advantage?

At the end of the day, the questions that need answering are: “Will the customer buy? Why / Why Not?” “How much will the customer pay? Why / Why Not?”

Is the offering truly innovative or is it just a small variation of a set of features? Can a valuable business and company be built on this innovation or is it better off being part of a larger offering? Is the offering just a “nice to have” set of features that customers can live without?

d) Model: How will your company make money on the bottomline – is it clear? How much will customers pay? Why? What is the customer acquisition cost? What is the go-to-market plan e.g. OEM, license, direct, channel? Is there a partnership plan? How will customer support be undertaken? Is there a monthly financial plan especially cash-flows, in place? Any what-if scenarios planned?

What kind of partners does your startup have? Remember, tying up with another cash-starved company isn’t going to do you a lot of good. Two poor people don’t make one rich person. Find partners who are better, bigger, and have more money.

It is a good idea to develop a detailed monthly cash-flow plan for at least the first 12-18 months. Then, look at scenarios where the projected sales shifts by one or two quarters or if cycle-times (e.g. for hiring, development, sales, securing office space) shifted by a quarter or two or if costs increased by 50%.

e) Valuation: How much cash will the company likely consume it breaks-even? Will there be other investors interested in the company? How much can this company be worth in a 3 to 5 year horizon? Can it go public? Can it get acquired? What is the entry valuation?

Reaching out to VCs: Once the specifics have been thought through in detail, comes the question of reaching out to VCs. But how does one reach a VC? As usual, there are good ways and bad ways. A bad way is an approach that shows you are ill-prepared or that you have not researched the VC adequately as indicated earlier in this article. As you’ve probably guessed by now, sending in a well researched business plan consequent to a referral is a good way. A`VC receives many plans from various sources. So, to get any attention, a referral is probably the best way. A referral also implies that some kind of quality check has been done. So how does one get a referral? One way is to use the good offices of the Advisory Board or some other trusted intermediary.

In cases where a cold-contact just has to be done, the Executive Summary should be first sent in. This is a 2-3 page document that captures the profiles of the key team members, the market need / opportunity , the uniqueness of the offering , the business model, revenue projections, and some info on how much money is being sought and for what purpose. This should be a well written, professional and crisp document. If this is of interest, the VC will probably call you for a meeting. Go well prepared for the discussion. As the old saying goes, “you won’t get a second chance to make a first impression”!

Approaching a VC should be the job of the CEO. The CEO makes the elevator pitch, the main presentations and answers all the key questions about the company, the market, the positioning of the company, the road-map etc. It is a good idea to meet the VCs with the key team members in tow as it gives the VC a good perspective of the dynamics and competencies in the management team. Make sure the team members are well prepared. For example, the marketing person should be able to answer questions about the market, positioning, customer/prospects, pricing etc.

Presentation: It is extremely important to be able to clearly articulate the value proposition of the company without getting lost in management and technical jargon. In VC presentations, remember you are unlikely to get more than 30 to 40 minutes in the first meeting to make your case. Don’t go with 50 slides – VCs have short attention spans! What that means is that you have to make an impression in the first short meeting. This can only happen if you have a crystal clear understanding of the market, the opportunities, and the value proposition. If you cannot explain what your company is all about in a few short crisp sentences, you’ve lost the attention of the VC. This also means that you should be a great communicator. Practice!

Ideally, you should have no more than 20 slides (including the cover and “thank you ones) to cover the team, market, offering, value proposition, revenue model, and financials. If there’s interest, you can share more information or use back-up slides to respond to questions. You should demonstrate focus in your idea and in your execution plan. Practice with a few “friendly” VCs, take inputs from the Advisory Board, talk to experts and those who’ve “been there, done that”. This could be critical!

There is no shortcut. There is also no magic formula. The key is preparation and in knowing your market, the offering and in communicating the essence of the value in a crisp and clear manner.

Good luck!

The article was earlier posted in BusinessGyan ’07 edition.
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