Find Me a VC!
As an advisor, the most frequent question I get from entrepreneurs is “Where do I find a VC to fund my idea?” My response falls into three categories:
- An idea is typically not investment grade. Unless you are a proven success story, you are not ripe for investment. Support at the seed level is dismal. Investors prefer high-quality deals (a Series A or later offering). Bootstrap your concept up to a viable product to gain a minimum level of credibility.
- But you may be investment grade. Qualifying yourself as investment grade requires a proven team and a 10 to 30 times return expectation. That puts you in the 1 percent club. Go pitch to some credible VCs (although they’re mostly on the coasts).
- Or you may be angel grade. If you’re in the other 99 percent, you won’t even get a meeting with credible, ethical VCs, let alone get money from them. Your best bet is angel investors. Take your idea as far as possible and prepare an honest case.
Caution: If you are desperate, you may end up with investor misalignment or pick an unscrupulous investor. Watch out for these common mismatches:
• Mission and values: You believe that the investor is only interested in money, so you dress up your whole pitch accordingly. This is not the best approach—this game is about doing good work for people who value it.
Start a conversation rather than jumping into a fundraising pitch. If investors ask confrontational questions, they either don’t believe in you or in your ability to succeed. However, if they ask curiosity questions, they may have potential.
Stay true to why you are doing it. “To make a lot of money” attracts the greed crowd. In execution, your plan will likely fray. You want an investor who will stick with you in good times and bad.
• Proper pedigree: The investor talks about the relevant skills, connections, and reputation they can provide your company. This value-add is essential, but it’s not the central goal. In most cases, the VC firm’s staffer assigned to look after your venture may be a fresh graduate from a top college or someone with limited experience running a business.
Some investors made a fortune as an employee of Google (or Facebook or Twitter) in the early days. They portray themselves as experts by throwing around their big payday. But their knowledge base is still not that of a traditional moneyed investor. Do your due diligence on the investor, especially with investees who experienced problems.
• Misaligned structure: VC terms have become aligned with terms demanded by other kinds of accredited investors. Many clauses ostensibly protect the investor but have hidden risks for you.
Most funding is done through preferred shares or convertible debt structures, while you, employees, and early supporters usually hold common stock. Some investors use high valuation to entice you, then add terms, particularly anti-dilution clauses, that may not seem like much now but can shaft you down the road.
An investment banker once boasted that “if the venture is not in default on the day we sign the contract, we didn’t negotiate well.” Don’t be tricked by overvaluation with exotic instruments and stealth terms you don’t understand and whose impact you cannot predict.
“Some investors made a fortune as an employee of Google (or Facebook or Twitter) in the early days. They portray themselves as experts by throwing around their big payday. But the knowledge base is still not that of a traditional moneyed investor.”
• Speed and scalability: Many investor models based on VC criteria require rapid growth, with a lot of marketing and sales investment. Your venture may require a slower pace with research or for proving assumptions. A bicycle going at the speed of a Ferrari will surely crash. Commit to a pace consistent with the natural rhythm of the business.
• Timeline: If your investor is a fund, it usually has an investing period and a harvesting period. Investing toward the end of the fund’s life may force you to exit prematurely. Verify the time horizon.
• Conflict of interest: The chances are high that your advisor has an alignment (hidden or overt) with other investing institutions. Get the best unbiased advice without a conflict of interest.
Entrepreneurs are like a teenage boy who thinks anyone who smiles at him is in love with him. Investment is an adversarial engagement—the onus is on you to build strength before engaging with investors. That preparation boosts the chances of finding the right investor—one with a total alignment with you.