Venture Capital Investors 101
now we're talking about big money venture capital funds. Let's take all the intimidation and Mystique out of venture capital funds and this is your go to resource for the big idea, the big dream, especially if you don't have any capital to invest in your own business yourself. VCS could be the answer for you. When reality bites, I'm going to bring this up first in the last segment. We emphasized that what angel investors and VC investors do Is they give you a lot of time in a lot of space to succeed in general. You have a good 5-7 years to build up the value of your business. But this is when reality bites is you've got those investors as part of your company, as part of your board of directors as part of your day to day living. There's upsides and downsides of everything. But when you go into business with any funding partner, they are your partner up until the day you repay them or sell your business. you must keep that in mind. They are not silent partners doesn't mean they're going...
to be bossy partners. But I hate that word. Silent partner. What is a silent partner that they have? No say? They should have say they have given you a big check. They should have some say. And if you take the approach that you're going to collaborate with them, you're going to have a great relationship with them. That is step one. Good relationships are two way street, it starts with you and your attitude about what your expectations are and the relationship you want to have with VCS. They're great people if I do say so myself. But they are, they are engaging. Big thinkers, love the upside, wanted to protect against the downside, as I said, they do love and respect you. They admire you so often in business you're not going to come across that kind of mentality. But in VCS they do have that mentality. They do want to see you succeed. One of the big differences between an angel investor and VC investor is VCS earn a salary to read through business plans all day long, they are paid to do this work. Angel investors often have to take a hobby approach. Usually they are employed elsewhere and they do this in their spare time. So immediately when you're reaching out to VCS, you can capture their attention and you can see a lot more deal momentum because their whole world is and their job is to invest in unbelievably talented employees or entrepreneurs just like you who want to be big or bigger. They live and breathe this stuff. So right then and there, you know, when you have their attention, they're probably not going to go on vacation and not continue to interact with you, they can write really big checks, much bigger checks than the average angel investor. So this should be in your mindset, even if you're starting out with angel investors, but you want to build a very big business with international capabilities. VC should be somewhere in your funding strategy. These seas look for scalability. They love deals where you work out the beginning recipe and then their money comes in to, as they say, blow it up further to expand it further where the revenue growth can be exponential. They don't want to necessarily see their money go in too fast before you've worked out some of the kinks before you've really tested whether customers love it. So sometimes it surprises entrepreneurs when they hear a little bit too much of breaks, putting on the brakes and test test test. Let's make sure the business model works. And sometimes, especially in the early stages there's got to be some give and take and testing. You don't want to blow as we're going to talk about in an upcoming segment. The penalty to you in added dilution is if you raise way too much cash and it's, you know, spent on lots of marketing but doesn't return in the form of added customers and valuation growth. So a testing mentality, especially in the early stages, a collaborative mentality is not a sign of weakness. I consider it a sign of maturity, an incredible smart good sense. Get it right And then these seas and their cash can help you blow it up. But what a shame if suppose there is a big kink in your product or service and you get you blow it up and you get negative negative customer reactions, social media impact. That's much harder to overcome than smaller, testing fixed tweak and then blow it up so that's that kind of discipline. That is attractive to VCS who do ultimately care about scalability and putting the cash resources and helping you fund the talent and the marketing programs to help build that big business that you aspire to own and run. Here's what we do know about portfolios and portfolio management, interestingly for the average venture capital fund in America, there are always exceptions where one big deal just blows out the return rates of the fund. But in general, the majority of investments will not get in DC money back, especially at the seed and early level. So that means a couple, maybe two or three out of 10 investments must be so successful to overcome all the other losses where there is a complete write down of the investment or maybe all the um investor did was get their money back, but no profit on top. So two or three out of 10 have to pay for all those other losses. By the way, that's not too far off from the statistics of companies that succeed and fail without venture capital funding. The difference is the losses are greater in VC backed companies that fail. So again, Just getting a 20 return on invested capital And you happen to be the one winner in the is probably not going to be good enough to help those VCS in their own portfolio cover all their losses. That's why scalable businesses that can be home runs is an investment priority of VCS. Angels may be happy with a double or triple because it is entirely possible with an angel investment, that one or two rounds of angel investments and then the company is sold. You don't need millions and millions and millions of dollars of added capital to hit that high ground VCS need a big win. Their decisions are going to favor companies that can be big, important game changers or frequent lourdes you here. So they are swinging for the fences they have to, otherwise they won't when they completely raise or finish off their fund investor, all their money, they won't raise money. Again, that's the arithmetic behind what they do. That's why they are looking for scale ability and how their money can become worth so much more. The standard is higher than Angels. Okay, again, more companies in America will get angel investors. Then the number of companies in America that give BC funding Still possible, it's only two or 3000 a year. Get VC funding dozens and dozens more. Get angel rounds, you can get both, but know when you're ready to go to VCS, you have to be talking in bigger terms about what you can accomplish with a bigger amount of money and you can do that. And if VCS here's another motivation, so when they're asking you lots of questions about their business, if they recommend within their company to invest behind you and several other deals, if all their deals end up losing money, they can lose their job, an angel investor loses their cash. VCS can lose their job. Different thing, but the emphasis is on professional investment. So when they approach a deal, they almost have a checklist of what they're looking for so that they can demonstrate to their boss and their own investors that they've done an adequate amount of homework worthy of that check. So allow them the time to get that work done. Don't grumble, don't complain. They have to do it. They will do it. The only way you can speed up the process is to deliver the information as soon as they ask for it or try and anticipate it, be ready for it. It will not happen without them completing their own due diligence checklist. Don't complain. Stay ahead up. One other point I do want to say is there is definitely a sheep mentality and VCS will admit to this. There are trends in VC investing a few years ago, Right after 9, 11, Oh my gosh, all the security companies coming out of the world, big area for investing. Mobile, big area of investing, clean tech and the first company that does it, then everybody's after it. So if you hear in your space mobile gaming that there's a lot of VC activity going on in your space right now, there's a lot of money going after different types of education platforms ride the wave get out there. Companies are deploying capital. I don't want you going to the same VC that funded your competitor by the way, but use that information as confirmation that gee there is a market growing and VCS love getting in early in a growing market, a changing market. So just because you may hear a competitor got capital, don't be discouraged. It may be a part of a new trend in investing and VCS are sheep, they follow the herd, they follow the trends, which does make sense. It sounds like it's a real slam, but it makes sense because they love to get in a new and emerging markets and then when the noon market emerges, that's when they love to get in, ride those waves. Pay attention to that deal flow. All VCS are not the same. Okay, earlier on, we emphasizes the stages of business development. That is, we want to be great shoppers here and match our business, our industry, our stage of business development and our geographic location to the VCS that line up best to that. It's the best way to avoid a fast now. So some specialize in only investing in one stage of business development. Maybe it's early stage every once in a while. The very large funds may be what's called stage agnostic funds and they will say we invest across the board now between you and me, they're likely to favour early and expansion stage versus seed. If your seed level company, I really want you going to those funds that really specialize in seed investing, they're likely to lead the pack. Some VCS will only emphasize one industry sector. Most VCS Invest in two or 3. And there is a partner within the fund who tends to specialize in consumer or clean tech. Guess what? That's the partner you want to present to. So if you're pitching a clean tech deal, find the clean tech partner, don't send it to the I. T. Software guy, they may refer it on. But let's be more precision based. Show them that you can read right and dive into their website. Find the partner. How do you tell just by looking? Usually it'll say, but what boards of directors that partner sits on? If they're all clean tech companies, there's your clean tech specialists. It's matching your shopping, right business location. The earlier stage business works for Angels. The tendency, even though a fund might say a seed stage son will invest in any opportunity anywhere. For the most part, there is greater comfort in the earlier stage deals by investing regionally, it is not uncommon for somebody in Canada and I know we have a big Canadian audience at Creative life, a Canadian entrepreneur to move down to the Silicon Valley because there's an appetite for investors down here just to get those first round stone. So you may be mobile, but regional emphasis does matter. There are some funds that only specialize in companies where the the product or service can will be sold in china. There are some funds that one just west coast deals deals in the south, new England mid atlantic states because they don't want to travel beyond that. Pay attention to it. They won't make exceptions were very, very rarely. So these are the things on how you line up your company to your perfect funding partner. Mhm. Here's what else I can't emphasize enough if you are a consumer deal, both of you are technically kind of consumer, maybe a little it here there are going to be more early stage vcs than seed stage. So what if you don't get their seed stage money with just a little bit of progress? Start reaching out to the early stage ones knowing full well that you haven't quite progressed, but start to get to know them, you will get into their sweet spot, have them fall in love and be impressed with the progress. So I know if I was starting a company today, I'd want to know the seed early and expansion stage companies that love my kind of deal because these are the people I want a network to now and in the future. I want them on my radar screen. I want my company to be on their radar screen. So it's a little bit of forward thinking in the same way where you know what customers you may want now and where you want to go in the future. Same thing because remember your shoppers for cash and up until the day you sell your company, your job is to make sure your company has enough cash to operate. You can never delegate this responsibility as master mixologists. It's a little bit more on the smart match because I'm sure people in the audience are wondering why my seat in my early in my expansion by this, somebody that here's the attitude of it, a seed stage V. C. We'll have to do because you may not have a product in place or even your first customer, they're going to spend more of their time, their due diligence time understanding the potential market demand. I talked a little bit about this before. I can't emphasize this enough. This is your sweet spot. Know that they are high risk investors and they have the highest expectations for return on invested capital because they're going to be in their deal the longest. They will probably be in that 5-7 years. You better like them and encourage them that they are going to make a lot of money with you that will make it worth their time and attention to you. There will be larger equity stakes and more preferences that we're going to talk about in the next segment. Their deal terms may seem more tougher. Yes. To protect them from losing all their cash. But still there are opportunities for you to make that money back. Survival is a big issue having enough funds to complete R and D. When you present your company and you are developing new products or services spend time really thinking how much cash you need to get that done. And the types of people, sometimes the people you may hire to be a part of your company and some of them may be contractors. You have to be precision based of getting and employing the people to get this first job done. You may not get to a second round if you hire badly in the first round early stage species, that means a little progress. You're early. It's kind of like what you know? And one of the funny things is um, getting some people think getting up at 11 a.m. Is early, I think it's six a.m. you know, so it's room for a lot of interpretation. But in general an early stage VC is already starting to think a little bit nationally. They expect you to be farther down the road in product development, you may have first customers, you may even be profitable. You may even have hit cash flow break. Even this is a big sweet spot for investing. Sometimes you might even find an expansion stage company that ends up getting venture capital from an early stage just because it's available. And they like the deal, the technology emphasis um, is important. They tend to favor technology deals, but they may also favour non tech deals. If the expansion potential is incremental restaurants that can duplicate over time, um, your education software business, they will pay attention to the reasonable scalability. What do they want their cash to go to that rapid expansion? So you're gonna have to line up, what are you gonna do with the money and the people to get that growth going seed stage? They're not necessarily looking at fast growth for that first round. They're looking for perfecting the product. Early stage are starting to get hungrier. Show me more people hitting your website. Show me more customer engagement. Show me more orders. They're pushing you harder. Survival is still an issue, but less You're less likely to completely tank in the next 12 months or somebody has really not done for two diligence investment horizon, maybe As low as four years here is a tricky thing. A good question asked seed and early stage funds, Maybe even expansions funds. They have a pool of funds. All right. They start spending that pool of funds. Are you getting in the door of the VC at the early stage of that fund? And let's say they have a 10 year investment horizon. It's important to know if they are starting to wind down their fund, they may end up favoring deals Closer to the four Year Horizon. For true early stage companies, it's great to get in when the fund is robust and in the earlier years you may have a little bit more leeway to get the job done. Always find out where they are in their own investment cycle. It's what may make an early stage VC favored deals that are a little bit farther along than yours expansion stage Vcs, here's where they really want to goose a lot of growth. They're going to pay more attention to the quantitative elements of which your business is accomplishing, maybe even funding international growth. They may supply funds to help you buy another business. Their investment horizon is really dialing back to three or four years for later stage companies, they're not necessarily gunning for a seven year deal. They want it back earlier. There is an opportunity for you to even turn to expansion. Stage VCS to sell, Let's say you wanna cash out a little bit, but you want to remain in the company. A seed stage VC would not engage that idea at all. Remember how vigorous we talked about these investors will not pay off your own debt, will not get your money out expansion to stage VCS because the risk of going out of business is so much less, but they want to be a part of your deal. They may play ball and help you sell some of your shares so you take some cash out of the table. You won't find this attitude in seed stage businesses. We want you to have skin in the game and be dependent on building, building, building. We get a little bit more lax at this level. Plus there's so much more backup in a company in terms of executive management surrounding you at this stage, VCS and investors are less dependent on the founder to really deliver value. I'm going to look at it a little way and we know in our course materials, we list many more VCS and there are hundreds of them that invest regionally and nationally, we cannot cover them all. But just to whet your appetite here are some seed stage um funds and some of them have that regional emphasis. What you'll find in the kind of continuum of starting up at the siege all the way up to expansion level. VCS as you'll see in terms of industry areas of emphasis here is greater comfort in investing in technologies, especially groundbreaking technologies. I want to emphasize this one point again, you will find if you start to look at expansion stage VCS, the kinds of businesses that they love to invest in and they'll tell you, we love manufacturing companies, consumer brands, they love that over there. You won't see the appetite as strong at the seed and early stage where the appetite is usually technology driven. I don't want people who are coming up with consumer oriented deals or platforms to think they can't get funding just because they don't see consumer there. But understand the appetite, it's up to you to present the value of your deal and why you're worth investing in and why you can double triple quadruple the value of their investment. Okay, some other things about new trends in VCS corporations are increasingly setting up their own venture capital funds. Again, they want innovation, they want earlier access to the creative, talented people who are driving great new ideas and products and online services. So it's not necessarily the corporation, for example, Comcast has Comcast ventures with offices on the east coast and the west coast hearst hearst Interactive Disney, Steamboat Ventures Microsoft Microsoft first called the Big Fun. Now, it's called Microsoft Fund Cargo G. Novartis. You find in a lot of biotech companies, pharmaceutical companies, so they have a very specific interest. They're not just financial investors, like traditional Vcs, they're looking for some sort of strategic link. So if you have a media idea hearst Comcast, they're the biggest media and sometimes their role as a corporate venture capital fund is to be the wonderful conduit introducing you the entrepreneur to greater corporate assets. They might help publicize your deal more. They might help you provide technology or collaborate in different ways. You might piggyback onto their own sales and distribution assets. They're looking for a little bit more. Sometimes these funds are called strategic investors, but make no mistake, They want the very same financial returns as other Vcs and they are great partners. They often partner with other Vcs where you might put together three Vcs and each one writes a check for a million dollars. Or one of these corporate investors might serve as the lead investors and say, I like this. I'm going to call up some of my friends to come in and um, and form a syndicate behind you, but a lot of people are not aware of this is out there for them and don't be shy about it. Uh, the U. S. Army has a venture capital fund. The CIA has a venture capital fund called in Q. Tel. The army's is called on point why they love innovation. They are big buyers of technology that they deploy worldwide insecurity. It, you name it, it's out there there there, wow a lot of funds that most people thought we're out of their reach may not be. Does this encourage you knowing? Gosh, you know, there's a lot out there. Another way to look at it. So some only invest in health care or life sciences or consumer e commerce, internet media platforms, Some specialize in gaming. You have the cool game idea. There are funds that just love that all day long. And if you go to specialists in your industry, make no mistake, they know the industry. So if you say I am first, they may know better just because you're not out there and you don't see it out there, doesn't mean they have not already seen a business plan or even funded it. Oh, which brings me to a key thing. Vcs and most angels are not going to sign confidentiality agreements. If you send a note to any of us saying by the way, sign this confidentiality agreement. So you don't steal my idea, it's gonna be kicked back to you. How can they sign an agreement like that? How do you know? They haven't seen your same deal two weeks ago. Their view is, it's not their job to police innovation. That's the patent and trademarks office job. If you want to be first, you better file your patent first, right? But they will not sign confidentiality agreements. If you send it, they'll assume you don't get it. You don't, you're clueless. Don't bother. You can hold back, especially if you have a patentable secret sauce, you don't have to disclose all of that. Initially, you can describe what you're doing, who your customers are, the value in the marketplace, the strategic advantage. You don't have to necessarily show them their code. They're not asking to see your code but you have to explain what you do and what you want to accomplish. And as you get more comfortable then you open the kimono a little bit more. You don't have to do a day one and certainly not in your business plan but just say how are you going to make money? Why will their money grow into more money? What is the relevance of what you're trying to accomplish from a commercial standpoint? That's all you have to do in the beginning. But don't underestimate how much they know about their specific industries of expertise. You in fact may be able, especially if they become your investment partners to continue to learn more from them because they are watching industries very very closely. Oh also noticed there was a little soft social enterprise development. One new trend is V. C. Like funds that invest in for profit or nonprofit companies that take a very entrepreneurial approach to solving a major problem related to poverty, education and so forth. So social venture partners, which has multiple offices around the United States. Just does that? How cool is that again? Here's a little map of some funds with regional emphasis, madrona, Voyager, pacific northwest. Don't send them a deal. If you live in north Carolina, they're gonna say no. So again, you're matching geography industry stage of business development. How easy is that? They're out there One thing, most of these regional VCS, they don't necessarily have the big kleiner Perkins name. Everyone hears all about kleiner Perkins in Costa, but it's harder for them to hear about the regional funds because the funds don't advertise. They don't have to, but they're out there. And I bet within your community you can start asking accountants and lawyers and so forth. Are there some regional funds available for me? We have some listed, certainly in our bonus materials, many more names than are listed here, but they're out there. Don't assume they're not.