How things look from the investor’s side of the table

power law

Eric Feng, now a VC at Kleiner Perkins, but previously a CTO of Flipboard, founder of Erley and founding CTO of Hulu knows what venture capital looks like from both the founder’s and investor’s sides of the table.

His article A stats-based look behind the venture capital curtain on Medium has an analysis of trends in VC funds in the US over the past 15 years that is highly recommended reading for any founder seeking capital.

From 2003 to 2011, an average of 157 new funds were raised each year. But from 2012 onward, that average rose to 223, or an impressive 42% increase. More funds equals more active investors working at those funds.’

Another insight from Mr. Feng is that all the recent growth in the number of funds raised has been from seed funds, not venture or growth funds.

There has been an even bigger increase in the number of seed investors active in this country because of the disproportionate growth in the number of seed funds raised each year. So if it feels like there are thousands of new investors in the industry, particularly seed investors, that’s because there are.

“A lot of capital does disrupt venture capital, which is the problem we’ve had as an industry.”

— Sarah Tavel, Benchmark

Founders heed well: So even with the sharp influx of seed funds, the vast majority of the dollars are still invested by traditional venture and growth funds. Since 2011 the average number of seed deals per years (4,300) is not about equal to then number of non seed deals *(4,500).

But as veteran VC Bill Gurley says: “Venture capital is not even a home-run business. It’s a grand-slam business.” Virtually every founder I have met with over the past couple of years just assumes they will raise venture capital. However,

As investor Marc Andreessen has said, “returns are a power-law distribution” with the majority of returns concentrated in a small percentage of companies. That’s true now more than ever, and one of the great promises of the venture capital industry that motivates and drives investors.

So while this article is written from the viewpoint of a venture capitalist, it is well worth studying for founders in search of capital. Basically if you can’t show a VC that you have the potential not to just hit a home run, which was good enough the previous decade, now you have to show that you have the potential to hit a grand slam. Otherwise you are unlikely to even get a meeting with a VC, let alone an investment. Yet at the same time there are significantly more investors today than 15 years ago. The size, growth rate, and dynamics of your target market are the gatekeeper metrics for a venture capitalist today. In other words, disrupting a very large market is table stakes. If you are going after anything smaller you need to either bootstrap (be self-funded) or find an angel that falls in love with your startup,

Getting a VC investment has now become much like getting an acceptance to an elite college or university. The strategy is the same, send out a lot of applications and pull every string you can find in your web of contacts to get warm introductions. The only exception to this rule is Demo Day, where you get to present to a mass of investors, alongside your fellow founders. Demo Days are highly efficient for both founders and investors as both sides can cut through the introductory dance to get directly to a presentation or demo of the venture’s product. In higher education the table is tilted in favorite of athletes and legacies – children of alumni. How does a founder tilt the table in the VC game? By being a serial founder! It’s a chicken and egg problem, if you can’t raise money because you never have raised money what can you do? For one thing, find a partner who is a serial entrepreneur. Beyond that close advisors, like your former professors, with deep startup experience can help you distinguish your startup from all the competition.  But keep in mind where you truly need to distinguish yourself is in the minds of customers. If you can do that the money may well beat a path to your door.

Things you should know about VCs

vcThere are lots of myths out there about VCs, about how they will take over your company and replace you as CEO or that getting a VC investment paves the way on your path to riches. But Jason Lemkin of SaaStr, the world’s largest community of SaaS executives, founders, and entrepreneurs, has an excellent article on some facts you should know about VCs – forget about those myths!

  1. Entrepreneurs tend to think about VC firms, but in reality VC firms don’t do investments, individual partners at VC firms are the ones making the investments. Just like medical device makers don’t sell to hospitals, they sell to the individual financial decision makers in departments in hospitals that need those devices. And the hard truth is that partners at VC firms do very few investments per year, typical just one or two. So as a collective firm they may do a significant number but the individual partner who’s a potential fit for your firm only one or two. So you need to have a really compelling fit for that VC and you better know from your research which partner in the firm might invest in your firm. That knowledge should be based on their track record, blog posts, social media presence, and G2 you can gather from their portfolio companies.
  2. As the Bob Dylan song goes, “Everybody gotta serve somebody” and in the VCs case it is their limited partners, those pension funds, college endowments, and wealthy individuals who invest in venture capital as part of their diversified investment portfolio. So check out the limited partners, for example, when we were talking to Greylock about funding Course Technology it turned out they had six or seven limited parters which were college and university endowments – so they were excited to invest in our educational software and publishing company.
  3. Partners are diversified, you aren’t. Unless you are Elon Musk or Jack Dorsey, chances are very high that the only company you are fully invested in is your own. Not so for partners in VC firms. In essence they are portfolio managers; your firm is just one amongst several in their portfolio. So they will tell you that their interests are fully aligned with your’s but in fact they are not. Resources – money, connections, and their attention – will go to only those firms in the portfolio that they perceive as the winners.
  4. VCs don’t just make money on exits, they make money on management fees. And to make a lot of money on management fees – typically 2% of funds invested per year – they need to raise multiple funds. And they raise those funds by getting step ups on the valuations of the companies in their portfolios. Yes these are paper gains but they can show their LPs strong IRR on their current investments. So VCs always have one eye on the next fund and how they will raise it.
  5. Small VCs Align With You, But Lowball You.  Big VCs Don’t Align As Well, But Can Pay More. Big VCs can write big checks and they also can hold funds in reserve, so they can participate in multiple rounds without getting diluted. But small funds will probably have to syndicate their rounds – share the investment and any returns – with other firms. Big VCs can write very big checks, but then they need to have a big return to impact the fund. And partners can only serve effectively on just so many boards – typically no more than seven to nine – so if you only need a small amount of funding they can’t afford the opportunity cost of taking the time and attention to invest in you, let alone serving on your Board.

Entrepreneurs have learned about product/market fit, but investor/venture fit is equally important. The amount you need to raise, the market you are targeting, how you play with the partner’s portfolio, and your need to raise multiple rounds to get to breakeven are all factors you need to take into account before you even start contacting VCs. As Sun TZu wrote in his work The Art of War, “Every battle is won before it’s ever fought.”

10 key steps in approaching your first VC


If you are indeed investor-ready, then it’s time to take these key steps before you approach your first venture capitalist for an investment. And you do have a warm introduction to this VC, right? If not, go back a step and get one!

  1. Review the investor’s portfolio, which is virtually always on their web site. Are any of these companies competitors to you or potential competitors? If so, you should steer clear, as the only reason you will get the meeting is to have their partner gather information about you, for them.
  2. Are you at the right stage for this fund? Some funds primarily do follow-on rounds, they virtually never do seed stage. Make sure you are at the stage that is a fit with your target investor.
  3. Is the timing right? VCs, like founders need to raise capital. You don’t want to target a firm that’s closed out their first fund and is in the middle of raising capital for it’s next fund. Or a firm that has invested virtually all of its fund already. You may need to ask the partner the stage of their fund, this is not publicly available information.
  4. How much runway do you have? It can take 6 months to raise an institutional round. You might need to raise friends and family capital first, if you haven’t already. Or perhaps you start with an angel round. The cardinal sin in startups is to run out of cash! And you don’t want to be negotiating with a VC from a position of weakness because you cash is about to run out.
  5. Brief your team. They should know what firms you are approaching and which partner in those firms. You never know when a VC’s path will cross with one of your team’s.
  6. Create a killer two-sentence summary of your firm to go in the body of your email.
  7. Create an exciting one page summary of your business, including the team, your market opportunity, and secret sauce. Don’t forget your contact info!
  8. Come up with a good subject line for your intro email. Such as “Bill Jones recommended we talk with you” where Bill Jones is the person giving you a warm intro. Obviously, if he’s gone as far as sending you both an email, then the subject line would be “Following up on intro from Bill Jones.” VCs get a lot of email! Don’t let yours get lost due to a vague subject line.
  9. Do not send your pitch deck. Even if they ask for it. Politely explain the deck has been designed to support your presentation, not stand in for you. You want to use the one-pager to get the investor meeting, where you will be glad to present the deck. If you really want this meeting and the VC is adamant about wanting your deck first, you can one of two things: one, walk away. That may actually impress the VC; or two, craft a more detailed deck that can standalone as a document presenting a complete view of your business. But keep in mind, decks get passed around, do you want that? Better that your one-pager gets passed around.
  10. Do not specify how much money you are asking for! It may be too much for the fund you are targeting or even too little. Don’t give them the opportunity to use that excuse to ignore your email or follow up phone call. Once you get into the meeting your ask will be the last slide in your deck.
  11. Last and probably first: talk to some founders who have received funding from this VC. Do they think you are a fit with their fund? Do they recommend the VC? And most important, how does the VC act when times are rough? Read my post Founders need to perform due diligence on prospective investors.

So we’ve done it the Spinal Tap way, turning up to 11! There’s more to say, such as rehearsing for a phone call to or from a VC, but we’ll stop here so you can get going.

Pros and cons of investing in your own startup


Lessons from my own experience

I recall being told by VCs not to invest in my own companies. Investing should be left to professionals (e.g. venture capitalists), founders should focus on building their companies. I’m sure that there is some self-serving in this advice as VCs want to buy the biggest slice of a company they believe will be successful. If founders self-finance they may have less need for VC funds. On the other hand, the advice from angels was just the opposite. They want to see founders’ skin in the game. They are suspicious if you don’t invest in your own company. “Why should we invest in something you won’t invest in?”

I managed to get through my first four startups with only VC funding, no self-funding, no angels. But once I dropped out of the major leagues, which I did after leaving
Mobile-Mind and went into the minors to work on a mobile shopping app that was funded mainly by my partner. He did inveigle me into putting a small amount into the venture, which I ended up losing, as the world wasn’t ready for a mobile shopping app in 2002, duh!

Unfortunately, I did not learn my lesson with SmartWorlds and cajoled a friend and former successful VC into us self-funding a startup based on his idea. This was a great idea, it became Stories for Instagram. But we didn’t have the Instagram platform to launch this early version of Stories, so like the mobile shopping app, we belly flopped. But my biploarity had its switch flipped still in manic mode, so once again I tried to start a company with my own idea, as I did with Throughline. While we had a modicum of success with Throughline, our investors lost confidence in us and were afraid of our entrenched competitor, so we shut down the company.

I should have learned that my role in the ecosystem of startups was to help visionary founders build their companies – I have no sense for what’s commercial, so the visions I had for Throughline and PopSleuth never gained traction. But fool that I was I put my own money into PopSleuth, which was created to help solve my own personal problem: how could I keep up with the latest releases and appearances by my favorite creatives -writers, directors, actors, authors, and musicians? I believed in the idea that successful entrepreneurs built products to solve their own problems, like Dan Bricklin who invented VisiCalc to save himself the labor of trying to revise financial models using just a calculator in his Harvard Business School classes. It is true that many successful startups were founded to solve the founder’s problem, that doesn’t mean you will be successful just because you are creating a product to solve your own problem.

So after being burned twice by investing in my own startup ideas, I’ve gone to the sidelines to coach other entrepreneurs. And often the subject of self-funding or funding via friends and family come up.

I advise them founders that:

1.  self-funding should be a last resort and a bridge to either shipping your product or bringing in outside investment.

2. You should not invest more than you or your friends and family can afford to lose.

3.  Only if you plan to raise angel capital will self-investment be a plus, otherwise it won’t help you gain institutional investment.

4. If you do bring in substantial outside investment odds are you will get very diluted by the time you exit the venture, so what good did that self-investment do? (see number one).

The best capital is not your own capital, it is not investor capital, it is customer capital. Bootstrapping to build your product is the best way to go. Even if customer revenues are slow to take off your venture will be far more investable with a complete product and some customer revenue.

So basically there are only two pros to investing in your own startup: it acts as bridge to outside capital or customer revenue or it helps persuade an angel or angel group to invest. Unless you have made substantial money from a previous startup or have inherited wealth, your investment probably won’t represent meaningful equity after a several rounds of investment. You would have to continue to invest your own money in these rounds to maintain your equity share. I don’t know anyone who has done that.

Blood, yes. Sweat, yes. Tears, yes. Your own money, in most cases, no. Bringing in outside money is real validation you have a viable venture; investing your own money validates nothing.

Lessons from Jean-Louis Gassée, former VP of Software Development at Apple, and founder of Be Computing

For another tale of investing your own money, read Jean-Louis Gassée’s Monday Note50 Years In Tech. Part 16: Be Fundraising Misadventures. JLG paints a very accurate picture of the difference between professional investors and amateurs, i.e. founders like himself.  You have to be a fan of the history of computing like me to read all 16+ parts of JLG’s history. But I do highly recommend part 16 for anyone contemplating investing their own capital in their venture. Here’s a few tidbits:

I wanted to keep Be out of the vulture capitalists’ talons, so to fund the company in its early years, I put my own money into the venture. That was the first of a series of fundraising mistakes.

…I thought I was doing the right thing, but, as I found out, professional investors in the US are suspicious of self-funding. They prefer a clean division of labor: The entrepreneur provides the idea, the psychic energy, the leadership; the pros supply the financial fuel.

When my personal coffers began to run low, I accepted investment money from friends and business acquaintances.

JLG’s note does a good job of listing what he calls the Laws of Professional Venture Investing. If you don’t know them, I’d advise you learn them before you start your venture.



Are you investor ready?


Today is the deadline for applications to MIT’s Demo Day to be held in April. Demo Day gives selected Venture Mentoring Service founders five minutes to pitch to the audience of VCs and angels.

I work almost exclusively with raw startups, whether at MIT VMS, The MIT Sandbox Fund or the MIT Post-Doc Association. Very, very few founders want to rely on bootstrapping, the vast majority have “how do I raise money?” on their agendas early in the mentoring process.

But what I find is that few new founders understand what it means to be investor ready. Here’s a snapshot of what is needed before you decide to apply for investor pitches:

  • Team – most investors I’ve known focus on the team first. And in fact of the team, 90% of the focus is often on the CEO. Does she or he have what it takes to drive a company to a $100 million sales run rate? Or will the investors need to replace the founder with a seasoned veteran as the founder either can’t handle running a company with several hundred employees, or is often the case, is not really interested in doing so. They prefer to build things, as most founders tend to be engineers and engineers build stuff. So you need a CEO who presents well: confident, articulate, and passionate about the business, with a vision for how they will disrupt an existing market or create a new one. While investors don’t expect raw startups to have full teams, it’s tough being a singleton. At minimum you need a partner who complements, not duplicates, the founder’s skill set. Too often I see two engineers, a CEO and a COO – both are makers, not sellers. While it’s usually too soon to attract a proven sales person, early stage startups have to show that the founders can sell. We used to call that “executive sales.” Even when a startup hires sales staff often customers or clients need to be closed by the CEO – they want to know who is running the company they are betting on.  A good two-some is an engineer and an experienced digital marketer. A three-some might add someone with business development experience – building partnerships that turn into channel sales.  Teams whose members know each other previously and/or have worked together tend to be more successful than strangers brought together through networking events.
  • Product – investors want an unfair advantage, as one veteran VC told me. What’s your unfair advantage? These days with so many AI startups that advantage may be an algorithm or patent pending technology.  Secret sauce is hard to manufacture. But differentiation isn’t. How are you different than other products or services targeting the same customer? What is your sustainable competitive advantage? What is remarkable about your venture? The downside of today’s entrepreneurial explosion is that there may be a raft of competitors, no matter what niche you choose. And first mover advantage is not always that. But if you can’t demonstrate – show, don’t tell – a clearcut differentiator that will appeal to customers don’t bother apply to demo days. The stage of your product is also vitally important. The best is that you’ve launched and you not only have traction, but you have viral growth. That’s pretty exceptional and but a few very smart MIT founders have even raised money with just a prototype. But the further along the product lifecycle you are and the closer you are to building a customer base, the better.
  • Market opportunity – far too many founders want to boil the ocean. If you suggest they target a niche to start off they get visibly anxious that they will be leaving millions of customers behind. Quite the contrary, if you can dominate a niche you can then move into adjacent markets. Facebook’s classic rollout started with Harvard, then other Ivy League schools, then other elite colleges then to anyone with a .edu email address and so on. Mark Zuckerberg was careful not to make the mistake Friendster made of having so much demand their servers failed repeatedly. VCs want billion dollar markets and your market needs to be growing, not static nor shrinking. The better you can explain your market dynamics and how your solution will win against competitors or whatever customers are getting by with, the better.

VCs are all about managing and reducing risk, contrary to their popular image as swash buckling risk takers. There are three types of risks: management, technology, and market. To be investor ready you should be able to convince investors that you have significantly reduced risk in all three areas.

There’s one other intangible to being investor ready: capturing investors’ imaginations. While these Ivy League MBA-wielding financial managers pretend to be data-driven, they really go with their gut (and often what their kids say about consumer apps) and then justify their decision to their partners with the numbers. I have found one key way to know that you have captured an investor’s imagination: when they start telling you what new markets your product could conquer. A truly excited investor buys into the vision and will demonstrate that by throwing out ideas on how you can make you product even more successful instead of their default mode of strafing the poor founder with a fusillade of reasons why their venture will never work.

So run through the big three – team, product, and market opportunity – and if you think you have critical mass in all three areas go for it, otherwise get back to work. Don’t worry, investors will always to be out there and interested in a world-class team with a breakthrough product, solving a big problem for millions of customers.

Why a giant market is no longer enough


nvidiaThe received wisdom on startups is that you need a very large market – at least $1 billion – if you are going to build the size company VCs expect. But there’s another important factor to a large and growing market: volatility.

The article in The Wall Street Journal is a perfect example of this issue: Nvidia Lowers Guidance on Weakness in Gaming, Datacenter Businesses, subtitled Chip maker calls latest quarter ‘unusually turbulent,’ will take about $120 million in charges.

The Santa Clara, Calif., company’s stock sank to $138.01. The shares have fallen further than every other major technology company since an industry rout began in October—a skid that erased more than half of Nvidia’s market value.

Like Apple, Nvidia blamed the slowdown in the Chinese market for its sharply reduced revenue. But that’s not the only issue, a downturn in virtual-currency prices drove cryptomining enthusiastsfrom that market, leaving Nvidia with excess inventory.

And while the article doesn’t go into any detail, Nvidia’s products have been key components in gaming PCs and a weakness in that market has hurt Nvidia’s revenues.

And Nvidia had problems in yet another market:

Nvidia also said it didn’t close as many deals as it had expected in the last month of the quarter for its chips used in data centers.

That business had been a major draw for investors, Mr. Rasgon said, but given the limited number of large cloud-computing players, revenue from the business was “lumpy under the best of circumstances.”

So what will Nvidia do as three of its markets take major hits, tell investors there’s yet another market that will drive sales: “Nvidia said it remains well-positioned as a supplier for artificial-intelligence-driven and high-performance computing, which it said represents a large market.” But how credible is that projection given they failed to project the downturns in the Chinese, crypto-mining, gaming, and data center markets?

So what’s the lesson for founders here? Consider the stability and volatility of the markets you are targeting. Large markets are not sufficient, they need to be growing markets. And even large, growing markets are not sufficient, they should have low volatility as well.

This is far easier said than done of course; if large, mature companies like Apple and Nvidia can be hammered by unforecast downturns in their key markets how can startups avoid this problem? Well you are again forecasting the future, the best you can do is to study the history of your market and look at new factors – such as a megatrend like machine learning or the Chinese governments increasing control of its tech companies – and how they will effect your target market.

Globalization and the rapid rates of technological change are disrupting markets as never before, but as you present your market opportunity and revenue forecasts to investors make sure you include projected stability of your market – large size and rapid growth are no longer enough.

Why you should avoid funding from friends, family or yourself


Millions of words have been written about fund raising for startups. So why am I adding to them? Because the received wisdom is that the place to start is with “friends and family” money. And I beg to differ with that wisdom. I’ve been told on more than one occasion that VCs in particular, but angels as well, respect founders who put their own money into their startups.

I’m a faithful reader of Monday Note , Jean-Louis Gassée’s weekly email newsletter.  Jean-Louis was an executive at Apple Computer and after leaving Apple he did his own startup, Be Inc. Be were developers of BeOS, originally developed to run on BeBox hardware. I never met Jean-Louis, but he was kind enough to send me a personal, hand written note when I applied for a job at Apple (though I never even got an interview). His latest post 50 Years In Tech Part 15. Be: From Concept To Near Deathabout starting Be, Inc., has some words of wisdom for founders seeking to raise money. Here’s one quote (Steve Sakoman was Jean-Louise partner.)

Early demos impressed visitors to Sakoman’s clean room, so much so that an early investor friend wrote a second check on the trunk of his rental car at the end of his visit. (I’ll write a separate Monday Note on the Don’ts of my dangerously naive fund raising efforts. In short: Skip Friends and Family, go for cynical Deep Pocketed Pros.)

And Jean-Louis held the very common prejudice against institutional investors:

I also told Sakoman I’d fund the project, perhaps with friends’ help so as not to fall prey to Vulture Capitalists. This proved severely misguided and almost lethal.

While we have to wait until next Monday to find out more about Jean-Louis’s funding efforts, here’s a few points about friends and family funding;

  • Funding from institutional investors, be they VCs or corporate venture funds, sends a strong credibility signal to potential customers and other investors. Funding from Friends and Family (FAFs) sends exactly the opposite signal.
  • Even worse than FAF funding is putting your own money into your venture. While I was trained that this was a mistake, I did run into numerous investors who told me that putting your own money in meant you had skin in the game. Don’t believe them! I made this mistake not once but twice! Those stories will be told in future posts.
  • Unless your friends and family are successful serial entrepreneurs or professional investors, don’t go to them for money. Not only can they not add any value to your venture, they may turn into back seat drivers. Worse yet, if your venture fails they will lose all their money, which can damage or even kill a friendship and hurt family relationships.
  • Raising capital should have one purpose: to grow your company. You need to build your product out of blood, sweat and tears – which far exceeds “having skin in the game.”
  • The best funding is customer revenue. Bootstrapping beats fund raising as the use of your valuable time – the only resource a founder has – though it lacks the glamour of raising money from wellknown angels or VCs. Better yet, if you successfully bootstrap your venture the odds are good that the angels and VCs will come to you, eager to invest. You then have leverage, which helps greatly in negotiating an investment.
  • Great VCs can be great partners. But as I’ve written previously, the VC way is the superhighway. If you aren’t prepared for the extreme measures needed to gain growth at virtually any cost then institutional funding is not for you. And be prepared to give up control, as is usual when companies raise multiple rounds to fund hyper growth and founders get diluted.

Jean-Louis wanted to sell BeOS to Apple, which badly needed a successor to the MacOS, but as those who follow Apple history know Apple bought Next, Steve Jobs’ company and got Steve Jobs along with a new OS. Jean-Louis ended up selling Be, Inc. to Palm, yet another extinct company.

Of course, there are exceptions to every rule of entrepreneurship and you may have very wealthy friends or family who are happy to support your vemtire and won’t bat an eye if you end up losing all their money. And if you are simply using FAF funds as a bridge loan between where you are and a term sheet and eventual funding from angels or VCs that’s a different story than trying to fund product development with FAF funds.

We will hear more from Jean-Louis about how he got Be funded and what happened to his startup. Which by the way, violates another one of my startup heuristics: build hardware or build software, but don’t try to take on both. It  will sap all your resources as you face divided yor priorities. Both Steve Jobs Next and Jean-Louis’ Be, Inc. both made this classic mistake.