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The Three Enthralling Factors Of Venture Funding

Naval Ravikant, Co-Founder of AngelList and Venture Hacks, details a variety of factors that influence your chances of raising venture funding in this informative interview. Of the factors referenced by Naval, three which are difficult to directly influence have a disproportional impact on an entrepreneur’s ability to secure institutional funding: location, sector and stage.

I do not advocate that you perform unnatural acts in an attempt to make your company more advantageous to venture funding. However, it is prudent to be acutely aware of these factors as you engage in your fundraising efforts.

LOCATION: I Wish They All Could Be California Companies

A clear trend over the past 15-years is that many Silicon Valley venture capitalists enjoy investing within driving distance. As an early stage investor, I recognize the importance of being accessible to your portfolio executives, so a concentration of venture funding in Silicon Valley is certainly not a surprise. However, the fact that nearly half of all venture funding in the United States consistently occurs in Silicon Valley is shocking.

This concentration is partly due to natural causes – successful startups spawn other successful startups. It is also somewhat of a self-fulfilling prophecy. If the tech community believes that a certain area is the epicenter of a particular industry, motivated entrepreneurs will start their ventures in such locations, thus reinforcing the geography’s perceived advantageousness. A more nefarious reason for the density of Silicon Valley startups is the fact that many of the venture capitalists make relocation to their backyard a condition of funding.

Partners at large venture firms generally believe that Orange County is the ideal geography for medical devices, San Diego for telecom and life sciences (along with Boston) and Silicon Valley for everything else. Other than shortening the investor’s quarterly commute to your Board meetings, the net benefits of relocating for many startups are illusory, as I describe HERE. For years, well-intentioned venture capitalists asked me when we planned to move Computer Motion (NASDQ: RBOT, sold to Intuitive Surgical) and Expertcity, (creator of GoToMyPC and GoToMeeting, sold to Citrix). Despite the fact that we never moved, both companies were successful.

I recently spoke with an unhappy early-stage investor who described the demise of a life sciences startup which was moved from Santa Barbara to San Diego at the behest of a large venture firm. The Partner at the big firm was convinced that it was impossible to grow a medical company in a backwater town. I guess no one told him about the medical startups that were purchased by Medtronic, Linvatec, Storz, Mentor, etc., all of which continue to thrive in Santa Barbara to this day.

The uprooted company found that less of their time was spent developing valuable science and more was devoted to finding (more) expensive office space, negotiating with (more) expensive employees all the while fighting to retain transplanted employees who hated San Diego. End result, the company’s product timeline has been pushed back substantially and the company’s morale is at an all-time low. Thanks Mr. Big Firm VC.

Naval Ravikant describes how Silicon Valley’s dominance over the venture capital landscape will evolve over time in the previously mentioned interview.

STAGE: Few Harvests, Little Planting

As shown in the following chart, the overwhelming focus of investments during Q1 of 2011 was in later stage companies. This is not a quarterly anomaly – this trend has held firm for over a decade.

The lack of exits in the last few years has certainly impacted this statistic, as venture capitalists have been forced to continue investing in some portfolio companies beyond their expected exits. However, a review of historical data confirms that this trend remains consistent, even in boom times.

SECTOR: Software, Energy, Bio Or Bust

In addition to the geographic and stage concentrations prevalent among venture funded businesses, venture capitalists also focus most of their attention on a handful of industries. Notably, there were 426 investments made in software, medical and clean tech energy companies during Q1 2011, which represents 58% of all the tracked deals and 60% of the total dollars deployed. Although clean tech is a relatively recent sector, historical concentrations in software and healthcare date back to the early 1980s.

Do The Math

Consider your adVenture’s stage, geographic location and sector when assessing the likelihood you will obtain venture funding. For instance, if you run a later-stage software company located in Silicon Valley, then your prospects of obtaining future venture financing are highly favorable. However, if you operate an early-stage financial services company headquartered in the Southwest, consider the following:

Southwest percent of total VC money deployed = 2%

Financial Services percent of total deals = 2.58%

Early stage percentage of total deals = 2.05%

Although the math is imperfect, it is instructive to calculate the relatively small dollars that are likely to be applied to this particular venture by multiplying the total VC dollars deployed in Q1 2011 by the above percentages. The resulting $62,000 is theoretically available to early stage, financial services ventures based in the southwest. The reality is that such funding events are binary, they either happen or they do not. Even so, the above analysis illustrates how unlikely it is for an. The Founders of such a startup would be well served to invest their time pursuing non-venture capital funding.

Nine Positions I Do Not Need

The fact that something is difficult or even unlikely will not deter a determined entrepreneur. At one time in my career, I was told, “The chances of you getting accepted are low, as there are only ten positions.” I laughed and said, “Great, that is nine more than I need.”

Savvy entrepreneurs understand that venture capitalists are just one of many sources of funds. By better understanding the three intoxicating factors which predominantly influence VCs, entrepreneurs can efficiently focus their fundraising efforts on the most likely sources of capital.

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…welcome back. As Fred points out, many entrepreneurs hear the word “debt” and promptly run the other direction. In the past, venture debt was often viewed as a funding vehicle of last resort. When the current investors were tapped out and a bigger fool could not be brought into a venture, all eyes turn towards debt. However, when deployed judiciously, venture debt can mitigate investors’ and founders’ dilution.

At Rincon Venture Partners, we are in the midst of negotiating a term sheet with a cash-positive startup that is growing aggressively. The nature of the company’s business model requires it to fund certain costs before it is paid by its customers. Thus, even though the company is cash flow positive, its growth is constrained by the amount of payables it can fund. Enter venture debt.

By combining our equity investment with a tranche of venture debt, the company has avoided a larger equity round, which would have significantly diluted the Founders’ ownership share.

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Venture Debt Tips And Tricks

Strategic Tranches – Many venture debt providers will allow you to draw down the money you borrow in multiple allocations. Seek maximum flexibility by expanding the length of time you have access to the funds and minimizing the amount of money you must accept upfront.

Death By A Thousand Fees – The more you need the money, the more expensive it will be. The true cost of debt is often obfuscated by the inclusion of numerous, arcane fees. Rather than trying to negotiate each individual fee, consolidate them and negotiate the percentage that the fees represent of the loan’s size.

No Early Payback Penalties – Many venture debt lenders attempt to discourage early payment of their loans with onerous penalties. Although an early payment fee of 1% of the entire loan amount is common, refuse to accept such a provision.

Dollar Blend – Many venture debt lenders require that their funds be accompanied by an equity investment, generally from legitimate venture capitalists. Although this might be advantageous to you (as it might spur your equity investors to invest new funds), give yourself greater flexibility by not agreeing to debt that is contingent on raising new equity dollars.

Investor Threshold – If possible, avoid accepting more venture debt than your investors can reasonably payoff with an equity infusion. In this way, you are assured you can retire your debt if your adVenture hits an economic bump in the road.

Multiple Proposals – Venture debt terms are notoriously non-standard. Thus, garther several term sheets and combine them into an ideal agreement. Then take your “greatest hits” term sheet and communicate to each debtor, “I like this rate, that fee, this covenant, this drawdown schedule and that interest-only period. Do we have a deal?” As with most negotiations, competition is the only way you will obtain an optimal result.

Brand Names Matter – If you violate a debt covenant or otherwise have difficulty servicing the debt, a venture debt lender can destroy your adVenture. Thus, avoid one-man-band lenders, anyone new to your market or a firm that is lending outside of its core market segment. Do your research and identify lenders which care about their reputations and have a track record of lending to venture-backed startups.

Minimize Covenants – Negotiate terms which mitigate the impact of violating any particular covenant. The less time you have to spend managing your covenant compliance, the more time you will have to deliver a compelling value proposition to your customers.

No Guarantees – Avoid personally guaranteeing the debt’s repayment. Instead, collateralize it with your company’s assets. You have enough stress, without risking the loss of your house and other personal assets, in the event of default.

Mr. Mojo Rising – Real-world Example

During the summer of 2006, I joined RedMojo as an Advisor. Consistent with the advice I outline in Free Advice Worth Half The Price, I was paid solely in equity. I also participated in a small convertible debt round. The terms of the deal offered creditors the opportunity to earn a healthy interest rate, and a decent multiple on their principal, in the event the company was sold within a specified time period. The investors also had the ability to convert their debt into equity at a discount to the value established in a subsequent venture round; otherwise known as convertible debt.

A convertible debt structure is often deployed when the debt is a bridge to either an equity investment or a liquidity event. Ideally, the option to convert the debt should be at your discretion and not that of the debt holders. It is also common to provide convertible debt holders with a discount off the valuation applied to equity investors. For instance, in an equity round with a $5 million pre-money valuation, a convertible debt holder with a 20% discount could convert their debt into equity at a $4 million valuation.

The standard discount associated with convertible debt ranges from 20% – 30%, depending on:

• Length of time before the equity round is estimated to close – the longer the time, the higher the discount

• Relative probability of closing an equity round – the higher the probability, the lower the discount

• Overall risk profile of the company – the higher the risk profile, the higher the discount

Be aware that if you grant debt holders a discount above 30%, you may be forced to renegotiate the rate, if subsequent equity investors find it too generous.

RedMojo’s CEO orchestrated the venture debt round masterfully. Equity funding would have diluted the Founders while simultaneously complicating the company’s equity structure, thus making a potential sale of the company more cumbersome. In addition, if venture capital funding were secured, the company’s ability to control the scope, nature and timing of its exit would have been greatly reduced.

As I point out in Who Wants To Be A Millionaire?, institutional investors generally do not invest in quick flips. Thus, if a venture capitalist had invested in RedMojo, it is likely they would have encouraged the CEO to grow the company in order to enhance the return on their investment. Conversely, they may have discouraged and possibly even blocked the sale of the company until such time that they felt their return was maximized. Institutional investors generally seek deals with a potential to return 6x – 10x of their initial investment, not the 1x – 3x return they would have gotten from a quick sale of RedMojo.

Accepting equity funding and growing RedMojo might have proven to be a sound strategy, but it would have forced the CEO and the rest of the Core Team to increase the overall value of the company considerably, just to recoup the impact of the dilution that would have resulted from the equity investment. For instance, if the Founders relinquished 33% of the company’s capitalization to equity investors, they would have had to increase the company’s overall value by one third, just to recoup their prior equity ownership positions.

Although equity funding was seriously contemplated, the CEO ultimately sustained RedMojo’s operations solely via debt, which proved to be highly advantageous , as the company was eventually sold to Novell for $9.72 million. The sale resulted in a nice return for the Founders, employees and creditors.

Equity Is Forever

Some investors erroneously believe that the relationship between an investor and an entrepreneur is akin to a marriage. Such investors are mistaken. Equity investors are more analogous to blood relatives – love them or hate them, you cannot divorce them.

In contrast, debt is similar to friendship. Although it can be emotionally painful, friends can terminate their relationship without calling a lawyer. The degree to which debt offers you greater flexibility than equity is based upon your wherewithal to pay the ongoing interest and ultimately repay the debt. If you leverage debt as a last resort, then expect it to greatly limit your flexibility. However, if you can accurately predict your cash flows and structure a loan with minimal covenants, debt can afford you more flexibility than equity.

Factor The Math

If your startup has contracts with large corporations or government agencies that have solid credit ratings but pay their bills at a glacial pace, factoring your receivables might make economic sense. Unfortunately, like venture debt, factoring is too often erroneously associated with struggling companies that have no other funding options.

Factoring involves selling your accounts receivables for upfront cash, effectively accelerating the collection of your receivables. For instance, if you have high-quality accounts receivables totaling $100,000, you can generate $80,000 – $85,000 of near-term cash. The primary issue which dictates the discount factor is the probability that the receivables will be collected. Thus, the payee’s credit rating and the number of days the receivables have been outstanding both impact the discount factor. Distressed receivables which have a low likelihood of collection are difficult to factor and will result in a much higher discount (as high as 90%, depending on the expected collection rate) and thus will net you significantly less near-term cash.

Forcing Your Investors’ Hands

Much like Corporate Venturing, venture debt can act as a catalyst to spur your current or prospective investors to act. Current investors will often prefer to commit additional funds, rather than see their investment subordinated and the company’s assets secured by debt. As such, the equity investors may opt to stay at the front of the line with respect to receiving any proceeds from an exit by putting forth their own funds and thus averting the company’s need for debt.

Debt Downside

The obvious downside of debt is that, unlike equity, you actually HAVE to pay the money back. Thus, never enter any debt transactions lightly. Even though venture debt offers you more flexibility than an asset-backed loan granted by a traditional lending institution, such as a bank, you must still pledge the company’s assets to collateralize venture debt, including your intellectual property, accounts receivable and even, in some instances, control over your bank account (in such cases, the lender has the right to unilaterally transfer cash out of your bank accounts upon a covenant violation).

Despite its potential downsides, the next time you contemplate an equity round, give venture debt its due consideration. If you are judicious, you might be able to leverage venture debt to jumpstart your fundraising process, while retaining the lion’s share of your equity ownership.

By the way, if you still have not read Fred Wilson’s Venture Debt post, you can check it out HERE.

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The company hired the Dominican actor Geoffrey Holder, who delivered the commercial’s signature tagline with memorable panache, “Maaarvelous, absolutely maaarvelous.” Overnight, “maaarvelous,” spoken in an exaggerated Caribbean accent, became a national catchphrase.

What made the commercials noteworthy was not their charismatic pitchman. It was the fact that the Seven-Up Company defined its product by describing what it was not, via the “UnCola” label.  When evaluating a potential Institutional Investor, entrepreneurs should consider what they are not, as much as what they are. Entrepreneurs in search of startup capital are well served to seek an UnVentureCapitalist (UnVC), an investor who understands and appreciates the unique benefits of capital efficiency.

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Collapsing Startup Costs

Because of the advancements in cloud computing by companies like RightScale and open source software such as MySQL, the costs to create a scalable web service have decreased by a factor of ten since the year 2000. When we launched GoToMyPC in 2001, we were forced to purchase hundreds of servers and pay expensive hosting fees to third-party datacenters. We also incurred substantial software licensing charges from Sun Microsystems, Microsoft and Oracle. The disappearance of these legacy costs has spawned a legion of Capital Efficient Startups (CESs), described more fully in Pour And Stir. Founders of a CES should pursue investors that are best described as not sharing the traits of traditional venture capitalists, as described below.

Company Friendly – Seek investors who demonstrate with their actions, and not solely their words, an entrepreneur-centric approach. For instance, a company-friendly investor will typically only participate in a follow-on funding round beyond their pro rata participation with the Founders’ explicit approval. In this situation, the company-friendly investor will maintain their agreed upon relative position in future funding rounds. For example, if they own 15% of the company in a Series A round, then they will only invest an amount in the Series B round such that their overall investment remains 15%

This approach ensures that the investors’ advice regarding future funding events is not self-serving. Investors that do not invest beyond their pro rata share are relatively indifferent as to a follow-on funding round’s valuation. Investors that insist on investing more than their pro rata allocation in follow-on rounds have an incentive to compress the company’s valuation, in order to maximize the percentage ownership acquired by their investment. Such depression of funding valuations increases the entrepreneurs’ relative dilution.

Small Rounds, Aligned Interests – CES entrepreneurs who have previously participated in large funding rounds with high valuations appreciate the direct correlation between the post-money valuation of their latest funding round and the range of financial outcomes that will be acceptable to their investors.

Although it may initially sound counter-intuitive, large funding rounds at high valuations can actually decrease your chance of success, rather than increase it. For instance, I recently met a young CEO who had previously founded a company that raised a sizable round at a $30 million pre-money valuation from two large, Bay Area VC funds. Shortly thereafter, the company received an acquisition offer which would have put over $15 million into the Founder’s pocket.

When the CEO excitedly called his venture capitalists, he was shocked when they literally laughed in his ear. When their laughter subsided, they condescendingly explained that they did not invest in his company to get a “2 or 3x multiple on our money.” The company was subsequently sold for far less than the total capital invested in the business. Rather than walking away a decamillionaire, the Founding CEO lost a significant amount of his own money, as well as that of his friends and family. This CEO is now looking to fund a CES and he is not interested in a large round or a particularly high valuation.

Funding Paths To Profitability, Not Burn Rates – UnVCs do not encourage entrepreneurs to develop large cash burn rates that must be fueled with future funding rounds. Although this can be an effective way for large Institutional Investors to efficiently deploy their capital, it reduces the spectrum of acceptable exits and significantly dilutes the entrepreneurs’ ownership stake, as depicted in the following chart.

Assume your investors will not be satisfied with anything less than a 5x return. Thus, if they invest $10 million and own 35% of your company, your adVenture’s exit must be at least $140 million (($10 million x 5) / 35%). Per the above data, such exits account for less than 30% of all recent VC-backed exits. Conversely, if you execute your go-to-market strategy with investments totaling $3 million, you disproportionally expand the spectrum of potentially acceptable exits without limiting the size of your exit.

Smaller funding rounds with modest valuations often results in less dilution for the Founders and their employees. However, the most effective way to minimize dilution is to extract capital from customers’ pockets. CESs often devise short and direct paths to revenue as a means of balancing dilution with funding an optimal growth trajectory.

Management Is Not Fungible – UnVCs tend to invest in serial entrepreneur teams, not market spaces or ideas. Such firms do not typically enter into investments with the intention of replacing members of the management team with either their own executives “in residence” or from their professional network. This approach actually increases the company’s execution risk, as significant uncertainty is inherent whenever an ad hoc team is formed. When a senior executive is “transplanted” into an existing team, the risk that the transplant will be “rejected” should not be underestimated.

When entrepreneurs are viewed by investors as their partners and not their subordinates, a healthy, long-term and mutually beneficial relationship often develops. When entrepreneurs feel they serve at the whim of their investors, trouble (especially for the entrepreneurs), usually ensues.

Multiple Winners – Certain markets lend themselves to one or two companies owning their space, such as eBay, You Tube and Twitter. UnVCs do not demand that entrepreneurs pursue such winner-take-all strategies. Many large-fund venture capitalists overly value grand slam outcomes, as they can be career-building investments. An investor looking for a career-making deal might encourage you to take imprudent chances in the hopes you are the sole winner in a highly competitive and capricious market. If you fail, their downside is minimal. They will remove your company’s logo from their website and try to forget they ever made the investment. For you, the impact of a negative outcome is a bit more tangible and dramatic.

Bring In The Fences

The fact that capital efficient businesses raise modest amounts of money does not necessarily result in smaller outcomes. You can achieve “homerun” returns with such adVentures, without having to hit the ball as far. By minimizing your dilution and aligning your company with investors who appreciate the decreased risk associated with a broad spectrum of outcomes, you effectively bring the homerun fence in from 400 feet to 40 feet. What would be a double or even a pop fly at an overly capitalized business can be a homerun at a CES.

Double Hit Of Lithium Please

Venture Capitalists are held in low regard by many entrepreneurs for a reason. Money and power are strong corruptive agents. However, even at the most traditional of venture firms, UnVCs are emerging.

When Charles Grigg invented 7-Up in 1929, he originally called it  “Bib-Label Lithiated Lemon Soda” in homage to the mood altering lithium, which it liberally contained. The formulation proved effective as its initial positioning was as a hangover cure. Unfortunately for stressed out CES entrepreneurs, lithium was removed from 7-Up in 1950.

Geoffrey Holder’s tagline was eventually changed to, “Maaarvelous, the smell of success is never too sweet.” As any CES entrepreneur can attest, with enough sweet success, you will never pine for the days when 7-Up was lithiated.

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John Greathouse has held a number of senior executive positions with successful startups during the past fifteen years, spearheading transactions which generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.
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Copyright © 2007-10 by J. Meredith Publishing. All rights reserved.

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In this video Jim Andelman explores venture capital investing and the emergence of capital efficient businesses.

Bio:

Jim Andelman, co-founder and General Partner of Rincon Venture Partner

Jim is a co-founder and General Partner of Rincon Venture Partners. In this capacity, he is responsible for driving the fund’s investment activities, as well as the firm’s operations. Jim has more than fifteen years of experience in venture capital investing, technology investment banking and advisory services and strategic business consulting.

Previously, Jim led software investing at Broadview Capital Partners, a $250 million expansion-stage venture capital firm. Jim was responsible for developing investment themes, sourcing investment opportunities, performing company assessments, negotiating and executing transactions, and advising portfolio companies. Jim led the assessment of over 300 investment opportunities, participated in the deployment of $78 million across five portfolio companies, four of which exited via acquisition despite a challenging macroeconomic environment.

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Years after Alger created this new genre, it was derisively (and incorrectly) termed “rags to riches.” A common critique is that Mr. Alger’s heroes succeeded by conveying a simplistic formula comprised of honesty, cheerfulness, virtue, thrift, and hard work.

Dismissing Mr. Alger’s works as juvenile rags to riches novels misses the author’s primary point and the reason why the books had such a tremendous impact on several generations of American entrepreneurs.

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Five Dollars And Two Hours

If you were given $5 and two hours to “make as much money as possible”, what would you do? This is question Tina Seelig, Executive Director for the Stanford Technology Ventures Program, asks her entrepreneurial classes.

The students are given several days to devise their plans. However, once they open the envelopes which contain their seed capital, they then have two hours to execute their plans.

The majority of students fret over the fact that they only have $5 of capital and limited time to launch their money making ideas. However, the teams that consistently make the most money ignore the fact that they are given $5. They move forward with the ideas they brainstormed before they knew how much capital they were given. In many cases, they devise ideas which require no cash.

Just like the heroes in Horatio Alger’s novels, the teams that make the most money realized that the world is not comprised of limitations. As described in Small Ideas, Big Benefits, an entrepreneur’s world abounds in opportunities and successful entrepreneurs learn to recognize them while ignoring externalities that might otherwise restrict their achievements.

To learn about Ms. Seelig’s students’ winning ideas, I highly recommend you watch the following six minute video.

Santa Barbara Foundation

A number of years ago, I was honored to join the Santa Barbara Foundation’s Katherine Harvey Fellows. The organization was created to teach (relatively) young professionals the “art of philanthropy.” The group of approximately a dozen people was drawn equally from the non-profit world and the business community.

We were given $10,000 to distribute to three or four worthy organizations of our choosing. Not surprisingly, the enterprising Katherine Harvey Fellows quickly identified a long list of promising charities. Unfortunately, our limited funds were insufficient to make a significant impact if we spread it over several charities. To address this reality, some of the non-profit professionals suggested that we allocate all the money to a single charity to ensure that our grant would make a sufficient impact.

Conversely, a contingent of the business folks proposed that we raise more money in order to make meaningful grants to multiple organizations. We took this path and eventually raised over $50,000. The additional capital allowed us to make substantial grants to three organizations and still leave a cash endowment to the following class of Fellows. This “self-sufficient” approach has been adopted by all subsequent Katherine Harvey classes, resulting in a sizeable, ongoing financial legacy.

Novel Of Point Of View

Contrary to the disparaging opinion of modern-day literary critics, the protagonists of Mr. Alger’s novels seldom achieved great wealth or power. Rather than attaining riches, they generally became modestly successful contributors to their communities. Rather than “rags to riches”, a more appropriate label for Alger’s genre is “rags to self-sufficiency.”

What the critics fail to realize is that Mr. Alger’s protagonists see the world as fraught with opportunities, rather than limitations. It is not their “cheerfulness” that causes these fictional characters to excel. It is their utter disregard for the amount of money in their pockets and their unrelenting focus on identifying prospects missed by others. As discussed in The Fringe, point of view is worth at least 30-IQ points. Mr. Alger’s heroes significantly increased their entrepreneurial IQ’s by maintaining the proper perspective.

Tackle Ms. Seelig’s challenge with the mindset of Hortio Alger’s heroes and “make as much money as you can.”

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John Greathouse has held a number of senior executive positions with successful startups during the past fifteen years, spearheading transactions which generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.
______________________

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Copyright © 2007-10 by J. Meredith Publishing. All rights reserved.

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This was the situation faced by the hundreds of comedians who debuted on “The Tonight Show” during Johnny Carson’s 30-year tenure. If they succeeded, Johnny shook their hand at the end of their routine and offered them a seat in his guest chair. This small gesture indicated that he approved of their act and would invite them back for a future performance.

The careers of nearly every successful comedian during the 1970s and 1980s, including George Carlin, Flip Wilson, Freddie Prinze, Sr., Joan Rivers, Roseanne Barr, Ellen DeGeneres, Jerry Seinfeld, Robin Williams, Jay Leno and David Letterman, were launched by a brief monologue on “The Tonight Show.”

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Entrepreneurs’ careers seldom come down to a single make-or-break moment, such as a debut before a national television audience. However, entrepreneurs often give presentations which, if properly executed, can be life-changing. Such presentations might be to a potential lead investor, an initial key customer or a group of opinion leaders at an industry tradeshow. Irrespective of the audience or venue, many of the tactics utilized by comedians to hone their routines and make the most of their “big break” are applicable to entrepreneurial presentations.

A presentation’s objective can be thought of as the entrepreneur’s Ask, what they want to achieve as a result of the presentation. The Tonight Show comedians’ objective was to be well-received by Johnny, so they would be invited back to a future show. For business entrepreneurs, the “Ask” often involves a request for an investment, a partnership or a purchase order.

The worlds of comedy and business are not as disparate as they may appear at first glance. Comedians are entrepreneurs. They often write their material, book their gigs, arrange their travel and negotiate their compensation with each club owner. In addition, comedians must engage and entertain their demanding audiences within a strict time period. Business entrepreneurs are similarly challenged to present their ideas in an engaging, informative and pithy manner. As such, there is much that business entrepreneurs can learn from their comic brethren.

Established comedians, just like successful, serial business entrepreneurs, can rely upon their reputations and past successes and do not have to “nail” every performance. Conversely, up-and-coming comedians and unproven entrepreneurs must win their audience over each time they present. They cannot rely upon their past successes to predispose their audiences to be convivial to their message.

The characteristics of a successful comedy routine, which are also applicable to business presentations, are described in detail in the remainder of this article. They include:

• Strong Start – Grab your audience’s attention at the outset

• Punch Line – Quickly tell the audience who you are and why it is important for them to listen to you

• Heckler Management – Do not alienate your spectators by too quickly shutting down troublesome audience members

• Rehearsed Spontaneity – Practice thoroughly such that all of your remarks seem fresh and spontaneous

• Audience Interaction – Control your audience repartee, especially questions and answers

• Segues – Make it easy for your audience to follow you, especially when transitioning between topics

• Humor – Utilize tactful humor, relevant to the topic at hand

• Fini – Close with impact and clearly communicate your call-to-action Ask

Comedic Tips

Strong Start – Due to their limited stage time, comedians must quickly set the tone of their act. Often the success or failure of the opening joke determines how well the routine will be received. As noted in How To Give A Horrendous Investor Pitch, approximately 55% of a speaker’s communication during the first few minutes of a presentation is nonverbal, while an additional 38% is tone of voice. A mere 7% of a speaker’s initial communications comprise the words they utter. At the outset, it is not what you say, but how you say it that has the greatest impact.

Consider the way many comedians open their show. They frequently bound onto the stage with tremendous energy and drive. They often smile broadly, laugh and nod their head up and down in an affirmative manner as they tell the audience, “It is great to be here.” Business presenters should also quickly engage their audience and make it clear that their presentation will be lively, informative and entertaining. If you lose your audience in the first few minutes by exhibiting low energy, it is often impossible to recapture their attention.

When appropriate, open with an anecdote or personal story that makes the audience care. A good opening establishes empathy and a positive rapport with your audience. A good opening describes who you are and why the audience should share your passion for the topic at hand. Once you have established who and why, then tell your audience how you will fulfill your vision.

An example of a compelling opening comes from Alison Perry, one of the Co-Founders of Inogen. Alison passionately describes the genesis of Inogen’s mobile oxygen concentrator. After spending Christmas break with her grandmother, who had recently been housebound by chronic obstructive pulmonary disease, Alison returned to college determined to find a solution to her grandmother’s immobility. Alison describes how she did not give up, even after she spoke to numerous industry experts who told her it was impossible to build an oxygen concentrator smaller than the size of a college dorm refrigerator. Like the entrepreneurs described in Reinventing The Wheel, Alison and her Co-Founders ignored Conventional Wisdom and created the world’s first portable oxygen concentrator.

Punch Line – Comedians often have extremely short time windows in which to perform; a five to eight minute comedy set is not uncommon. This forces comics to quickly deliver their punch lines while remaining cognizant of the time remaining in their set. In many instances, if they exceed their allotted time, the house MC will cut them off and their chances of a repeat performance at the club are diminished.

Entrepreneurs should also be mindful of their stage time. If the audience is relatively small, confirm your allotted time at the outset of your talk, even if you think you know the time afforded you. By asking, “I know we scheduled thirty minutes, does that still work for you?” you communicate deference and respect. If the audience is large, confirm your stage time with the appropriate show organizer before taking the stage.

As the end of your prescribed time approaches, ask if you should wrap up your presentation even if things are going well. In many cases, if your presentation is well-received and the audience is relatively small, you will be given more time. However, never assume that your stage time has been expanded without explicit confirmation. If you continue your presentation without acknowledging that you have exceeded the agreed-upon time allotment, you run the risk of alienating your audience.

Heckler Management– An audience has a group identity, even when they do not know each other or have any affiliation. They relate to you as the presenter and they relate to each other as the collective audience, which effectively creates an “us versus them” paradigm.

Experienced comedians understand this dynamic. If a comedian immediately shuts down a heckler, she risks estranging the crowd. Even when a heckler is rude, the crowd will naturally “side” with a heckler if they feel the comedian’s response is disproportionate or premature. Instead, veteran comedians endure a heckler’s interruptions until it is clear that the audience is also annoyed. Once a heckler begins to detract from the show, the comedian can shut them down while retaining the audience’s empathy.

The success or failure of business presentations often rests upon the questions and answers following the formal pitch. An audience member who asks an irrelevant or nonsensical question is analogous to a heckler at a comedy show. The presenter must initially respond respectfully. If the questioner continues to ask off-base or overly pointed questions, the audience will eventually become agitated. Once their impatience is evident, the speaker can then politely dismiss the questioner by indicating they will take additional questions “off-line,” after the presentation has concluded.

Rehearsed Spontaneity – The documentary “The Comedian” chronicles Jerry Seinfeld’s effort to create a new comedy routine. It makes clear that nearly all new material bombs. Comedy requires extensive trial and error to separate the bad bits from those that work. The same is true with business presentations.

The next time you go to a comedy club, watch the waitstaff. In most cases, they stoically move about the room, even when the audience is laughing uproariously. Why? Because they have heard the jokes over and over, in the same order and delivered in the same “spontaneous” way. In the rare instances when the waitstaff does laugh at a comic, it usually indicates that the comedian is new to the club. Great comedy appears effortless, yet is actually the result of painstaking practice.

It is very hard to tell a joke over and over and make it sound like you just thought of it. However, a joke that sounds like it has been told repeatedly is usually not funny. Making a well-rehearsed business presentation sound fresh is similarly difficult. When Computer Motion went public, we conducted a three-week road show in which the executive team gave the same presentation day after day, often multiple times per day. Our most effective presentations were those in which our well-rehearsed “adlibbing” actually sounded somewhat spontaneous. If you prepare thoroughly, you can achieve the same rehearsed spontaneity that distinguishes professional comics from amateurs.

Audience Interaction – Comedians often ask their audience questions and make comments about people’s wardrobes, dates, drinks, etc. If you pay close attention, you will notice that these comments are often not directed to anyone in particular. However, the audience assumes that the guy drinking the “girlie drink” in the back of the room really exists. In most cases, the comedian makes the same audience jokes at each show and directs many of his audience comments to no one in particular.

Business entrepreneurs clearly are not well-served by chiding or mocking their audience. However, the act of soliciting their participation, especially in an intimate setting, can effectively keep the audience engaged. If the crowd’s size is intimate, you should engage the group by using their first names and asking them relevant questions that will solicit responses congruent with your ask. Like a good trial lawyer, avoid asking questions to which you do not know the answer. Otherwise, you may inadvertently elicit responses that are in conflict with your Ask.

Comedians often ask questions as a platform for delivering their punch lines. In business presentations, your responses to questions should convey a message that supports your ultimate Ask. An example of how to inject your message into the answer to an amorphous, ill-conceived question occurred during the first Presidential debate in 1992. President Bush was asked a nonsensical question about the economy by a confused (and likely very nervous) woman. Although there was no real answer to her non-question, Mr. Bush attempted to explain how he planned to stimulate the economy, using technical jargon that the questioner did not appear to understand.

Candidate Clinton then stepped forward and said to the woman, “Tell me how it has affected you again?” The questioner still could not put together a coherent sentence, but this did not deter Mr. Clinton. He answered his own question by saying, “You know people who have lost their jobs and lost their homes?” He then went on to deliver his infamous “I feel your pain” response, which was clearly a well-rehearsed talking point. He conveniently used the poorly structured non-question as a platform to deliver his Ask, which was “vote for me, I am in touch with the average American’s financial plight.”

Segues – Proper pacing is of vital importance in a comedy routine. Comedians must allow adequate time for the audience to comprehend each joke and react. At the same time, an imbalance of too many pauses or too many laughs is also ineffective.

One way to ensure effective pacing is to establish segues that alert the audience that you are moving from one subject to another. In comedy, empty phrases such as, “Anyone here from New York?”, “Did you guys hear about the _________?”, “Has this ever happened to you? I was recently _____,” are often used to mark transitions between humorous topics. Such verbal landmarks give the audience a chance to catch their breath while guiding them on to the next subject to be discussed.

Entrepreneurs should afford their audiences similar mental respites. Your audience will more readily focus on your message if you give them ample time to digest your remarks while clarifying when your talk’s path is changing direction via clear transitions.

Humor– Contrary to popular belief, business presentations do not have to be boring. Interjecting humor into business presentations, when done judiciously, can make them more entertaining and thus more impactful. Entertained people are more engaged. Engaged people are more receptive to an Ask. In one company-wide presentation, I explained our aggressive marketing campaign to promote GoToMyPC, by morphing Dr. Seuss’s character Sam-I-Am into “Spam-I-Am.”

My talk was delivered in a humorous manner, which reduced the tension surrounding a contentious issue and helped me belie our employees’ concerns regarding our marketing tactics. My Ask was for our employees to appreciate the revenue contribution generated by GoToMyPC and for them to be patient as we explored various emerging marketing tactics, some of which were controversial, such as pop-up and pop-under ads.

Fini – Comedians often deploy the bookend technique, in which they reference their opening joke at the conclusion of their show. This gives their performance a feeling of completion and symmetry. Entrepreneurs can utilize this approach as well, by referring to their opening anecdote in their closing remarks. In Alison’s case, she could cite her grandmother as an example of the market segment that will benefit when her Ask is fulfilled. They key is to ensure that your presentation end on a high note.

Three-Drink Minimum

Let’s face it. Comedians have some significant advantages that are not available to most business entrepreneurs, including the three-drink minimum. I am confident I could have significantly boosted sales revenue at my past ventures if I could have required each prospective customer to down several stiff adult beverages during my presentation. It is admittedly easier to entertain a crowd of semi-drunk people than to engage and inform a group of jaded, semi-interested business prospects. However, if you treat each presentation like it is your “big break” and prepare in the way a professional comedian would, you will greatly increase your odds of reaching the equivalent of Johnny’s guest chair and achieve your Ask, while potentially turning your presentation into a life-changing event.

As you never know who might be in the audience and how they might be able to help your adVenture, you should put forth a 100% effort with each presentation. However, all is not lost if you are unable to connect with a particular audience. Even Johnny Carson was not always right.

For instance, in 1981, a young comedian made his first television appearance on the Tonight Show. Johnny, clearly not impressed with the comic’s resume, introduced him as someone who “has worked a lot of small clubs, both in New York and Los Angeles.” Not exactly a ringing endorsement.

After struggling through a mediocre five-minute routine, marred by microphone problems and a lukewarm audience reception, the comedian awkwardly waited for Johnny’s reaction. Johnny gave him the OK sign with his left hand and told him, “Take a bow,” which meant “get off the stage.”

That comedian was Jerry Seinfeld.

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Copyright © 2007-9 by J. Meredith Publishing. All rights reserved.

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Each aspect of your BDCI relationship, financial and operational, should stand separately on its own merits. If there is not adequate strategic value in the relationship, do not accept BDCI funding.

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Funding from a corporate investor should be considered guilty until proven innocent. In other words, you should assume that such funds will come with adverse stipulations unless you contractually limit the negative impact of any potential conflict between your company’s strategic goals and those of the BDCI.

One way to prove corporate investment dollars innocent is to draft a definitive, strategic agreement that clearly outlines the scope and nature of your startup’s operational obligations to the BDCI. If the strategic, non-financial aspect of the partnership is not one you would enter into without an investment component, then you should reject the partnership and the investment. There are plenty of venture investors who are willing to invest their funds with no operational strings attached. As such, it never makes sense for you to encumber your adVenture with guilty funding.

Ensure that the non-financial aspect of your BDCI relationship is adequately strategic by decoupling it from the investment discussions. The strategic deal should not be the tail that wags the investment dog. This approach will help ensure that you maximize the deal terms of both the partnership and the investment. Any unilateral financial concessions you make for your BDCI could adversely impact your ability to cut an optimum deal with other, non-strategic investors.

In two separate adVentures, I had very positive experiences with respect to corporate investments. In both cases, we crafted a separate partnership agreement that clearly specified the responsibilities and expectations of both parties and allowed my companies the flexibility to charter our own course. The corporate investments were made on the same terms as all the other investors and the BDCI’s were not granted any meaningful preferences with regard to the timing, scope or nature of our exit. Such a healthy separation between the strategic and financial aspects of a Corporate Investment is key to ensuring that the relationship is rewarding for all parties.

Potential Advantages of a Corporate Investment

• Valuation Insensitivity – BDCI’s often accept higher valuations than Institutional Investors

• Stalking Horse – BDCI’s can motivate Institutional Investors to act

• Passivity – BDCI’s generally do not attempt to influence a startup’s overall business

• Non-Investment Funding – BDCI’s often provide startups with non-investment cash infusions

• Vested in Your Success – BDCI’s can be powerful market allies

• Market Validation – BDCI’s involvement can represent significant market acceptance

Valuation Insensitivity

One of the most positive aspects of a BDCI is that they generally are not as valuation-sensitive as a traditional Institutional Investor, such as venture capitalists. This is driven by the fact that a corporate investor’s primary goal is to gain a strategic advantage over their competitors. The return on their investment in your adVenture is of secondary consideration. Use this fact to your advantage.

BDCIs will generally not establish the valuation of an investment round and thus will not lead an investment (see Follow The Leader below). However, as noted in the following section, the BDCI’s relative lack of valuation sensitivity can influence your valuation upward, especially if the Institutional Investors are concerned that one or more BDCI’s will edge them out by funding the entire round. In such cases, the Institutional Investor may accept a higher valuation than they otherwise would have preferred in order to fund the entire deal and keep the BDCI out of the funding equation.

Stalking Horse

BDCI’s can act as powerful competition to Institutional Investors. As noted in Funding From the Fringe, one of the most challenging aspects of fundraising is to force investors to commit their funds. In nearly every instance, in the absence of competition, investors are better served to wait as long as possible before committing their money.

The longer they can wait, the more time they have to assess your ability to deliver on your promises. With the achievement of each milestone, you reduce your adVenture’s market uncertainty and operational risk. The most insidious reason investors tend to delay their investment decision is that they know you will be more pliable as your cash balance approaches zero. Thus, by stalling, they can place you and your adVenture under duress, which may lead to disadvantageous terms for you and highly advantageous terms for them.

Given the natural inertia that precedes a funding event, you must engender competition among your potential investors. A BDCI can often serve as such a catalyst. For many of the same reasons you want to include a BDCI in your funding round, many Institutional Investors prefer to avoid deals in which BDCI’s participate. As such, you may be able to force the Institutional Investor’s hand by indicating that a BDCI may fund the entire deal or even buy you outright.

Passivity

Most BDCI’s invest in smaller companies as a way to stake a claim in an emerging market that is currently outside the scope of their near-term strategic roadmap, but may eventually become more central to their long-term plans as they continue to grow. In such cases, the financial aspect of the investment is of secondary importance, and the BDCI is content to stay in the background to a greater extent than the typical Institutional Investor.

Although most BDCI’s are too distracted to become active in the operations of the companies in which they invest, a minority of BDCI’s do take active investor roles and others treat their startup investments as outsourced developers. It is vital that you fully vet such motives during the structuring of your strategic agreement, as a non-passive BDCI is almost always detrimental to a startup’s ultimate success.

If the BDCI requests a Board seat, you can reinforce their passive role by limiting their Board-level involvement to a non-voting Observation seat. This will allow them to attend Board meetings, but without the ability to vote on Board resolutions, thereby greatly diminishing the impact the BDCI can have on your adVenture’s operations.

Non-investment Funding

Profitable, growing BDCI’s often do not know what to do with their mounting cash reserves.  Help them out. Allow them to become your never-ending source of non-investment funds, much like a gullible, rich uncle. Such funds will help you execute your strategy, without suffering the dilution associated with an equity investment. Some of these funding vehicles include:

Co-marketing Funds – Co-marketing partnerships often include matching funds in which you and the BDCI share certain marketing costs. Associating your adVenture with a more widely known and respected brand will enhance your legitimacy, while effectively doubling the size and reach of a portion of your marketing budget.

Paid Pilots / NRE Fees – In most instances, the strategic aspect of your relationship will involve your team building something on behalf of the BDCI, usually an interface between your solution and their legacy product(s). As discussed in Kiss of Death, mitigate your opportunity cost by charging for all the development work you perform. If you craft such deals appropriately, you can get the BDCI to fund projects that are already on your development roadmap and that you can sell to a wider market, independent of the BDCI’s needs.

License Fees / Product Sales – Just because the BDCI is an investor does not mean it can utilize your technology for free. A “friends and family” discount might be appropriate, but BDCI’s should always pay a fair price for any and all products or services you make available to them.

Free Tradeshow Space – As noted in Best Of Show, BDCI’s can save you significant money, while providing you with meaningful visibility within your industry, by allowing you to utilize space within their tradeshow booths.

Vested In Your Success

George Orwell was wrong. Sometimes having a Big Brother around is a good thing, especially if you are the new kid on the playground. For instance, if your technology is bundled with one or more of the BDCI’s key products, the BDCI will have a vested interest in your success that supersedes their financial interest. This may prove handy in the event that a competitor attempts to disrupt your business via a price war, an intellectual property lawsuit, etc. The fact that competitors may also have to deal with your strategic partner if they play rough with you may increase the chances that they give you a wide berth.

Market Validation

Even though they are generally not considered sophisticated investors, obtaining money from a BDCI remains a significant point of third-party validation. Such an investment communicates to the market that your solution is important enough to warrant the time, attention and cash of an established (and hopefully respected) market player. The formal association with a BDCI can bolster your credibility with potential partners and customers while mitigating the natural concern associated with your startup’s financial viability. You can generate a great deal of comfort in the minds of your prospects by having a household corporate name on your investor roster. I routinely and shamelessly dropped the name of my BDC Investors when I was pitching to prospective customers, employee candidates and potential partners.

Potential Disadvantages of a Corporate Investment

• Bad Touch – BDCI’s can overwhelm and disrupt your team

• Round Trip – False funding, as investment dollars flow back to BDCI

• Follow The Leader – BDCI’s seldom act as a lead investor

• No Exit – A BDCI can reduce a startup’s exit options

• Corporate Pet – Market may assume the startup lacks independence and autonomy

• An Open Kimono Is Drafty – Due diligence activities could allow BDCI to compete

Bad Touch

Just as children should understand the difference between good touches and bad touches, startups must recognize the difference in their interactions with BDCI’s.

For instance, you should always be in a position to say “No.” As noted in Kiss of Death, one of the most important aspects of a strategic deal with a larger company is to clearly and pedantically articulate the Statement of Work (SOW). If the relationship grows beyond the scope of the SOW, your firm should always have the option to decline the expansion of your operational commitment. If you choose to devote resources beyond those obligated in the SOW, the BDCI should know the cost in advance and agree to compensate you for your out-of-pocket expenses and opportunity cost.

Round Trip

Although changes in accounting rules following the bursting of the Internet bubble in 2001 caused Round Trip investments to be less prevalent, they still exist. Such deals require the startup to purchase certain goods and/or services from the BDCI. Thus the investment dollars come in one door and immediately go out another. For instance, a corporate investment might be tied to the exclusive use of certain routers (e.g., Cisco) or you might be required to incorporate certain microprocessors into your product designs (e.g., Intel) or you may be forced to utilize certain hardware in your datacenter (e.g., Sun).

In some circumstances, Round Trips can make sense for all parties. However, never ever agree to purchase goods or services from a BDCI if such purchases will not improve your probability of success or if such items are not competitively priced.

Follow The Leader

Although the introduction of a BDCI into the investment equation may motivate Institutional Investors to act, most BDCI’s will not lead an investment. In other words, they will only put their money into your adVenture after the deal terms have been negotiated and the due diligence has been performed by an Institutional Investor.

However, having the commitment from a BDCI can provide an Institutional Investor the comfort they need to move forward with an investment. Even though BDCI’s are often looked down upon by Institutional Investors, their presence in a deal can reduce a startup’s risk of failure, especially if there is a compelling strategic aspect of the BDCI relationship.

No Exit

As described more fully in Kiss of Death, BDCI’s will often attempt to significantly limit and/or influence the nature of your adVenture’s exit. This control most commonly manifests itself in the form of a Right of First Refusal. This onerous provision requires the startup to notify the BDCI whenever it is approached by another company that expresses an interest in acquiring the startup. The BDCI then has an opportunity to review any such acquisition offers and issue a counteroffer, if they so choose.

Obviously, such a provision will greatly encumber your ability to maximize the value of your exit. If the BDCI is insistent with regard to the inclusion of this provision and there is a compelling strategic aspect to an operational partnership, consider compromising by agreeing to a Right of First Offer. This somewhat less onerous provision simply requires you to notify the BDCI anytime you receive an acquisition overture. The BDCI then has a defined period of time to make the first offer. Although such a provision will slow down your acquisition discussions, it greatly limits the degree to which the BDCI can control the process and it allows you the flexibility necessary to negotiate the highest price possible for your company.

Corporate Pet

Depending on your relationship with the BDCI and the competitive makeup of your industry, there is a significant risk that accepting a corporate investment could limit and possibly preclude business interactions with your BDCI’s competitors. The potential impact of this risk should not be underestimated.

Fortunately, you can mitigate this risk. For instance, in your discussions with the BDCI’s competitors, make it clear that you maintain your independence, and that your company does not share competitive, confidential information with the BDCI. In your press releases referencing your BDCI, emphasize the non-exclusive nature of your relationship, by way of phrases such as: “We continue to search for opportunities to partner with other companies in a similar manner.”

I have been able to successfully manage around this potential conflict, although I know of investments that have been returned to BDCI’s because of the detrimental impact they had on the startup’s ability to grow their business. As Kevin O’Connor, Founder and former CEO of DoubleClick explains in his book The Map Of Innovation, Bozell Advertising’s investment in DoubleClick was detrimental to DoubleClick’s ability to establish partnership with other advertising agencies. These competitive agencies perceived DoubleClick to be Bozell’s surrogate and thus equated working with DoubleClick to working with their archenemy, Bozell. Fortunately for Kevin and his team, they convinced Bozell to significantly reduce their investment to the point that it was immaterial and no longer a barrier to DoubleClick’s ability to establish other ad agency partnerships.

An Open Kimono Is Drafty

In rare instances, a BDCI will leverage a promised investment as a means of learning as much about your secret sauce as possible. A certain PC software company comes to mind… Fortunately, such predatory BDCI’s quickly develop a suitably negative reputation after they take advantage of a couple small companies, and find it difficult to sustain such blatantly nefarious practices.

Even though an overtly duplicitous approach is unusual, you should keep it in mind as you entertain potential corporate investors. One way to limit your exposure as you open your kimono (sadly, pun intended) is to judiciously share information in concert with the maturation of your relationship. As your relationship with a potential investor develops and becomes more and more likely to result in a meaningful partnership/investment, incrementally increase the sensitivity, proprietary nature of the information you share with the potential BDCI. Your most sensitive, proprietary information should be withheld until all other aspects of due diligence have been completed. As noted in Private Means Private, do not be hesitant to say “No” to requests that seem too premature. This is a great way to establish ground rules that will lead to a healthy, bilateral relationship.

Although risks clearly exist within the context of any partner or investor discussions, the advantages of a corporate investment can outweigh the potential disadvantages, if you craft separate partnership and investment agreements that allow you to call the shots at your adVenture, including your ultimate exit. As such, do not be afraid to establish a healthy, arm’s-length relationship with a BDCI. A properly crafted strategic BDCI relationship could result in a business version of the Mod Squad that allows you and your BDCI to collectively vanquish your villainous competitors.
—

Copyright © 2008 by J. Meredith Publishing. All rights reserved.

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Ask any venture investor. They would love to slather their startup investments with Nair. Why? Because every deal has unwanted hair – one or more significant flaws which make the deal imperfect. Savvy entrepreneurs also understand this reality. As a result, they do everything within reason to reduce the hair on their adVenture before they seek investment capital.

Startup hair is often related to two key issues, (i) the experience and maturity level of the Core Team and (ii) the adVenture’s stage of maturation. These two factors can counteract each other. For instance, if a Core Team is relatively inexperienced, but the adVenture is generating revenue, has a cadre of satisfied customers and a reasonable path to sustainability, then the operational risk associated with the Team’s limited experience is significantly mitigated.

Conversely, if the adVenture is in the product development, pre-revenue stage, the operational risk is reduced if the Core Team has a relevant track record of success. These two criteria are obviously not exhaustive of the factors investors consider when evaluating a venture investment. However, when these two risk factors are evaluated in tandem, the results can be enlightening, as depicted in the following four-by-four.

Who Loves Ya?
A Kojak deal is one with virtually no hair. In the above example, it represents a deal in which the management team has applicable experience and the adVenture’s business opportunity has been validated. Much like the fanciful storylines of the 1970s Kojak TV show, such deals are largely fictional.

Kojak deals command hefty valuations, which are advantageous for the operators, but ironically represent a form of hair to potential investors. As such, no matter how perfect a deal may seem, there are usually countervailing factors which will make the deal less attractive to a subset of potential investors. To quote the lollipop-sucking star of Kojak, the fundraising process is a painful way to determine, “Who loves ya baby?”

They’re Creepy and They’re Kooky

At the other extreme, Cousin It deals are covered with hair. Just as you cannot see Cousin It’s face in the 1960s TV show The Addams Family, Cousin It deals are so inundated with hair that it is often impossible to see the opportunity that might lie beneath. In the above example, management may lack relevant experience and the business opportunity is unproven. Such deals are best funded by customer dollars until the opportunity is adequately proven and/or management accrues an acceptable level of experience. Even if you soak these creepy, kooky deals in metaphorical Nair, it will likely only result in unsightly burns and itching, making the deal no less difficult to fund.

Despite the Kojak and Cousin It extremes, most deals that qualify for serious evaluation by institutional investors are Nair deals. These deals comprised both attractive and troubling attributes. No matter how attractive the opportunity, there are always risk factors that detract from a deal’s desirability. Entrepreneurs must proactively identify such concerns and either Nair them away or devise a reasonable story which acknowledges the problematic issues and explains why they will not materially impact the adVenture’s chances of success.

Throw Hubby Under the Bus

After many months of discussions with a promising software company, our venture fund declined to invest in the company, as the Founders were not willing to address the hair on their deal. In this instance, the Founders were married. The wife was the CEO and her husband was heading up sales, product development and customer service. Rather than proactively address the concerns that such a familial relationship raised at their startup, the Founders denied that it was “an issue.” As a result, we decided to not invest in the company.

My favorite counsel to someone who has a poor rapport with his or her boss: “If you have a problem with your boss, then you have a problem.” This same sage advice can be applied to a Nair deal. If your investors have a problem with your deal, then you have a problem. Denying an issue or trying to convince an investor that he or she is “wrong” are generally not viable strategies.

In the case of the software company, Nair could have been applied in the form of hiring other senior, strong-willed executives who could counterbalance the input of the married Founders. Although this would not have eliminated the issue, it would have mitigated potential investors’ concerns that the company might become a myopic dictatorship run by two very closely aligned people. Augmenting the management team with senior talent would also reduce the risk that deterioration in either the Founder’s marriage or the job performance of one of the Founders would fatally impact the organization.

Shining, Gleaming, Steaming, Flaxen, Waxen

Deal hair, just like the real thing, comes in a variety of colors and styles. Some of the most common types of deal hair include:

Junky Capitalization Table – A hodgepodge of small investors that could cause potential headaches for management and/or institutional investors.

• Nair Solution – Repurchase as much stock as is practical and convert any remaining preferred stockholders to common stock status.

Untenable Bridge Terms – Convertible debt terms that are prohibitive to an institutional investment, such as large discounts and/or warrant coverage that dilutes the intuitional investor’s investment.

• Nair Solution – Marginalize the relative dilutive impact of these terms. For instance, a discount of less than twenty percent is usually deemed reasonable. In addition, converting warrant coverage to non-participating status will also enhance your adVenture’s fundability.

Band of Brothers – Friends, family, former roommates and other unqualified people occupy senior management positions.

• Nair Solution – Replace such mis-hires with strong-willed, independent executives who have relevant, successful track records.

IP Confusion – Questionable ownership of key intellectual property, including non-exclusive licenses, potential infringement of a third party’s technology and/or inappropriate use of open-source tools.

• Nair Solution – In most failed adVentures, the only asset of value upon dissolution is the underlying intellectual property. As such, it is paramount that investors can unequivocally evaluate its veracity.

Legal Landmines – No matter how frivolous, lawsuits will seriously chill investors’ interest.

• Nair Solution – As noted in Roping In The Legal Eagles, it is generally advantageous to fight nuisance lawsuits to avoid becoming known as easy mark for unscrupulous lawyers. However, when fundraising, it is more appropriate to expeditiously resolve any litigation (potential or otherwise), rather than expend energy convincing a skeptical investor that your legal issues are without merit.

Geographic Dispersion – Significant physical separation of Core Team.

• Nair Solution – During an adVenture’s early days, virtual teams are often viable. However, as a company accelerates its growth by deploying its institutional funding, the Core Team cannot afford to be handicapped by disparate locales. As such, the Core Team should be prepared to relocate to a central location within a reasonable period after obtaining funding.

Way Outsourcing – Outsourcing core competencies.

• Nair Solution – Identify the areas of your adVenture that are critical to its success and internally develop the necessary levels of core competency. For instance, technology startups should maintain key development resources in-house, rather than relying exclusively on third-party, contract labor. If your business model is predicated on superior online marketing expertise, do not utilize consultants to craft and execute your online marketing initiatives.

Double Agent – Problematic agency issues, such as high salaries, non-entrepreneurial perks (car allowances, exorbitant travel expenditures, etc.), side businesses and/or cross-ownership of related businesses.

• Nair Solution – The addition of disciplined, experienced investors to your adVenture team will require you to run your business with a focus on creating long-term value. As such, eliminate any unconventional forms of compensation or other potential areas of Agency conflict before you are forced to do so by a prospective investor.

Before you seek investment capital, do what you can to make your adVenture smooth and shiny, with no nicks or cuts. Although judicious use of metaphorical Nair on your adVenture will help your fundraising efforts, it is often also necessary to unequivocally acknowledge the remaining deal hair. It should be shampooed, conditioned and styled in the most attractive manner possible. Trying to cover up deal hair with a cap and deny its existence is not a viable strategy. If you remove and groom the hair on your deal, there will be no doubt as to “Who loves ya baby?”

***************************

Special thanks to Jim Andelman, Founder and General Partner of Rincon Venture Partners (www.rinconvp.com) for his hairy suggestions.
—

Copyright © 2008 by J. Meredith Publishing. All rights reserved.

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If you follow the tips outlined in this entry, you will be guaranteed to suffer absolutely no dilution, as there is zero chance that any reasonable investor will be compelled to purchase any of your equity. With a bit of effort, your pitch will cause the audience to walk away with no empathy for you, a vague, disinterested understanding of your adVenture’s value proposition and absolutely no desire to fork over their dough into your sweaty hands.

Bootstrapping may limit your adVenture’s ultimate chance of success, but at least you will never have to deal with pesky institutional investors.

Pop Quiz: What are the top five phobias?

As discussed in The Personal Pitch, the primary door-opener into the world of private equity has always been personal contacts. At one time, the written Business Plan was the chief communication tool to articulate the details of a prospective venture investment. However, the increased competition between Venture Capitalists and the decrease in cycle times between the emergence of discontinuous technologies have led to a de-emphasis on the importance of the written Business Plan and a greater focus on the Investor Pitch.

Answer: The top five phobias, from most feared to least feared, are as follows:

1) Public speaking

2) Heights

3) Insects

4) Poverty

5) Death

As such, one way to guarantee giving a terrible investor pitch is to do so while on brink of bankruptcy, dangling from a high building and wearing a beehive on your head immediately after learning that you have a terminal illness.

Given the importance of the Investor Pitch, it is not enough to simply craft a lousy Business Plan. For those unfortunate, fully solvent entrepreneurs who do not have a terminal illness nor access to a beehive, there is still hope. The horrendous investor pitch is within your grasp. Simply follow the tips outlined below.

Open with an Offensive Off-color Joke

The great thing about beginning your pitch in an awkward manner is that you can alienate the majority of your audience quickly, making the fact that you are unprepared (see next suggestion) much less relevant. If you do not turn the crowd against you from the outset, you run the risk of creating empathy. When investors view you in abstract, impersonal terms, you increase the likelihood that you will not have to deal with an intrusive, strong-willed, ROI-focused, outside Board of Directors.

In addition to being blatantly offensive, avoid establishing the proper context of your pitch at the outset of your talk. The less foreshadowing you provide the audience upfront, the more confused and disengaged they will become. Also, ignore the First Impression Rule, which dictates the relative importance of the following messaging modes: 55% (non verbal), 38% (tone of voice), 7% (verbal). The best way to botch the First Impression Rule is to speak in a nearly inaudible, flat, monotone voice accompanied by distracting and random facial expressions and hand gestures.

Wing It With Sonic Fillers

Would you study for a test, train for a marathon or memorize your lines for a play? Of course not. Such preparation would be a waste of time. You are an entrepreneur – go for it. If you need to fill any uncomfortable pauses, just utter brilliant sonic fillers, such as: “you know,” “like,” “ah,” “let’s see,” “as I was saying,” “you know what I’m saying,” “uh,” or the classic standby “ummm.” The “um” is especially versatile, as you can sustain it for as long as needed and thus effectively fill nearly any awkward silence.

Obscure How You Will Make Money

Throughout your presentation, emphasize fluff over substance. Liberally utilize video, graphics and other eye candy that distracts from your pitch and is irrelevant to your overall adVenture’s value proposition. If you are forced to display financial data, ensure that the slides are unintelligible. To further obscure how you will earn a return on the investors’ money, verbally stumble through the description of your financial forecast and make it clear that you only have a cursory understanding of the assumptions underlying your business model.

To further weaken your credibility, speak in the future tense as frequently as possible. This will make your adVenture seem less real and more intangible (e.g., we will eventually complete our development, once we begin shipping product, etc.). Avoid specifying concrete action steps by keeping your comments vague and circumspect. The more generic and jargon-laden your remarks, the greater the extent to which you will be perceived as an insubstantial and ineffective dolt.

Do Not Put Yourself in Your Audience’s Shoes

OK, you know that most professional investors listen to hundreds of pitches each year. So what? In order to deliver a particularly terrible fundraising presentation, disregard the fact that your audience is likely highly sophisticated and somewhat jaded. Make it clear you do not know their investment focus (e.g., early-stage, late-stage, market-sector focuses, etc.) nor did you take the time to research the investors’ respective investment portfolios.

One way to unequivocally convey that you did not take the time to understand your audience’s frame-of-reference is to tell them things you are certain they already know. For instance, emphasize basic market issues that are familiar to even the most casual observer of your adVenture’s space.

Another tactic that will effectively demonstrate your complete lack of self-awareness is to disrespect your audience’s time constraints. If one of your audience members tries to speed you along, consider this an overt challenge to your ability to give a decidedly poor presentation. Slow the cadence of your pitch to a crawl. Also, consider utilizing irrelevant tangents and frequent repetition to further lengthen the grueling duration of your remarks.

Death by PowerPoint

An effective method to incite Death By PowerPoint is to deploy an extraordinary number of slides. A minimum of 8 to 10 slides per minute is a reasonable rule of thumb. In addition to relying on an enormous slide deck, you can accentuate Death By PowerPoint in a number of ways:

• Hide behind a podium
• Avoid eye contact with your audience
• Turn your back to the audience and read each slide verbatim from the screen
• Limit the use of pictures or graphs on your slides
• Utilize extremely small fonts so you can maximize the amount of text per slide
• Select a complicated, distracting background that will compete with the content of the slides

Apologize Profusely

Nothing more effectively conveys the sentiment, “I do not respect you. As such, I did not spend the time necessary to ensure that your time evaluating my presentation is well-spent” more than an explicit apology for being unprepared. You should also interlace your remarks throughout your presentation with apologies for: your slides, your disheveled appearance, starting the presentation late, running over your allotted time, etc. Such apologetic remarks will incrementally help to further erode your credibility.

You can also interject subtle, apologetic language into your pitch, such as: “sort of,” “pretty much,” “kind of,” etc. These qualifiers will denude the impact of your comments and reinforce your lack of self-confidence.

Evade Questions

Q&A can often make the difference between a mediocre and a compelling bad presentation. This is an opportunity for you to shine. Irrespective of a question’s validity, approach each with an overt air of disdain. Never admit that you do not know something. If you are unsure of a factual response, make up a fictitious one. Investors are looking for someone who can think on their feet, so show them how you can spin a tall tale in real time.

In addition playing loose with the facts, be defensive and argumentative if a question is too pointed. If the questioner persists with a follow-up question, provide a rambling, semi-coherent response. If you speak long enough, you can be assured that you will squelch any additional questions.

Except as noted below, avoid preparing for Q&A. Do not anticipate questions or think through your responses in advance. You are winging it, remember? This includes Q&A. With that said, there are a few areas in which a practiced response will serve you well.

• If asked about the future growth of your management team, make it clear that you and the rest of the team are capable of leading your adVenture all the way through its IPO and beyond. Leave no doubt in the investors’ minds that there is no need to add ANYONE to your team. Consider reviewing Founderitis – A Ten-Step Recovery Program for related themes you can weave into your pitch.

• If asked about your adVenture’s exit, make it clear that you will refuse to accept anything less than $500 million. You should also state that you expect to be in a position to cash-out and move onto your next venture within the next 10 to 12 months.

• If asked about your “Plan B,” sarcastically ask the inquisitive party what they plan to do when their portfolio goes into the red, which is clearly what will happen if they do not invest in your adVenture.

Do Not Follow Up

Once the presentation is over, forget about it. If a potential investor asks a question that requires additional research, blow it off. In addition, do not bother tracking down the investors to solicit their feedback after the pitch. If they really want to invest, they will seek you out. You are far too busy for such Tomfoolery. Besides, such follow-up might inadvertently result in ongoing investor interest.

Cocktail Hour Infamy

If you follow these tips, you will be assured to deliver a horrendous investor pitch. If you are diligent, the investors will remember your pitch for years and will liven up many a cocktail party with anecdotes from your talk. Differentiation is a good thing, so relish the notoriety that these tips will help you achieve and rest assured that you will never be saddled with troublesome investors.

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We have all been there. Please share the most egregious Death By PowerPoint moments you have experienced and what the speaker could have done to alleviate your pain.

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With each passing decade, the pendulum swings back and forth among the intelligentsia as to which factor has the greatest impact, but for an entrepreneur on The Fringe, the answer is clearly: Yes.

Location, Location, Location

Obviously, both Nature and Nurture matter to an entrepreneur’s success. Given that you cannot do much about your gene pool, the pragmatic entrepreneur will do everything they can to stack the cards in their favor with respect to their environment. If you are attempting to start a biomedical venture, you have a much higher probability of success if you start your venture in an environment which has a track record of sustaining such ventures. Why attempt to swim upstream, when you can expend far less energy, go further, and move more quickly by going with the flow.

You would not plant corn in Antarctica, and you should not start an Internet services company in Alabama. This is not to suggest that Alabama cannot support an Internet company. I am sure the Alabama Chamber of Commerce could proudly point to the handful of such ventures that have ‘made it’ (relatively speaking). However, if you toss enough corn seed onto the tundra, a few stalks might come up during the Arctic’s short summer season. Yet a few sickly seedlings would not be justification for starting a large farming enterprise at the South Pole.

At first glance, an emphasis on the location of your adVenture may seem at odds with the trend toward virtual, decentralized organizations. Take another glance. It is true that you can and should leverage tools that allow your organization to draw upon employee talent across a broad geographic area (like the globe…). However, unless your organization is comprised of a relatively small number of employees, you will likely be forced at some point to hire a concentration of employees from within a comfortable commuting distance.

Transplanting is Not Painless

Entrepreneurs who are not on The Fringe start their venture wherever they happen to be at the time they conceive of their startup. These folks allow the location of their friends and family to dictate the location of their startup. However, just because your great-grandfather decided to settle in the middle of nowhere 100-years ago does not mean that your adVenture must suffer.

Be proactive and launch your startup in the most ideal location. Jeff Bezos, Founder and CEO of Amazon, was a Wall Street banker in New York when he conceived of an online bookstore. He realized that the initial location of his startup was of vital importance to its ultimate success. As such, he selected Seattle, primarily because: (i) it was near Ingram Micro, one of the largest book distributors in the country and (ii) there was an abundance of software developers and high tech managers close by who had been educated on Microsoft’s dime, and had been instilled with Microsoft’s ubercompetitive corporate culture.

Do not fool yourself by thinking that you will eventually relocate your startup “at the appropriate time”. Once your adVenture is launched, there is tremendous inertia that is difficult and expensive to overcome.

With the addition of each new employee, supplier relationship, establishment of office space, etc. it becomes more difficult and more expensive to transition the company to a new location. In addition, in any such transition, you risk losing some of your employees, which translates into the potential loss of valuable institutional knowledge.

Come West Young Man

In the United States, as with most developed nations, certain geographic regions have robust Entrepreneurial ecosystems. These communities all share a number of commonalities which you should look for when deciding where to launch your adVenture. Silicon Valley is the most well known of these entrepreneurial enclaves. However, it has become such a Mecca for startups that the landscape is crowded and the soil has become less fruitful than it was in the past.

In addition to terrible traffic, exorbitant commercial rents, rampant smog, and horrible weather, Silicon Valley also boasts a job-jumping workforce that tends to work on a two-year cycle. For many Valley workers, the mentality has become: join a venture, vest half of your options during the first two years and then head on to the next venture as a means of ‘diversifying’ your options portfolio. This is great when your company is growing and you are hiring new talent, but it can be devastating if your startup’s growth slows. This lack of loyalty can also be an issue as your employees move closer to full vesting of their initial option grant, which may prompt them to look for greener pastures.

You may be better off launching your adVenture in an emerging entrepreneurial ecosystem that offers more reasonable commercial rents, and more loyal workforce. Fortunately, there are a number of communities in the US which embody the factors that are conducive to allowing a venture to prosper.

Entrepreneurial Ecosystems

When you are selecting the location to launch your startup, assess the degree to which the following factors are present.

Inexpensive High-tech Workforce – Most entrepreneurial enclaves are situated near a University that has a strong technical curriculum. These workers are everything you are looking for: young, cheap, hungry, and technologically proficient.

Equity Driven Workforce – Unfortunately, much of the US suffers from a post-unionization mentality that dictates that you should get paid for every hour that you work and that “overtime” is at the employee’s discretion. You do not have the time, and you cannot afford to expend the required energy to fight this ‘old world’ mindset. I am not being a ‘fly over’ snob here. I lived in St. Louis for years, and it is a great city to launch a family. However, it is not a great city to launch a venture. Just the thought of trying to convince a middle-America workforce that ‘options are good’, and that they should work late into the night (night after night) exhausts me. Thus, launch your adVenture where you can draw upon a workforce with a work ethic that appropriately values equity compensation.

Start-up Centric Service Firms – As discussed in “Roping In The Legal Eagles”, you will need a special breed of accountants and lawyers who understand the common issues faced by new ventures; in addition, many of these firms will be willing to exchange some of their services for equity.

Venture Investment Community – Follow the money. Certain areas of the US have an extraordinarily high concentration of startups which are funded by institutional private equity. For instance, according to the Q3 2006 PricewaterhouseCoopers / National Venture Capital Association MoneyTree™ Report, Southern California venture investments totaled over $853M. This is more than the total raised in all of the New England states combined, more than was generated in the NY Metropolitan area, and more than the aggregate VC funds raised in all of the 33-states at the bottom of the list combined.

Even if your adVenture will not require venture capital funding, the lack of a robust institutional private equity infrastructure in your community is likely indicative of an environment that is less than ideal for a startup.

Affordable Housing – One of the biggest challenges in a number of regions that are conducive to startups is the stark lack of affordable housing. Younger workers can generally be accommodated, as they are usually flexible and are willing to live with multiple roommates.

The primary housing challenge tends to be with respect to middle managers who are in the midst of starting a family, and thus, desire a home with a yard, garage, etc. Fortunately, in a number of entrepreneurial enclaves (such as Southern California), the temperate climate allows workers to spend a lot of quality time outdoors, which reduces the claustrophobia they would otherwise feel in their $1 million 1950’s track home – or “Quaint California Cottage”, as it is known in real estate parlance.

Proven Entrepreneurs – A vibrant pool of skilled and willing entrepreneurs who have ‘made it’, and thus have discretionary time to help you avoid common startup mistakes, is a key component of an entrepreneurial enclave. Such Donors (see “Personal Pitch”) make excellent Advisors and Board Members.

Smell of Money in the Air – As described in “Make Stone Soup”, the smell of money is a powerful thing. If you are trying to launch an adVenture in a community that has fostered few startup successes, you will have to ‘sell’ the idea of working ungodly hours in the hopes of a large payday to a group of folks who have no first-hand experience with such success. However, within an entrepreneurial ecosystem, the chances are greater that your workforce will have some association with someone in the community who has reaped the rewards of a successful entrepreneurial venture. Knowing that entrepreneurial success is ‘real’ and that it can happen to otherwise ‘ordinary’ people is a great motivator that you should not underestimate.

In the world of startups, it is clearly nature over nurture. Given this reality, why try to grow corn in the Artic, when you can live in a sunny, pleasant locale in which other entrepreneurs have created a well trod path to entrepreneurial success.

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