As part of our ongoing series examining the ecosystem necessary to bring technology to market, we asked veteran technology executive and angel investor Ron Weissman to share his thoughts on how startups can overcome the challenges of securing early-stage financing. This is the first of his commentaries and we welcome your comments.
Why do some first-time CEOs find it hard to get to first base with investors? The product story that CEOs want to tell has often little to do with the business story that investors need to hear before they will invest. Product- or engineering-driven CEOs new to the VC world beg, “Please let me demo my product! It will change the world. For $500,000 you will own a piece of the next Facebook.”
But the story that investors need to hear is different. “How does your business work? How will you scale to become a profitable market leader? Is this the kind of business that meets my investors’ financial objectives?”
Unfortunately, the conversation goes like this:
“Why will you succeed in a competitive market?” asks the VC.
“Because my network routing algorithm is better,” answers the CEO.
“But there are lots of players, including Cisco, in your market. How will you gain market share from entrenched leaders?”
“Because my routing algorithm prevents more collisions,” says the CEO, only this time, louder.
“How will my fund make money?”
“By backing my company, which has the best routing algorithms in the industry,” the CEO hollers insistently, now getting red in the face and pointing to a stack of scatter diagrams that the VC studiously ignores.
“You don’t get it,” says the VC, thinking, “Oh, God, another propeller head with zero business savvy.”
“Arrogant, ignorant VC,” mutters the entrepreneur, walking away, angry at yet another rejection from a soulless MBA.
How sad. Another lost opportunity to do good and do well. What happened? The entrepreneur had no idea what kind of story VCs need to hear. And the VC, seeing that, assumed the entrepreneur was too naive or too caught up in a science project to be fundable.
5 battle-tested rules
How should the entrepreneur proceed? With five battle-tested rules for telling VCs his story.
VCs invest to make money for their investors, a.k.a limited partners or LPs. If they don’t, they’ll never raise another venture fund and will have to find real jobs. LPs need to make “supernormal” returns to satisfy their pension or university endowment obligations. That’s why venture capital exists. Period. Changing the world is nice, but it isn’t the main reason why VCs get to play with other people’s money. They need to see a way to make a return of three to 10 times their investment in your company over the next several years or they won’t invest.
Rule #2: Explain why your technology or product will create a great business.
Most VCs want to invest in great businesses, not just great technology. Great businesses address large markets, grow fast and ultimately make boatloads of money. A great technology isn’t always a great business. You need to explain why your great technology will create a great business.
Rule #3: Explain the pain.
You are an unknown startup with zero credibility. Nobody, not even your mom, cares about your company. So the pain from existing solutions must be pretty severe for a customer to risk buying your product. Why would customers risk their career or budget to buy from you?
Rule #4: VCs back winners. Explain why you’ll win.
Like a horse race, typical markets will see, at most, three winners. If you’re not a “win, place or show” company, you won’t be the one that partners with market makers, gets market buzz and ultimately drives a high-value exit when you’re acquired by an industry leader. What is your world domination strategy? How will you gain market and mind share before the other guys do? Can you do it on a budget smaller than a U.S. government stimulus program? And why you? What is it about your background that makes you the right person to make this business a market leader?
Rule #5: Explain the gain.
VCs fund you to make money for their investors. They do so when you are sold to a bigger, more successful company or you IPO, which, chances are, you won’t. Who are your potential buyers? What is the exit scenario for investors? (Hint: lots of buyers are better than only one conceivable buyer.)
- Think of your audience first. What they want to hear is more important than what you want to say.
- VCs are motivated by many considerations. Your product is only one of them.
- VCs are investing in your business, not buying your product. A VC pitch is different than a product sales pitch. It should describe how you build a successful business.
- There are lots of great businesses, but not every good business fits the VC profile. Tell the story that VCs need to hear: describe how you will turn great technology into a great business, how much cash it will take to get there and whether this is a business capable of generating a return of three to 10 times their investment.
- Get help to fix the gaps in your story. If you have game-changing technology but a weak game plan, find a mentor or recruit a business-savvy co-founder to develop a real business plan.
Lastly, did you watch the video link at the top of this post? You really want to; pure gold from 1946.
VC Brain image: God in Chief
Ron Weissman is a Silicon Valley-based venture capitalist and angel investor. He chairs the Software and Internet Special Interest Group of the Band of Angels, Silicon Valley’s oldest angel organization. He blogs about entrepreneurship and venture capital investing at www.perworks.com/weissman