Compared to most other areas of finance, venture capital is practiced as more of an art, as opposed to a science. For that reason, it’s often said that VCs learn the business best through an apprenticeship model, under the wing of a more experienced pro. The art of venture capital also means that for entrepreneurs raising it, there isn’t one definitive playbook which can be used as a guide. Rather, over time, a series of collective experiences has solidified into a set of conventional wisdom which is shared repeatedly. Many common rules of the thumb are absolutely true (maximize the outcome of a fundraising process by approaching many firms simultaneously; deals should accelerate towards a close), but there are a handful of ones which just aren’t so:
MYTH: Entrepreneurs need a “warm introduction” to a venture capitalist to get a meeting.
REALITY: A warm introduction is neither necessary nor sufficient to get a meeting with a VC. What really matters is getting a VC’s attention. A truly “strong trusted endorsement” will do so, but that’s much harder to obtain than just a warm introduction. Otherwise, what I’d call a “credible introduction” is sufficient provided there’s also an additional piece of information (key founder background, specific space, etc.) It doesn’t matter how well the referrer is known, how “warm” it is, as long as it’s credible. The exception is if the referral is coming from a trusted inner circle and it’s a meaningful recommendation, not just an intro.
MYTH: VC’s need 20% ownership in their investments to make money.
REALITY: VC ownership targets depend on many factors and aren’t set in stone. The myth has been discussed and discredited in blogs for years, yet it continues to persist. And it manifests itself in pernicious ways. To make money, VCs should aim to have meaningful target ownership in their portfolio investments, but 20% is by no means some kind of magic number. The impact of a single investment on a fund depends on ownership percentage, as well as the fund size and the portfolio size (i.e. number of investments). A larger fund will want to have larger ownership targets than a smaller one for any given exit outcome to make an impact (… even larger than 20% for mega-funds). A seed fund with fewer investments will require smaller ownership than one with a broad portfolio to make the same impact. Entrepreneurs should remember that while these targets are real, they’re just that – targets. VCs who swear publicly that they’ll never make an investment with less than 20% ownership show up on cap tables in the teens… the 20% pronouncements are just posturing for negotiation.
MYTH: Goal of entrepreneur’s VC fundraising is a term sheet.
REALITY: Goal of an entrepreneur’s VC fundraising should be a closed investment, which includes both partnership conviction and an agreement of key terms. My recent blog post digs into these details.
MYTH: Venture capitalists are looking to replace founders with “their guys.”
REALITY: The earlier-stage an investment is for a venture firm, the more the bet is on the team, the more reticent they are to want to change the core DNA of the company. (The caveat here is for later-stage venture investments, the Founder/CEO role is sometimes seen by investors as a hired role which is currently being held by someone who has been there since inception but doesn’t need to persist indefinitely.) However, any early stage venture capitalist knows that many of the most transformative companies (read: profitable investments) in history are those which are founder-led throughout. At the early stages, the primary investment thesis rests on the team, rather than the idea or market (which are less unique and more easily fungible). When a VC backs a founding team, she’s doing just that, backing a founding team.
MYTHS: VCs add no value -or- VCs add indispensable value.
REALITY: Common polar viewpoints of either venture capitalists being literally useless beyond the cash they invest or VCs solely transforming their portfolio companies are vastly exaggerated – the truth is always somewhere in between. Even the most elementary venture capitalist has the privilege of serving on boards of a number of startups. That set of experiences alone provides a unique perspective about companies facing similar challenges which adds constructive diversity to board room discussions. More importantly, a handful of VCs are indeed truly engaged supportive partners with entrepreneurs in building their businesses. They contribute in ways from opening their personal networks to providing counsel during important strategic decisions. But hyperbolized claims about “platform offerings” replacing key team functions or the ultimate success of a startup hinging on an individual VC’s contributions are vastly overstated.
MYTH: Entrepreneurs should avoid larger VCs in seed rounds because of “signaling risk.”
REALITY: Larger VCs in seed rounds do indeed alter dynamics of future financings, but not always for the worse. Although the negative signal potential of a larger VC which participated in a seed round not continuing forward can damage the prospects of raising a subsequent round, there are both benefits to their participation and ways to mitigate those effects. A recent CB Insight study concluded that the highest follow-on rate occurred when BOTH a multi-stage VC AND seed VC participated in a seed round.
MYTH: The venture capital model is broken.
REALITY: Venture capital is a business driven by asymmetric outcomes and therefore asymmetric winners. People are accustomed to normal distributions, as they’re both intuitive and commonplace. Along many dimensions, the structure of venture capital is anything but normally distributed. Most entrepreneurs who seek venture financing don’t receive it, yet for the ones who do there is immense competition from multiple sources vying to invest. Most entrepreneurs who raise venture aren’t successful, yet those who are, are wildly. Typically one to three of these winners within a VC’s portfolio significantly drive overall fund returns, not the median investment set. And those winners aren’t normally distributed across firms and funds, so as an “asset class” VC performs poorly. But within the space, there are entrepreneurs, VCs, and LPs who all benefit… just not on average. Rather, the distribution of everything in VC is asymmetric, not broken.
Posts in the blogosphere, conversation on panels of/about VCs, etc. all talk about the best way for entrepreneurs to optimize their fundraising process with the end-goal of receiving a term sheet. It’s often spoken as if the second that magical term sheet document is in hand, the process is over. Unfortunately, that’s an oversimplification which should be recognized by savvy entrepreneurs.
The goal of any VC fundraising process is in reality a bit more nuanced, as there are two key events an entrepreneur should be working towards:
- Partnership Conviction – having not just the sponsoring partner at a VC firm, but the entirety of the firm’s partnership, on board with the investment.
- Agreement of key terms between entrepreneur + VC firm. A meeting of the minds about the key components of an agreement (structure, valuation, key features).
Most often a signed term sheet entirely recognizes these two events (hence the simplification), but in many cases term sheets are issued before either or both of the above are present.
How can this situation happen?
- Some VCs merely view term sheets as “marketing documents.” Given that it’s a non-binding piece of paper, it’s relatively easy to share one and appear to be further along the process of conviction and agreement than is really the case. This situation can even sometimes lure entrepreneurs into abbreviating their full fundraising process to vie for competitive offers. It doesn’t mean that the term sheet is without merit, but just that the process of conviction and agreement needs to catch up to the documentation.
- Many times (seed) investments (especially) don’t have true partnership conviction. Depending on a partners position in the firm and the size of the potential investment, there is typically some ability to issue term sheets (and even write checks in seed rounds) before the whole team is on board. In those cases, the propensity for time to kill all deals for this round and starting the race for the next round of financing can start behind the starting blocks with the VC firm of current investors not completely bought in.
- Entrepreneurs pushing for a term sheet from one firm to use in leverage with other firm’s negotiation. Again, it goes back to if there is really belief behind the document on either/both ends. This approach is a high risk/reward strategy… which can work, but can also fall like a house of cards if the ultimate agreement on either side is based on fear of losing the deal, not excitement about winning it.
- Term sheet is an opening in a negotiation rather than the codification of it. Sometimes term sheet negotiation processes play out with multiple term sheets being shared to reflect the current state of discussions until one is signed, instead of just one final one reflecting the ultimate agreement.
Different firms have different perspectives on term sheets. I know some firms who won’t share a term sheet unless they believe there is complete agreement understanding in place with an entrepreneur and s/he is ready to sign immediately. Others I know view it as a fruitful way to open a dialog with items outlined in black and white as a foundation. The key takeaway is for entrepreneurs to initiate a conversation during the middle of the fundraising process with a potential VC partner to learn their philosophy on sharing term sheets and then understanding the context when one arrives (or doesn’t arrive) in an email inbox.
After we sold our startup Sombasa Media just over a dozen years ago, I embarked on two distinct “journeys.” The first was a month-long 1500+ mile cycling trip from the southern tip of England to the northern tip of Scotland (“Land’s End to John O’Groats”). The second was a trip where we hiked the “Inca Trail” in Peru to Machu Picchu. Both trips “rhymed” with each other in that the point intentionally was about the experience of the voyage rather than merely the destination itself. I think that the reason founders are attracted to entrepreneurial endeavors often stems from the same intrinsic motivations. It’s not fully about the eventual outcome or exit of the business (— yes, of course that matters), rather the process of creating something out of nothing and building a meaningful endeavor.
There are many differences between the two trips which I took, including that the cycling trip was a solo endeavor and the hike was a group one. But this isn’t an analogizing blog post about having “co-founders.” It’s one about having a sherpa. Obviously, I don’t mean literally a cultural Sherpa… but instead a sherpa who is a largely silent but proactive guide providing support along the journey.
Yes, my analogy description of a sherpa very much sounds like a mentor. But I think that there are subtle distinctions:
- A mentor has been down this path previously; a sherpa has traveled the road too many times to count.
- A mentor walks beside you along the way; a sherpa is often running ahead to help clear the path.
- A mentor actively talks through the issues and challenges at hand; a sherpa foresees the challenges ahead and positions the journey for you to help overcome them.
- A mentor is interested in both your personal growth as well as success; a sherpa wants both but also feels duty to protect when calamity is near.
- A mentor brings a set of expectations about the relationship; a sherpa often surprises you with his involvement (or intentional lack thereof at times).
- A mentor is typically one or two stages ahead in (career) experience; a sherpa has seemingly been doing this forever.
All along my professional career I’ve aggressively proactively sought mentors to help with the journey. However, it wasn’t until we started NextView a few years ago did I (along with my partners) find sherpas who possessed an extremely generous willingness to help in building our firm, and I discovered a kind of advisor which was really different. Startup founders similarly look to bring in outside help with both formal and informal advisors into the orbit of their companies. While accessible mentors should and do play an invaluable position, I think it’s helpful for entrepreneurs to also seek and individuals who can play a sherpa role. An unexpected clearing of a path ahead rather than just a warning about an obstacle can preserve energy and resources for bigger climbs ahead. And the wisdom from someone who grew up on the mountain rather than just someone who “knows” it is invaluable.
The web has become increasingly visual.
Of course the same broadband penetration trends which catapulted the rise of online video over the previous decade also empowered delivery of image-heavy web pages. But more importantly and more recently, the proliferation of high-resolution screens epitomized by Apple’s Retina display means that today’s web browsing experience can be far more visually stunning than ever before.
And so the past few years we’ve seen glossy graphically-rich sites which are image-centric become commonplace. The endless scroll of Pinterest, Polyvore, The Fancy, Behance, Tumblr, are just a few mainstream examples of a broader trend towards graphically-rich design, but this aesthetic carries to longer-tail sites like foodgawker which have embraced this paradigm. The content on these sites are laden with products, largely submitted by consumers. These product images represent valuable brands – in categories ranging from beauty and home goods to fashion and food. Yet brands don’t understand how their own image and photo content is being shared across the broader web, either on the above sites or even core social sites like Facebook and Twitter.
In comes Triple Lift. It offers the first marketing platform built for the visual web which takes into account how a brand’s images resonate among consumers. Using real-time image engagement analytics, the company identifies and amplifies brands’ images through initiating paid media and catalyzing earned media. Triple Lift is an ad tech company, which means that the power of the offering is really under the hood. So rather than going into the details about how the combustion engine works (which you can begin to read about on their product page), better to share what they’ve already powered: Triple Lift has delivered successful campaigns for brands like Gucci, Martha Stewart, and Puma just to name a few.
With all of our seed stage investments here at NextView, we both look at the market opportunity as well as the team behind the startup. All three Triple Lift co-founders – Eric Berry, Shaun Zacharia, and Ari Lewine – come straight from AppNexus … exactly the right core advertising technology DNA which we’d want to see in an authentic founding team.
Today Triple Lift announced their $2M seed round financing. We at NextView Ventures are happy to join co-investors True Ventures, iNovia, and the rest of the syndicate. With this investment, everyone around the table is excited about transforming marketing on the web as we know it. As the web changes, so should brand’s approach to reaching consumers on it. The visual web has arrived… and so has Triple Lift.
VCs like to give out homework. They won’t call it that, though. But rather they use words like “diligence” and “information requests.” Just like in school, the homework can actually be productive, as in this case it can lead to a new customer or advisor. But just like bad teachers did in grade school, VCs sometimes assign completely useless busywork.
Receiving a homework assignment or two after initial meetings with a venture capitalist is generally a good sign – it signals that the potential opportunity is interesting and exciting enough to engage further. They’re often positioned as simple diligence requests that (actually often genuinely) help an investor get a better sense of the startup and its prospects. Yet as those initial assignments turn into an endless string of assignments, the signals can turn south. At the best it’s an indication of indecisiveness, and at the worst repeated homework can be indicative of bad intentions to show minimal engagement to “hang around the hoop.”
There are a number of reasons why venture capitalists give out homework to entrepreneurs who have pitched them… usually the rationale isn’t one of the following, but rather a combination:
- Answer specific questions. Whether it’s about the market, competition, etc., VCs typically want to “get smarter” about a domain, especially if they’re less familiar.
- Validate thinking. VCs walk out of a pitch with a thesis – it might be about the team or the market opportunity or whatever – but they like to hear from others that that thesis is indeed sound. In other words, they seek supporting points to verify their reasoning.
- Overcome their partner’s objections. If a new non-linear homework assignment comes up mid-evaluation process, it’s typically a direct reaction to a VC’s partner objecting to the investment on specific grounds. The homework assignment can be a way to provide ammunition to overcome those objections politically (especially within larger firms).
- Build trust. Sometimes the content of the assignment is irrelevant, but rather the VC is utilizing the process as a way to build a rapport and see how an entrepreneur interacts beyond an hour pitch-meeting. The process can reflect if an entrepreneur listens well and is open to feedback, meets expectations about output, and generally does what he says he’s going to do.
- Delay. Going through a process of repeated diligence requests can sometimes be intentional stalling tactics to a deal process, allowing VCs to gather more data and preserve optionality for as long as possible.
- Play chess. Assignments can be a part of a larger power-play game with respect to negotiation of an eventual deal.
Given the above motivations, a number of kinds of homework tasks can emerge:
- Produce more internal reports. Often VCs are looking beyond the headline numbers in a pitch deck to validate that the “traction” is truly real or just spun for a presentation, but other times the requests are just to verify what an entrepreneur said is true is.
- Produce financial models. Sometimes these spreadsheets are helpful to run different scenarios about what the drivers are of the business are and/or outputs under different sized capital raise. But more importantly, it’s a way to demonstrate deliberate thoughtfulness about the business. However, there is a risk (and I’ve seen it happen) of VCs sending an entrepreneur on endless modeling exercises which are completely useless – you can’t dictate the impossible into reality, but you sure can model it.
- Assemble (third-party) reports. Additional information about the market sizing, competitive dynamics, potential acquirers, etc. can help educate an investor about a space where s/he is less familiar.
- Allow for customer / partner / advisor / employee conversations. It’s sometimes a sensitive topic to allow potential investors access to key constituents within an emerging organization, especially customers, but they are often the most revealing about the opportunity and can be the final convincing data to push an investor towards conviction.
- Talk with a own domain expert. VCs have their go-to people in their network, sometimes formally affiliated with the firm or sometimes just friendly informal relationships, who they introduce to entrepreneurs to hear their perspective on the opportunity (see #2 and #3 above).
- Talk with new potential customers or partners introduced by the VC. Often if a VC has made other investments in a (related) space, he is able to introduce potential new customers or partners to a company even before making an investment. These kinds of intros (if they’re actually apropos) can be beneficial to the startups, but they also give an investor the ability to first-hand see how a potential new customer reacts. Trouble, however, can arise if that customer isn’t as good a fit or has another idiosyncrasy which generates erroneous feedback back to VCs.
In all of the above, I haven’t shared a value-judgment to either the motivations for these assignments or the types of them. But it’s clear that some can be quite constructive for a startup, while others can be neutral to even unconstructive. My partner Rob Go wrote a post a couple years ago about interpreting diligence requests to figure out whether indeed they’re “bad” or “good.” Because just as a VC uses the diligence process itself to evaluate an entrepreneur as the leader for an investment opportunity, entrepreneurs can similarly use these interactions to decipher if a particular VC is going to be a good partner to the company going forward once an investment has been made.