Handling a VC opportunity
June 29, 2010 2:12 PM Subscribe
My small company has been approached out of the blue by an established venture capital group. It's all very exciting because we'd love the opportunity to grow, but we also don't so much want to get screwed.
I realize there is probably a fairly small number of people out there who have had first hand experience in this area, but I've got faith in MeFi :). This is also of course still very early and likely won't go anywhere, but it's always good to be prepared.
I'm pretty comfortable with how to present our business, our plans for the future, and roughly what we would need to grow. We don't currently have a formal business plan doc, I do understand that's something we need to pull together quickly.
On the other hand, I'm totally unsure about what to expect from the VCs and what they will expect from us. I gather they usually take a significant portion of the company in exchange for funding, but what else? Do they usually insist on certain hires?
I'd appreciate any general advice on how this relationship usually works, what we should watch out for, who we should talk to and when. Any recommended reading (books, sites, whatever) would also be appreciated. Thanks in advance!
I realize there is probably a fairly small number of people out there who have had first hand experience in this area, but I've got faith in MeFi :). This is also of course still very early and likely won't go anywhere, but it's always good to be prepared.
I'm pretty comfortable with how to present our business, our plans for the future, and roughly what we would need to grow. We don't currently have a formal business plan doc, I do understand that's something we need to pull together quickly.
On the other hand, I'm totally unsure about what to expect from the VCs and what they will expect from us. I gather they usually take a significant portion of the company in exchange for funding, but what else? Do they usually insist on certain hires?
I'd appreciate any general advice on how this relationship usually works, what we should watch out for, who we should talk to and when. Any recommended reading (books, sites, whatever) would also be appreciated. Thanks in advance!
Sounds like good news to me if the VC fund that has approached you is a reputable one and before goint too far please do the following:
1. Check that they are a member of NVCA if they are in the US (or whichever country they are).
2. Check their website, ignore all the crap they all say and go to the list of their portfolio companies and look for:
a) do you know any of these companies? Can you speak to someone there?
b) are they 'your kind of' companies
3. Check that the VC actually manages funds and not an intermediary (the site should have something line 'assets under management of x million'. If not, you need to ask.
Once these checks are done and you are reassured you should move forward and also keep in mind that:
- It is not unusual for VCs to approach a number of companies in the same sector in order to identify a winner. Good VCs do this ethically but they are under no obligation to tell you that they are speaking to your competitors in the same way as you dont want to tell them that you are talking to other VCs
- And you must! (talk to other VCs) in order to get a better view on the sector
Once you get through the preliminary stuff there are more detailed things to look at but I must leave as it is very late here. I am sure other MeFites will pick up from where I am leaving otherwise you can MeMail me and I will try and help,
Good Luck!
posted by london302 at 2:43 PM on June 29, 2010 [1 favorite]
1. Check that they are a member of NVCA if they are in the US (or whichever country they are).
2. Check their website, ignore all the crap they all say and go to the list of their portfolio companies and look for:
a) do you know any of these companies? Can you speak to someone there?
b) are they 'your kind of' companies
3. Check that the VC actually manages funds and not an intermediary (the site should have something line 'assets under management of x million'. If not, you need to ask.
Once these checks are done and you are reassured you should move forward and also keep in mind that:
- It is not unusual for VCs to approach a number of companies in the same sector in order to identify a winner. Good VCs do this ethically but they are under no obligation to tell you that they are speaking to your competitors in the same way as you dont want to tell them that you are talking to other VCs
- And you must! (talk to other VCs) in order to get a better view on the sector
Once you get through the preliminary stuff there are more detailed things to look at but I must leave as it is very late here. I am sure other MeFites will pick up from where I am leaving otherwise you can MeMail me and I will try and help,
Good Luck!
posted by london302 at 2:43 PM on June 29, 2010 [1 favorite]
In lieu of a longer, more useful answer, one thing I will point out is that 99% of the time, there is some analyst at the firm who basically has to call a million small companies to look like he's being productive. So (a) don't get too excited and (b) don't sink too much time.
A lot of times, VCs won't even be really interested in your company at all, they just want someone at their shop to have info about the space, so they start contacting people at startups in that space to set up calls where basically, you will explain to the VC analyst what you and everyone else in your market does to make money and where you see things going, and the VC will essentially socratic-method himself an education in your space, while you think you are pitching him.
VCs, even that actually want to do deals with you, are huge, huge time burglars. I think that honestly the majority of them don't have enough work to do, and idly chatting about technology and technology businesses feels enough like work to them that they convince themselves its the same thing. So, basically, don't be afraid to tell them you are busy and have to get off the phone, you are probably not throwing anything away. After a few go-rounds of these, you will develop a sense for serious vs. tire kicker.
There's a lot of good information about startups and VCs on Marc Andreesen's blog (blog.pmarca.com). As far as 'what to watch out for' goes, everyone should read Philip Greenspun's Ars Digita story. You might also like the book "Founders at Work". There's a lot of writing about pitching from VCs, the blogs of Paul Kedrosky and Fred Wilson spring to mind. However, I am skeptical about how useful this information is. My guess is that asking a VC what makes a good VC pitch is like asking a movie goer how to make a great movie or a restaurant diner how to cook a great meal: they think they know, but almost
none of them have ever actually tried to do it.
Most of this kind of stuff will be about the general case: how VCs investments can turn out to be bad for startups (obviously, they are very frequently good as well), or the perils of the wrong VC-company-market matchup at the wrong time, but they won't really address specific things like term sheets. Its good to know some of this stuff, at least the basics (like the various preferences VCs will want added to term sheet and how badly they can go against you: thinks like board constitution, dilution prevention/ratchets, liquidation preferences, ISOs with extremely high strike prices...there are lots of places where a specific term can, depending on circumstances, go from 'oh well that's not too great' to 'now we are adversarial to our largest shareholder and they have all the cards'. HOWEVER, there is a limit: you basically are going to need a lawyer that's on your side regardless, so its not really worth worrying about until things get pretty far along. In other words, the VC will have a lawyer, and then you will try to find a good lawyer who works for the company pre-the VC's investment, and that guy will explain all the details to you.
In general, its worth keeping in mind that when a VC actually invests in your company, they are generally going to be on your side most of the time; you will have the same interests. Not always, but that's the normal case. But BEFORE they invest in your company, as much buddy-buddy as everyone is being, they are adversarial to you. Your interests are in nearly direct opposition.
A lawyer I once met, who's practice area was technology startups, described taking money from VCs as putting a gun to your head AND pulling the trigger. Now you have to outrun the bullet. At the time, I thought he was a crazy idiot, but that's stuck in my brain in the seven trillion years since then because its basically right on.
posted by jeb at 2:44 PM on June 29, 2010 [5 favorites]
A lot of times, VCs won't even be really interested in your company at all, they just want someone at their shop to have info about the space, so they start contacting people at startups in that space to set up calls where basically, you will explain to the VC analyst what you and everyone else in your market does to make money and where you see things going, and the VC will essentially socratic-method himself an education in your space, while you think you are pitching him.
VCs, even that actually want to do deals with you, are huge, huge time burglars. I think that honestly the majority of them don't have enough work to do, and idly chatting about technology and technology businesses feels enough like work to them that they convince themselves its the same thing. So, basically, don't be afraid to tell them you are busy and have to get off the phone, you are probably not throwing anything away. After a few go-rounds of these, you will develop a sense for serious vs. tire kicker.
There's a lot of good information about startups and VCs on Marc Andreesen's blog (blog.pmarca.com). As far as 'what to watch out for' goes, everyone should read Philip Greenspun's Ars Digita story. You might also like the book "Founders at Work". There's a lot of writing about pitching from VCs, the blogs of Paul Kedrosky and Fred Wilson spring to mind. However, I am skeptical about how useful this information is. My guess is that asking a VC what makes a good VC pitch is like asking a movie goer how to make a great movie or a restaurant diner how to cook a great meal: they think they know, but almost
none of them have ever actually tried to do it.
Most of this kind of stuff will be about the general case: how VCs investments can turn out to be bad for startups (obviously, they are very frequently good as well), or the perils of the wrong VC-company-market matchup at the wrong time, but they won't really address specific things like term sheets. Its good to know some of this stuff, at least the basics (like the various preferences VCs will want added to term sheet and how badly they can go against you: thinks like board constitution, dilution prevention/ratchets, liquidation preferences, ISOs with extremely high strike prices...there are lots of places where a specific term can, depending on circumstances, go from 'oh well that's not too great' to 'now we are adversarial to our largest shareholder and they have all the cards'. HOWEVER, there is a limit: you basically are going to need a lawyer that's on your side regardless, so its not really worth worrying about until things get pretty far along. In other words, the VC will have a lawyer, and then you will try to find a good lawyer who works for the company pre-the VC's investment, and that guy will explain all the details to you.
In general, its worth keeping in mind that when a VC actually invests in your company, they are generally going to be on your side most of the time; you will have the same interests. Not always, but that's the normal case. But BEFORE they invest in your company, as much buddy-buddy as everyone is being, they are adversarial to you. Your interests are in nearly direct opposition.
A lawyer I once met, who's practice area was technology startups, described taking money from VCs as putting a gun to your head AND pulling the trigger. Now you have to outrun the bullet. At the time, I thought he was a crazy idiot, but that's stuck in my brain in the seven trillion years since then because its basically right on.
posted by jeb at 2:44 PM on June 29, 2010 [5 favorites]
Without having a better understanding of the details of your company (e.g., industry, business plan, duration of existence, level of development / sophistication, profitability, staffing, etc.), it is only possible offer generalities.
In general, it is fair to state that, in exchange for investing in a company, venture capital firms expect to take the bulk of ownership / equity and insist on exercising significant control over decisions going forward. (And yes, that includes staffing.) The firm's original founders can easily find themselves marginalized, sometimes to the extent that they become little more than figureheads, depending upon how the deals are structured. There are often clauses in the agreements that lock in key personnel (especially the founders) for certain lengths of time after a deal as well as non-compete agreements that can limit what the people can do elsewhere if they leave the firm. The VC view in this regard can be summarized as: "They who have the gold make the rules."
And it also goes without saying that you don't want to sell yourselves too cheaply.
One of the most important decisions you will have to make if you decide to engage in discussions with a VC firm is your choice of legal counsel. Tangling with the venture capital community is one of those situations in life in which having a good team of lawyers to look after your interests is absolutely vital because the absolute last thing the venture cap crowd cares about is the interests of any party other than themselves.
Good luck!
posted by SuzB at 3:01 PM on June 29, 2010
In general, it is fair to state that, in exchange for investing in a company, venture capital firms expect to take the bulk of ownership / equity and insist on exercising significant control over decisions going forward. (And yes, that includes staffing.) The firm's original founders can easily find themselves marginalized, sometimes to the extent that they become little more than figureheads, depending upon how the deals are structured. There are often clauses in the agreements that lock in key personnel (especially the founders) for certain lengths of time after a deal as well as non-compete agreements that can limit what the people can do elsewhere if they leave the firm. The VC view in this regard can be summarized as: "They who have the gold make the rules."
And it also goes without saying that you don't want to sell yourselves too cheaply.
One of the most important decisions you will have to make if you decide to engage in discussions with a VC firm is your choice of legal counsel. Tangling with the venture capital community is one of those situations in life in which having a good team of lawyers to look after your interests is absolutely vital because the absolute last thing the venture cap crowd cares about is the interests of any party other than themselves.
Good luck!
posted by SuzB at 3:01 PM on June 29, 2010
If there is any and I mean ANY POSSIBLE WAY you can get by without VC money, then do so.
Even if the outfit turns out to be legit, and genuinely interested (per the other answers), think long and hard before you take their cash. Yes, there will be strings attached. Lots of strings. More strings than you can imagine from this side of the desk.
Every start-up I've worked for has bemoaned the need to accept VC money. Most of the people I've talked to would cheerfully go back in time, reject the VC, and take the slow-and-steady route.
It may mean it's longer before you can hire more people, it may mean sticking with your current crappy infrastructure, it may mean you won't have a "real" office for a while longer. But it also means that you're free to run your company the way it ought to be run, and that when you do finally earn that money it will be YOURS and not just repayment on a loan.
posted by ErikaB at 3:03 PM on June 29, 2010 [1 favorite]
Even if the outfit turns out to be legit, and genuinely interested (per the other answers), think long and hard before you take their cash. Yes, there will be strings attached. Lots of strings. More strings than you can imagine from this side of the desk.
Every start-up I've worked for has bemoaned the need to accept VC money. Most of the people I've talked to would cheerfully go back in time, reject the VC, and take the slow-and-steady route.
It may mean it's longer before you can hire more people, it may mean sticking with your current crappy infrastructure, it may mean you won't have a "real" office for a while longer. But it also means that you're free to run your company the way it ought to be run, and that when you do finally earn that money it will be YOURS and not just repayment on a loan.
posted by ErikaB at 3:03 PM on June 29, 2010 [1 favorite]
Is your growth potential worth more than the loss of equity you'll see from a VC investment? What would you use the VC funds for?
posted by clicking the 'Post Comment' button at 3:25 PM on June 29, 2010
posted by clicking the 'Post Comment' button at 3:25 PM on June 29, 2010
I know this space thoroughly - I've taken VC, invested in VCs and I've participated in many investments as an angel. Drop me a line privately and I can give some advice. (Google for my userid to figure out who I am.)
Like SuzB said, The most important thing you can do is find a lawyer who represents venture-backed companies. A good one will help you navigate the space, including the relative quality of the venture funds.
Jeb's advice re analysts is very likely exactly correct. Look to see if the person contacting you is listed as a partner of the firm. General Partners are the main guys, and Venture Partners are less central, generally.
ErikaB: There are good VCs out there. I would happily take money from the people who invested in my startup before again.
posted by joshu at 3:45 PM on June 29, 2010 [1 favorite]
Like SuzB said, The most important thing you can do is find a lawyer who represents venture-backed companies. A good one will help you navigate the space, including the relative quality of the venture funds.
Jeb's advice re analysts is very likely exactly correct. Look to see if the person contacting you is listed as a partner of the firm. General Partners are the main guys, and Venture Partners are less central, generally.
ErikaB: There are good VCs out there. I would happily take money from the people who invested in my startup before again.
posted by joshu at 3:45 PM on June 29, 2010 [1 favorite]
Seconding what joshu said. I have also taken VC money and I'd be quite happy to do it again.
At the start the VC is looking for a good deal - more of your company for less of their money, plus whatever control and protections they can get. So they are not looking out for your best interests. They will try and get the best deal for themselves without making it so bad that you tell them to get lost. They're not evil, its just business. The best way to get a good deal from VC's is to have more than one of them bidding against each other to invest in your company. At this stage there is no substitute for advice from your own attorney who is familiar with VC investments.
Once a VC invests, then depending on deal they got they may or may not have control of your company. There is no rule that says you have to sell them more than 50% of the company or give up control. However whether you give up control or not you should realize that the objective of the VC is to make money from their investment. You have to be aligned with that objective. Often this is no issue because the entrepreneur's objective is also to make money. If your objective is different from that, maybe you just want to be your own boss and earn a good living, or your business is fulfilling a social or personal goal in addition to profit that's important to you, then taking VC money is probably not a great idea. You won't be aligned with your investors and that basic disconnect will create a world of hurt later.
A couple of final points:
I would take anything you read on The Funded with a grain of salt - the signal to noise ratio is pretty high.
You don't need a formal business plan (like a 30 page word document) for VC's they wont read it. You will need an investment pitch of 10~15 foils (lots of examples around, drop me a line directly and I'll send you some templates). You will also need a pretty detailed financial spreadsheet (Revenue model, P&L, Cash Flow) for the next couple of years (with fantasy projections out maybe 5 years).
posted by Long Way To Go at 4:57 PM on June 29, 2010
At the start the VC is looking for a good deal - more of your company for less of their money, plus whatever control and protections they can get. So they are not looking out for your best interests. They will try and get the best deal for themselves without making it so bad that you tell them to get lost. They're not evil, its just business. The best way to get a good deal from VC's is to have more than one of them bidding against each other to invest in your company. At this stage there is no substitute for advice from your own attorney who is familiar with VC investments.
Once a VC invests, then depending on deal they got they may or may not have control of your company. There is no rule that says you have to sell them more than 50% of the company or give up control. However whether you give up control or not you should realize that the objective of the VC is to make money from their investment. You have to be aligned with that objective. Often this is no issue because the entrepreneur's objective is also to make money. If your objective is different from that, maybe you just want to be your own boss and earn a good living, or your business is fulfilling a social or personal goal in addition to profit that's important to you, then taking VC money is probably not a great idea. You won't be aligned with your investors and that basic disconnect will create a world of hurt later.
A couple of final points:
I would take anything you read on The Funded with a grain of salt - the signal to noise ratio is pretty high.
You don't need a formal business plan (like a 30 page word document) for VC's they wont read it. You will need an investment pitch of 10~15 foils (lots of examples around, drop me a line directly and I'll send you some templates). You will also need a pretty detailed financial spreadsheet (Revenue model, P&L, Cash Flow) for the next couple of years (with fantasy projections out maybe 5 years).
posted by Long Way To Go at 4:57 PM on June 29, 2010
VCs are looking to get their investment back out - do you envision going public or getting bought by a larger company within 2-5 years? What would you use investment $$ for? Depending on what sector you're in and what kind of money you need to bring your company to the next step will have a huge impact on whether it makes sense to look at vc money. Good, patient, supportive professional investors are a huge asset to a start-up. Impatient investors who are focused on a quick turnaround will not have your company's core interests as their interests. You need to know what the exit strategy for any investor will be.
Along with what everyone else has said you should expect that any deal will include a certain number of seats on the board. VC money can be a godsend for a growing company but you need to not be naive - get good advisers including the crucial good lawyers aforementioned.
posted by leslies at 6:40 PM on June 29, 2010
Along with what everyone else has said you should expect that any deal will include a certain number of seats on the board. VC money can be a godsend for a growing company but you need to not be naive - get good advisers including the crucial good lawyers aforementioned.
posted by leslies at 6:40 PM on June 29, 2010
Not all VC is dot com type, instant turn around, funding. Some funds invest in privately held, profitable businesses with long term investment goals. I can think of several companies where I know either someone doing the investing, or someone working at one of the companies where money is invested. In none of those cases are the companies likely to go public.
What they are likely to do is capture a vertical market where there is money to be made. Capital makes it possible for them to spread wide enough to capture a niche and become a market leader, and thereby a constant flow of money to the investor.
That said; I've seen VC drain a company of it's talent, it's IP and it's lifeforce. I've also seen VC that thought they should apply Wharton rules, which in turn destroyed a more organic talent pool, and thereby killed the company.
Don't open negotiations without an attorney experienced in this field. Don't spend a lot of time prepping materials for *this* VC until you know they're actually interested, and not just scattershot cold calling for market data.
Do avail yourself of the mefites whom have offered services and materials in this thread. Also, go have a beer and think about what you really, really, REALLY, want for your company.
posted by SecretAgentSockpuppet at 8:06 PM on June 29, 2010
What they are likely to do is capture a vertical market where there is money to be made. Capital makes it possible for them to spread wide enough to capture a niche and become a market leader, and thereby a constant flow of money to the investor.
That said; I've seen VC drain a company of it's talent, it's IP and it's lifeforce. I've also seen VC that thought they should apply Wharton rules, which in turn destroyed a more organic talent pool, and thereby killed the company.
Don't open negotiations without an attorney experienced in this field. Don't spend a lot of time prepping materials for *this* VC until you know they're actually interested, and not just scattershot cold calling for market data.
Do avail yourself of the mefites whom have offered services and materials in this thread. Also, go have a beer and think about what you really, really, REALLY, want for your company.
posted by SecretAgentSockpuppet at 8:06 PM on June 29, 2010
Don't be shy with your questions. Ask tough questions and demand good, reasoned responses. Make sure your business is solid enough to be able to at least survive without the money so you can keep the power dynamic between you at least a little bit in your favour. If they're really serious and really trying to work with you and for you (in a way, you should think of investors as working FOR you, not the other way around), you'll get good answers and an opportunity to work through any differences. This is the time to build a working relationship you feel comfortable with - even if it's only for long enough to get the deal done (unlikely).
posted by mikel at 8:43 PM on June 29, 2010
posted by mikel at 8:43 PM on June 29, 2010
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posted by signalnine at 2:40 PM on June 29, 2010 [3 favorites]