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VC Cliche of the Week
When a startup company needs to raise money, a rifle shot approach is always better than a shotgun approach. This is true of every raise, but it is particularly true of the second and third rounds, once there is already a VC firm or two in place. Raising money is time consuming and you must focus on a small set of highly likely prospects if you want the fundraising process to go quickly and end successfully.
I always tell the entrepreneurs and managers that we need to put together a "short list" before we start the fundraising process.
Building the short list is an iterative process. Someone starts it off, usually the company, but sometimes the investors. Then they pass it back and forth, usually in an excel file, and make modifications. The short list should be shared with everyone in and around the company who has relationships in the venture business, including your lawyers, advisory board if you have one, angel investors, and even employees and friends.
What you are looking for in a short list is a list of venture capital firms where you can get a high level (partner level) introduction, where your business is a very tight fit with their investment strategy, and where you have reason to believe that the firms can be helpful in the development of the business going forward.
I would suggest that the short list should be no longer than ten firms, and ideally as short as five or six firms. But the short list should start much longer, probably around twenty firms, and then get whittled down using the iterative process I described above.
There is a tendency to build the short list around brand name firms. How many times have I heard, "we need a top tier west coast VC in this round"? While the top tier west coast firms are very good investors, just because they have a brand doesn't necessarily make them the ideal investors for your business.
There are something like 800 venture capital firms operating in the US right now. There are roughly 550 firms who are members of the National Venture Capital Association. So they are a ton of options to choose from and you should take the time to do the upfront research, get suggestions, do more homework, and build a great short list.
One thing that is critical in putting together the short list is figuring out the stage and valuations that the various firms like to invest at. If you have done two rounds of venture capital already and are targeting a $30 million valuation, you don't want to focus on early stage firms who focus on the first venture round, as Union Square Ventures does. But there are plenty of firms who prefer to invest a bit later in the development of the company and they should be on your short list if that is your profile.
Once you have your short list nailed down, its time to do more homework. You should know about every portfolio company in your general market sector of every firm on your short list. You should know the names of all the partners and associates and analysts at every firm on your short list. You should know the most successful investments of the firms and particularly the partner you are targeting as your entry point. You should spend some time on Linked In and figure out who you know who knows the firm and the partner you hope to work with. These bits of information will be very valuable as you navigate the process with the firm. Don't throw them all out in the first five minutes of the first meeting, but keep them in your head and use them at the opportune moment to solidify trust and comfort which are the most important ingredients in a successful fundraising process.
In summary, you must have a short list to execute the optimal venture capital fundraising process. And the firms on the short list must be pre-qualified by your network to be highly likely to be interested. Getting it right will make a big difference.
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Tracked on Aug 17, 2005 9:55:29 PM
Posted August 17, 2005 in Venture Capital and TechnologyComments
Great post Fred!
Isn't it amazing just how complicated venture financing is, not that there is anything wrong with that...but some things just don't seem to add up and short listing is a good example. It's just fascinating how much hearsay, recommendations, tips and favors have to do with what is, on the face of it, a straightforward financing decision.
One of the interesting things I find, from the entrepreneur perspective, is how venture firms are practically impossible to compare in terms of cost of capital. Surely, some firms are more expensive than others, but it's not like anyone's gonna be comparing term sheets side by side, or be accessing the kinds of comparison services offered to those shopping for mortgages or margin loans. Maybe it's a truism that short lists are best done on the basis on a hunch, affinity, and the goodwill of your mates and your mate's mates.
So, it seems, vcs can't be short listed on the basis of projected cost of capital, or any other, brutally rational expectation.- and then everything gets trickier…you know… who's got the connections, the domain experience, the reputation, the brand name etc. Selecting vcs really is like jumping off the cliff- except it’s worse ‘caus you really don’t know what might happen because none of the major reasons for selecting vcs seem to be enforceable. How can a term sheet guarantee the value of going with a top tier?
So, other than co-founders having to sell the benefits of these soft, decision-making parameters to earlier angel investors, entrepreneurship as a whole might be suffering from this lack of information in the market. Nevertheless, who knows whether American innovation would benefit from greater transparency in venture capital? I certainly don’t.
That said, history has shown that greater transparency and availability of information has greatly benefited firms in financial services. More people invest as information and transaction infrastructure becomes available. In the case of venture capital, entrepreneurs are the investors vcs should be worrying about, not the LP’s. In other words, all these burdens attached to venture capital and complimentary services, do nothing but deter entrepreneurs from allocating their savings to nascent ventures and taking on risks. It’s not right if investing in my own company is about as straight forward as putting money into a Kamchatka goldmine [for example]. I really think the venture financing process could benefit from streamlining and one or two technological innovations, to make the whole thing easier and safer for everyone involved.
Finally, isn't it arresting how the very people, who have been financing all the major breakthroughs in how we work and live, operate a business model which hasn't significantly evolved since Queen Isabella and the fellow by the name of Christopher? I can't wait to see if venture firms innovate and actually do a good of competing to get short listed. Trust in one another goes a long way, but it still seems irresponsible for CEOs to shortlist vcs based on what their lawyer reckons...or what anybody reckons for that matter. I respect the value of a personal introduction, but more reports and disclosure from financiers would sure make me just that little bit more comfortable.
Posted by: Daniel Nerezov | Aug 17, 2005 1:43:43 PM
Pass it back and forth in an excel file? Come on Fred, that is so 1998. Why don't they use wikis for that?!
Posted by: Rob | Aug 20, 2005 8:31:07 AM
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Excellent! I enjoyed reading your material. Port aBuayar: http://johnedithnotes.blogspot.com/2005/10/slatecom.html , bring heavy cream just to a boil
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Posted by: accords | Nov 4, 2005 9:10:36 AM
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