The current excitement among entrepreneurs and venture investors is palpable. After a few long recessionary years, companies are lining up to IPO, hiring is on the rise, and the business climate is improving. The next generation of Internet, technology, and consumer business leaders are emerging.
With this return to optimism, venture firms are again keen to invest in high-quality startups with the potential for greatness. The result, as always in times like these, is that too much money is chasing too few good deals. Entrepreneurs are in the driver’s seat.
If you’re a proven entrepreneur starting an innovative, revenue-generating business today, you’ll probably have your pick of venture firms. VCs had the upper hand in structuring deals during the recession, but many are beginning to realize they need to “earn the right” to invest in the best companies. At Maveron, a venture firm founded by and for entrepreneurs, we’ve always taken this approach. We approach venture investing as a partnership; we provide the funds to support an entrepreneur’s dream of building a great consumer business.
The shift today toward an entrepreneur-driven funding market is not just a temporary result of the return of high-profile exits and increased optimism. In fact, the entrepreneur should always be in the driver’s seat no matter how the exit markets evolve. Why? Because startups simply are not as reliant on VCs as they were 10 years ago. There are several reason why this is the case.
One, it is cheaper to start a startup today. Moore’s Law has made hardware cheap; open source has made software free; the web has made marketing and distribution platforms accessible; the cloud has made geographic location irrelevant; and more powerful programming languages mean development teams can be smaller. In other words, the entrepreneurs who created all this amazing technology have changed the game for the entrepreneurs who come after them, making start-up costs much lower and the need for a big infusion of venture capital less pressing.
Second, startups are reaching profitability sooner. Every startup is constantly calculating the “runway” – how long they have until the money runs out. But because startups have become cost effective to run, that runway is longer and the threshold of profitability can be reached sooner. If you have a profitable company, you don’t necessarily need venture capital to sustain growth.
Despite these realities, VCs aren’t about to disappear overnight. The firms that understand this new world of “capital efficient startups” will not only survive, but thrive, in the coming decades. Entrepreneurs that want to build really big global businesses will still need venture money – because even if you’re profitable enough to keep growing slowly and organically, you’ll still need a big capital injection to take a big leap.
If you’re an entrepreneur in this position right now, how should you vet the VCs clamoring to fund your company?
1. Approach the fundraising process as “buying capital” rather than “selling equity”. You need to buy capital at the best possible terms for your company, with the goal of using that capital to reach clearly defined growth goals.
2. Research VC firms carefully and come up with a short list of firms that are the best fit for your company. Things to consider are:
3. What business sectors does the firm have expertise in? Does this expertise map to your business?
4. Do they have any partners who are proven experts in your industry? Do they have operating backgrounds?
5. Which companies in your space have they already backed?
6. What is the potential “network effect” via the key partners’ industry contacts?
7. How much does the firm typically invest per deal and how much “dry powder” do they have in reserve?
8. How are their investments typically structured?
9. What are their exit expectations?
10. Are they known as entrepreneurial friendly and can they be referenced to prove that?
Competition among VCs for the most promising companies is fierce right now – and due diligence is a two-way street. As an entrepreneur, you should be as interested and concerned about the qualifications of your potential investor as they are about your qualifications, business plan, and execution strategy. Ask for references and investigate each partner’s professional and career background. Ask for a list of the CEOs of their portfolio companies, so you can contact them to get better understanding of how they work with entrepreneurs. Meet all of the investment team members and the other partners in particular.
Finally, it is critical that trust, honest communication, and respect form the foundation of every new funding relationship. Building a company is likely the most challenging thing you’ve ever done – and you want a venture partnership who shares your goals and is “in it to win it” right alongside you.