12 July 2010

When Is A Startup "Venture Fundable?"

I spend a healthy chunk of my time helping startups think through their capital raise strategies.  Part of this work involves assessing whether a company is “fundable” given its current stage of development, traction and business plan. 

Being strategic about when to raise capital is important, since a full-court investor press takes a huge amount of time and effort to do right.  Fundraising essentially becomes a full time job, and can easily become a distraction for founders who should be focused on growing their businesses.  I’ve seen worst-case scenarios in which the fundraising becomes so consuming that important business milestones slip, which then derails the fundraising—a dangerous spiral. 

To try to bring some clarity and structure to the critical decision of when to raise capital, I have attempted to boil down the basics of what constitutes a “fundable” company in today’s market.  In a nutshell, the main factors are: 

1.  The “Big Idea.”  A good first filter is to honestly and objectively assess whether your startup is doing something truly novel.  Novelty and originality are surprisingly rare traits; many startups are highly derivative-- a slightly better mousetrap or an incremental improvement over what’s being done today (think: Groupon clones).  While a better mousetrap can certainly be the basis for a profitable niche business, it is not usually venture fundable (or at least, not easily fundable—it becomes more so, with #3 below).

By contrast, pitching something truly unique, big, and audacious—what Mike Maples calls the “thunder lizard” startup—creates an entirely different response from investors.  I’ve worked with startups doing something interesting but not game-changing, and I’ve worked with startups with ideas that seemed crazy—but if they worked, they’d be huge.  

The latter situation is much preferred, and makes the tiring work of raising capital exponentially easier. A really cool technology with the “wow” factor or a big, audacious, disruptive concept is almost magical in the way it can cut through the noise and generate buzz amongst jaded investors. At a minimum, VCs will take a meeting to hear what the hell you’re talking about.

2.  A Story, Well Told.  While the Big Idea is the cornerstone of the foundation, the pitch is what gets people to stop and take a closer look.  Investors are pitched by literally thousands of good companies each year; an outstanding pitch will break through the noise and set your company apart from the unwashed masses.   

A solid pitch neatly packages the company, vision, and deal in a compelling manner (typically via your slide deck, exec sum, and model), with a narrative crafted to appeal to the nuances of what investors are looking for.  It involves telling a clear and exceedingly simple story, so the message is frictionless and can be circulated among the partners at the VC firm and among other VCs in a syndicate.  In other words, the pitch is portable (and often somewhat “viral”).

A solid pitch also includes polished and practiced Q&A, and an overall story that strikes both rational (how do I make a return on my investment?) and emotional (why do I want to be part of this vision?) chords.  Bringing all these elements together is surprisingly difficult, but when done well it is a beautiful thing.  

3.  Supporting Evidence.  This is the clincher, and the one most startups miss.  VCs fund businesses, not concepts.  A concept alone is not fundable--startups must get the fire lit; venture money fuels an already-burning fire. Or, to put it in other terms, VCs typically want to see most of the technology risk and at least some degree of the business risk removed before doing a deal.   

In the absence of some special factor (for example, a founder with multiple successful exits under the belt), startups need to generate some evidence of "market validation"—e.g. initial traction, early customer adoption, or a monetizable proof of concept--before approaching investors.  In short, startups need data showing the beginnings of a growth curve.  


Fortunately, it only takes a few data points to show a pattern. I’ve seen startups with just 3-4 months of live customer data get a lot of investor interest.  Investors recognize that the delta between a startup with "deal in hand" and one that "will have a deal, if  we raise funding" is very large, and they use this gap as a filtering mechanism.     

This is why designing and presenting startup metrics plays such an important role--metrics like engagement (MAU, DAU), stickiness & retention, upsell / conversion rates, virality, etc.  In a perfect world, you can show—even with just an initial, limited data set—that your average revenue per customer is greater than your cost to acquire said customer.  In such conditions, an investment is a no-brainer; this is what closes venture rounds.  

While I’m a huge proponent of “pitching the numbers,” qualitative evidence can be useful as well, such as blogger support, press and journalist attention, rabid Facebook fans, evangelistic Twitter followers, etc. Regardless of the form, it’s a powerful combination when you can start your pitch with a right-brain lead-in (i.e., an emotive, visionary angle) and finish with a left-brain close (rational, unambiguous data). 

Those are the three foundational pillars that offer startups at least a fighting chance at raising venture capital.  Keep in mind that raising external funding is significantly “harder than it looks”—estimates from the SBA and Angelsoft show that only around 2% to 5% of startups seeking angel or VC dollars actually get funded.  The bottom line is that being strategic about it— getting your sh*t together, and timing your investor outreach for when momentum is building around (and within) your startup—will greatly improve your odds of success.  

Analysis of Common Mistakes

The most common mistake, in my view, is trying to pitch too early without any supporting proof / evidence / traction / metrics.  Without any data, you’ll tend to get a lot of false positives-- meetings that just lead to  “let’s keep in touch” responses. This is a huge time sink, and it is often hard to re-ignite the conversation weeks or months later when you finally do have some data points to show.   

Indeed, there is a direct correlation between customer traction/momentum and the speed at which a deal gets done.  Thus, one of the key success factors in getting funding is that founders somehow get their startup trains moving—by bootstrapping, doing consulting work on the side, tapping friends and family or "dumb money,”—and come at Sand Hill Road from a position of strength.  The alternative is just too frustrating and draining.  

Another common mistake is going out with a rough-around-the-edges pitch. The people you are pitching probably sit through 10+ pitches each week, and a confusing or overly complicated message won’t stand out, or worse, is quickly forgotten.  Clear pitches—the kind, as Sequoia puts it, that can be elucidated on the back of a business card—enjoy a “halo effect;” muddled pitches are weighed down by their own inertia.     

One more note: if you’re missing one of three key components described above, then, like the guy driving next to you in the large Corvette, you’d better have an oversized version of something else to compensate.  No real traction, but your concept is so big—so truly disruptional—that if it works it will be the next Zynga or Facebook?  You might have a shot, if you can adequately tell/sell the vision in your pitch.  Or, no pitch developed, but your unique monthly visitor growth on Compete.com is going hog wild?  You’ll probably have VCs (or at least their associates) calling you.

(**Just to be clear, there are many, many other things that are important, and that can make or break a deal—things like the team, defensibility, IP, advisors, partnerships, market size, relative degree of customer need, and so on.   This blog post isn’t a comprehensive summary of every factor; rather the aim is to set an initial threshold of what needs to be in place so you’re not wasting your time on a fruitless money hunt.) 

So that’s it in a nutshell.  Big idea + attractive story + supporting evidence = fundable deal. 

Have you got it?  If not, what can you do today, tomorrow, and next week to get it? 

7 comments:

  1. Nathan, great article with compelling points. I find that strong market opportunities pursued with talented management teams ultimately produce the strongest companies.

    Once you have a strong company, the option is open to the management team to pursue outside capital or not. Under this scenario, it's a tough decision, as strong companies can usually make it on their own. Capital should be an option to more aggressively pursue a market opportunity, versus a requirement to make a company work.

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  2. Nathan, your use of "Venture fundable" means VC and not angel venture funding. In most cases this means some sales ($) adoption needs to be in place. Chasing the wrong source of money too early can also be a problem. Good sound "value added" angel money first can help get the company ready on many aspects for pitching VCs.

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  3. Rob- Totally agree. Team is, realistically, the most important factor, and the one that drives the three criteria I list (and everything else, for that matter)....rockstar teams get funded (often pretty easily). In some ways, this post is about what it takes to get funded for first time entrepreneurs or those without a string of "hits" under the belt.

    David- Also great points. The proper title for the post should probably be "What it takes to be VC-fundable" (but that was the intent). I would say that angels are looking for startups where (most of) the technology risk has been removed, while VCs are looking for startups where both technology risk and some portion of business risk has been eliminated. Having said that, it's still pretty hard to raise even angel capital on concept alone...

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  4. Nathan - great article. As a start-up owner I am always looking for insight on how to approach VC / Angels. Bootstrapping seems to be the best approach until our numbers match the desires

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  5. Nathan

    Hello. I have a quick question. See, I have a very good idea, but I really cannot pursue it because I really don't know how to develop it. I want to hire IBM to develop this application (they can do it, i canned them.)

    So, how do I get money for this company? how do i start? Can your company help?

    Please reply, I will check daily for your reply. thank you so much, Luke

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  6. Hi Luke-- ideas by themselves are not fundable; you have to get the wheels moving on your own. Numerous ways to do this...e.g. finding co-founders who bring development skills, setting up a consulting practice to help fund development, raising money from "friends family & fools" (who are mainly investing in "you" vs. the concept), and so on. Another idea-- if it's a truly worthwhile project, and you bring a complementary set of skills to the table, perhaps try to pitch it to IBM as a JV. Best of luck, Nathan

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  7. Nathan


    Thank you so much for your reply. I am trying to get someone as a co founder with those sort of skills. I'll also check out if IBM does joint ventures.

    Thank you so much,

    Luke

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