Saturday, October 28, 2006

So... can I send you my business plan? Advice for the cash-strapped entrepreneur

I've been meaning to write a lengthy response to one of the comments to my earlier post about geek business myths. Joseph J. Loew (would it be a low blow for me to call him Joe Loew? ;-) wrote:

Ron, are you ready to fund a company focused on Highly Targeted Advertising for music and video? Vibe Technology will do for media content what AdSense did for direct marketing text ads.

My goal is upwards of 30% conversion rates.

Ready to put your money where you mouth is??? :-)

In other words, "Can I send you my business plan?"

The short answer is: Of course you can. Why do you think I went to the trouble of writing the myths post?

But the longer answer is: if you have to ask the question, then the chances that I'll actually be interested in funding your business are pretty slim. There are an awful lot of business plans out there looking for funding. In LA it's a tossup between bizplans and screenplays, and in both cases most of them are not very good. Nine out of ten startups fail. My job is to find the one in ten that will succeed, which is, of course, more art than science.

It's helpful to think about this from the VC's point of view. The way a typical VC works is they will take money from rich people and pool it into a fund. They then take that money and dole it out to startups. If the VC doesn't make those investments, they don't get paid, and if the investments they make do badly they will have a hard time raising their next fund. (Most VC's actually structure their deals so that they make money even if their investments tank. But you can't stay in business long that way.)

The point is that VC's are highly motivated to find good businesses to invest in. That's our job.

It's not an easy job. It typically takes between two and six months to close a deal, most of which is spent doing due-dilligence. Bcause it takes so long, the cost of doing due-dilligence is enormous, both in terms of actual cost and in terms of opportunity cost. This is the reason that many VC's don't like to do small deals. The overhead of doing due-dilligence is so large that they can't turn a profit on a deal worth less than a few million dollars.

The upshot is that it's really really important for a VC to develop a good instinct for recognizing fundable companies before the due-dilligence process begins. So we have a few rules of thumb that we apply to filter out the clueless people before we waste too much time with them. And heading the list of dead-giveaways to cluelessness is issuing a challenge like the one above, because it demonstrates very clearly that the issuer doesn't understand how we do business.

Since the top-ten list format seemed to be so popular, here's my top-ten list (with nine items this time instead of eleven) of things you should never do when approaching someone to invest in your company:

1. Don't ask them to sign an NDA. Instead, ask them verbally not to pass the information along. The actual value of an NDA is virtually zero. To capitalize on it you'd have to prove in a court of law that a particular person leaked the information. The chances of your being able even to find out the origin of a leak, let alone prove it, are vanishingly small. Sophisticated invstors know this, and if you ask them to sign an NDA all you will be accomplishing is demonstrating that you don't know it. If you ask them simply to promise not to pass the information along you are demonstrating that you trust them, which is actually much more likely to achieve the goal of having them keep the information to themselves. But most new entrepreneurs worry about this way too much (see geek business myth #3).

2. If you're cold-calling, don't send anything longer than a paragraph or two. Just introduce yourself, give a few sentences about your background and what you're up to, and ask if they'd like to know more. I once got a cold-call email that began, "I would like to ask your advice..." and then went on for, no exaggeration, ten pages. My response was, in its entirety: my advice is never to send an email this long to someone you don't know.

3. Don't fake it. If you have no clue what your market size is, don't pretend that you do. It's much better to know than not to know, but it's far better to admit you don't know than to pretend that you do and get found out. Honest ignorance will get you much further than bullshit. Also, don't assume that just because no one is calling you on it that we don't know that you're faking it. We can tell, even if we don't let you know. And think about this: do you really want to do business with someone who is so easily duped that you can con them?

4. Don't get too excited if a VC shows interest. I learned this one the hard way. Until the check clears (and sometimes not even then) the deal can fall through. Some VCs will string you along even if they are not actually interested. Maybe you are a potential competitor to a company that they've already funded (a good reason to do your homework on a VC before you approach them), or maybe they want to keep you in their bullpen, or maybe they're just assholes and want to mess with your head. Remember, this is business. It's not about your hopes and dreams, it's about money. A certain amount of detachment and hard-nosedness is required to succeed. It takes a very strong person to get through the process with all of their humanity intact.

5. Don't need money. What I mean by this is: don't think of yourself as a supplicant asking for a favor, think of yourself as somone providing a scarce product that VCs want: an opportunity to make effective use of capital. In that regard you can think of a VC as a customer. It's not quite the same attitude as you take with your actual customers (since the product your providing is very different in both cases) but the attitude should be the same. If you show desperation to sell, no one will buy. That's true whether the product is apples or investment opportunities.

6. Don't spend too much effort polishing your business plan. Spell check it and make sure it looks reasonably presentable, but don't agonize over the format. Don't put fancy covers on it. Don't put bullshit sections in there just because you think (or even because someone told you) that they need to be there. (See point #3 above.) Just describe the opportunity as simply and clearly and straightforwardly and completely as you can. Always start with a one-page summary.

7. Don't go it alone. Make friends with a good bizdev person. A bizdev person (a.k.s. a VP of business development) is someone who knows how to ferret out and talk to customers. He or she is the kind of person you mostly didn't hang out with in school because they were the cool kids who went to all the parties while you stayed in your dorm room and hacked. Now is the time to seek those people out and make friends with them. Get them excited about your product. Find one you like, who seems to get along with everyone, who has a lot of energy, and wants to make money, and ask them to join your company.

8. Don't try to start a company without any background. A few people have done it successfully, but getting some experience under your belt first makes it so much easier. And I'm not talking about taking a salaried position at IBM. Join someone else's startup, preferably one being started by someone with experience, and the earlier the better. It doesn't even matter much if you don't like the company's prospects (ask for salary instead of equity in that case). You can often learn more from watching a company fail than you can from watching one succeed. Join it with the expectation that you will get nothing but an education out of it and you will not be disappointed (and then if the company makes it you will get a nice bonus). Alternatively, work for a VC firm for a year or two.

9. Stop asking for advice and just do it. There is no formula for success. Every successful business person has to figure it out (or stumble on to it) on their own. Also, there are some things that sophisticated collaborators will just expect you to figure out without your being told. And no, I'm not going to tell you what those things are. But here's a hint: there's no excuse for not knowing something that you can learn with a Google search.

Good luck.

1 comment:

Ron said...

So the best VC's are only really interested in huge deals. Consider $5mil the entry point.

I would take issue with the word "best". It is true that all else being equal VC's make more money on big deals than small ones. But all else is rarely equal. Venture capital is a business like any other, and there are small boutique and startup VC's who do smaller deals because they can't (or don't want to) compete with the big fish (yet). That doesn't necessarily mean they aren't good, just that they have a different business strategy. At my firm $5M would be one of our bigger deals. $1-2M is typical for us, and we've done them as small as a few hundred $k (but that is unusual).