Take the Money and Run! An Insider's Guide to Venture Capital

Take the Money and Run!

An Insider’s Guide to Venture Capital

by

Gerry Langeler

SMASHWORDS EDITION

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PUBLISHED BY:

Gerry Langeler at Smashwords

Copyright 2011 Gerry Langeler

Smashwords Edition License Notes

This ebook is licensed for your personal enjoyment only. This ebook may not be re-sold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each person you share it with. If you're reading this book and did not purchase it, or it was not purchased for your use only, then you should return to Smashwords.com and purchase your own copy. Thank you for respecting the author's work.

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About the Author

For over 20 years, Gerry served as a Managing Director with OVP Venture Partners (OVP), the most experienced venture capital firm in the Pacific Northwest. OVP was formed in 1983, and raised seven venture capital funds, the most recent at $250 million. The firm focuses on early-stage companies in clean tech, digital biology, and information technology. Since its founding, OVP has backed over 125 startups – and seen over 50 liquidity events including 25 IPOs and more than 30 others being acquired by public companies.

From 1981 to 1992, Gerry was co-founder of Mentor Graphics Corporation (NASDAQ: MENT) where he served as President and Board member. He helped lead Mentor to over $400 million in sales and $1 billion in market capitalization. The company remains the fastest growing public software company to $200 million (in constant dollars) in US history.

His service as a board member covers the range from communications, digital media, energy, enterprise software, and network security to biotechnology.

He is the author of The Success Matrix – Winning in Business and in Life (Logos Press, 2014), and The Vision Trap (Harvard Business Review, March 1992), which continues to be widely used in business schools and corporate training sessions. He also authored a chapter in Venture Capital Best Practices, Aspatore Books, 2005 and a chapter in Great Patents, Logos Books, 2011. More about Gerry’s latest book at www.thesuccessmatrix.com.

In 2011, Gerry was awarded the Oregon Entrepreneurs Network Lifetime Achievement Award. In 2012, he was selected by Oregon’s Governor to be a founding member of the Oregon Growth Board, where he serves as co-chair. More about Gerry at www.langeler.com as well as on his Linked-In profile: www.linkedin.com/in/gerrylangeler/

He holds an AB in Chemistry from Cornell University and a MBA from Harvard University.

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Acknowledgements

This book is a compilation of the most relevant articles I wrote over thirteen years, initially for the OVP Venture Partners newsletter and later for various blogs. Resurrecting all that source material from both electronic and printed media, putting it in some sort of logical sequence, and then serving as editor-in-chief of the text has been masterfully done by my long-time assistant and friend, Linda Hoban. There would be no book without her fine efforts.

My partners in the venture capital business, especially Bill Funcannon and Chad Waite all have contributed their wisdom directly and indirectly via their counsel and at times tough-minded questions as we have looked at new potential investments and worked to help existing ones. Professor Rob Wiltbank of Willamette University has provided important encouragement and guidance in my literary efforts.

The book is dedicated to all the entrepreneurs I have known. Without your bravery in stepping out past the comfort of your secure corporate jobs, out over the abyss of start-up land, usually without a net, there would be no need for venture capitalists. Your drive and dedication is what makes technology advance and the world a better place.

Finally to my family: Kim, Chris and Michael, thank you. I treasure your support in letting me do what I love, putting up with the travel, the breakfast and dinner meetings, the late-night emails, and for still always being there at the end of the day.

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Foreword

This book is for entrepreneurs who want to realize their vision, want to build a major enterprise, and want to change the world. To do that, you’ll need two things: cash and speed. You’ll need to get the money, and then run like mad before a big existing competitor slows you down, or another fast-moving start-up runs up your tailpipe.

To get the money, you may want to consider raising money from institutional investors, the venture capital firms. The good news is that venture-backed companies rank among the most successful enterprises ever created. The bad news is far fewer than 1 in 100 companies approaching venture capitalists ever get to take the money.

So, the first section of this book gives you a behind-the-scenes look at how venture capital firms work, and much more importantly how they think. You’ll get first-hand insight into what things you can do to improve your chances and the things to avoid that can doom your hopes.

The second section of the book will help you run. It is a series of short pieces of advice covering almost every segment of start-up operations, from product development to financing to staffing to sales and marketing. The chapters catalog some of the best start-up practices seen over the last 20 years, and also some of the biggest errors made.

Best of luck on your journey!

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Contents

Take the Money…

Chapter 1: Avoiding the Quick No

Where Does VC Money Come From; Why Do VC’s Say No Most of the Time; How to Avoid a No – People; Product; Market; Financing; Potpourri; Business Model Muddle

Chapter 2: Making Your VC Pitch Count

What’s Hot In VC – Don’t Ask, Don’t Tell; After You Leave - What Do VCs Say Behind Closed Doors; Vitamin, Aspirin or Vaccine; How to Wow a VC in Seven Slides

Chapter 3: Questioning Our Way to Yes

20 Open-ended Questions; Your Business Plan, For Better and Worse; Numbers, Numbers; Five Percent of a Huge Market Stinks; Is it You or Your Location; Incoming Term Sheet; Dilution & Ownership

Chapter 4: To Know Us Is To Love Us

How to Buy a Venture Capitalist; Why Syndicates Matter; What Do VC’s Do All Day; What is a CEO-a-thon; How to Manage Your VC

…Run!

Chapter 5: In the Right Direction

Managing in Uncertain Times; Make a Plan You Can Make; The Myth of No Surprises Management, Hocus Focus; Two Frogs with One Hand; Goldilocks Financial Projections

Chapter 6: Don’t Look Over Your Shoulder (We Are There)

The Back Channel & Triangle of Trust; The Good, The Bad & The Ugly; Seven Reasons to Remove a CEO

Chapter 7: Get the Product Right

The Beauty of Asymmetric Warfare, Know Your Competition, Know Your Customer, Your IP Is Patently Ridiculous

Chapter 8: The Sale’s the Thing

Sales DNA, It’s in the Genes; Time Kills All Deals; Pricing for Fun & Profit; Navigating Channels; Branding, What’s in a Name; Three Universal Truths

Chapter 9: To Your Reward

The Price-Progress Paradox; A Pull Through Financing; When is a Strategic Investor Like Baseball; Exit, Stage Right

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Chapter 1

Take the Money: Avoiding the Quick No

Where does VC money come from?

Let's start at the beginning, a very good place to start, as Julie Andrews in The Sound of Music would say. For those start-ups interested in raising venture capital (VC) dollars, it pays to understand your customer. In this case, the customer is for your stock not your products and the buyer is a venture capitalist - but the same principles apply. The better you know your customer and their care-abouts, the more likely you are to match your offering to their needs.

Most dollars managed by venture capital firms come from institutional sources such as pension funds, charitable trusts, university endowments and the like. And just as you need to understand your customer, it never hurts to understand your customer's customer. Those major institutional sources of money have a couple of things in common.

They put a rather small percentage of their total capital into private equity overall (which includes buyouts, etc.), and usually less than half of that into venture capital. As an asset class, we are a very small piece of what they do every day. So, while they invest in venture capital funds to try to get better returns than they can in public markets, and are ready to accept some added risk and illiquidity to do so, if we don't deliver they get more grief than the dollars involved probably justify.

They are judged internally on internal rate of return (IRR) in most cases. A select few get judged also on multiples on capital. But by being on the IRR clock, they care about not just how much we make, but how fast we get that cash back to them. If you ever wonder why VCs say they are patient money but seem to be impatient sometimes, here's a place to start.

In the venture capital asset class, those institutional investors have literally hundreds of funds to choose from. And while we have all heard the mantra that past performance is no guarantee of future results we also know that most decisions by these folks are driven very strongly by what your last fund or two did, not how convincing your presentation is.

About every four to five years, we have to go back to raise a new fund. That is because each fund we raise has both a total expected life of about 10 years, and a contractually limited investing in new companies period of about five years. So, it is at times like those that we very literally find out if we get to stay in business. If our investors, called Limited Partners, don't find the performance and prospects of our recent prior funds compelling, their easy option is to say no to the new fund. Remember, they have hundreds of other choices, and we are small potatoes in their eyes.

So, when you wonder why VCs are both VERY selective about where we place our funds, and VERY involved in how well those investments perform, you now have a picture of our world.

We have to raise money just the way you do. We have competitors just as you do. In fact, we have many more. And we all recognize that no matter how successful we may have been in the past, What have you done for me lately? applies to us as much as any other industry.

It’s not a pile of cash in the corner.

VC funds receive cash from our investors in tranches. We don't want the money all up front, because that would start the IRR clock ticking on all that cash, most of which would be sitting in the bank earning meager interest. However, we get to call the tranches as we need them, called a capital call in our parlance. So, we wait until either we have an investment coming up, or need money for our day-to-day operations, and then call an amount that matches our need.

The money isn't exactly allocated over time, but we do plan on a spread of need in the following way. We get a management fee on the total amount of committed cash - usually in the 2% area, and that covers our salaries, office rent, travel, etc. We plan on that being available year after year over the 10 year life of the fund, although it usually tails off in later years.

Then we make our investments to build the portfolio of companies. We plan to average about one new investment per partner per year. So for my firm, with 5 partners and a 5 year investing life, we target about 25 total investments per fund. Every time we make a new investment, we allocate follow-on funds to that company; notwithstanding the fact that all of you claim you'll only need one check! In fact, for every dollar we put in initially, we usually put two dollars in reserve. Often, even that is not enough.

When our companies are sold or go public we return those funds to the Limited Partners. Initially, they get their money back in proportion to the amount invested by them and from our private contributions to the fund. However, once we have paid back all their capital in (the total size of the fund), including the management fees we’ve taken as essentially a loan, then we get what is called carried interest on the gain. For most funds, that amounts to about 20% of the profits.

If there is no profit on any individual deal, such is life. This is a high risk business we are in, and most individual projects fail. But, if we don't generate a profit on the whole portfolio, then our Limited Partners get very cranky with us - as they should. But, beyond not investing in any future funds of ours, that is the extent of what can happen at that point.

If a start-up doesn't perform in the expected time, but is still promising, we call it, Normal. Not a widely known fact, but of the 125 some-odd companies we've backed over 30 years, not one (that's right NONE) has made their original business plan. Yet, we've had the pleasure to grow some very successful enterprises that made our investors a lot of money. This is why we reserve those extra dollars you don't think you'll need!

VC firms and partners profit in essentially only one way. It's what I call the Vidal Sassoon model, If you don't look good, we don't look good. If our portfolio companies (in aggregate) return considerably more than what we paid in, then we look good. You'll hear about how we like to make 10 times our money or better (this is true!). But, the reason we have to shoot for those numbers in each project is that usually we're wrong, and the company either loses money (often all of it) or doesn't make much. So, to cover our losers and our day-to-day expenses, we need our winners to be big winners.

A respectable venture fund will return somewhere above 2x what its investors committed. At 3x or more, everybody gets very excited. Another way to think about this is a spread over the S&P 500 Index. Most investors will tell you that if they can net 500 basis points (5%) or better over the S&P, compounded over the ten year life of the fund, they are happy.