Nesheim Online

CUSTOMER REFERENCES: They have to say what you have to say to get the (VC) money

Did you know your customers have to agree with you in order for you to get your money?

To get VCs to eagerly race for their checkbooks, they must hear on the phone customers raving about your product for the same reason you pitched it to venture investors.

How do you do that?

Simple: position your product with the same messaging used for customers and investors. It must be thrilling to both groups. Same story, same emotional response. That is what positioning is all about.

How good is your message? Try testing it against this criteria:

• Is it simple? Too many words are hard to quickly grasp and repeat.
• Is it easy? Can any customer understand and repeat it without needing a PhD. in technology or a college education in the jargon of your market?
• Is it exciting? A thrill to a customer means your product brings amazing benefits and leaves the person raving about what you just sold him.
• Is it compelling? What about your product makes the customer eager to purchase it? Hot, demanding it.
• Is it unique? No one else can have what your message says your product is about. The more different it is, the better.
• Is it bold? If every one else is wearing black, wear red. You will stand out. Your message should be that strong because it does what you say it does. Confidence turns into boldness.

If you are getting repeated "No thank you" from your presentations to potential investors who have spoken to your first customers, it is time to re-think your positioning. To confirm you have this problem, look for feedback that includes these words:

• "Our expert had doubts about your technology"
• "The customers did not have much to say about how your product would greatly assist them in business over the next coming years"
• "We decided we could not distinguish your product from the crowd"
• "Too many competitors in your market"
• "We found your idea interesting, but not all that compelling"
• "Okay management"

Your basic message needs to be spoken by your customers with the same zeal as you presented it to the investors. If you lose that zeal, you lose the race for distinguished leader and become one of the crowd, undistinguished in an ocean of undifferentiated black.

If this sounds like I'm talking about secrets in your company, please do not email me. This challenge is fundamental to all startups. I get emails and phone calls every week from startup people around this busy planet that are facing this problem. So welcome to the club!

BOTTOM LINE: Work hard to be very different and the same. Different from your competition. With a clever positioning message that customers immediately understand, get excited about and repeat eagerly. So then when the customer reference talks to your potential venture investor, the investor hears the same story you told in your presentation to the investor. When you can do that, you'll have both customers and investors lined up at your door banging to get in. It is central to building your unfair competitive advantage.

MARCH TO IPO: (Part of a series) - What kind of money do you want to raise?

"We can raise some seed money from a private person or from venture capitalists? What do you think we should do?"

Good question. Simple to answer.

There are 3 kinds of startup money:

1. Life Ring Money. You need it to save your startup. Often sought when everything goes bad but you are determined to continue. You cry "We just need a bit of time to prove we can turn this thing around!" Comes in $100,000 amounts, sometimes several rounds in a row. Not a sign of strength. Company is desperate.


2. Pillow Money. You put it in the bank to sleep better. Used in case of the rainy day (which will come, that is for certain in startups). Classic round for startups that are growing and successfully on the path to IPO. These are multi-million dollar rounds from mid term investors. The startup is very close to or already at profitability and positive cash flow.


3. War Money. This is for declaring to the world your intention to enter the contest to climb the new mountain to become the gorilla of a new category. Serious money. In the millions. Will take several rounds to know if you have achieved your ambitions. From seed rounds to later stage hyper growth rounds. Aggressive investors with deep pockets are needed.

BOTTOM LINE: Decide on what kind of money you will raise. That will focus you on the precise type of investor you will need. If you need survival money, rethink your plan. Some of the companies I have watched have switched from being careful to being aggressive and have altered their business pland and thereby moved from life ring money raising to completing successful war money rounds. A well financed startup has a greater chance of executing on its plan. That wisdom contributes a vital ingredient to building your unfair competitive advantage.

MARCH TO IPO: (First of a series) - Aim before pulling the trigger

"Hey, John, we are a bit worried. We have a great idea, a couple of great people and see a hole in the market to exploit. And we got $1M from a wealthy internet millionaire. I know that sounds good but now we are wondering about the next round of financing. Did we rush into the seed round and damage getting the next one?"

That is a wise question. You will find several of similar language in my emails. In this case it's a bit late to do much about repairing any damage. But let's respect the questioner because most seed rounds done by first time founders do have major errors in them that can make the next round very difficult.

Here are some of the tips I give the startups I coach:

• Plan all the rounds on your way to IPO. If you don't you may find your first deal will have a valuation or special terms in it that are so repugnant to the next round investor community that none will be interested in talking to you. For instance, who owns your intellectual property?
• Value your company for each year up to IPO. Investors want to see the numbers. If you don't provide them, they will invent their own. How many people will you hire? What cash will you need each year? What will sales and profits be each year? The VCs want to see what return on investment they might get if all goes well. How many times will their investment be for waiting how many years for what percent per year ROI? Do your numbers.
• Beware of the devil in the details of your seed investor's term sheet. Board seats, veto authority on certain subjects and actions, approval rights on the next rounds of financing and more are all going to restrict you and the next round of investors. Get them right to get the next round.
• Get a lawyer who has done startup rounds before. You must learn what is standard practice with startup investors in your community. A lawyer active with startup financing will know what to negotiate.
• Respect that your march to IPO will be full of surprises. Anything can happen. Including Google or Microsoft knocking on your door sooner than you expected. Or stealth startups popping up to give you the scare of your life. A corporate buyer can suddenly back out of acquisition talks for reasons not related to your business. Or you may find even amazingly greater success than you could ever dream of. I have experienced all of those and more. Whatever you think today of such uncertainty applying to your startup, be sure to do a sketch of your march to IPO. You'll find yourself in a much better position to guide your fledgling business to success, including getting the investors you need, year after year, to IPO.

BOTTOM LINE: Before you accept your seed round, do a sketch with numbers of your march to IPO. That will give you a more realistic way of preparing for your subsequent rounds without having to do repairs. I have spent as much a three years helping undue messes created in one startup that got off to an unwise start with a poorly done seed round. They have survived and are now doing well. But most suffer a lot more. Use that good mind God gave you. Do your thinking. Do your numbers. Prepare. The march to IPO is hard enough without having to do a lot of repairs along the way. A great seed round will germinate a great harvest. It is one way serial entrepreneurs build their unfair competitive advantages.

"Bite!": Your story needs it (to get the money)

"It doesn't have 'bite' " said the VC partner.

The founder and core team sat in silence. They had come to try out their presentation of the startup's business plan as part of preparing to raise a large B round. Their startup is doing amazing things and has multi-billion dollar potential. But less than a minute into the trial presentation the VC's exclamation leaped out at them.

The discussion that followed turned into a workshop with everyone innovating and making suggestions. The result was a much more compelling story, from the first to the last slide. It took a lot of hard work and experience to get to a successful conclusion. But at the end of the morning, the story had "bite."

I believe your story will not get the money unless it has bite. Nor will it attract great employees. Nor will it get bloggers or end users excited. You have to have it. It's a sign that you have an unfair competitive advantage.

So what is "bite?" These are what I think it is about:

• Bold. Your claim to fame must be bold. Shocking is overdoing it.  Boring is death.
• Story. It must be a story. Stories are attractive. They are interesting. They stir emotions. They have beginnings and plot and intrigue, and a happy ending for the heroes.
• Emotion. You must stir emotions with your story. Use facts but more than facts. Use facts to trigger emotions.
• Poignant. Your idea needs to treat a significant pain. A pain being suffered by the end user. That is what is meant by a compelling value proposition. The listener must feel the pain and respond poignantly.
• Grabs. Your story has to grab the attention of the listener. Like a hand that reaches out and pulls the listener into the room. Swiftly and powerfully.
• Believable. It has to be believable. That is where you win or lose. Realistic carries the day. Able to do an amazing thing. Wow!

BOTTOM LINE: Test your idea. How much bite does it have? Is it a bold story that triggers emotions, stimulates a poignant response as it grabs the listener who at the end of the tale believes you can do it? When you have that, you are ready to tell your story. Then you'll have built a powerful element of your unfair advantage.

QUESTION OF THE DAY: Should I work with an Associate at a venture firm?

"We emailed a Partner at a venture firm about our idea. He had an Associate contact us and request a lot of information. Should we respond to the Associate? How much should we reveal to him?"

That's a question I am often asked these days. A decade ago VC firms had only Partners. The current generation is using Associates as they begin to establish hierarchies and career paths in the second generation of modern VC firms emerges.

Here is how the VC funding process works for many first time entrepreneurs:

1. You email something (one page long) about your idea to a Partner whom you found somewhere on some web page on the Internet.
2. The Partner glances at your email and sees it is in a new space that he has been looking at for a while.
3. He decides to have Kim, the Associate, get more information from you.
4. Kim immediately jumps on the project (one of 99 he is currently working on, 36 hours a day, 8 days per week) and emails you a request for your bplan and "the deck".
5. So what do you do now?
1. You could send him your bplan (if you have one. The chances are you do not. And most likely you do not have a financial forecast of the balance sheet, income statement and cash flow. And you are not sure what "the deck" should be, and you wonder how to value your company to open negotiations with the VC Partner).
2. You could send him an executive summary. But that would reveal a lot of information to a stranger. The VC firm may already have invested or be about to invest in a competitor. Your info will then be used as part of "due diligence" work by the VC prior to investing in your competitor.
3. You could politely email the Associate that "We need to speak with the Partner before revealing further proprietary information." Then on the phone you could investigate any conflicts of interest with the Partner, and you could check him out (to see if he has any hope of understanding your cool idea and if he has what you want in network and contacts to boost your competitive advantage).

I recommend 5.3 at this stage. I have 100% results with deals introduced via Associates: zero money in the bank. I find few others with better track records in this regard. You should speak with a Partner before going further.

Is there a better way to get your money?  Yes, there is. Here is a process that I have found more success with:

1. Research the best VC Partner to work with you for half a decade (to IPO). Find people, Partners, not VC firm. You get money from a Partner, not a firm.
2. Choose 12 VC Partners and rank them top to bottom.
3. Finish your homework: business plan, executive summary, financial forecast and Power Point presentation ("the deck" of PPT slides), Elevator Pitch (30 second and 3 minute versions) and pre-money valuation of your startup (a. the opening offer valuation for negotiations and b. a second valuation, your walk away number). Like the Boy Scouts say it, "Be prepared."
4. Get 100% commitment of your core management team (to come to talk to the VC Partner). That is CEO, VP Business Development, and VP Engineering.
5. Pick the top 6 VC Partners and find people (lawyers, CPAs, entrepreneurs, friends, school alumni) to make a personal introduction to the Top 6 Partners.
6. Get personal introductions to VC Partners. Never contact one of the Top 6 Partners without a personal introduction.
7. Speak to the VP Partner (via the personal introduction) and ask for a date to present to the Partner. That is the purpose of your Elevator Pitch.
8. Keep at least 6 VP Partners active until you have a term sheet (summary of the financing). As soon as one of the Top 6 Partners drops out, substitute one from the remaining list of 12 VC Partners on your long list.
9. Continue until you have 2 or 3 VC Partners eager to offer a term sheet. Get the VCs competing for your deal. Competition is the entrepreneur's best friend.
10. Decide on the one VC Partner with whom you will negotiate a term sheet.

That is how serial entrepreneurs do it. It is the process that is fastest to money (and to the supporting resources that come with the money). There are various hybrid versions of the process, so be wise about how to innovate in your local area, each has its special needs, around the globe, in each country and city.

BOTTOM LINE: Avoid those hard working, well intentioned Associates. Work with Partners. You'll have more success getting your money. You'll be quicker to launch, faster to domination of your new space and more likely to become a gorilla. Understanding and executing this VC raising process is part of your unfair advantage. It is worth the hard work and time it takes to do it right.

QUESTION OF THE DAY: How conservative should our financial forecasts be?

"How conservative should our financial forecasts be? We plan on raising a $500,000 seed round with a venture capital firm."

That is a question I often get. The answer is simple: Do not be conservative, NEVER, NEVER, NEVER!

Why "NEVER"? Because the VCs will cut every sales number in half, will double the cost to get the first product launched and assume you need twice the capital you planned on to get going, regardless of how you try to show them that you are conservative with your numbers.

That is "The Rule of 2" applied to financial forecasts of startups. It is a hard rule, meaning it is always applied and never forgotten (by investors).

Engineers want to construct safe inventions so they build in safety factors. They do the same to their financial forecasts. That is good for building airplanes but bad for raising money for startups.

You want your story (bplan) to be believable (plausible). So the numbers have to be realistic. Yet the numbers have to reflect your optimism (MBAs call this your best case scenario). Entrepreneurs are optimistic. It is in their genes. It never goes away. The glass is forever half full.

BOTTOM LINE: So behave like serial entrepreneurs and forecast with confidence. Get excited with your numbers. Be bold without being arrogant. Go for it! The large valuation, the huge IPO, the dream come true. That is what this is all about. That reflects an unfair advantage manifest in numbers that make people say "Wow!" It is yours to forecast and tell exciting stories about.  Just do it!

QUESTION OF THE DAY: Should I contact VCs financing my competitors?

The following are important questions about raising venture capital money and are often asked in my emails:

Questions:
A. Would it be wise to avoid contacting venture capital firms that are closely related with our competitors in fear of having our competitive or unfair advantage leak out?

We've identified a number of venture capital firms that we would like to contact; most of which are prominent firms in the States. However, after doing some research, we realized that some of these firms are currently funding our competitors. In fact, one venture capitalist sits on the board of a competitor.

B. If per say our first choice firms are associated with our competitors, do we then go with a venture capital firm that is lesser known to avoid our secret sauce from leaking to our competitors, while compromising the value of what our investors will bring to the table because our investors are perhaps less prominent?

THANK YOU, S.

ANSWERS

S., you have asked two very important questions. The answer to the first is NEVER NEVER NEVER even think about communicating anything to a VC, even one casually associated with your competitor!! NEVER. Treat them as dangerous competitors themselves.

Your goal is to identify 6 world-class candidate Partners (never Associates) to contact. From that group of COMPETING firms, your aim is to get 2 or 3 competing for your deal. Think about them as rival gangs eager to competitively punch out the other to get your deal.

There are 2,000 VC firms in the U.S. You have many to choose from. They come in different flavors. Pick based on the skills of a single Partner in each firm. Some confident entrepreneurs want to get a lot of attention from their investors, so they pick the second tier of eager VCs. Others want the marquee name and pick the famous branded VCs. Some choose because the partner is easier to get along with. Some look for VCs who are experts on the new domain the startup is focused on. Others think a VC has an amazing network of valuable contacts. So think about your selection criteria first, and then gather your list of 6, before you start calling VCs.

BOTTOM LINE: Get competition working for you: Do your research, carefully, on the Partners of venture firms. Prepare a list of selection criteria, the reasons for saying yes or no to letting a VC invest in your startup. Then go through the list of thousands of VCs and start screening them. When you have your Top 6 list ready, then figure out how to get a personal introduction to each. Never call on them, email them, cold. And never talk to a VC who is even remotely connected to a competitor. Never, ever. To do so will greatly weaken your competitive advantage, it will no longer be unique and then it will never be unfair.

 

 

STOCK MARKET PANICS AND VENTURE CAPITAL: Respect their links and long term investing

Panic hit stock investors around the globe over the recent trading days (during Jan 18 - 22, 2008). Should a startup founder be worried?

In a nutshell, sort of, but not really.

Here is what I mean: Robust stock markets are places needed to do IPOs. Sick stock markets mean few IPOs as liquidity events. That is not good for startup founders or its investors.

If a VC firm is sitting on a startup board which is ready to IPO, and if the stock market gets sick for a few months, the VC firm may have to do a special round of financing to keep the growing startup cash flow positive. That can be expensive for everyone. It is good to try to avoid that. But sometimes the timing of the sick stock market cannot be anticipated and life must go on via (costly) bridge loans to IPO.

The VCs get their fresh cash from huge institutional investors (pension funds, university endowments, and lately sovereign nation funds). When those institutions get cautious during a sick stock market, it becomes difficult for VCs to get fresh money for a fresh fund. So VCs can suddenly become very cautious with the remaining cash in their by-now-diminished fund. You do not want to be needing desperately to get cash from such VCs, ever, and never when a sick stock market arrives.

But VCs are in the business of playing long term high risk investing. So a hiccup in the stock market (they seldom last more than a few months) should not impact your attracting VC money from one of the top VC firms.

But do expect a negative stock market to be an excuse for a lower valuation of your company than you would like. I suggest you simply ignore that excuse, remind the VC that you'll be going public many years from now (3 to 5) and there is lots of time before that happens. In other words, today is not relevant to setting an IPO price 3 to 5 years from now, so don't accept a reduction in your valuation for the passing panic of today.

BOTTOM LINE: Put sick stock markets into perspective. Look half a decade ahead. Negotiate accordingly. You are in business to be a hero in 3 to 5 years, not today. Focus on finding long term thinking investors. Skip the VCs who panic with stock markets. They'll be the ones who panic at your first customer order cancellation (there will be many). Life is too short to live five years with frightened people. Assemble a board of directors who are long term investors and behave that way. They will be part of your unfair advantage.

INVESTORS COME IN FLAVORS: Pick carefully

Last night I facilitated a Cornell University event from the entrepreneurial community of Silicon Valley. This morning I listened to a VC tell me about plans for a round of financing for a hot startup.

As I reflected on what I heard, I was reminded of how different each investor is and how important that is to the entrepreneur.

Some VCs are control experts (very left brained, mostly male, mostly ex geeks, who became successful as VPs of large public companies that are famous). Others are big picture thinkers (very right brained, include the rare female, from a variety of job functions - often marketing or selling, and often from prior startups that succeeded). And there is a mix of both extremes among the VC crowd. There are many to choose from.

Angels also consist of very different types of personality and control.

So what? Well I suggest that as you meet and get to know a prospective investor, you should focus much of your thinking on how the person is going to manage you. And they will manage you.

Remember that managers are people put in charge of other people to get them to do the difficult things  people do not want to do.

On a board of directors, the investors (who have the gold) try to set the rules. The CEO's job is to manage the board, including the directors who are investors. That is a tricky balancing act. Good investors on the board can bring abundant resources to a CEO (the proverbial network to customers, strategic partner introductions, and so on). They are the people you want to find.

But when the startup hits the wall, when it runs into trouble delivering technology, or is stalled and unable to sign up customers quickly, then the worst in people comes out, the true character of your investor. That is when many CEOs I've spoken to regret their decision to choose the investor that now is pushing the CEO in directions the CEO believes is not good for the startup.

Do not misunderstand me, I do think that all too often that investors are wiser than the startup CEO. Then the sparks fly. But that is also when the board of directors meets to iron out the mess and make the wise decisions. Investors are not categorically bad. Startups are always difficult to manage, for anyone, even serial entrepreneurs.

What I do mean is this: Your choice of person to bring the money you need comes with a personality and style of decision making that will impact you for the rest of half a decade of your life. So pick deliberately, not randomly. Be very wise.

Talk to other entrepreneurs. Attend meetings they attend. Find school alumni to speak to. Your old professors can help. Discuss investors with your lawyer. Talk to CPAs. Take a look at the provocative web site that lets disgruntled people complain about VCs at thefunded.com. Get to know the person (who may be your lead investor) before you decide on your choice of investor.

BOTTOM LINE: Startup investors come in flavors. They are people, each with different ways of managing, investing and behaving on a board of directors. Before you chose one, get to know that person. Picking wisely is one of the smartest decisions of your life. Great choices of great investors lead to building unfair competitive advantages. I wish you The Best!

VALUATION FOR YOUR STARTUP: Set the $ amount before opening negotiations

“What is the valuation of your company?” I asked the co-founder. “We think about $50 million today, before the next round of funding. That seemed fair to us” was his reply. “So how did you get to that number?” was my next response. “Well, we did an MBA type of discounting of net income and guessed at the discount rate.” That told me these founders were not prepared to enter the rooms of investors looking to put money into their excellent startup idea. They would get fleeced.

Liquidity event. That is what venture investing is all about. Convert paper into cash. Real money. If not, all that the investors will hold is wall paper. Worthless. The shares must turn magically into cash at a point in time known as the liquidity event. That is what an IPO is all about. Or an acquisition by a public company. Buy a word of caution: If your company is acquired by another startup, you are not yet public. That is not a liquidity event.

So start your valuation work at the most valuable liquidity event: the IPO. Pick your company’s IPO value. Base it on sales, not net income. That is what IPO investors do. Use a multiple of sales that is similar to companies like yours in your industry. I use handy industry tables from Schwab. It is a bit of extra work, but worth it. Worth millions.

With the IPO value pegged (the liquidity event), then start pricing your company for each of the years prior to the IPO. Set the company value so that the ROI for investors (percent per year ROI, and the multiple of $1 invested compared to the IPO value) is what they expect for each year prior to IPO. If you don’t know those ROI expectations, try using QuickUp (http://www.nesheimgroup.com/). It has the standard ROI expected by professional venture capitalists.

When you are done, you can tell a seed round investor, or any later investor, what to expect in ROI for that round of funding. Then you can return to discussing how to get to those wonderful sales in the year of your IPO. That is where you should be talking. Get the valuation stuff over with, and focus on the business. Your goal is to get to IPO within five years, build an outstanding company and become a gorilla of a new category. Then your valuation will be justified.

LESSON OF THE DAY: Do your valuation homework before you start to raise your next round of financing. You can read more about doing this in Chapter 9 of High Tech Start Up and Chapter 22 of The Power of Unfair Advantage . Do not let the investors set your valuation. Become a black belt at it!