4 Critical Missteps When SMBs Talk To Venture Capitalists
Venture funding can supercharge the growth of small tech firms and other startups. Here's how to avoid killing your chances with potential investors.
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The do-it-yourself ethic typically serves small and midsize businesses (SMBs) quite well, but sometimes it's nice to have a little help.
That can be particularly true for startups that hope to grow into much larger businesses. While the concept of bootstrapping a company from day one--building it without outside investments--might embody that DIY spirit, venture capital and other early-stage equity investments can supersize the growth chart, or simply keep the lights on when cash flow is anything but positive. In the technology world the list of successful venture-backed companies reads like a Who's Who directory: Apple, Google, Amazon, and Citrix are just a few examples of companies that received venture funding at one point.
Of course, venture capitalists don't hand out cash to anyone who asks for it; they make money by being picky. While "hot" categories for VC investors come and go--data analytics is a current one--the fundamentals they look for stay largely the same, according to Caine T. Moss, a partner at the law firm of Goodwin Proctor. Moss works primarily in the firm's technology practice, representing early-stage firms like Aurora Networks, Klout, and Square. He also deals with some of the heaviest hitters in the venture capital world, such as Sequoia Capital and Khosla Ventures. Since he works both sides of the venture-funded street, Moss sees daily the mistakes startups make that send VCs running in the opposite direction.
"There are so many of them," Moss said in an interview. "Where do I start?"
He started by saying that SMBs with venture-backed dreams should pay attention to these four critical missteps that can sink their chances of getting funded:
1. Cold pitching
VCs don't often sink their money into investment opportunities that just saunter in through the front door one afternoon. The "warmer" your introduction to a potential investor, the better your chances of being taken seriously by them. It's one of the key reasons why Silicon Valley remains the sought-after destination for technology startups, even as the world continues to digitally shrink--the area is still the epicenter of venture capital activity.
"It doesn't matter how killer your idea is. If you're not getting connected to the right VCs by the right people, they're not going to look at it," Moss said. "The venture community and the Valley in general is small, and the more you're in it, the smaller it gets."
2. Bad timing
"Too many entrepreneurs think that if they can just go out and get funding, they can build something great," Moss said of the importance of timing. "Jack Dorsey can do that; most of these guys aren't Jack Dorsey."
Put another way: Wait until you're ready before going after funding. Moss said unproven commodities usually get only one shot with VCs--take that shot too soon and it might be your last. "It doesn't matter how much progress you make after you've gone to them and they've said no," Moss said. "There's a very high likelihood they're not going to fund you if they've already rejected the idea. Timing is absolutely critical."
3. People problems
No matter what's "hot" at any given time, people are a constant. VCs don't back just a good idea; they back people they believe can actually turn that idea into a successful business. A brilliant programmer who doesn't want to leave his bedroom, for example, could be in for some tough sledding in the venture-funded world. "If this guy just can't communicate in an effective way, he's going to have a problem getting funded," Moss said. Sometimes it's simply a matter of finding the right personality fit. VCs possess a variety of backgrounds and personalities. That's another reason the aforementioned warm introduction is critical.
The good news: You don't necessarily need to be a master self-promoter or salesperson to impress VCs, but you do need a public face that can talk, even if it's not you. "It's important that founders have someone who can communicate the vision in a compelling and effective way," Moss said. Usually, that someone is the CEO. "If that CEO can't sell the vision, then you need someone on the team who can."
4. Poor corporate housekeeping
Entrepreneurs often do damage to their startups early on by not carefully shepherding the mass of legal, financial, and other considerations that come with starting and growing a business. "When it comes time to go get funding, their due diligence is a disaster because they don't own their IP, or they promised equity to a guy who's no longer there and they have a potential liability, or they incorporated in the wrong state," Moss said. And those just are a handful of the myriad early formation pitfalls startups can encounter. (They're also one of the reasons law firms like Goodwin Proctor exist.)
While those problems can often be solved retroactively, too many of them can cause a VC to pass simply because the headaches outweigh the potential return on their investment. While early formation issues can vary widely, Moss pointed out some of the common ones:
--VCs don't like it when the equity distribution doesn't reflect who is actually most important to the company. For example, if there are four founders with equal ownership stakes but one of them is clearly the "rock star"--the person that the company needs to succeed--that gives VCs pause. "That's either going to be a problem down the road, or they're going to ask for some equity redistribution up front," Moss said. "[Make sure] that the equity that gets issued is weighted commensurate with the value that's being brought by the founders."
--Nor do VCs like it when companies give away too much equity early on. If you grant stock options to everyone who stops by the office--vendors, partners, contractors, and so on--you're likely making yourself unattractive to venture investors later on.
--Don't get cute with your own stake in the company. "Founders that get over-elaborate in terms of the bells and whistles that they put on their equity are often a turn-off to VCs," Moss said. The temptation comes from stories about the likes of Zynga co-founder Mark Pincus or Facebook co-founder Mark Zuckerberg--especially stories about the various wealth-generating characteristics of their stock ownership. As a result, "acceleration," "super-voting shares," "FF preferred," and other equity terms take up residence in entrepreneurial daydreams. They can also scare off potential VCs, according to Moss. "If it's a company that's unfunded and unproven, VCs will look at these guys and [say]: 'Who do they think they are?'"
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