Venture Capital Archives - Next Coast Ventures

How entrepreneurs and investors can use their respective insanity to work together and drive better alignment and results

(A version of this post appeared on Forbes)

Fund-raising is always tough. I originally wrote a version of this post a month ago to help entrepreneurs navigate the always trepid waters of fund-raising. In the past few weeks, with the outbreak of the COVID-19 pandemic, the challenges entrepreneurs face raising capital (along with everything else) have been magnified a hundredfold. Yes, you can still raise capital, but in these unprecedented times, it’s going to be a lot harder. Having been on both sides of the table in good times and bad, I’d thought I’d share some insights on how investors and entrepreneurs can work together in this uncertain environment. For some perspective, let me start by recounting two recent video conference calls…

At the end of a very long day, I logged out of my Zoom account for the day and shook my head. How did two video conference meetings on the same topic produce two totally different perspectives and agendas?

We were considering leading the Series A capital raise for a seriously innovative company. The first call, with a partner in another firm who was considering joining us in investing, was business-like, almost clinical. “This is a really exciting deal,” they said, “and we would be interested in investing if the valuation and terms make sense. Given this COVID-19 thing, we could probably jam them a bit more on terms, especially valuation.” Cold, impersonal and without emotion—just like any good serial killer in the Stephen King novels that fill my sleep with nightmares.

The second call, with the company’s founder, was packed with energy and emotion. “We want to build an amazing company, and we feel like we have established product-market fit,” they said. “With some more capital, we can continue to make our life mission a reality. Yes, COVID-19 is a real consideration but should have no long-term impact on our business model.” Highly emotional, passionate and enthusiastic—just like any of the great entrepreneurs who likewise must be partially insane to deal with maddening highs and lows of starting a business.

So, which was it? Was this a “deal” or a “life mission”? The answer depends on your perspective. Now, more than ever, it is incredibly important to understand the difference between the mindsets of the entrepreneur and the investor. As we all work through the panic, troubleshooting and adjusting financial projections, it is hyper-critical to be as balanced as possible. For both sides to achieve the outcome they’re looking for, it pays to understand the other side’s perspective. We all miss sports, among other things right now, so maybe a quick analogy will help…

The Golfer and the Quarterback

Sports fans know how to appreciate different perspectives. I like watching both golf and football (or at least I used to...now I try and remember what a live sporting event is actually like). But there’s a big difference in how Rory McIlroy (currently the #1 ranked professional golfer in the world) and Patrick Mahomes (Kansas City Chiefs quarterback and Super Bowl MVP) go about their jobs.

When McIlroy is about to tee off, he considers the variables (distance, wind, club selection, etc.) and then he takes an isolated action (the swing). When the ball leaves the club, the result is already determined, and he can only watch and contemplate the outcome. Even with a bad shot, he knows he’ll get 60-70 more shots that day. Consideration, decision and action, then watching the results and knowing that while each shot is important, no single shot will make or break the match. That’s the approach and mindset of an investor with a portfolio of investments to oversee.

Contrast that to a typical play in the NFL. Patrick Mahomes calls a play based on the current down and distance. He takes the snap, and all hell breaks loose. He must make multiple decisions based on the huge number of events quickly unfurling around him. After that play, he huddles with his team and quickly calls another one, all the while knowing one bad pass could cost him the game or he could be knocked unconscious—or worse—by a 350-pound linebacker who literally is trying to kill him. Chaos, uncertainty, making decisions on the fly: That’s a day in the life of a high-growth company. Every plan feels like it could be his last—he has no “portfolio”—and tomorrow seems like a meaningless consideration.

Rising Tensions at Investment Time

The contrasting approaches of investors and entrepreneurs meet head-on when it’s time for a company to raise a funding round. And if each side isn’t careful, what should be a momentous event in a company’s history can strain relations long after the deal is done.

It begins with the process of determining a point estimate, essentially the best guess at how much the company is worth. It’s almost ridiculously difficult, building a specific business case that takes into consideration terms, price, ownership and dozens of other factors. When markets and valuations are experiencing incredible volatility - as they are now - these differences get magnified dramatically. But the process is critically important to the investors. The sad part is that 99% of an investor’s success will be determined by the investment she chooses to make and the price that is to be paid for that investment. Just about everything else is noise.

While entrepreneurs are certainly on board for any deal that maximizes their price and minimizes the dilution of their shares, they also know that the details really won’t matter that much if they execute on their vision and plan. They don’t see much point in painstakingly determining a fixed point estimate when conditions change every day. The bulk of her success will be determined by the execution during the years after the investment—and if she is successful, the valuation and price paid at the time of the investment will be largely meaningless.

See the contrast inherent here?

It’s also critically important to note that investors are dealing with a portfolio of companies. They can afford to be wrong every now and then, provided there’s a big win mixed in along the way. For entrepreneurs, the success of their business is all or nothing. There’s nothing for them to fall back on. This simple fact can magnify an already conflict-ridden environment.

A Simple Solution For Both

When we consider leading an investment, we try to do a couple of simple things to bridge the gaps between us (as investors) and the entrepreneurs we are backing. It starts with an open dialogue. We sit down with the entrepreneur before any investment and share our business plan, our perceived investment risk and our expected valuation outcome for their company.

We also ask the entrepreneur to share with us what he or she most wants to happen with the business over time: hopes, dreams, aspirations and best-case and worst-case outcomes. At the end of this discussion, my favorite thing to do is to ask the entrepreneur one simple question. “Five years from now, we are sitting in a bar, and we are either celebrating a great success or drowning our sorrows. Tell me why either happened.” This question more than any other helps both of us get a shared view on what could go right AND what could go wrong – and start the relationship from the same perspective on both.

“Five years from now, we are sitting in a bar (not watching each other sip beer on our webcams), and we are either celebrating a great success or drowning our sorrows. Tell me why either happened.”

We also write an investment memo for every deal and share it with the entrepreneur. The memo spells out our thoughts on the deal—both the upsides and downsides—so that there’s full transparency.

When we do this, we get reactions like, “Holy cow. Thank you! I never understood how this works, and this helps me plan my business and board updates accordingly.” The entrepreneur understands our perspective, risks we see in the business and the outcome we are focused on achieving. From day one, we have a shared perspective.

Both a Hole-In-One and a Touchdown Are Worth Celebrating

The very best investor-entrepreneur relationships are based on trust and openness, along with a shared vision, goals and expectations.

It’s so important for entrepreneurs to know the key assumptions, financial metrics, and risk factors that the investors are considering. It might be scary to hear, but it establishes the right level of trust and communication with the investment team.

It is equally important for investors to get into the mind of the entrepreneur and understand what she does (and does not) want to do with the business over time.

A shared perspective and understanding not only builds trust and openness from day one, but it also provides a shared viewpoint when things do and do not go as planned. Maybe, just maybe, it can also cut down on the therapy bills for both—but that concept will require a much, much longer blog post to really do it justice!

This was originally posted on Ventureburn on Feb. 14, 2017.

As an entrepreneur involved with two highly successful full-stack technology businesses, I spent fifteen years curiously wondering how venture capitalists make decisions. When I wasn’t focused on delivering value to customers and employees, I focused on how I could demonstrate that value to VCs in order to raise capital.

Often the process felt like it was shrouded in mystery—conjuring images of tribal gatherings, Shark Tank-like voting sessions and perhaps an Ouija board or two. Even after I secured capital with several of the best firms, I still felt like an element of luck was involved.

Now that I find myself on the other side of the table after founding my own VC firm, the mystery has been revealed. In short, I have discovered that successfully presenting your company is a skill that can be learned by understanding the venture capitalist point of view, and gaining clarity into the VC approach is different from understanding how to be an entrepreneur.

The biggest difference between an entrepreneur and a venture capitalist comes down to mindset. Entrepreneurs specifically tend to take an insider’s view of their business and then extrapolate that view to the market while venture capitalists do the opposite—take in the market landscape first. Understanding this difference is the key to securing critical capital necessary to keep dreams afloat.

The following chart illustrates what those views look like in practice:

The differences are subtle but important. Entrepreneurs that understand these framing devices can modify their approach to raising capital by crafting a compelling story that appeals to investors’ practical market sensibilities.

A winning story should address all of the following aspects:

1. Be conservative and detailed when you talk about the market you’re addressing.

Spend a significant amount of time thinking about who exactly will be your customers, making sure to differentiate between total available market, serviceable available market and serviceable obtainable market. Be accurate and realistic.

2. Give VCs a balanced view about potential competition.

Don’t just make a simple competitive landscape grid that magically depicts your business in the upper right quadrant. Instead, think deeply about current and future competitors, and show that your company has a plan to handle competitors as well as to discourage substitutes. Explain why you are winning today and why you will continue to win tomorrow.

3. Give VCs a view into the customer’s mindset.

Why are customers buying your product and how satisfied are they? What steps are you taking to maintain or increase that satisfaction? Explain to us what your average customer is thinking as they buy and use your product.

4. Help us understand how you are building your team.

We’ve already read your biographies and know about your past work experience but we are looking for more context. Be prepared to tell us why your current team is relevant to your strategy and talk openly about future executive needs.

5. Spend time on key business metrics, not just financials.

Financials are helpful, but at an early stage, money may not be the best indication of future success. Focus instead on spelling out the key unit economics that will be crucial to financial success as your business grows, such as gross margins, the cost of customer acquisition, and the lifetime value of a customer.

6. Be thoughtful about what could go wrong–both internally and externally.

My favourite question to ask is a simple one. Let’s say we are in a bar, two years from now, drowning our sorrows because this business failed … what happened? Think about external factors and internal factors. This isn’t being negative, it is being thoughtful and showing a critical mindset about how you will grow and expand your business and what obstacles you imagine you will have to overcome to do so.

7. Passion might not win the day, but it is incredibly important.

If you, as the entrepreneur, are not personally convinced that the idea you are pursuing is worth every waking moment of your professional life than you cannot expect others to get excited either. VCs are looking at both the idea and the entrepreneur’s personal commitment to making an idea a success. Do not underestimate how critical your passion, commitment and enthusiasm is to making your dream a reality.

An entrepreneur’s job is to educate potential investors

Any presentation that follows all of the above guidelines will help to close the massive information gap between an entrepreneur and a source of capital. Too often, entrepreneurs feel like venture capitalists “just don’t get it,” but this idea usually stems from the fact that no one has done a thorough job of explaining it to them. VCs’ tough questions or reticent attitudes are often just ways to push entrepreneurs to give a more comprehensive and outward-facing view.

An entrepreneur who gives potential investors what they want understands better how investors evaluate potential and assess risk. If you can show us that you understand and appreciate our interests and the VC point of view, we will be more eager to work with you to help you grow and improve your business in ways that appeal to the market.