Month: October 2008
Q: I am part of a tech start-up that’s in a slight conundrum. In order to place our product in its market, we’ve had to provide it to customers free of charge. Now, the majority of our revenue model is based on advertisement fee’s and service fee’s collected after the product has already been placed, so normally such a move would not be a problem; however we are finding it hard to raise the money to produce and install our first product.
To date we’ve raised money from angel investors. When we approve VCs, we get the same reply, "let’s first see a market reaction, and then we can talk about investment." But, without VC money, we can hardly demonstrate a proper market reaction.
Should we concentrate on finding more angels, or should we look harder into the VC option?
A: (Brad) Concentrate on finding more angels. You are in a classical circular discussion with the VCs you are talking to. Without knowing the details, my guess is the VCs you are talking to are basically saying no to you, without saying no directly. You can waste a lot of time continuing to go in circles with them, or you can focus your time and energy on getting enough angel money to get to the next step of your business.
It is equally important that you re-evaluate exactly what you are trying to accomplish with the angel money. Assuming you believe you’ll ultimately need more capital for your business, at some point you will use up your sources of angel money, or you’ll get to a place where you need a larger capital infusion that angel investors won’t be able to provide. Given the feedback you are currently getting from VCs, you should rethink the approach you are taking to enter the market to demonstrate the elusive "market reaction" the VCs are looking for. If you feel like you’ve developed a good relationship with at least one of the VC firms, see if you can enlist them to give you direct feedback on what they’d need to see (other than the generic "market reaction") to take you more seriously.
Two great posts on this lovely day in Boulder, Colorado. The first is Due Diligence Reveals All – To The VC by Jeff Bussgang at Flybridge Capital Partners. Jeff explains the three stages to the VC due diligence process and how it works. The second is Be Careful Who You Deal With by Matt McCall at DFJ Portage. Matt explains how "as these markets continue their chaotic path downward, people’s true colors come out." Matt has a "life is too short to deal with assholes" rule and explains it clearly.
We’ve gotten many emails over the past few days wondering how the meltdown is going to affect VCs and startups. The quick answer is "not much of an effect – so far." Just linking around, here are some posts that you might want to check out if you’d like to read more.
Mendelson’s Musings: How Does the Market Craziness Affect Venture Capitalists and Startups? – Talks about VC and Startup fundraising environments.
Feld Thoughts: Build Trust by Staying Steady in Rocky Times – Talks in detail about macro cycles, banking and how it ties to the VC ecosystem. Also see: Gloom and Doom – or Capital Efficiency – reference Fred Wilson’s posts on similar subjects and argues that we aren’t in the worst case scenario.
or see this presentation from Sequoia Capital which tries to put the current situation into historical perspective.
There are many other good blog posts if you go hunting around, but this should get you started.
Tom Crotty, managing general partner of Battery Ventures, has today’s best post of the day up over at PEHub. It’s titled The Portfolio Effect: Battery’s Tom Crotty on Why VCs Should Back at Least 25 Companies in Every Fund. Tom explains that, regardless of fund size, each fund should try to have between 25 and 30 companies to get the right scale and diversity. He doesn’t talk about the time frame for the initial investments in these companies; we’ve concluded from our experience that a three year cycle of initial investment (e.g. the 25 to 30 companies get invested in over three years) creates the right amount of time diversity.
Q: We pitched to a venture group 3 times in July and August. They kept telling us that they were very interested and wanted to learn more about our venture so we shared complete details of our venture hoping that they would invest.
Now for last 6 weeks they have gone completely silent. They used to respond to our emails within hours but now…no response to emails or phone calls. Once we got one of their partner on the phone and he promised to call back and hasn’t yet. We would like to move-on. Are we nuts? Why would they spend so much time then behave like this? Why won’ they just say "NO" to us?
A: (Jason) To answer your first question, no, you aren’t nuts and yes, you should move on. Clearly they aren’t interested in funding your company.
The bigger questions is "why do some VCs act this way?" I really don’t know or understand this behavior, but it’s not uncommon. We hear on a regular basis from entrepreneurs that VCs frustrate them this way.
What’s probably happening is that they have other companies in their pipeline that are sorting higher in interest than yours, but they’d like to keep you as a potential option if their other opportunities disappear. That being said, I’ve never heard of a situation where a VC lead goes completely cold and then becomes hot again. Think of this similarly to any romantic relationship that you’ve ever had.
We think it’s really important to say "no" quickly. While it’s not always easy to say no (see Brad’s post on "Why am I passing?"), it really is the most fair thing to the entrepreneur, even if hard to hear. Dragging the process along does no one any good. Sorry to hear about your experience – not all VCs are this way.