by Robert J. Creeden of Blackstone Entrepreneurs Network
As a venture capitalist for 23 years, two common questions people would ask me are why it takes so long to make an investment decision and what was I reviewing for such an extended time period. These excellent questions posed by entrepreneurs mirror the exact same ones my partners and I discuss on a regular basis. No matter which side of the investment table you’re on, the issues, questions, and decision points are vitally important. Simply put, the process requires – and deserves – time and care, both for the investors and the entrepreneur.
Making a venture capital investment brings to mind the age-old analogy of peeling an onion, layer by layer. As investors answer one question, or peel one layer, new questions and new issues emerge, leading to another layer that requires diligence, and another, and another. This action repeats itself until the investor is comfortable that the risks of the investment have been identified and minimized in a way that facilitates success for the company. As frustrating as it may be for the entrepreneur, this takes time – granted, sometimes too much time! As an entrepreneur, your most effective strategy is to be prepared for the diligence and questions from potential investors and to manage your company (and your expectations) with the recognition that fund raising may be a lengthy process.
Because even the best diligence is essentially an educated guess, the investor ultimately must make a bet, and that bet might be based on any number of factors – product innovation and differentiation, market need, growth and adoption rates, management team, funding needs now and later, and the exit strategy, to name just a few. As with peeling an onion, each factor in the diligence process leads to another and to another and that takes time. Again, being prepared for this is one important way to move the process along more quickly.
Here are six essential “first-layer” issues entrepreneurs should be prepared to address:
- Management: For early-stage investors, the biggest bet will be on management, best summed up by the old cliche that you bet on the jockey, not the horse. Investors are likely to ask: Does management have the skills necessary to execute the plan? What is their experience and how does that relate to the expertise needed to make the company successful? Do they have realistic answers to questions regarding financials, market, the board, product development, and hiring, to name a few? Do they realize and fully commit to the understanding that they can’t do it all alone, they may need to add senior management, and they may have to step aside to another position to contribute at a higher level? And finally, what is management’s ability to get the company through the inevitable speed bumps that will come along? Every business hits speed bumps, and how you navigate them is critical to success.
- Market: From a market standpoint, investors look at the demand drivers in the market. What problem/factors are driving the demand for this solution, and more specifically, what is driving the demand for your solution? Do you have initial traction – product, customers, revenue, team? What is the economic value or ROI for your customer? And perhaps most important, how do you sell, what is the size of your target market, and what is the growth rate of that market?
- Product or technology: This building-block comes into play no matter what you develop. So where are you in terms of development – prototype? Beta? Commercial Product? What more needs to be done to make it bulletproof and sales-ready? What is the competitive advantage your product provides, and what is the defensible position that will help you maintain your leadership position?
- Financials: The deal itself, along with financial considerations, is a critical issue. What funds have been raised, and what did you accomplish with that money? What is the use of proceeds of the current round, and what will the future need be for the company? Don’t be fooled into thinking you will not need any more. Having invested in more than 50 companies, I can tell you that they all needed more money!
- Valuation: Valuation is a key component of any deal, and I’ve engaged in many a tug-of-war about valuation with the companies I’ve funded. My best advice on the first round is this – as long as the investor is not taking so much of the company that you feel like you are working for them, take the money and get going. Worrying too much about control sends the message to an investor that you are more concerned about building a kingdom rather than a successful company. It is critical to get the cash and start building a valuable company. If you do that, the valuation will take care of itself, and you will be well-rewarded.
- Exit Strategy: Even at this early stage, take some time to consider your exit strategy. Your potential investors will need to know what you are thinking about the most likely scenario. Although you can’t predict the future, be prepared with an exit strategy, along with some idea as to who would buy your company and why.
Use this basic template to prepare for your first meeting with investors by having compelling answers for these “first-layer” questions. It won’t necessarily get you funded, but it will give you a much better chance of getting to the all-important second meeting and to the next layer.
Bob Creeden, now Executive Director of the Blackstone Entrepreneurs Network, has more than 30 years of experience in commercializing new technologies, both as an entrepreneur and venture capitalist. Just prior to coming to NC from Boston Bob spent over 20 years as a General Partner at three venture funds ranging in size from $35 million to$150 million. Prior to his time in venture, Bob was COO and CFO of a number of start-ups on Boston.