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The
Hidden Benefits of Raising Venture Capital |
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By Stuart Layzell, Chief Operating Officer and Senior Vice President of Defywire, Inc. (Published October 18, 2004) For many entrepreneurs, the thought of raising venture capital
can be both daunting and exhilarating. As with most things in life,
before the exhilaration comes the hard work. At the end of the process, if you are successful (and by the way, the odds of finding capital in recent years have not been good – as most VCs preferred to lick their wounds or deal with post-investment indigestion from the bubble era), you will have the luxury of handing over significant control of your company and sharing a large portion of its future economic success to your new VC friends. Is it all worth it? Yes, but perhaps for a surprising reason. Clearly the exhilaration and validation for your business model on closing an institutional round is great. However, your business might not succeed just because you have matched a great idea with smart capital. It is likely to succeed because of the hidden benefits of raising the money – the rigors of the process itself and the value of the “dispassionate investor” mindset. A new mindset for management teams – The dispassionate investor Raising any form of capital requires a management team to look at their business in a completely new light. In many cases, it is not the quality of the idea that gets supported, but the rigor and vigor with which the business plan is prepared and presented. Many people in the VC community talk about “backing the jockey, not the horse” – meaning that by backing a great team, their chances of investment success are much greater. What is behind this premise? Great teams have the ability to step away from a passionate belief in an idea and put in place business processes and analyses that allow ideas and results to be judged. They move from brown bag accounting records to a system that allows them to monitor and control costs. They implement policies and procedures that will allow their business to run smoothly as it grows (or at least more smoothly!). They attempt to define their market and where their business will fit within that market. This process alone often creates debate within the management team about the true state of their product or service and whether it is truly competitive. This is the first sign of the dispassionate investor mindset setting in. In doing all of these things, entrepreneurs are taking the dispassionate view of their business. The reason for doing this is to raise venture capital, but, in fact, often unknowingly, they are putting in place the foundations for a robust and scalable business. Avoiding venture capital? In the last 24 months, more and more companies have decided not to pursue venture capital investors for their company. This is often driven by a realization that they may not be suitable for venture capital funding or by their desire to avoid giving up the operational or economic controls of the business. Irrespective of the rationale for the decision, the smart entrepreneur should try and recreate the benefits of the process without the heartache by applying the dispassionate investor mindset. The typical steps or requirements involved with raising venture capital provide an excellent template around which to build your thoughts. These steps often include:
By considering how to address each area or phase of the process, management will be putting in place some invaluable foundations for their business, as each step can be applied to a company’s day-to-day business. And even if your company is not sure it wants to obtain VC funding, attempting to get your company plan reviewed by a few venture capitalists can help you build valuable skills and uncover some of the weaknesses in your business. Elevator pitch and summary The “textbook” says that when you are networking with a VC, you need to be able to deliver a short sentence to interest the investor enough to delay one more trip to the bar or buffet. Creating and delivering this sentence is great practice for a trade show event or a brief meeting with a prospective customer. The ability to confidently engage someone and articulate your company’s message is a core skill. Once perfected, you will ensure that a potential customer stays at your booth for something more compelling than a free pen or combo torch/compass/screwdriver key fob! Business plan and executive summary Creating a business plan and getting a VC to read it is an excellent proxy for many key skills that you will need for your business success. First, writing a plan forces the whole team to document their thoughts and provides a structure. More importantly, the traditional sections such as marketplace and competition are often areas that a technically minded team has not considered. When your first draft is complete and you realize that you have 55 pages on your ground-breaking technology or product and three weak pages on market and competition, it will force your team to revisit its thoughts on market and positioning – an invaluable exercise. The biggest challenge in technology is often not the technology itself but finding someone to buy it. Management teams often stay within their comfort zones. In many technology companies, this means over-engineering the product and not applying enough resources to market and product management. Once the plan is written, note that sending it to a venture capitalist is not the same as getting a VC to read it. Typically, unless your elevator pitch is stunning, your chances of success are greatly improved if you can have a trusted contact of the VC introduce your company or at least give the VC a validating nudge of encouragement. Finding ways onto the radar screen requires research, planning and usually networking. This is no different from the challenge you will face when targeting decision makers at customers. With a VC, you need to find out their areas of expertise, investment focus and investment style. If you replace these with “business needs, technology platform and budget availability” you are now addressing a customer’s needs. Successfully lobbying a decision-maker such as a CIO will be easier when you network or find a trusted source to reference you……..all skills you will have honed in the fund-raising trenches Exits and liquidity This is probably the one area where the VC process will not enhance your approach to customers, but it will certainly enhance the benefit to your shareholders. More than anyone, you should care about valuing the time and money you have put in the business, which means spending time determining how to ultimately realize a return on that investment through a liquidity event. By understanding what is valuable and at least keeping as many options open as possible, you will probably make good business decisions on a day-to-day basis. A VC will not like your business relying too heavily on one customer, as it usually reduces your options for any exit. Knowing this may encourage your team to review the company’s customer concentration. In doing so, you are likely to focus resources on new customer acquisition, bringing greater diversity to your customer list as well as new sources of feedback for future developments of your product – all healthy activities. Credible financial planning and supporting information A VC will expect your financial plans to be supported by solid assumptions. As a manager, you should expect the same. This will force your team to break out of the “build it and they will come” approach to financial planning and clearly document the rationale behind the assumptions, especially on revenue. How much of the total market does your revenue represent? Are you basing your revenue projections on top down market assumptions? An example of this would be to show a multi-billion dollar market and then simply assume that you capture some minute fraction. Mathematically at least, you can easily prove you have hundreds of millions of dollars of potential revenue. How does that match to your current pipeline or planned price point? Can the price point be supported by the market and how many sales does this imply that you need to hit your targets? Due diligence Even if you never plan to raise outside capital, thinking through how your corporate records are prepared will be invaluable. If the legal documentation surrounding your intellectual property is incomplete and your business succeeds, this may be a costly mistake. In preparing the documentation for due diligence, you are ensuring that you can defend the assets of your business in the long term. Board of advisors or directors VCs often evaluate your support group as validation of the business model and a test of your ability to attract talent. They do this because they know that you will have ups and downs in your business and your chances of success are greatly improved if you have access to different ideas and experience. Why wait for a venture capitalist to suggest you do this? Building up your support group, irrespective of funding plans, is a great move. Everyone benefits from advice and mentoring, and, by the way, this is a great chance to further hone your budding networking skills! Having your cake and eating it too? For many management teams, raising capital becomes the only goal for the business rather than a step in building a solid business. For these teams, the day after receiving funding can be daunting when faced with the huge responsibility of deploying the capital wisely. Avoiding venture capital might be a rational decision. Missing the chance to look at your business as a dispassionate investor is not. Stuart Layzell is COO and senior vice president of Defywire (www.defywire.com), a leading wireless middleware provider. The company’s flagship product, Defywire Mobility Suite, extends the enterprise by providing mobile employees with secure, real-time access to corporate information systems. Stuart can be reached at slayzell@defywire.com and 571-323-2178.
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