Wednesday, October 22, 2008

VC Research - Choosing the Right Venture Investor (Part 1)

When entrepreneurs bootstrap the business to significant milestone, they start to think about raising external capital, often from VC firms.  I've recently spoken to a number of entrepreneurs seeking anywhere from 200k to millions of dollars.  I often start out the meeting by asking, "What can I do for you?".  Almost always, the very first thing they spit out of their mouth is, "I need $xxx to support my crazy growth.  I need capital and advice from the VCs to turn this company into a big time success."  Sounds familiar?

Without going too deep into re-re-re-talking about the venture money management business, let's get this straight.  When VCs raise a new fund, the partners spend a good chunk of time talking about the investment strategy.  Yes, VCs have their own strategy of investing their own money.  One of the reasons that a majority of the business plans coming thorugh the pipeline shoot directly to trash via a "delete button" is that they just don't have the right fit with their fund's strategy.  

So, what's the problem here?  I just can't say how many times entrepreneurs approach any VCs without having done extensive research and figuring out the "fit".  It just sounds too mundane to even bother talking about it, but it's just so crucial.  Here are the REAL-LIFE discussions with entrepreneurs.  For the sake of protecting their silliness, I'm not going to use any real names.

  1. An entrepreneur with a great idea and significant early-stage traction in the consumer internet sector wants to raise a VC round.  He talked to xxxx (growth equity investor) and one angel investor.  He thinks both of them are very interested in his business and was asked to meet more people.  What is the pitfall here?  S/he just wasted time and emotional excitement.  Since when growth equity and one angel investor are positioned to fund and advise an early-stage company?
  2. A consumer mobile application company approached a very well-respected early-stage IT company.  He thought the investor's prestige and knowledge will take his business to the next level.  Yeah... enterprise software sales isn't really same as advertising-based business.
  3. An entrepreneur's goal is to "flip" the business for $10-20m within the next 4-5 years.  He approached one of the top-tier VC firm.  The VC's partner is not interested, because the market size is too small.  The entrepreneur is pissed to get this typical rejection.  What he didn't realize is that the VC firm's strategy is to "invest in self-sustainable businesses requiring a long-term commitment".  In other words, the VC's not interested from the beginning.
Seriously, I can go on and on about approaching the wrong guys.  Would you ever pitch a mobile social networking idea to a biotech venture investor?  If this sounds too easy, spend more time really understanding what the investors do.  Same thing applies to the venture investors, but they much less often make these mistakes.

For the sake of my readers, I will aggregate some of the VC's strategies, and you will see the stunning differences in what type of capital gap the VCs are trying to fill in.