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February 19, 2006

VC Primer from an Entrepreneur’s POV – Finding First Round VCs

You “need” a million dollars or more to take your wonderful idea the next step.  Remember that it’s very hard to do a VC round for less money than that.  If you need less, see last week’s post on angel investors.

Let’s also assume that you need less than four million.  As a debut entrepreneur,  you’re going to have a hard time raising more than that unless you already have a business which is up and running; financials which are meaningful; a top-caliber team with a “name” or two on it; and/or some unique advantage like a significant contract with a long time to run.  If you need more than four million dollars and you don’t have any of these things, think again about how you could use a much smaller angel or VC investment to get to the stage where you qualify for more.

Best thing is to know a VC.  Next best thing is to know someone who knows a VC.  The investment process page on the website for Mobius Venture Capital is frank and succinct: “The best way to submit a plan is through a personal connection -- someone who can introduce you to someone on our investment team and who can recommend you personally.”  Mobius goes on to say that they look at EVERY plan that is submitted.  You start with two strikes against you if you are both untested as an entrepreneur and unknown.  But it takes three strikes to be out.  You’re an entrepreneur.  DON’T quit just because you don’t know anyone who knows any VCs.

VC firms are easy to find by Googling.  Go through what they say about themselves, what they invest in, and the purposes of their various funds (see this post for the difference between VC firms and VC funds). Look at the list of portfolio companies they have already invested in; look for patterns. Some firms will have different partners specializing in different areas.  Identify the relevant partners(s) if possible.  Google them.  If they have blogs, read them. And ask yourself, again, as you find out more about the partners who you know who might know one of them or one of the executives of one of the VC’s portfolio companies – how many degrees of separation can there be?

There is absolutely no point in trying to convince a VC firm to go out of its business area of interest.  If the firm has a geographic specialization, you are not going to convince them to move beyond that either.  VCs often want to see the companies they invest in; they want to attend physical board meeting (even though these often end up being on the phone).  They don’t want to spend more of their life on planes than they have to.  And the network they rely on for information may also be local.  They mean it when they say they have geographic limitations.

Some VC firms specialize in first round investments.  That’s what you’re looking for.  Other VC funds specialize in putting larger amounts of money to work in later rounds; we’ll talk about them when we get you to later rounds but they don’t want to spend time with you now and you don’t want to spend time with them.  The real vulture capitalists put large amounts of money to work refinancing or buying failed companies; hopefully you’ll never have to deal with them although they also fill a necessary niche in the capitalist ecology.

This is your prospecting.  It’s important that you make a short list of VCs that you want to approach starting with those early-stage firms interested in your area where you know someone or know someone who knows someone (this category may be a null set).  For all those firms where you don’t know anyone, rank them by how relevant your idea is to the kind of investment they say they make and the companies they’ve actually invested in – sometimes there’s a difference.  If so, go with what they do rather than what they say.

Of course, the firm that might be most interested in your idea may already have invested in a competitor of yours.  In that case, whether or not they have a policy of avoiding investments in companies which compete substantially with their portfolio company, take them off the list.  Some financial institutions including investment bankers say they have “Chinese Walls” which allow them to deal with conflicts of interests.  The only Chinese wall I know of which is at all effective is the one that separates the Chinese Internet from the rest of the world – and I hope that’ll spring a leak.

“Why so important to have a short list?” you ask. “All these firms want at first is an executive summary.  It says so right on their websites.  Doesn’t cost me anything to email the same executive summary to a zillion firms who might be interested.”

The answer is that, if you don’t have anyone to introduce you to fund and you don’t have your own track record as an entrepreneur, you already have two strikes against you (see above).  Sending the same executive summary to everyone is an invitation to a fast strike three.  If your executive summary is coming over the transom it MUST be customized to the firm, the fund, and, the partner that it is meant for.  You don’t want to be obvious that you’re customizing but that’s still what you want to do.

Use their buzz words correctly.  Describe the business environment the way they do and in terms of companies they’ve already invested in.  Differentiate yourself from their other portfolio companies.  Show how an investment in you will fill an unfilled and crucial niche in their portfolio.  Think like you think they think.  Doing all this right means a lot of work for each submission.  That’s why you need a short, well-targeted list.

Here’s a hint: you’ll notice as you do your home work that VC firms tend to co-invest in repeating clusters.  You’ll find the same group of VCs investing together time after time.  If one firm in a cluster catches your attention, promote the rest of the firms in the cluster on your list.  You want to hit them all.  They talk to each other.  Buzz in a small circle can be created this way.  They’re also competitive.  If a few friendly firms are all interested in you, they’ll start jostling to be the lead VC.  That’s good for you.

Next, what VCs will want to see once you do get in the door.

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Tom Evslin continues his series on securing VC financing with some tips on finding first round VCs: Let’s also assume that you need less than four million. As a debut entrepreneur, you’re going to have a hard time raising more than that unless ... [Read More]


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