f317 – venture capital & entrepreneurial finance businesses that attract venture capital

F317 – Venture Capital & Entrepreneurial Finance

Businesses that Attract Venture Capital

One of the greatest mysteries to entrepreneurs is the process by which Venture Capitalists assess their businesses for purpose of an investment.

Specifically, why do they keep saying “NO”?!?

10,000 FT View

A Couple of points to consider about Venture Capitalists

1)They cannot see the future;

2)They are wrong more than they are right; and

3)They invest in what they know….which means you may simply be presenting your business to the wrong Venture Capitalists.

However, there are some general guidelines that all savvy investors

follow in order to determine whether they would invest.

That’s what we are going to cover today

Rule # 1 – Money chases companies that have a large

growing base of customers/users.

Rule # 2 – Making money is not just a good thing….it’s a great

thing

In sum: Companies that have a large and growing customer base and are generating meaningful revenue get a speed pass through the VC process.

Rule # 3 – VCs follow the leaders in their industry

Thus….if you,

1) Don’t have a large and growing user base;

2) Are not generating meaningful revenue; and

3) Haven’t found a “Lead” investor to “vouch” for the project…..

You have 4 hurdles to overcome to raise Venture Capital.

NOTE THE FOLLOWING

This presentation “ASSUMES” that an entrepreneur already has:

1) A working product or service;2) Some market verification that the

product/service has value to the target audience.

VCs don’t fund ideas/business plans

Hurdle #1:Big Enough

Market

Hurdle #2: Right Market

Timing

Hurdle #3:Defensible Position

Hurdle #4:Management

Consider the following:

Mike the Stick Figure VC Invests $1,000,000 in a startup.

He has a ROR of 60% and a 7 Year time Horizon.

For his investment, he receives 20% of the equity.

Hurdle # 1 – Big enough Market

In year 7, based on a 60% ROR, the value of his Equity should be:

$26.5 Million

Hurdle # 1 – Big enough Market

If he owns 20% of the company (and it’s supposed by worth $26.5MM), then the value of the entire company in Year 7 should be:

$134 Million

Hurdle # 1 – Big enough Market

What are the odds of a company growing from $5MM in valuation to $134MM in valuation within 7 years?

Without a large and growing addressable market, it’s extremely challenging.. (taking market share is hard)

Hurdle # 1 – Big enough Market

# of businesses in the US< 20 Employees?

# of businesses in the US21 – 499 Employees?

# of businesses in the US> than 500 Employees?

Consider the Following ( based on 2011 Statistics):

5,104,014

562,739

17,671

89.7%

9.9%

.31%

Hurdle # 1 – Big enough Market

What’s the pain point being addressed?

What’s the size of the target audience?

What are the existing options?

Hurdle # 1 – Big enough Market

3 Questions need to be asked when assessing the size of a potential market

What’s the pain point being addressed?

What’s the size of the target audience?

What are the existing options?

Using email to send large files; mobile access to data

Anyone that sends documents, pictures, etc. via email

Email, USB Sticks, Intranets

Hurdle # 1 – Big enough Market

EXAMPLE

What’s the pain point being addressed?

What’s the size of the target audience?

What are the existing options?

Taxis are unreliable and People don’t want to be late

Anyone without a car and in reliance, in part, on taxis

Taxis, walking, public transporation, car ownership

Hurdle # 1 – Big enough Market

EXAMPLE

Venture Capitalists would prefer to invest in a company going after 20% of a projected $5 Billion dollar market (with multiple competitors) than a company seeking to dominate a $100 Million market (with limited competitors).

Odds of success are better.

Hurdle # 1 – Big enough Market

Hurdle #1:Big Enough

Market

Hurdle #2: Right Market

Timing

Hurdle #3:Defensible Position

Hurdle #4:Management

Hurdle # 2 – Right market timing

Market Growth

Time

Early Adopters

Late Adopters

2002

Hurdle # 2 – Right market timingToo Early!!!!

What are the challenges of being too early?

1) It’s expensive to both sell and educate the market;

2) Will have to keep up with innovation within the space; and

3) May have to raise a lot of money to stay afloat while the market develops

Hurdle # 2 – Right market timing

What are the challenges of being too late?

1) Product has become a commodity;

2) Competing against well funded, entrenched companies;

3) Fewer exit opportunities.

Hurdle # 2 – Right market timing

Market Growth

Time

Early Adopters

Late AdoptersThis is when VCs want to invest.

Hurdle # 2 – Right market timing

Hurdle #1:Big Enough

Market

Hurdle #2: Right Market

Timing

Hurdle #3:Defensible Position

Hurdle #4:Management

Hurdle # 3 – Defensible Position

Great idea! Great first product!

Now, how do you keep competitors from mimicking your product, marginalizing your competitive advantage, and killing your business?

Every business wants a Monopoly….so it can maximize its profits without working all that hard…..

Hurdle # 3 – Defensible Position

But it’s unrealistic to assume that competitors will not jump into your circle. If it’s a big enough market, you will have significant, well-funded competition

Example 1

Example 2

In order to ward off competitors, strong businesses work hard to develop every possible strategy to keep competitors at bay.

For start-ups, Investors want to only invest in companies with a strong defensible position.

Hurdle # 3 – Defensible Position

Intellectual Property Strategies:

Patents / Exclusive Right to commercialize an invention (17 Years)

Trademarks / Exclusive Right to a Brand/Certain Language (Very important for consumer-facing businesses)

Hurdle # 3 – Defensible Position

Intellectual Property Strategies: Challenge?

You have to defend the Patent or Trademark Infringement in the courts. Going to court costs a lot of money.

(Hint: Investors don’t like to fund lawsuits.)

Hurdle # 3 – Defensible Position

Market-Based Strategies:

High Switch Costs – It’s painful for a customer to leave one service for another service

Customer Experience – Customers don’t want to leave you because you provide a great experience (difficult to scale)

Proprietary Technology or System – You are able to deliver a product/service more efficiently than the competitors.

Hurdle # 3 – Defensible Position

Market-Based Strategies:

High Switch Costs

Customer Experience

Proprietary Technology or System

Hurdle # 3 – Defensible Position

Last Point:

Having competitors isn’t a bad thing. If you can gain enough market share (and have a defensible position), then the business becomes an attractive acquisition target.

Easier to acquire than fight it out on the market.

Hurdle # 3 – Defensible Position

Hurdle #1:Big Enough

Market

Hurdle #2: Right Market

Timing

Hurdle #3:Defensible Position

Hurdle #4:Management

Hurdle # 4 – Management

Can the team execute on the vision????

Consider the following:

Way too much emphasis is placed on the founders in the media….(i.e. Visionary, Brilliant, etc.)

Venture Capitalists are not looking for the next Steve Jobs. They are looking for a team that’s “smart”, “nimble”, “experienced”, and, most importantly, of high integrity.

Hurdle # 4 – Management

What helps make the case?

Graduating from a top-flight university or MBA program (if first-time founder);

Having more than one founder on the team;

Having worked for a start-up that’s had success (i.e. facebook, google, etc.);

Having actual experience in the market segment addressed.

Hurdle # 4 – Management

What hurts the case?:

Being Arrogant;

Being a single founder (with an entourage);

Not knowing everything about the business, competitors, etc.;

A bad reputation.

Hurdle # 4 – Management

in the end:

The Venture Capitalist (or any investor) is going to use their gut on this and may pass even if everything else is a go.

Many VCs will even have a psychological examination conducted of the Founder(s) to see if the personality is a fit with the fund.

Hurdle # 4 – Management

Overcome these 4 hurdles and you will have success raising

Venture Capital

Big Enough Market

Right Market Timing

Defensible Position Management

End of Lecture

Questions?