Top 10 lies entrepreneurs tell potential investors
At IMES, we work with a lot of Australian start-ups that are either in the midst of raising capital, have done it already or are thinking about it in the near future.
Many of these entrepreneurs won't be able to raise the capital they need and will be forced to bootstrap it (often a good idea if they can manage it).
Some will get it via the three F's: Friends, Families and Fools. And some will get it from Angels or Venture Capitalists.
Wherever the money comes from, either to seed or expand a business, the bottom line is that they will have to make a pitch in order to get the investment. That's where the dance really begins!
Let's be honest here. Raising capital is tough to do and it takes a special team to make it happen.
Keeping your venture capital slide deck short and sweet as well as your executive memorandums (to get to pitch) are a couple of the many keys to a successful raise.
But what of the pitch itself? How far should you stretch the truth and will investors immediately find you out?
Silicon Valley investor Guy Kawasaki, of Garage Ventures, is an expert in spotting the start-up bulldust.
On his blog, he has posted the top 10 lies told by entrepreneurs to investors.
I have taken the liberty of adding some comments to Kawasaki’s top 10 to highlight the investor/investee dance of words and posturing that goes into every potential deal.
Here is a list of the top 10 lies entrepreneurs tell potential investors, and what entrepreneurs really mean:
1. “Our projections are conservative”
What this really means: But if I don't show a hockey stick of growth you won't listen and will tell me I can't make money fast enough for your investment window (usually a VC fund is 10 years).
The challenge here is that most VCs only want home runs because at least 80% of the companies they invest in will fail and the earlier they fail the better from their perspective.
In order to mitigate for anticipated failures they want your company to make up for their bad investments. Therefore, if you can't show tremendous upside in a large, well-defined market, you're unlikely to gain their attention or a meeting in the first place.
2. “Jupiter says our market will be $50 billion in ten years”
What this really means: And if the market research we show you indicates only a $500 million target, you will tell me it is too small for a VC of your stature.
Another challenge here is VCs always say they want a disruptive technology/company but then struggle in the valuation phase because they don't have a good comparison company to benchmark it with.
3. “Several Fortune 500 companies are set to do business with us”
What this really means: Yep! And if I don't have name clients ready to go, you'll tell me to go get them before you can consider funding us.
This is always a catch-22 issue. An entrepreneur usually gets to a development stage and then needs money to market and sell it to gain some traction (which requires more capital).
Unfortunately, this is also the same time the initial seed money tends to run out and the entrepreneur is in a bind.
One way to mitigate this problem is to get a named client to buy into your product or service early on in the development process to validate what you're doing.
4. “No one else can do what we’re doing”
What this really means: As if I’d tell you there's lots of competition and we're not very different except for our positive attitude!
There are exceptions to this such as the plethora of group buying wannabees that have sprung up around Groupon's success, such as Australian start-up Spreets.
The founder, Dean McEvoy, was in Silicon Valley with another start-up at the time Groupon was gaining traction. He saw what they were doing, knew the model was pretty straight forward and convinced some investors he could copy their model and succeeded.
5. “Hurry up because other investors are about to do our deal”
What this really means: We all know you're going to drag your feet and take your time completing your due diligence and you know we need investment yesterday. So what would you like me to say? Take your time because you're the only game in town?
Every entrepreneur should strive to have multiple potential investors interested and in the bidding when possible.
The reality is that start-up and investors’ needs don't always line up at the same time. Most VCs have a 10-year fund investment window.
They want most of the initial investments to be made in the first three to five years, then they will reinvest in those that have gained traction (this varies but VCs generally keep around 20% of fund value for later investment rounds).
This is also why they would prefer their investments to fail earlier than later.
That way they can focus their resources on the winners earlier in the fund window and it’s also why entrepreneurs need to do just as much due diligence on the VC as they will do on the start-up.
6. “Our product will go viral”
What this means: Hockey stick again. We are poised for slow steady growth but if you don't think you'll get your money back within the life of your current fund you won't invest in us.
That's why we're telling you our sales are going to go through the roof in no time.
7. “The large companies in our market are too big, dumb, and slow to compete with us”
What this means: If we didn't think we could beat them why would we be here and why would you invest in us?
8. “Our management team is proven”
What this means: Would you prefer "We're a bunch of propeller heads but we will learn on the way – with your money. We're good to go"?
The reality is a good mix of experience and upstart energy is optimal but doesn't always happen. VCs generally prefer proven winners – but often those winners take their money and go it alone the next time as they don't want VC interference in their next start-up.
In the US, VCs are more willing to invest in people from failed start-ups than in Australia (where this is seen as a real problem) as long as they can tell the VC why they failed, what they learned and what they would do differently next time.
This is a known cultural issue that can make it tough for Aussie entrepreneurs who failed the first time and are looking for local capital.
9. “We filed patents so our intellectual property is protected”
What this really means: And if we didn't have any IP you would tell us that if we fail you will have nothing but promises to back up our investment in you.
But, you'll also tell us IP is worthless without a solid business model and sales to go with it when you look at valuation.
One of the challenges with IP for smaller companies is the fact that large companies can often put more lawyers on the job and litigate them to a business death regardless of who is right.
Having a large VC behind a start-up acts a protective barrier that can often come in handy in a litigious marketplace.
10. “All we have to do is get 1% of the market”
What this really means: Yep, didn't we hear that with China?
Similar to #1 and #2 above, entrepreneurs must spin a great story and show how their "magic" recipe will grab market share from competitors.
The good thing is that if 1% of the market will make this company a success then the target market is likely large enough for a VC to be interested in it fulfilling challenge #2.
Kawasaki says: “The average number of these 10 lies that I hear in most pitches is 10. At the very least, tell investors new lies.”
If you think about this from an investor perspective, they look at hundreds if not thousands of business opportunities a year.
Most of the start-up executive memorandums and business plans submitted to the larger VCs are looked at first by entry level MBAs from expensive schools.
How long do you think these guys would last if they asked a partner to look at an investment that has little potential for fast growth and will require many years before they get a decent return back?
Same thing goes for the partners. No partner wants to go into a deal on their own without any other partners from their firm thinking it could be a home run.
They want all the partners to buy into a company they champion so if it goes south they don't have a finger pointed at them down the road when the fund hasn't made a great return to its investors (only the top 25% of VC funds make profitable returns and half lose money).
Entrepreneurs must take a step back and look at the big picture in order to properly prepare themselves for the investment game.
These are the things that any potential investor will wants to see in order to invest in your start-up and you.
You need to tell the truth as much as possible but also know this is a dance and you need to get in the door to pitch your idea and your team.
On the flip side, investors often anticipate a bit of exaggeration during the pitch process and it is built into their evaluation of your company.
David Brown is the founder and managing partner of IMES, a technology commercialisation consultancy focused on helping Australian start-ups enter North America. Dave's passion for marketing, strategic planning and startups has taken him across the globe and spans numerous industries. You can follow him on Twitter @IntlMktEntry as well as IMES Facebook.