Top 10 lies investors tell entrepreneurs: Finance
Top 10 lies investors tell entrepreneurs
By David Brown
Last week, we outlined the top 10 lies that entrepreneurs tell investors and what was "really" being said.
But this is only half the story of the investment dance. Plenty of start-ups are fobbed off and outright lied to by investors they pitch to. But why?
Venture capital funds are an investment vehicle for those that are looking to gain potentially higher returns than they could in a traditional banking set-up.
Money can come from many different sources such as institutional investors, university endowment funds ($400+ billion in the US alone), superannuation funds or wealthy individuals, to name a few.
During the 10-year average life of each fund the management team needs to go through a period of start-up investment analysis and investment (year zero to three), pruning companies that don't look like winners or outright fail, reinvesting in companies that look like winners (year three to seven) and finally selling off their assets to return the fund proceeds to the investors.
During this time they are investing their knowledge, connections and management skill to create as many winners as possible while killing off potential losers as early as possible in the process.
If their fund isn't going well it will be much harder to raise fresh capital for the new fund, so most funds need to show some winners before the second capital raising window.
Many entrepreneurs often forget or gloss over the important fact that venture capitalists have to report to their investors just like the entrepreneurs do.
It is also critical to know where each fund is at in the investment cycle in order to hit the sweet spot, unless they are looking at a top up Series A/B/C round when it is less important.
Now that we have a better idea where investors are coming from when evaluating start-ups, let's take a look at the top 10 lies told to entrepreneurs, as outlined by one of Silicon Valley's venture capital stars, Guy Kawasaki of Garage Ventures.
I’ve added my own comments to Kawasaki’s 10 lies to help you through the bull dust and get down to what is "really being said" in the investment dance.
Here is a list of the top 10 lies investors tell entrepreneurs, and what they really mean:
1. “I liked your company, but my partners didn’t”
What this really means: This happens; VC partners don't always agree, and don't want to be the only one to pick a company within their own VC team. If something ever goes wrong guess where the finger points!
Start-ups should evaluate the partners at a firm just like any sales opportunity and try to win over as many high-level people as possible.
This will come in handy when the road gets rocky (which it inevitably will) and you need as many internal champions as possible to support your company rather than killing it.
2. “We are patient investors who want to help you build a great company”
What this really means: Ha ha! My fund is a 10-year closed one and I have three years to invest, three more to re-invest and four to divest – you figure out the timing.
We're not patient, we expect you to shoot off like the rocket on the sales hockey stick you pitched us with and if you don't we'll end your run and look at investing in another potential winner before we run out of time.
3. “If you get a lead, we’ll invest too”
What this really means: Umm. I didn't say I would invest with just any other lead investor, did I?
I have to like them, they have to give us favorable terms, we keep a majority stake/board seat and we want to call the shots.
Oh, did I forget? We golf on Tuesdays so the board meetings can only be Wednesdays at 3pm.
4. “There are no companies in our portfolio that conflict with what you’re doing”
What this really means: Yep, there is also this game called liar's poker and man, are we good at it! Please come in and tell us everything you're doing so we know what competition our current investments will face.
5. “Show us some traction, and we’ll invest”
What this really means: Can't laugh at this one because it is fair, most of the time. But if I don't have money to gain traction – how can I do it?
This is a really tough one for start-ups and speaks to having sales/clients lined up while you're creating the product or service.
Find out what the sales dollar number they are looking for is, if there are specific clients you have to sell into and what time period you have to get traction in.
Then, get them to agree that if you do x, y and z they will invest in you. Don't leave the traction question open ended, it rarely works in the start-up’s favor.
6. “We love to co-invest with other firms”
What this really means: As long as we take the lead, they follow what we want, our lawyer is bigger than theirs, we get our equity out first, we choose the next CEO, board, management and so on.
On the larger, later A,B,C rounds this is pretty standard practice and often a good thing because it means the start-up is winning.
However, if this is a seed round it means they may not have enough faith, money or know-how to help you – but you have a good idea.
7. “We’re investing in your team”
What this really means: But wait, didn't we already say we don't think your team is proven? Once the money is in the bank they have invested in your team.
This is a cliché but it usually is true – unless they invest with the caveat that they bring in their own CEO, CMO and sales team, etc, most VC investments are in software start-ups with little that’s tangible beyond the brain power and drive of the team they are betting on.
8. “We have lots of bandwidth to dedicate to your company”
What this really means: As long as it doesn't interfere with our golf and sailing schedule – we're so busy you know.
Oh and don't forget if one of our companies starts looking like the next Google, Facebook, Groupon, etc, we're really, really busy.
The bottom line is that start-ups should look at firms that have people with the connections they need to make things happen faster whenever possible.
The problem here is that the top 20% of firms often get to see deals first and they are in the driver’s seat.
Start-ups often have to go with whoever will give them the money.
Therefore it is important that they have a good idea what they can realistically expect a firm to do before they sign on the dotted line.
9. “This is a plain, vanilla term sheet”
What this really means: Except for all the perks for us that may hurt you down the line, you have no idea how much we pay our lawyers to slide stuff in, and we know you can't afford a top notch lawyer.
Sadly, once the lawyers get involved things often slow down and usually when the start-up needs the capital infusion the most. This is where you need due diligence.
Hire a strong, competent lawyer or preferably a firm that is not in bed with the VC and realise you're going to have to pay more to him than you think you should to protect your company.
You can also sometimes hire lawyers and pay them based on a successful raise rather than upfront, which doesn't save you money but may allow you to get better counsel than you could otherwise.
10. “We will get other companies in our portfolio to work with you”
What this really means: Right. They are under the pump just like you are.
They may have some good advice and it doesn't hurt to ask but don't count on that once the term sheet is signed.
Another perspective is that as a start-up you will be introduced to winners in the VC’s portfolio that will sing the VC's praises.
Make sure you find some of the "losers" and ask them how things worked when the bull dust hit the fan and they really needed some help.
Will they roll up their sleeves and help you out or tell you to figure it out on your own and even pull your funding?
By looking at both winners and losers you'll get a better overall perspective on what your investor is like to work with.
Venture capitalists/investors have the money and can tell start-ups what they want to because they are usually in the driver's seat.
They almost always have more deal flow than they can handle and more investments they would like to make than time and resources to make deals.
They are also under enormous pressure to make a fantastic return for their investors just like start-ups for their VCs.
The life of investors and start-ups can be thrilling as well as extremely lucrative. However, with every success there are four or five failures in a normal investment fund cycle.
Start-ups need to do their homework and read between the lines whenever they are speaking to investors in order to understand what they’re really saying.
When evaluating which VCs to go after, ensure that the investment firm is in the right investment stage for them as well as looking at any potential competitors, and a good investment fit.
VCs will not sign non-disclosure agreements so anything you tell them is liable to go to your competitors.
If they have direct competition then that is not the fund for you and you should avoid them.
Also check out the partners, the overall recognition of the firm and be clear on what each firm realistically can deliver to you as part of the investment deal.
All VCs/investors are not created equal. Sometimes a better dollar investment, while looking good on the surface, doesn't equal a better deal.
Start-ups should ask tons of questions both inside and outside the organisation and treat an investor as they would a potential marriage partner.
Once they take the investor’s money they are in it to win it or lose it with the VC they have chosen.
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.
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