Bill Reichert: Top 10 Lies VCs Tell Entrepreneurs

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thank you very much it is it is my great honor and distinct pleasure to be here today back in a room where I took several different classes actually but I I was asked to come back after last spring I had made a presentation to the Stanford venture capital Club I guess and I did as part of that presentation talking about venture capital I did my top ten lies of entrepreneurs and VCS so I gather the organizers asked me to come back and do an encore performance but it wasn't which I'm delighted to do but it wasn't crystal clear from the title on the program exactly what the session was supposed to be about so if there is any confusion you know why I'm talking about lies the point of this session is to talk about that process of venture capital where the entrepreneur and the VC get together to talk about raising capital so there's a lot of discussion in entrepreneurship about building companies and building teams and strategy and all that stuff not a lot of discussion about that that fairly unique odd little experience that entrepreneurs have which is talking to VCS and raising capital and then dealing with the VCS so in order to try to make some what light and interesting of what is otherwise a fairly serious and painful topic we we created a garage a series of of lies that VCS tell entrepreneurs and entrepreneurs tell lies as a way of elucidating the process and trying to talk a little bit about what works and what doesn't work when you're raising capital with venture capitalists to be to be more precise the origin of this particular this particular session was way back when we were starting garage I was at a conference one of those big VC conferences where you get entrepreneurs on stage and they get six minutes to expose their lives to an audience filled with feces who are passing judgment on them so you pay thousands of dollars to go to these things and I was at that point I felt like an interloper I had been an entrepreneur all of my career I had been on the other side of the table the guy who stood up there and exposed his life and now I was in the audience and I was sitting with the VCS and I was standing in the back of the room listening to the entrepreneurs watching them feeling their pain and there in the back of the room next we were two VCS and one VC turns to the other and he says how do you know when an entrepreneur is lying and the other VC kind of looks at him and goes I'm not sure how and the first VC says his lips are moving so the point is if you're a VC and you're listening to pitch after pitch after pitch after pitch you know in spite of what everybody says about the importance of entrepreneurial passion and enthusiasm and optimism the reality is investors really don't want to invest in people who are out of touch with reality and so what happens however is all of us who are entrepreneurs and our enthusiasm we tend to stretch the truth and by doing so we lose credibility with investors and so from an investor point of view to twist another adage there are lies there are damn lies and there are business plans and so the point of this presentation is to talk a little bit about typical areas where entrepreneurs tend to go beyond the bounds of appropriate passion enthusiasm and tend to misrepresent the reality of their business so with that let's go through the top 10 lies of entrepreneurs when pitching to venture capitalists lie number one is our projections are conservative so virtually now every entrepreneur has been taught not to say this but the reality is when you get down and dirty into financial projections every entrepreneur has to at some point they come to that point in the sentence when they say but but but there's so many things we can do I mean there's so many other markets there's so many other products these projections are really real me and they you know they're trapped at that point and they look at them you know they stand up and they say conservative realistic I really think we can hit them but the reality is the reality is everybody misses their projections and so does on the one hand and every VC knows you're going to miss your projections and the point of projections is not to be precise and accurate the point of projections is to tell the story of your business and what it could be so on the VC side we never really really expect you to hit the projections we certainly hope you're going to hit the projections and we certainly want to understand the logic behind the projections but the fact that you're an entrepreneur means by definition they can't be conservative because entrepreneurs by definition aren't conservative so don't say our projections are conservative my number two our market is 56 billion dollars and again you know MBA after MBA entrepreneur after entrepreneur pulls out statistics from IDC and Frost and Sullivan and all of you know Gartner group with these reports that say hey you know by the year 2010 conservatively projecting this market is going to be 56 billion dollars but of course all that shows the investor is that you haven't done good market segmentation because certainly no entrepreneur no startup company is targeting a fifty six billion dollar market you know best case you're going to get some fraction of a fraction of a percent and that's not really what business is about and so what you want to do as an entrepreneur building your business plan is you want to carve up that market and figure out what in fact is the sub segment of that market that you're targeting because from the point of view of the investor saying your market is 56 billion means that you don't really understand the narrow specifics of your market and the opportunity that you're targeting line number three our contract with Cisco Microsoft Oracle whatever our contract is going to be signed next week so one of the dirty one of the dirty little secrets about the venture capital funding process is that when you walk in and you pitch an investor you're not going to get a check that day it's going to be an extended process in fact it's going to be months not just weeks between the time that you meet with the investor and the time that they're actually going to close the deal so anything you say to an investor about something that's going to happen within the next six months had better happen it damn sure better happen but in all of your enthusiasm because you know you've got a contract in legal at Cisco you know you want to share this wondrous story of how you're about to close Cisco right but inevitably inevitably it's going to get quote hung up and legal or somebody's going to go on vacation or something like that and you have just said to the VC last week our contracts going to close you know next week two weeks later they finally get around to following up and they say oh yeah that contract that closed last week how's it going well you know and so all of a sudden you've blown your credibility again because in the space of one week you've already failed to live up to your projections if you can't if you can't hit a one-week deadline how the hell you going to hit a five-year deadline right so if you've got a lot of great stuff going on while you're talking with the investors play it low-key only talk about the stuff that you've actually accomplished you know thrill the investors with what you have in fact accomplished a date and then in the weeks that follow surprise them delight them with the news that you've closed a new contract you've got another customer you've got a beta you've got you know you've hired some you know wondrous Talent don't promise things unless your apps are absolutely sure that you're going to deliver it line number four if we only sell 40% of the company we'll still have control now one of the big concerns entrepreneurs have is the structure of the cap table they're anxious about you know kind of at what point can those investors wake up on the wrong side of bed and decide to throw my ass out of here and you know that's it's a reasonable concern but the assumption that happens sort of outside the VC room the VCS aren't in the room and then the-- you know the entrepreneurs are sitting there looking at term sheets or thinking about valuation issues and they're thinking to themselves was long as we don't sell 51% of the company you know we'll still control this company two big problems with that one it's wrong you know as soon as you sell a single share of stock to somebody else you have a fiduciary responsibility to other people you know so that's just sort of basic law but the second issue the second issue is that this raises a huge red flag for investors if you're concerned about control if you're concerned if you have a point of view starting at the beginning that you have an adversarial relation to the Senate ownership it doesn't set up a lovely relationship with your investors so you want you first of all if you are anxious about control then you got to make sure you work with investors that you like to work with people who have a reputation for integrity honesty being straight with you who you know aren't going to screw you but you got to pay attention to the fact that it's not about the percentage of the cap table it's about your relationship with your investors and your performance as an entrepreneur line number five there's no competition in our space we hear you know all sorts of variations on this particular theme one is you know there's there's no direct come there's no direct competitor throw there's the other famous one is no one else can do what we can do so that's a form of non competition I suppose the question of course is do you understand what competition means when you're building a business there's no competition in our space implies that nobody's doing what your solution promises to do because if nobody is because if somebody is doing it then there's an alternative to your solution and if there's an alternative to your solution then of course there's competition it's that usually and frequently for early-stage companies that alternative is the status quo it's either you know doing it yourself or using an old technology to do it but if somebody is if if you have a value proposition whether it's to speed up the infrastructure of an enterprise network or if it's to offer messaging over mobile phones to consumers there are other there are other solutions out there that may not use your technology but they're an alternative solution to achieve the same value proposition so when people say there's no competition we have one of two reactions either maybe indeed nobody in the face of the planet has ever done this before in which case it's probably not that interesting you know it's probably a classic example of a technology in search of a solution and that's not to interest interesting or or the entrepreneur gets up there and says there's no competition when in fact you know a couple of minutes on Google would reveal the result sorts of competition and then we realize the entrepreneurs bozo and that's not conducive to raising capital either so make sure no matter what when you're talking about the competitive environment at least you acknowledge the status quo at least you acknowledge you know the homebrew solution or whatever the alternatives are as a way of explaining how you're going to compete in the marketplace and what your competitive advantage is line number six we've assembled a world-class team now every once in a while this is true but you know even for great experienced serial entrepreneurs at the early stage it's pretty much impossible to have assembled a world-class team but again everybody every on Twitter are wants to be wants to be thrilled with their partners and wants to show the love that they've got for the team that they've assembled and so you're sitting in the conference room with you know their roommate the engineer and their wife's brother who is the sales guy and you know you're standing up there and saying you know we've got a world-class team and they may be great people and they may be perfect for the stage of the company but they're probably not world-class team and they're probably people who are not going to be the senior executives two or three or four years from now assuming you're successful and so I'm not suggesting that you shouldn't be delighted with the team you have but I'm suggesting it's important to be realistic about the need to evolve teams over time and that may include you yourself independently as an entrepreneur you may be absolutely the right person to start this company up but over time you may take a different role an appropriate role in the in the company as it grows excuse me why number seven our sales cycle is three to six months and that's conservative by the way so you know this is yeah this is probably the single biggest problem in hitting financial projections hitting goals and objectives for companies everybody everybody gets this wrong and I don't I don't know why that is you know every you know you hear the you hear the examples of course every once in a while they're famous they're on the covers of magazines because they actually meet their plans right there very few companies that actually hit their sales plans and that's because entrepreneurs you know people generally miss estimate the sales cycle and one of the reasons this happens and you know having been this been through this myself is you're sitting there you're trying to plan out the operating plan for the year and you're looking at your pipeline and you know the customers you've got going and you're looking your products and all that and you're saying to yourself okay you know let's look at the last 10 deals we closed well you know we look at the last 10 deals we closed and they closed on average in 4550 days you know and so you know we've got data we've got data that shows that on average you know we close our deals in 4550 days so let's be you know let's hedge that a little we'll say three to six months right but statistically and in the real world what really has happened is you've got ten deals you've closed and you've got another forty deals that you haven't closed right it's the rest of the pipeline hopefully god bless you you have 40 more deals on your pipeline but all of those 40 deals haven't been averaged in two that 45 50 day calculation so you're off by that factor right you know however long it's going to take to close all those guys actually has to be averaged in and so again it varies from business to business but unfortunately the way the calendar works the way humans work it's really really hard for anybody to get a contract to get a contract signed by an organization in less than a six month period and usually you know when just looking out there at different businesses and enter particularly if you're selling to companies the time from the very first meeting if you're talking if you're time from a very first meeting through all the evaluation through god bless it you got a pilot you know god bless it you got the CIOs got to sign off before you're going to plug this thing into anything you know and God bless legal gets through it in less than 30 days right it adds up nine 12 months minimum to get these sorts of things done but it's it's really hard when you're putting together the operating plan of the business plan forecast to admit that you know it's going to take twelve months on average to close each of these deals so be very cautious about this and be able to explain how it is that your sales cycle is going to evolve in your particular business ideally somebody on your team has had a lot of experience selling into your market and has a lot of real-world experience and what all of the elements of sales are but frequently and this is one of the I think one of the biggest issues facing a lot of companies you know even facing the MBA curriculum I think is that the discipline of sales and sales processes are not well taught well understood and well managed in most startup companies line number eight we have the first mover advantage so this was actually this was particularly exciting during the bubble its I noticed you know it kind of disappeared when the bubble burst does this phrase but I noticed it's coming back it's coming back particularly in web get all these web 2.0 things because with web 2.0 you know it's really easy to get something up and running and you know so the game is who gets the critical mass and the buzz and you know the mentos video first right and so it feels as though and I've even you know read books by credible authors about you know the importance of first mover advantage and you know in some cases it's taught in the curriculum about you know the importance of being first and that is the basis of market share and market share is the basis of the experience curve and the experience curve is the basis of competitive advantage and so first mover advantage is you know historically it's an important thing but the reality in startup companies technology based startup companies is there's a whole bunch of stuff that can go wrong if you're the first mover first of all generally the first guys to have the clever idea that you know once the technology is good enough to enable you to do something interesting like you know integrated messaging systems using your cell phone or something the problem though is you've got the first generation of technology protocols that are going to be you know they're they're not quite stitched together all that well and they're still pretty expensive and you got a lot of heterogeneity in the system not a lot of standardization and so frequently the first movers are the guys that spend the most money trying to get to market and at the end of the day they wind up having a you know mediocre solution and so they spend a lot of money take a number of years for you know enabling the market to figure out how do we really want to do this thing that these guys have invented and then a whole bunch of other guys come along swoop in take over the market and so you see that time and time again in the VC marketplace so when an entrepreneur gets up and says you know we're going to be the first movers that's a red flag to us because we're we're thinking to ourselves well first of all are they really the first movers in probably they aren't because probably we've already seen four five six other teams that may or may not be in stealth who are doing exactly same thing but secondly the question is can they really get to market and stay ahead of the curve or are you going to wind up building a building a solution on a platform of code that's going to be obsolete in 18 months and the guys that come along in 18 months using the next-generation protocols the next-generation standards they're going to be able to get to market with a solution that's even better than yours in five weeks from the time of introduction and you're going to be scrambling because you're gonna have to rewrite your entire code base from scratch so it isn't necessarily the most compelling business idea to be the first guy to create a solution once a solution becomes technically possible so that's that's I got to tell you having been on the entrepreneur side of this that's that's a tough one because once you have the idea you know you're standing there in the shower thinking to yourself this is a great idea right and nobody else has done this yet wouldn't it be cool to be the first guys to go do this and that that probably can make sense you just got to think through do you have the resources and the staying power to be the first guy out there and then to also be the fast follower to be too quickly cannibalize what you've learned and get a new solution out there before everybody else leapfrogs ahead of you line number nine all we have to do is get 2% of the market right so this is the coral area of our market is 56 billion right so you get you you know you segment your market carefully you identify all the possibilities you know after all there are now two billion cell phones on the planet right you know selling it close to a billion a year so boy you know two billion cell phones and all of them can receive a text message right so let's see I you know it's certainly possible for me to get to a couple hundred million cell phones that'd be pretty easy to do wouldn't it I mean it's not that many so it's really easy to talk yourself into this sort of rule of large numbers that says there's so much stuff out there and there's so many people doing things in this space you know myspace is the other favorite you know if I could just get a few people to start a viral kind of adoption of this widget on MySpace you know it's a piece of cake for me to have 10 million people in you know implant my widget on their MySpace page I mean of course that's easy to do right so the point is you get you get wrapped up in how many people and how many how many dollars and how many potential customers there are for a given solution and there you are looking at your Excel spreadsheet and you're thinking yourself I can't go to these VCS and tell them we're going to be two billion dollars in you know year three right because it's you know it's unrealistic to be two billion dollars in year three but at two billion dollars that's only 10 percent of the market right so you know so we'll be conservative and we'll cut it back well the problem there is not that you've been optimistic about your market share the problem is that you've missed defined the market that you're going after you know there's a very narrow for most applications there is in fact a very narrow customer base that you really can go after who are likely to adopt it within any sort of realistic time frame so it's about narrowing your target market of which you will then have a significant percentage rather than taking a big market and saying you know we're going to start year one we think we should be able to get 1/10 of 1% of the market and that's you know a five million dollar company right so we see this all the time you don't want to take an arbitrarily large market and then do a bottoms-up assumption on how you're going to generate revenue what you want to do is you want to isolate the target prospects for your business think about you know specifically who are the customers who might buy your product in the first 24 months and if you're selling into business you should be able to name them and figure out or if you're selling into a consumer market you should be able to identify the channel by channels who you're going to get to you know can you realistically get into Best Buy in the first 12 months of being a business or whatever I don't know pick your market take it apart deconstruct it and then figure out bottoms up sales call by sales call marketing campaign by marketing campaign realistically how are you going to build up these numbers against what market are you targeting so if you say all you need is 2% of the market as an investor we say well you know either you don't understand your market or we want to go after the company that's going after the other 98% and then line number 10 my number 10 is I'll be happy to hand over the reins to a new CEO this goes back you know to your world-class team and it goes back to you as an individual entrepreneur as well that you know again most entrepreneurs now have been coached well enough to know that at some point in time maybe they're not the right CEO for this company the issue that investors have is when the entrepreneur says this are they in fact sincere or is in fact what the entrepreneur saying in subtext I will hand over the reins to a new CEO if that new CEO is the right CEO for my company right and that's just a big red flag you know if you think it's your company then we're likely to have a problem that is a concern for investors because it is not your company it is our company it includes the rest of the management team it includes the rest of the investors it includes all the employees it has to be a team effort if you have an ego centric perspective that this is your baby and your baby alone and it's your job as steward of this baby to make sure that you were the one who decides who the right CEO is for the company you're likely to butt heads not just with your investors but with the other people on your management team so this is a way that investors can set out what is the real ego involvement of the entrepreneur in this in in this particular company so those are the top 10 lives of entrepreneurs I guess question is whether it's worth taking some questions now or should I dive into the to the other side of the coin and take questions at the end so anybody sitting here with an absolutely earning pressing got to have an answer to now kind of question or shall I go on to the top 10 lies of VCs okay in that case I will go on to the top 10 lies of venture capitalists but first if I may by the way while I'm am well I'm catching my breath my dear friend here Larry kubal you were also Stanford right okay was suggesting to me that I have not completed the four square matrix here so we have entrepreneurs lying to VCS and we have VCS lying to entrepreneurs but as Larry points out being a VC at a firm called Labrador there's another dimension to this which is VCS line to these seeds which is you know extremely common you know you know if I yeah someday somebody's going to write the expose you know they're going to get into somebody's email box and all the you know all the pitches VC sent to VCS about their you know oh wow I found a great investment and you know we we just put the seed money into this company and it's going to be a rocket and I'm gonna because you're my dearest friend on earth I want to let you in on this deal great so so Larry what you think of that presentation so in any case top 10 lies of venture capitalists and again so here we are in this in this surreal world you know you as an entrepreneur trying to build a company and you know you're really focused on the important stuff right you know getting products that work and understanding the market and we're lining up customers and building a team and then you've got these other people you got to deal with these guys called venture capitalists and they're kind of a different breed they're not like your customers I mean your customers you know how to talk to customers but these VCS they don't react the same way as customers and it's hard to understand what's really going on in there and so the point of this presentation is to provide a guide to the language and culture of venture capital it's sort of a sort of a different world you're going into and it's valuable to understand what it is VCS are saying when they say things like I like the way you think so what do you really mean Larry when you say I like the way you think huh okay okay hey I'm not the SEC sure I understand what you're saying but you know unless I'm nice to you I won't hear anything more right right right so okay so with that let me share with you our particular perspective on the top 10 lies of VCS and by the way I should assure you you know this was it was really hard work distilling down from the hundreds and hundreds of possible lies but what happened in fact was so you know I had developed this top 10 lies of entrepreneurs thing based upon that conference I went to and we gave it you know in a few cases and it actually wound up getting published in the Harvard Business Review and then someone said well wait a second you know how come you're not you know giving equal time to the VCS and so guy came up with a with the you know this this idea we got to have top 10 lives of VCS and we sat down and you know we went through all these things that we said to entrepreneurs and that we've heard other people say to entrepreneurs over the years as entrepreneurs and sitting on that side of the table and so with that try to do our best to distill it down to the top 10 so line number one we like to move quickly you know and you know so again you know you go in you pitch to the VCS and they'll tell you how their streamlines I make quick decisions and you know the partners let's see it's Friday the partners meet Monday boy you know you should have a check by Tuesday as the impression you know they almost give and the reality is you know one you know these these are people too and they they over promise and under deliver as a rule and but the the dirty little secret underlying this particular point is the the process really does take a long time it does take months generally from sort of the initial contact to closing the deal and part of that is because it's extremely valuable to the investors to watch how you and your team perform over the period of negotiation with the VCS so it's you know we have this inside garage I'll be disclosing here and I probably shouldn't be but I will and anything so we we refer to deals as either microwave or slow bake and sometimes you get a deal and you say okay maybe this is a microwave kind of deal now 60 seconds boom we want to cook it and we want to make it happen and generally from a VC point of view it's a microwave deal if you're afraid that that you know if you don't move quickly something bad will happen and usually there's something bad that will happen if somebody else will take the deal right you know or this you know sometimes we're more altruistic than that and we say if we don't move quickly then we won't get the market opportunity we won't be able to take advantage of the market opportunity quickly enough but that's extremely rare almost every deal in the venture capital community can be a slow bake and the reason slow bake is good for the investor is again they get to see how things evolve over the weeks and months that pass so when you go in you pitch a VC and they say we like to move quickly be very very realistic about this and understand that you know it's going to be it's going to be multi multi weeks if not multiple months in the process and that there everything you do in that process is being evaluated it's not just about what's written on paper or what was on your slide presentation it's about your performance about it's about when and how you return calls it's about the quality of your emails it's about you know whether you actually deliver on what you said you would do the prior week all of these signals as to the quality of you and your team as an entrepreneurial team really really matter and that's part of the data that's being gathered yeah they talk about the formal due diligence process and you know they have lawyers that look at contracts and they look at your patent your patent applications but that stuff is really less important than how you're behaving over that period of weeks BC line number two we're value-added investors you know we can really help you build your company what they're really saying is because we're such great guys and such a great team we have such a great network you of course should take a lower price in the valuation of your company you don't want dumb money right you don't want dumb money you want to value at an investor you know surely anybody who bids higher for your equity then we bid you know must be dumb money right kind of by definition so we're value-added investors is all about saying you know we are going to help you with more than just money now I don't mean to suggest I don't mean to suggest that VCS aren't value at investors you know Labrador ventures for example is an extraordinarily capable venture fund in terms of helping companies build their companies right helping operators build their companies but when you're in a meeting before they've invested and they say this part of what they're setting you up for is when and if we give you a term sheet and you notice that our pre-money valuation is lower than some other firms pre-money valuation the reason for that is that we're going to make you richer because we're value-added investors so that's the subtext of that particular statement corollary to that is we have a great network part of being a value-added investor and when you probe down into that what you find out is that network network network includes things like my son plays baseball with Scott McNealy son lie number four I really like your company I just couldn't convince my partners basically what they're saying is I don't want to have to admit to you that I just wasted a bunch of your time going through this process it is in all fairness to venture capitalists it is you know it's a very challenging process that you see you know a great team with a great idea with a lot of energy and a lot of potential but the challenge for entrepreneurs is not is not proving it's not proving that you have a good idea that could generate a lot of money the reality is your that's that's not the proof point that's not where you're trying to convince the investors what you're trying to convince the investors is that you're the best next investment for their fund that's a very different sales proposition than proving that you're a good idea and the problem for you unlike selling to a customer if you're selling to a customer you know exactly what the alternatives are right you know don't buy the Cisco router by our right router because our writers spec spec spec spec spec benefit benefit benefit benefit you know you can sell against the known competition when you're selling to customers when you're selling to VCS you don't know what the competition is right you don't know what are the term sheets they have out or who else they're talking to and so there you are thinking that you've got a great brilliant idea and you've actually got a partner who probably is genuinely enthusiastic about your company but it may be that you're number four on their list you know being number four on the list is not at all bad it's just not good enough to get a term sheet and so on some Monday morning meeting with partners they sit down and they say yeah you know that team that came in really really interesting let's keep looking at them but no we're not going to we're not going to deliver a term sheet and this guy comes back in says you know how I said I thought I could have a term sheet by September let's see it's January oh yeah my I really want but my partner's it was my partner's who wouldn't let me do it so that's what the dynamic that's really going on behind the scenes line number five we like to syndicate huh what that means is if Sequoia gets excited about this you know we'll be happy to come in so again this is a little unfair to these C's because VC is in fact do like to a need to syndicate but there's a difference between a VC that is happy to take the lead and drive the process versus a VC that says to you if you find a lead let us know right so if if if the VC says to you if you find a lead investor let us know what that VC is telling you and very clear distinct languages no we're not investing right so the on the other hand if a VC says you know we like to syndicate and you say great who are your best friends and they say I'm going to call up you know Larry and Howe and Tim you know this afternoon and we'll get together and we're going to put this together that's very different if they're actually going to do the work to build the syndicate that's a great thing it's a great thing if you get a lead investor who's going to sell your deal to other VCS if you've got an investor who says they're enthusiastic but he's not willing to sell your deal to other VCS then they're not a qualified investor for your company well I number six we need to see a little more traction this is a famous one again what the investor is really saying is we're not going to invest but you know as Larry pointed out I don't want to close I don't want to close off my options because I really like the way you think I don't want to close off my options this may be an interesting deal let's stay in touch which is a way of saying report back to us on a weekly basis what sort of progress you're getting so the the challenge for the VCS again as I as I learned to appreciate after cutting over to the other side the dark side as they say is that every good deal every good deal in the history of edge venture capital was once a bad deal right Yahoo was a really stupid idea for the first 24 investors that looked at it you know nobody would invent nobody would invest at YouTube when the guys first launched YouTube right nobody would invest in you know pick a company right every successful company was a bad idea to a large number investors and then something clicked usually rarely was it that you know they you know magically the right investor came along and the clouds parted you know and the heavenly chorus explained the brilliance of the business idea to that particular investor that's rarely kind of the way the dynamic really works usually what happens is the team gets rejected and they tweak the model and they work a little harder and they seek out advice and then they get rejected again and then they tweak the model and they seek out advice in the build team and then they get rejected again and then finally after twelve or fourteen tweaks they click on something you know something happens and they get a beta test at some company or some advisor comes in and opens up the door to some big company something happens that changes the optics of the deal and then all of a sudden the investors have a different perspective on this deal so the challenge for entrepreneurs a challenge for entrepreneurs is having the staying power to do 12 to 14 iterations before you get it right and then what every investor knows is after the money goes in you're going to have to go through at least two or three iterations one more you know again before you get it right but as an investor you want to see the first twelve or fourteen done in somebody else's nickel you don't want the first twelve to fourteen done on your nickel so that's why investors say we need we need to see a little more traction and why it's perfectly legitimate for you to both hear it as a no but if in fact you can tweak it and change your model go back and find out if they're going to say something more substantive line number seven we invest in teams what they're really saying is you know assuming the technology works and assuming this is a huge market we invest in teams right and what the investors want you to know is you know you hear this all the time on these panels is that the success of a company is a function of the team does the team have the flexibility and the knowledge and the domain experience and the talent and the you know the right ego and the right confidence to evolve a business into a successful business teams are in fact critical but part of what the investors are saying to you when they say we reinvest in teams is they're trying to give you comfort that we think you're the right team and again they may in fact think you're the right team for exactly this moment in the company except for the fact that as soon as the money goes in we got to go hire a new CEO because you know your roommate just doesn't quite cut it he may be a good coder but he's not a CEO and then we got to go higher you know a guy who's really a VP of engineering who really has experience developing products you know on time on budget but for right now today this week the team you know is the right team so from an investor point of view we're not expecting the team to be the complete team when we write the check but we are expecting that the team works effectively together that you're perfectly capable of living on rice cakes and mountain dew for an indefinite period of time and most importantly that you're capable of attracting high-quality successors to each of you in your positions it's that issue of is there a dynamic here the you know this combination of excitement and opportunity and capability and competence that make will make other people want to jump on this team that will make very talented people give up their options in another company and give up a higher salary to come take advantage of this opportunity that's what we're looking at when we talk about investing in teams line number eight and the board meeting so from now on I guess the next three lies are sort of post investment lies okay so imagine you actually got through the hurdle and now now we're at the board meeting at the board meeting one of the one of your investors says you know when we were doing this at Cisco I watch out but that really means is all I've got is a hammer and you're looking like a nail to me you know the adage about if all you've got is a Hammer Every Problem looks like a nail and there is a challenge there is a challenge in the VC community that a lot of us come from very specific backgrounds you know I come from a software background and so a lot of my experience and a lot of my scars have to do with getting software out into a market through channels to customers big sales small sales channel sales all that stuff and you know on time on digit budget hitting plan so I've got all of this historical experience in my brain that that filters every problem I see when I'm sitting on a board and so the challenge you've got as an entrepreneur is you've got this entrepreneur who made several of this venture capitalists who made millions of dollars because he was employee number 785 at Cisco so plate number 785 and Cisco made millions of dollars that's pretty cool right and this guy thinks he was there you know and he'll what he'll say is you know I was there at the beginning right I wasn't play number 785 right and so they tend to assume that gives them wisdom about start-up experience right so I really don't mean to pick on X Cisco people I apologize if there's anybody there who made millions of dollars in Cisco but in any case there is this tendency for VCS to have a certain perspective it's one of the most important reasons to have more than one investor in your company and what sometimes happens that is a challenge for entrepreneurs you know sometimes they get a sole investor whether it's a VC or an angel a sole investor as the investor in their company and you know if you can do something to counter that I strongly urge it because there is a tendency if you have a sole investor for that person to say this is my money and I know how to do things the right way and let me tell you how to do them so you got to watch out for this particular VC line number nine is you're at the board meeting things aren't quite quite going right but the you haven't spent a lot of time talking with your investors on this and at the board meeting the investor says you should lean on us for help and the challenge you've got there is what the NVC is really saying is I don't know what's going wrong here I don't understand what's going wrong otherwise I would have told you what you should have done right but if they say you should lean on your board it means I don't have the answer but we need to spend more time trying to figure out what's going wrong on how to get to the right answer line number 10 is m and line number 10 is good work and what that means is I'm probably not going to fire you this week so again yeah the challenge fraud Twitter's and investors is if you make the quarter that's great but you know if you miss the next quarter I don't care if you made the last quarter what I care about is that you missed the next quarter and that's the the challenge that investors have so understand again the culture of the VC who is reporting back to his partners each quarter on the performance of the companies that he's watching over and you know you go back into your partners meetings and you talk about well there's this challenge and there's that challenge and no matter what the facts and circumstances one of your partners is going to say well is that guy the right CEO you know should we be thinking about a change right and so that's the the the problem for the VCS is that VCS are all taught that fundamentally their sole responsibility for managing an investment is the decision of the CEO and when to fire the CEO so it's all about you know should we make a change in the CEO position and it's a perfect it's a perfectly legitimate model for board governance and board dynamics but the challenge for an entrepreneur is once you take investors on once you take on a board it's that board's responsibility to evaluate you continuously and so if you you know if you do perform well that's great keep up the good work if things are going wrong you have to be aware of the fact that the board is going to be thinking at some point maybe it's time for a change and so what a lot of entrepreneurs do is they then hunker down and that's not necessarily the best solution the entrepreneurs that survive the process of the entrepreneurs that open up and they reach out and if something is going wrong instead of ducking it and saying let's have fewer board meetings this year you know why don't we just have a board meeting every six months that's a natural entrepreneur instinct right instead of doing that you go out to lunch with each one of your investors and you lay out what's happening and you talk about what you've done and what you've accomplished and you talk about what you identify as the challenges and you say what you wanted what you want to make sure all of your investors know and all of your board members know is that you do understand what the challenges are and you do have a plan on how to address them and you've got the team lined up and you are taking action as soon as a board sees or investor see that you're trying to duck responsibility you're trying to duck a communications role then they get scared or and scared or and you create this this vicious cycle of antagonism between the entrepreneur and the board as opposed to collaboration between the entrepreneur and the board so I use this as tongue-in-cheek around a very serious issue about communication with boards and again every every entrepreneur is taught when they start a board that the most important thing to do with the board is not surprise the board right you've never surprised the board if someone walks into a board meeting and hears bad news for the first time that's a bad thing because what they want they want to know the bad news before the board and they want to know that there's going to be discussion of how to address the bad news not a communication that there is bad news so as an entrepreneur as a manager your job is to make sure that all the communication gets to the board early as soon as possible you never want to hit a board member to hear bad news from someone else and that as quickly as you can you have reached out to try to find alternate solutions suggestions and that you as the senior manager in the company have these proposals or plans in place as to how address it even if the plan is simply a plan to figure out how to address the problem it's better than avoiding the problem altogether or just sitting there saying you know we missed the quarter I guess we'll just have to try harder next quarter right you better explain why you missed the quarter you better explain how you're going to try harder what you're going to change about your business otherwise you're going to lose the confidence of your investors so with all in all seriousness and all humor those are the top 10 lies of venture capitalists again I don't know I guess I don't know if they I did send some slides I don't know if they're available on some website or not but if you want the slides just send me an email at Reichert across a calm you can find them there if you have comments questions follow-up thoughts whatever you can also get me at my email address we also on our website have some other stuff for entrepreneurs we have a guide on how to write a compelling executive summary we have a guide on perfecting your pitch we have a few other things some of guy Kawasaki's speeches and then guy my partner has also written a book called the art of the start which is a compilation of everything we've learned in the eight years of of garage and he maintains a blog which he has recently renamed how to change the world you'll be stunned too you'll be stunned to know well you know you heard it here first it that will be the title of his next book probably so he figures if he just writes a blog a day for you know some period of time eventually he'll have enough words for a book and so that makes it a lot easier than sitting down and actually writing a book but so I with that having been said any any questions any comments yes sir I understand how you have a half a lie okay what question was about to in the business plan when you're doing the projections I've done a number of pitches and I've been given advice before to kind of pump up the projections by about twenty percent because the piece is going to cut them back anyways and I actually tried wants to do I call it a realistic plan with the longer sales cycles and so forth and the plant those plans just kind of hit the ground with bud having good there seems to be this dynamic I just wouldn't give any advice about how to break through that word so he's expecting a pump does you know I haven't cut it down right well so again I mean every every situation varies but and there's a you know even within my partnership we have controversies around this topic but my my experience is that that Excel the spreadsheet should putting in you know what you think is realistic even with six month nine-month 12-month seal cycles you should discover you know miraculously that's still a huge business right if it isn't a huge business even with quote unquote realistic assumptions then you got to drill in understand you maybe in fact it is going to take more work and maybe in fact you got to figure out you know is your pricing wrong is your market penetration value I mean is it going to take more capital to get to a bigger business than I would like so it's not usually the problem that even when you tailor back the numbers that the numbers look totally uninteresting right now the to get to the rules of thumb right everybody wants to know you know is it true that I have to have a hundred million dollars on my revenue line somewhere in my financial projections and I would say that the answer to that is unfortunately yes that is generally true is it likely that you will in fact hit the hundred million dollars you know within five so generally that's the fifth year projection and the reason that entrepreneurs do five years of projections is that it's just not realistic to get to a hundred million in anything less than Phi of yours so the other reason by the way to do five years of projections is and this is where guy and I differ guys attitude is we know they're lying so why do we even bother asking for five years you know and my point is well of course they're not right but you've got to give the company you got to give the entrepreneur enough space to flesh out the company to actually explain how the company is going to evolve because the first 24 months are one product one market that's just the reality of a business you can't can't get to more than one product one market in the first 24 months so you'll want to understand what the team is thinking in terms of the next market in the next product and that means you got to go three four or five years but the other good reason to go to five years is it gives you the chance to get to a hundred million and I hate saying it cavalierly that you know you've got to figure out a way to get to one hundred million not another case in this business but there are some circumstances though we're getting to 40 50 60 million is perfectly fine if you can get there and you're still growing fast and you're obscenely profitable at truly profitable as opposed to Excel profitable right then you can get a half billion dollar valuation on a company like that so so from a VCS point of view hey you know if I can get comfort that there's at least a hundred to two hundred million exit here and the possibility of upside to that and I've got a reasonably sized fund then I can be excited around a company like that so that's what's going on the VCS head is what can my exit look like and so the gamesmanship though is as soon as as soon as I see a yellow flag around your projections then I start carving back you know as soon as I think you're being somewhat unrealistic then I assume you're unrealistic on what unrealistic across a whole bunch of stuff and I just keep carving back so if I believe you're being realistic and if I believe that there might possibly be some upside I'm not going to carve back so that's you know that's the guy that is the game you're playing if I have any suggestion if there's any suggestion you pumped up the numbers you know then that's the last meeting and I just you know there's there's so much room in the marketplace for successful companies that to have to pump numbers is like you know forget it why you know why would I bother right so uh yeah that was hopefully that helped I don't know yes it was more also about like how much the investors want versus how much times burns your seeking at what target percentage ownership you know those kind of issues and get involved kind of how the pieces think about that but you know how they're usually R mismatched between entrepreneurs some pcs on that issues yeah yeah so one of the one of the important dynamics in the venture capital world is that funds have gotten bigger and bigger and meaning if there's more and more money to put to work and there aren't necessarily more good deals or good opportunities but as a result you are seeing VCS sort of pushing out at the edges and you know going International and going into clean tech and all that sort of stuff because they're trying to find places to put money to work but one of the challenges you know for you for any given entrepreneur is I'm a fund I'm a you know four hundred million dollar fund I see your particular business plan I want in any given situation I would like the opportunity to make my fund on my investment in your company right meaning I want four hundred million dollars back out of out of investing in you and so then you get the math working which is what's the possible exit well you know they're very few billion dollar exits in this world right and so I'm going to hope god bless everything goes right you're a 500 million dollar exit I can't make the math work right I got o ninety percent of you what eighty percent of you to get a five hundred dollar exit you know that dog don't hunt so that's the pressure that's the pressure I've got as an investor to want a larger percentage of your company because I'm looking at possible exits and much it can contribute to my fund and so I want a larger percentage of your company the counter pressure the counter pressure is I want the team to be motivated to build a great company so I'm always going to work the angles to make sure that the right three four five guys in the team see a window for becoming obscenely rich so I'm going to keep carving out enough options but of course the guys the founders if they're not adding value anymore and they're sitting off to the corner somewhere I know they got their founder stock and that's that I'm not that worried about them if they're not contributing anymore and the earlier investors you know the early investors I'm not that worried about them either right so but I am worried about the key management and I'm also worried the other piece I'm worried about is my syndicate partners right so I want to maximize my ownership interest but I also want to attract a syndicate partner alongside me because I don't want to have to carry this company myself so I got to carve enough out for my syndicate partner so you see companies getting recarved with every round of investment the first round is generally pretty easy right because you're only you're asking for a modest amount of money and there's plenty of room and the cap table for the investors to own 40% of the company and everybody else in you know the founders own 60% of the company and you got four million dollars and you know come by everybody's happy right but things go wrong there's a down round you bring in some more investors that's when that's when things get really dicey and you see these horrible cap tables where you know the founders have been almost washed out and these they know the seed investors the angels are getting screwed and you know so but there is no there's no I wouldn't say there's any hard and fast rule because there's so many different scenarios there are some companies very few that all they need is one round of investment there are other companies you know that are perfectly successful companies but they're in their Series F you know so you can have a successful company that takes a lot of capital but it's going to squeeze down the percentages over time so did that adequately duck your question because a minimum percentage that they would take or their minimum investment amount where you get to the point again this is not of interest to us yeah any venture capital fund will tell you that the minimum they'll take is 20% so you know the argument is if you don't have at least 20% then it's not worth the bandwidth it's not worth the attention it's not going to make a dent etcetera etc what I'm seeing and Larry and anybody else who's a VC tell me if you see something different more and more now I'm seeing the VC saying the minimum is 25% got one VC that said our minimum is 30% for a series a deal I mean are you seeing minimums go up angel type deals getting done I mean the angels are sort of coming back and some very small funds that are willing to do the angel sort of seed startup money so but for series a I've totally agree the minimum they're going up especially for the larger funds for the institutions right that's a really important point there is a whole community of investors out there that is somewhat different than what I was speaking of which are which are you know angels and angel funds you know sophisticated executives who are now turning into angel investors in some cases some cases they're a little less sophisticated but they're really rich you got to be careful in some cases it's a small fund that it's basically their money or their money and some other friends and angel money and those in those investors have some different behaviors and I you know they they can be a great way to get started you know particularly if they have a particular expertise that they can use to help your company yeah looking to take and if you know it's not to capital-intensive and choose an appropriately-sized form at under the font size because the dynamics of alia party I don't know anything what do you say but yeah I mean it is it's um you know we as a small fund strongly endorse that point of view you know and we see teams all the time that just came back from you know XYZ big billion dollar fund on Sand Hill Road who you know they can't believe when they walked out of the meeting the VC said you're not asking for enough money and that you know that seem counterintuitive to the entrepreneurs you know and I thought I thought we were supposed to be lean and mean and efficient and all that stuff but there is this countervailing pressure so yeah thank you for that point yes leasing entrepreneurs come to you saying things and kind of bet on the projections question saying stuff like well you know revenue generation isn't really a core competency for a consumer internet company that's looking to show hockey stick type growth so really the exit is based on traffic and how important are these types of revenue projections in that scenario yeah well I'll tell you we you know we have a we have a sign on our whiteboard that some and some entrepreneurs notice some don't it's you know the universal traffic signal with the red bar through it says web 2.0 right we are ye so this is us you know we're we're very very skeptical of web 2.0 deals and you know I hate to lump it all in one for and one in one bucket but the idea you know boy I've been there before that's based on eyeballs and advertising you know they're certainly you can build a successful company that way because we have the proof points that you can build a successful company that way but not all 632 companies that look exactly the same are going to be be as successful right and so from our point of view our ability to pick the one of the 632 that happens to get that you know mentos video or whatever it is and whatever you know social networking video hosting whatever I just we yeah we get these teams come in we get really excited it's fun it's great it's cool but ah it's just really hard to sit down and be disciplined about it so I would say I what I'm hearing is more and more VCS that are increasingly skeptical of this that are feeling you know we've got we kind of did our quota of eyeball and advertising deals for this fund and so if on if you have a business model that sort of is in that line I would strongly strongly encourage you to figure out another source of business economics another business model something that that people will pay for that is you know there's got to be some licensing model in there somewhere or some service model in there somewhere other than just eyeballs and advertising is what I would encourage you now you know for all I know you're the next Skype I don't know and I'm in up then I'm giving you really bad advice here but I would say on average the likely odds are that you know for for these kinds of traffic and advertising driven deals there are 32 other companies doing pretty much the same thing and that's going to be a real problem when it comes not only to you know going out there and competing in the marketplace but convincing investors that that this is a unique value proposition with a sustainable competitive advantage so the flip side of that is you know every investor when they look at a deal you got to spend time thinking about how is this company going to exit you know what's what's the way in which we are going to get our money back as investors you know increasingly you can't say IPO it's really hard for an early stage investor to imagine that any company that's two guys in a garage is going to get to an IPO within a reasonable lifetime so you know maybe eight nine ten years from now I mean God bless that's what it took Cisco that's what it took Microsoft that's what it took you know they took nine ten years to go public right so we can't expect an IPO that leaves you know an M&A transaction or possibly a private equity transaction you know another sort of emerging model for exits but to the extent that it's you know advertising and eyeballs there are pretty limited number of entities that are going to give you a good price for that and basically you got to be the winner to get a good price for that kind of business model so yes how many times have I been involved with well I did buy a compact computer so back in the day so yeah let's see um where else do we go but right the reality is that there are probably less than 20 venture backed companies in the history of enter capital that have gone from 0 to 100 million in in five years so we all know that that's the rarity so if you I mean I'm sort of leading the questioner here you're presenting your comment is probably why in the world would you expect 100 million in a business in a financial forecast if you know they're not going to hit it is that your question right because the theory of the financial forecast the theory of the financial forecast is that we address known challenges but we can't address unknown challenges so so as an investor and as an entrepreneur you know there are going to be unknown challenges but you can't cook them into your financials because the question then says well why does revenue and from year to to year 3 only go up by 5% and then it doubles the subsequent year right which is more likely to be the way the real world works you know because we had a recession because the CEO got hit by a bus you know I mean these are all sorts of things that happen in the real world but you're not going to cook that into a financial projection you're not going to say well we're expecting the CEO to be hit by a bus in June of 2010 and so you know well I would you know if somebody if so every plan that we see that comes in that has you know your five revenues one zero zero Millions and the metric behind it is 7.5 percent you know market penetration you know we dismiss but but if you can but there are lots of businesses that you can design from the bottom up that you could get to a hundred million and I agree I agree it's more realistic that it's going to be 40 50 60 million and I think as I said before if you've got a nice business model that's a perfectly fundable deal that is a perfect do not let me suggest to you that you shouldn't put out a financial projection unless it has 100 million in the fifth year but but if you're going after something that's interesting there should be a way there should be a way to see how if everything goes right you could get to 100 million because there are again 20 companies in the history of the world that managed businesses to 100 million within five years so we want you to model yourself after the most successful companies in the world within the bounds of realism may sound unfair but that's I mean that's the that's the psychology of it okay all right so who are you with I'm sorry ah okay so you're telling me that if a team came in with a really interesting idea just because it said 100 million in the fifth year you'd say forget it don't don't waste my time okay I mean so well there's an you know to this point and it's a reason this is somewhat controversial is that in my experience there are some VCS that are a little bit on the obsessive compulsive side in terms of numbers and there are some VCS who are like another line anyway I'm not going to waste my time and so you may in any given firm much less between firms come across very different VCS so you'll get one VC who says to you you know you asked them a question about their financial projections and the VC will say to you well I don't believe them anyway so I'm not paying attention to them and you'll get another firm another VC you ask them a question about their financial projections and they'll look at your gross margin in year four and they'll compare it to year three and year five and they'll say I don't understand exactly why the gross margin goes from here to here in year four and you go oh my god this guy's insane right but the purpose of that question is do you understand the underlying economics of your business do you have a business understanding and a financial understanding of your business or are you just a technologist or just a sales guy who knows how to make Excel show 100 million dollars so I will tell you I'll you know review I'm I'm a little on the obsessive-compulsive side my partner's are a little on the what the hell side so we have that dynamic within our own firm I don't know do you have do you guys very are you all personally I kind of look at the first two maybe three years but I like also to be able to squint my eyes and say this is going to be a big business and I guess my number would be over fifty but again the as we're talking about before the bigger the funds the more money they have to put in the bigger multiple to pay back the fund they're going to want the bigger opportunities you know do get to 100 million so that you get a billion dollar business right right so I'm sorry we're way past time here so thank you all very much I appreciate it
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Channel: Stanford Graduate School of Business
Views: 117,937
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Keywords: entrepeneur
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Length: 74min 51sec (4491 seconds)
Published: Fri Sep 25 2009
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