Conversations with Investors – Chapter One
Posted by Dr. Earl R. Smith II in Venture Capital, tags: adviser, advisory board, angel investor, board of directors, CEO, chairman, coaching, consulting, director, dr earl r smith, dr earl r smith ii, earl r smith ii, earl smith, Executive Coaching, federal circle, federal contracting, funding, Governance, government contractor, investing, investment, investor, Leadership, leadership assessment, leadership coaching, leadership development, leadership styles, management assessment, managing partner, Personal Growth, the federal circle, turnaround, Turnaround Management, Venture CapitalDr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com
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Jim Hunt of The MITA Group
In this series of articles, I will describe several discussions that I had with investors in the Washington DC area. They range from angel investors to senior partners in well established funds. I have known most of them for many years. That allowed us to cut through the usual PR crap and get to the heart of the process of reviewing investment opportunities. When I told them that my objective was to provide a series of articles which would help companies seeking funding, each was very willing to help – it is, after all, in their interest to improve the process. I owe each of them a debt of thanks for agreeing to sit down and ‘open the kimono’ so to speak.
Visit with an Angel Investor
I have known Jim for many years. Like many angels in the area, he was a very successful entrepreneur. A seasoned veteran of the technology industry, over the past twenty years he founded and ran four successful technology companies. Jim founded and served as President and CEO of Ernst & Young Technologies, Inc., leading it to $75 million in profitable sales after just three years of operation. He then orchestrated the sale of EYT in late 2000 to Cap Gemini and served as President of the newly created Cap Gemini Technologies. Prior to his work at EYT and Cap Gemini, Jim ran a number of firms including BDS, Inc., a systems integrator focused on sales to the federal government. In addition to Jim’s primary responsibilities as a line executive, he has helped launch and advise over a dozen companies in the high technology sector, with particular focus on software for federal and commercial markets. Much of his expertise has been directed at federal government market penetration for software application companies, system integrators, and IT service firms. In short, Jim has the experience to know what he is doing when considering an investment.
The Initial Screen
We sat down at a local watering hole and got caught up on the goings and comings of people and companies we knew. Then things turned to the ‘interview’. I told Jim that I wanted to focus on how he decided whether or not to make an investment. My first questions was, “What percentage of the deals that come over the transom do you discard out of hand?”
“Seventy percent of what I see is of no interest to me”, was his reply. That means that only three in ten get any extended consideration at all. His principal reasons for discarding opportunities were 1) it’s not in my area, 2) the team does not have the necessary experience and 3) they don’t have any adult supervision.
The first reason related to Jim’s area of expertise – what he knew about and felt comfortable getting involved in. What disturbed him was the tendency of some founders to lump all funding sources into a single category. “My history and investments are out there and easily found. People who don’t take the time to see if their company matches my interests don’t understand the process very well. I don’t pay much attention to them.” Jim’s statement is certainly true for all the other investors I interviewed for this series of articles. It is very easy to discover the interests and investment preferences of any established investor. People who do not take the time to match their company with those interests do themselves a great disservice.
Jim’s second screen is another one that I encountered in all of my interviews. He avoids ‘generalists’ who seem to be the ‘jack of all trades and master of none’. His focus is beyond the core technology of a company. “It takes a wide range of skills to build a company. A limited number of them relate to the underlying technology.” Jim looks for balance in the team. Do they have people who can handle the financial and HR needs of the company? These may be outsourced; but they need to be covered. Is there somebody who actually has successfully run a company – managed an extensive staff and budgets? “If these are not present, I am unlikely to spend much time looking at the business plan”.
It was Jim’s third screen that drew my attention. I had had experiences with the same syndrome – avoidance of adult supervision – and knew how important oversight was to the success of a new company. “If a team balks at supervision, I don’t spend much time reviewing their business plan”. The core truth is that everybody gets supervised in one way or the other. Recognition of that fact is a measure of maturity and evidence that the team understands how businesses are built. “If the team seems to see the process as I give them money, they go and do what they think best with it and I get the results, I decline to play that game”.
“How much time to you spend on each investment opportunity at this stage”, I asked?
“I see about a deal a day normally. Most are discarded quickly. Of those that I have some interest in, I generally spend about an hour to an hour and a half deciding if I want to see the team and go further into their business plan”, was the reply.
The 30% Remaining
“So, Jim, let’s focus on the roughly 30% that make it through your initial screening. What do you look for and what reasons cause you to discard them?”
Jim has four screens that he applies to those that survive the initial culling. The first is a more detailed review of the experience and past successes of the team. He focuses on the ability of the team to work together. “I want to see the tracks in the snow – evidence that they have met and mastered tough challenges in the past.” For Jim, resumes are not enough. He calls upon his wide network to check on the backgrounds and reputations of all the people on the team. A weak link means a weakness in the judgment of the founders.
Jim’s second screen is a deeper push into the question of ‘supervision’. If he ends up funding the team, he wants to know how they will relate to him as an investor. Both of us had encountered the hard-headed, technocrat who has little use for people with business backgrounds and experience. We’ve also had our share of midget Napoleons who seem to take a purely instrumental approach to other people. Good businesses are built through the combined effort of lots of minds. Like most investors, Jim avoids founders who tend to push such help away and assert their own omniscience.
If the teams pass the first two screens, Jim then turns to whether it has a “clear and credible path to revenue”. His diligence in this area extends far beyond the spreadsheets that come with the business plan. “I check through my own network to verify their assumptions and reach out to their potential customers”. I am amazed at how few founders actually think that this might occur. Successful and well-established investors will always conduct such diligence. In many cases, the investor will quickly end up knowing a great deal more than the founders about the company’s chances. How founders respond to this development is a very valuable character check.
All investors have their quirks and Jim’s fourth screen evidences one of his. “I look into the cash efficiency tendencies of the team. I don’t invest with a founder who drives a leased car. I avoid teams with multiple family members on the payroll. If a cash-poor, start-up team has state-of-the-art electronics, I generally turn away.” Jim has a aversion to investing in teams that seem to have a sense of entitlement – particularly if that leads to excessive spending on instant gratification toys.
10% of 30%
“Jim, of the 30% that survive your initial screen, how many get all the way through and are seriously considered as investments,” I asked?
“About one in ten,” was the reply. To put that in perspective, over a ten-month period Jim might see three hundred deals. Of that three hundred, thirty might get a second and more intensive look. Out of that thirty, three might be seriously considered for investment. That alone should tell founders why the money chase so often yields null results. The odds of success with each investor are somewhere around three percent.
Time was getting on and we both had places to go but I could not help asking about the next stage. “OK Jim, you have decided that maybe a team and their business plan may be worth an investment. What do you focus on next?”
His first response was, “I get to know the team better – watch them work together and see how they meet and overcome challenges – both with the business and in getting along.” Jim believes that the team holds the key to the businesses’ success. Their ability to work closely together sits at the center of their chances. He looks for indications of dissonance and conflict.
“Sure, I do all the normal things like cleaning up the balance sheet, resolving existing personnel issues and aligning compensation plans. I drive deeper into the value proposition, investigate the intellectual property that the team controls, probe potential customers and work with the team to sharpen their business plan. But my investment is, first and foremost, in people. I am an early stage investor and people are the primary asset for such companies.”
© Dr. Earl R. Smith II
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Related Articles:
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The Money Chase: Oil and Water
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The Money Chase: Should You
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The Money Chase: One Way to Avoid Being ‘Avoided’
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The Money Chase: Who They Do Not Invest In
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Funding Strategies for New Businesses
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Angel Investors to Avoid
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Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.
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[...] first article in the series – Conversations with Investors – Chapter One – focused on Jim Hunt of The MITA Group. Jim is a fairly typical angel investor – a successful [...]
Count me as another one who found this article via LinkedIn. Very timely information, as I’m about to become involved with a company that may be seeking angel and/or VC funding. Thank you for posting.
Don, I have not been able to discover any sense of entitlement in Jim. I’m pretty certain that the same traits that made him a successful entrepreneur are guiding him as an angel investor. There is one thing that is very hard to argue with. Jim has made hundreds of millions of dollars for himself and his partners. Investors who bet on his ability have been very well compensated for taking the risk. It is a variation of the old Nike commercial – when you can do it, it is not bragging. Dr. Smith
Paula, My experience with professional poker players is that they are very risk-averse. They spend most of their time trying to reduce risk and gain advantage when their opponent over estimates the situational risk. Anybody who would write such a book as you describe knows next to nothing about them. When I was at the Sloan School, MIT we studied entrepreneurs and found that the most successful ones were also risk-averse. The amateurs thought that being an entrepreneur meant taking risks – but they failed our tests quite quickly. The successful entrepreneurs were incredibly accurate calculators of risk and very good at mitigating it. They won by knowing when the odds were in their favor rather then hoping that the dice would prove them the anointed. Dr. Smith
Interesting article. As I read I tried to relate the article to investors who invest in film as this is what I am interested in. A book I am currently reading on how to find investors interested in investing in film encourages the reader to (only slightly tongue-in-cheek) find a poker player because they are accustomed to risk. It would seem that those individuals who are interested in investing in films and those investors interested in investing in technology are at opposite ends ot the investor spectrum.
Posted by Paula Smith
Dr. Smith,
I echo the comments above. While it initially seemed a tad bit generic, the description of the filters and the weighting of each was very helpful.
I also concur with the comments of David Nelson that there are a number of intermediaries who are a waste of time. I appreciate your insight and the time that you spent putting this together and sharing this with all.
Thanks,
Drew
I have read the article with great interest. Thank you.
Posted by Menino Lima
David, Thanks for your comment. I am happy that you find the article useful. The next chapter will come out later this week. The world you are looking to get into is very difficult to penetrate. The first requirement is that you have money to invest – the more you have, the easier it is to get into the space. Most angel investment groups are fairly clannish – they tend to associate with people who have a common experience. In the Northern Virginia area, for instance, most are successful entrepreneurs who have sold out their company and acquired substantial wealth in the process. There are lots of ‘advisers’ around but mostly they are relegated to bit parts. The key to the angel investment business is personal wealth.
Venture funds are a different matter. Institutional investors place funds with fund managers who make investment decisions. In the current economic environment it is virtually impossible for a team to raise a first-time fund. Investors are focused – tot he extent they are funding at all – towards teams that have made money for them in the past.
Best of luck in your efforts. Dr. Smith
Terrific insight.
I am fairly new into the PE/VC world as I am a displaced Mortgage Banker. As in all sales, success depends on matching “buyers and sellers” properly. I have exhausted many hours going down the wrong path presenting opportunities to many who turned out to be finders or brokers just like I am. Mentors in this arena have been hard to find; I appreciate reading articles such as this one and look forward to other similar posts.
Jim, thanks for your comment. You have put your finger on the first disconnect – the failure of the presenters to pre-match their business opportunity to investors. All of the investors that I have interviewed for the series say the same thing – they discard out of hand more than 70% of what comes over the transom. Most founders do not stop to think about what generally happens next. These investors – particularly angel investors – talk to each other and the word gets around that ABC team is just throwing mud up against the wall hoping some of it will stick. The negative branding makes each subsequent presentation less likely to result in funding. Dr. Smith
One of the thing I’ve learned from both representing VCs, introducing companies to Angel and Angel groups and raising funds for two start-ups I was directly involved in, is how many meetings are really a waste of time because the entrepreneur didn’t target the investor appropriately. Entrepreneurs just spend way too much time and energy trying to meet with the wrong people. Part of this is not really understanding the business of Angels and VCs. There’s all kinds of examples.
For instance, a company needing a seed round meeting with a late stage VC is a waste of time. Or biotech meeting with a VC that has never invested in a biotech company and doesn’t have the domain experience to help the company.
Or a company that needs $1.0 million and is speaking to Angels that are ‘five-figure’ investors not “six-figure” investors.
I made these mistakes myself. I spoke to an Angel group once about a technology for the investment managment business. These smart guys knew nothing about the real nuances of Wall Street. They were asking questions that were totally irrelevant. Another problem I’ve seen is company’s meeting with someone who is not a partner, gets good feedback from the guy but it goes no where! A non-partner has no money to invest he has to then convince the partner your business is worth his time and frankly the partner may not have any capital left in his allocation! Also, VCs are in the business of ‘anecdotal investing” they meet with lots of company’s simply to learn what’s hot, what’s going on, trend analysis etc…if you’re not in the area of expertise don’t take the meeting!
Bottomline, entrepreneurs need to take the time to learn about the business of VCs. It’s like studying your customer profile, study the VC business and their world. Then you’ll have a better chance to target the right ones, know what their interest is, learn if they have capital and are currently actively investing. Take one of Stephen Covey’s famous & Habits…”Seek to understand, before you seek to be understood”
I’m Jim Flanagan and I personally approved this message
The key matter is risk vs return , then how sexy is the investment story and last but not least did the women/men look as if you could sleep with them .
Posted by ADRIAN MATADEEN
You are quite right in your assessments of why the prospective “matches” don’t happen nearly as often on their own.
I kidded about being the “dating service/moderator”; but spend a great deal of time qualifying both sides before I put them together.
Some of those qualifying conversations always get interesting on the “inventor” or develop sides.
I have been fired more than once–largely at their claim of playing delaying games with them, trying to learn more to steal their idea, working for potential competitors and more!
I’ve also been present during and after “turn-down” conversations with potential investors—they tend to take it personal; but of course many have invested untold hours in isolation; and “sunk” all their money plus that family & friends, right?
Again, best of success. You’re works will help many more.
Duane
Paul, Subsequent interviews also touched on the ‘supervision’ issue – so stand by for future chapters. Advisory Boards focused on business development – professional organized and under workable metrics – are generally seen as a major positive. such a board reflects on both the judgment of the founders and their ability to bring together effective senior resources. such assessments are generally separate from team assessments. Dr. Smith
Dr. Smith:
Thank you for capturing and sharing Jim’s insights on screening opportunitites and the importance of team strength. I’m interested to hear more about the “supervision” element…is a strong Advisory Board and/or Board of Directors viewed positively by investors, or is it not factored into the initial assessment of talent?
Very good article. I am looking forward to the next one.
Thank you for this interesting article. It was very enlightening. I found your article through the LinkedIn network.
Best Regards,
Daniel