Learn how to improve your chances of getting funded from two experts in the field. You don’t have to come up short. There are things you can do to shift the odds in your favor.
Between us we have close to sixty years of working with start-ups seeking venture funding. Over that time we have noticed patterns – most of which lead to failure – in how founders approach the process of presenting to venture capitalists and attempting to arrange venture funding. In this column we will describe Gap Analysis – an approach developed to help focus presentations and significantly improve their chances of success. We will also briefly describe programs designed to significantly improve the chances of successfully arranging funding by combining this important tool with red teaming venture presentations.
The New Terrain
The investing terrain has changed markedly since the 1990s. Most literature available is out of date and does not tell the current insider’s story. Many of the changes have occurred due to the internet, others due to more options available to the average investor. Some of the major changes are:
1) There are more communications between potential investors. When a deal is presented a VC or other investor will ask who has seen it. If they know that person, they will send a quick e-mail to find out what they thought of it and why they did or did not invest. Angel groups and early stage VCs are heavily networked. There are many early stage angel networks. What you say to one gets relayed to the other.
2) There are fewer funds willing to do small deals. Though there is more money than ever, funds are doing fewer but larger deals. This does not mean that valuations have increased. A company that would support a $3 million valuation last year or 3 years ago will still get the same valuation today. But a three million dollar investment is less interesting to most VCs. Instead they are doing later stage, lower risk investing.
3) The money is smarter. Organized private equity groups, at the earliest seed stage – angel investors – are sophisticated. They perform due diligence and offer terms similar to VCs for smaller deals. In many ways they have become mini-VCs. And they communicate with each other as well. As founder of the Wharton Angel Network, Marty has several angel groups on his Rolodex and direct access to the Kaufman Foundation which runs the Angel Capital Association. The best of our peers operate similarly.
4) VCs are only one of many ‘alternative investments’ available to the investing public. In 1999, VC capital represented half of all private equity investment in the U.S. and was about 25% the size of the hedge fund marketplace. Venture capital currently represents less than 15% of all private equity funds and is dwarfed by the $3 trillion hedge fund industry, which is an industry based on making less risky bets on investments.
5) Today the overwhelming majority of early stage investing is done by angel investors. This group covers a broad range. Some are organized into groups which are topically focused. Others are free standing investors. As the University of New Hampshire’s Center for Venture Research reports, angels invest primarily and heavily in early stage companies. The total number of VC investments is less than 3000 annually with an average investment in excess of $7 million. In 2004, VCs invested in less than 175 deals seeking less than $2 million. There are more than 50,000 angel investments annually totaling more than $25 billion.
The business of arranging venture funding has radically professionalized over the last decade. In the pre-bust days it was often enough to have a sexy idea. Increasingly venture capitalists require that presenters not only understand their own business model but the business model of the investor as well.
We regularly hear stories from angels about the inability, or the unwillingness, of founders to view their company through the eyes of an investor. Whereas before a measure of the professionalism of a group of founders might be limited to their knowledge of their product, business model, value proposition and exit strategy, today’s founders have to adopt a much more sophisticated view. Increasingly there is recognition that the interests of the investors do not map exactly to the long term agenda of the founders. As a result, founders must understand their business from multiple points of view.
Shortcomings in this area often, and tragically, show up during an initial presentation to potential investors. Monocular understanding of the process almost always results in presentations which do not adequately address the investor’s concerns. We have found that a gap analysis and red teaming review prior to these presentations can have a significant impact on a company’s chances of successfully arranging funding.