Where are the isolated start-ups?

techcrunchThere is a funny article on TechCrunch UK where Nicola Robinsonova asks where the most isolated start-ups in the UK are. Well, I don’t know about start-ups, but I know about VC-backed companies. This is a map that Peter Lahoud, Stephen Siard and I made in 2006 when we were still at Library House:

I can see companies (for those of you from outside the UK, I have added additional comments in brackets) up in Scotland (very dark, rains very often). And at the West coast of Wales (yup, this is the places where it always rains). There are some at the tip of Cornwall (in the South West, where the wind never stops). And some at the East coast of East Anglia (Peter once lovingly referred to it as Dragon land, don’t ask).

Conclusion: they are everywhere. Must be some sort of unstoppable force… 🙂

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Venture Capital Cash Flow

union-square-venturesFred Wilson has an interesting article on VC cash flows and returns on his blog. I have taken his numbers and included the costs to show cash flows and returns from an LP, VC and entrepreneur perspective.

Please click on the picture to see a larger version (UPDATE: I have updated the graph with some additional assumptions based on Fred Wilson’s second article. The previous picture can be found here):

Number of comments:

Capital called and distributions: I have copied these numbers from Fred Wilson’s article for consistency.

Management fee: the management fee that I show in the calculation is, strictly speaking, not correct. However, in total, management fees make up some 20% of capital called (2% per year for 10 years or so). In order to keep Fred Wilson’s cash-flow numbers intact, I have assumed a 20% cost to each capital call. Update: I have taken the management fees from Fred Wilson’s second article. In order to keep the capital call figures from his first article, I have deducted the management fees from returns.

Fees associated with exit: can vary substantially, 2.5% sounds like a reasonable average value

Spread between founders & management vs. VC: If you raise two rounds of VC funding and sell a third of your company each time, then founders and management hold some 45% of the equity (67% * 67% = 45%).

Carried interest: I have assumed 20% carried interest which is the industry standard. Update: I have assumed that carry is only paid out once 1.00 capital has been distributed to LPs.

Please feel free to correct me on the above, should you find any mistakes or oversights. I would be very interested to see a correct model that includes correct management fees, by the way.

UPDATE: While I was writing my article, Fred followed-up his earlier article with a newer one.

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VC Fund Raising Manual – 4 The Pitch

People attribute a lot of importance to the pitch. I guess most people believe that if they give the ‘perfect pitch’, the VC will invest in them. I doubt very much that this is true. The reason for this is that VCs are much better at analyzing pitches than founders are at giving them. It is not so much in how well you pitch, but what you pitch that will determine the outcome of your first interaction and whether you progress to due diligence.

Overall, there are two aspects to pitching: how you pitch and what you pitch.

How you pitch means the way in which you construct your presentation, number of slides, topic of each slide, the order, the kind and amount of information on each slide, how you stand when you pitch, how you use body language, how you use your voice, where you place the emphasis etc. These are generic skills that you will need in business life. If you are inexperienced in giving presentations, then I suggest you take a course where you learn how to do that (seriously). I took one a few years back, very interesting and useful stuff. In terms of the presentation that you should put together, have a look at my previous post here.

What you pitch is far more important then how you pitch. In order to understand what to pitch, you need to understand what VCs are looking for. This is what this article is about.

At a top level, there are only a few considerations that VCs have when they are looking at an investment opportunity. Most people will tell you that VCs are evaluating the following aspects:

Market: Is this an interesting market that the company is addressing?

Product: Does the company have a compelling product that can address the market well?

Industry: Can the company compete effectively in their space and is there a good exit opportunity for them?

Technology (this links to both product and industry): Can they leverage technology to produce a product and does the technology give them competitive advantage?

Financials and business model: Do they make sense?

Team: Can they execute the plan well?

Investment case: Is this a compelling opportunity to make a lot of money?

The above is completely correct. If you have all these bases covered, you probably have an investable company. However, this is not all for which VCs are looking. In order to understand what VCs really want, put yourselves in their shoes. A partner at a VC firm makes ONE (1) new investment per year (meaning an investment in a company that they haven’t invested in before). So, you are asking the partner the following: “Ignore all the other deals that you are seeing right now. I am offering you the best opportunity to invest in. I am by far your best shot this year.”

A VC that I talked to last year summed this up very nicely: “Most entrepreneurs don’t understand that the thing that they need to do is make me clear my desk for them. They must make me believe that right now, this is the best deal that there is for me. They must manage to rise to the top of the pile.”

How do you get to be top of the pile? I am going to try and explain this by example. Imagine you’re a VC. A founder walks into your office. She gives you the following pitch.

Version 1: “Hi, nice to meet you. I am doing this great company that has incredible potential. Have a look at this great pitch. We are raising $5 million. We think we will give you a great return on your investment. Say five times in five years. And we will be great fun to work with, we have a great team. What do you think; are you interested in taking a look?”

So, what do you think? Does it sound like a great proposition? Let’s have a look what other people sound like when they pitch to the same VC in the same week.

Version 2: “Hi, we haven’t met, but you know Bill. As you know, I have worked with Bill in the past and we made a lot of money together. I am now raising money for my new company and I wanted to ask you whether you would be interested in taking a look at it?”

Sounds better, doesn’t it? Here is an even better pitch.

Version 3: “Hi, we haven’t met, but you might have heard of my company. It is going great. There are quite a few reference customers you can ask about that. Really, our users numbers are going up drastically right now. Are you interested in taking a look?”

And here is an even better pitch.

Version 4: “Hi, how are you doing? Remember the money we made the last time we worked together; I still can’t believe me managed to make that much! Listen, I am doing this new company. This time, we are really swinging for the fences! Our old friend Bill has already put some seed money in. I have also started working with the customers who bought from us last time, they are very interested and we have started ramping up some strategic sales. Our early user numbers are looking great. I am now raising a Series A round. Are you interested in taking a look?”

If you were a VC seeing all the above pitches in one week, which deal would rise to the top of your pile and which one would be at the bottom of the pile…?

There are two things that tend to positively influence any investor: trust in the people who run the company and objective proof of the (beginning) success of the company. The more a VC has reason to trust you and has access to evidence that your company is successful, the more you rise to the top of the pile. For the consultants amongst you, think of it as a two-by-two:

VC criteria
VC criteria

That is the ‘what’ of the pitch. Of course you are pitching a company that is addressing an incredible exciting market, has great products, powerful technology, a fantastic team and offers a compelling opportunity to make money. If you didn’t have this, you would be in the VC’s office in the first place. But really, what you pitch is that you are a trustworthy person who can already demonstrate that this company will be a great success. If you can do that, you are likely to progress to the next stage which is due diligence.

VCs are not risk averse. They simply invest in the best opportunities they can find. Or would you invest in anything else, if you were a VC given the choices that you have? Exactly.

Index of VC Fund Raising Manual can be found here.

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