Fear, Competition, and Greed: A Checklist for Making Your Deal Hot to VCs
An entrepreneur asked me at a recent networking event, “So, what makes a deal ‘”hot'” to a venture capitalist?” Of course I told her the stock answer that you would likely get from every VC when presented with that question, something like, “It is a great team with domain experience solving a tough problem in a big market.”
But I have to admit, that wasn’t all I was thinking. I clearly told her the characteristics of an investment that will likely get VC funding, but not how a deal becomes “hot” within the VC community. I didn’t tell her how experienced entrepreneurs often use emotion as a tool to create momentum, move deal terms, and get term sheets from VCs. From what I observe in many VC partnerships, a “hot” investment is as much about greed and competition quickly overcoming fear as it is about supporting due diligence.
Early stage investing has substantial risk—team, technology, market—this stuff is not for the faint of heart! Every VC has a track record (every company that individual invested in and the associated returns for each) that impacts him or her much more and much longer than, say, an entrepreneur’s failed enterprise from eight years ago. A VC’s track record is how that VC is measured by fund investors and partners—and you need to hold your own to keep both of those constituencies happy. Further, many VC investors are pension funds and endowments. Losing money for a pension fund that provides income for widows during retirement or for an endowment that provides higher education funding for under-privileged students certainly doesn’t make a VC feel very good.
It is a real emotional hurdle for a VC to write a multi-million-dollar check (okay, to authorize a wire). Fear is the emotion that favors making no decision or passing on an investment altogether.
So the challenge for an entrepreneur with a great investment opportunity is create enough momentum to push through investors’ fear of losing money. The challenge for an entrepreneur who wants a “hot” investment opportunity is to blow through that fear and get deep into VCs’ competitive spirit and greed!
VCs tend to be type “A” personalities, and many are (fading) athletes. When an investment happens by another partnership in a space that is close to me and I didn’t get to hear about the company, that is a problem for me. My partners expect me to see investments in my areas of core competence and I expect it of myself. I am letting them down if we don’t get an opportunity to hear the story and possibly invest. Every VC wants the option to invest in every “invest-able” opportunity, and certainly in the spaces that they cover. So, are VCs competitive with each other? You bet.
The greed part is obvious. VCs are in the business of making money for their investors. Meanwhile, if VCs are good at their jobs, they make a good amount of money for themselves in the process.
So, how does an experienced entrepreneur use this understanding of fear, competition, and greed to create the perception of a “hot” investment opportunity?
1. Experienced entrepreneurs target their fundraising efforts. They share their investment opportunities to the general partners who will “get it.” Those VCs either have relevant operating backgrounds, have made related (but not competitive) investments, or have shown an interest in the space (blogging, conferences, speeches). VCs who require an education process from the entrepreneur will more than likely fall victim to that fear of losing money sooner or later in the due diligence process.
2. Experienced entrepreneurs approach the target list of VCs they know or to whom they can get introductions. Introductions from your lawyer, accountant, or business acquaintances with VC contacts are invaluable. Approaches at a relevant conference or speaking opportunity can also work. E-mails or snail mail with business plans won’t get past an Associate’s screening process.
3. Experienced entrepreneurs understand and leverage the VC network. An entrepreneur can expect that a great investment opportunity will gain positive momentum by reinforcement. If an entrepreneur pitches a great idea to a relevant VC, the likely outcome will be positive buzz and promotion within the VC community. The converse is also true. No VC wants to be the last funding option for a tired and shopped investment opportunity.
4. Experienced entrepreneurs create scarcity in their investment opportunity. If there is an unlimited amount of time, a VC will inevitably use it to collect more data and more validation. However, if there are perceived time pressures of other VCs getting ahead in a process, competitive juices flow and momentum pushes the process forward. Also, having three or more VCs in the process creates scarcity because each knows that at least one investor will likely be left out of making the investment.
5. Experienced entrepreneurs negotiate from a position of strength. Having the luxury of multiple term sheets or multiple leads is a great outcome for an entrepreneur. They can then negotiate from a position of strength and push hard on terms that aren’t entrepreneur-friendly. The entrepreneur’s confidence at the negotiating table, a willingness to walk away or ‘fake it ’til they make it,’ often plays to the VC’s emotion, fear, and greed.
6. And finally, experienced entrepreneurs know that once negotiations are done, we all need to get on the same side of the table to build value in the enterprise. I am often very surprised when entrepreneurs continually bring up past negotiating battles won or lost, and are still justifying a position months or a year later. This just takes away from the goal of everyone who is investing time and money—that is, to build a great and enduring business.
So, I’ve now come clean to the entrepreneur at that networking event. The ugly truth is that a great investment opportunity is not necessarily a “hot” investment opportunity, and that it is only human emotion that separates the two.