Starting a Business: Bootstrapping versus Venture Capital, Part II

Previously, I suggested some pros and cons around bootstrapping when launching a business. An entrepreneur I recently talked to was considering getting seed funding from a venture capital (VC) firm, and I'd like to share some of those thoughts on how funding and involvement from a venture capital firm can add value to your business.

Many so-called "VC horror stories" occur when the entrepreneur and VC firm aren't explicit up front about expectations of the partnership. My strongest advice to entrepreneurs looking for VC or outside funding is to do as much research on their investors as those investors are doing on you. Be clear about what you want and don't want out of the partnership at the outset for the best results in the long term.

So, do VCs add value?

Many people know that venture capital funding can provide capital to expand your business quickly, additional contacts and networking to grow your business, and strategic advice based on experience with other startups. They also provide a stamp of approval on your business plan, the potential your business holds, and the strength of your team, adding legitimacy to your brand in its nascent stages. Approval from a VC confirms that you were able to convince a cynic. There is a lot of VC money out there and, while this isn’t a guarantee, some firms that are known to be very discerning prior to investing can be helpful in validating (or critiquing) your idea.

Are VC firms really "evil"?

I've heard some horror stories, but I also know plenty of entrepreneurs who've had great experiences taking VC money. Read on for my approach to developing a VC relationship, and deciding whether or not you want to enter into one:

• Focus on long-term relationships.
  I've met some great entrepreneurs who keep going back to the same VC firms even though they could afford to personally fund their subsequent businesses. These entrepreneurs view VC firms as long-term partners. And you would be surprised that pre-money valuations of these subsequent businesses funded by the same VC firms are often high--at that point, VC's are funding the person as a long-term investment over the business itself.

• Focus on the culture of your Board.
  Just as you would invest in developing the culture of your company, only take money from a VC you think would add not only monetary and strategic value, but who would also be great addition to the personal dynamics of your Board of Directors. As the CEO, one of your key responsibilities is managing the Board and you don't want it to take up all of your time. Another friend and fellow CEO told me, "I would have taken a slightly lower valuation for a better guy on my board rather than deal with the headache I have now. The board members have their egos getting in the way and they are pulling me in very different directions, thus resulting in paralysis for us." I've heard this story time and time again.

• Be up front about your expectations of the VC firm.
  If you are counting on your VC to attend every Board meeting, not read their Blackberry, and be responsive to each of your calls and emails, be sure to set expectations by telling them that up front. Or, if you are only counting on them from time-to-time and it's their business network that is most important to you, discuss that, too. Just be clear from the beginning about your expectations so there are limited surprises on both sides.

• Perform reference checks and due diligence on the VC firm, too.
  Remember you are assessing whether or not you want to enter into a relationship with them, too, and they certainly doing reference checks on you. Read their blog, visit their page on LinkedIn, check out their networks, and find as many articles on them or their past investments as you can. What is their track record like? Also, it's OK to ask for introductions to other CEO's and management team members they've worked with in the past and follow up with phone calls.

• "Don’t sweat the small stuff."
  One of my mentors once told me, "VCs are humans just like you and me. They have egos, moods, make mistakes, takes things personally, have insecurities, etc." It's hard to remember this sometimes, since we certainly have high expectations from our investors. It's especially hard if we enter the relationship with concerns that "VCs are evil."

• Passion for your mission and passion to make money.
  At the end of the day, you both need the VCs to put their faith in you. VCs have LPs they have a fiduciary obligation to and have to make a return on their money…so you still need to be focused on making them money.

• Be honest about the state of business and what you don't know.
  I've sat through some debates over whether or not a VC firm would invest in a company, and one of the key criteria is if the CEO appears honest and straightforward about what he/she doesn't know. VCs are there to help and they fear an entrepreneur or company that appears to "know everything" or may not be up front of their concerns, limitations, and challenges.

• Take money from more than just the VC firm.
  This is a basic rule of thumb I've heard from many seasoned entrepreneurs: Having more than one source of investment helps facilitate better decision-making.

• Lastly, try to get to know your "mother-in-law" and the other partners.
  There is a running joke that although you may marry (take money from) one VC partner, the leading managing partner in the firm is really your "mother-in-law" in the relationship. There are stories of VC partners that jump to different firms and thus a company may be left feeling abandoned by their champion. Also, for subsequent investments or future exits, developing a trust relationship with the entire firm is best for your champion VC to garner support for your company. And if you use this approach in developing the relationship with the firm in general and not just your investor and/or board member(s), it helps to partner with a firm that is well-run and where the partners get along (another point to find out in your reference checking!)

For more information on the basics of taking VC money, check out the following resources:

http://www.socaltech.com/Insights/Bowne_VentureCapital_Guidebook.pdf

http://blog.tomevslin.com/venture_capital/index.html

http://www.feld.com/blog/archives/venture_capital/

Cheers,

Sheila

Comments

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