Beating the odds | How to catch a venture capitalist's attention when a recession increases your competition
In metro markets like Boston, it is said that a venture investor looks at a hundred deals, seriously considers 10 and commits capital to one. One in a hundred…pretty bleak odds if you’re an entrepreneur looking for capital. If you’re one of the 99 rejected (likely by multiple funds), you’re likely to have a range of reactions, starting from “the VCs don’t get it” to despondency and despair that you may not see the maturation of the “baby” you’ve nurtured with your focus, energy and a good deal of your own, your friends’ and your family’s money. Why so many nos?
In part, it’s a supply and demand thing — there’s more demand for early-stage venture capital than there is supply. This is often referred to as the capital gap and has constrained growth-oriented entrepreneurs since the venture industry began.
Supply-demand aside, there are plenty of reasons why investors pass on what appear to be good opportunities.
Here are a few:
Relative appeal, or your idea is good, but not as good as someone else’s: The investor is too busy working on other prospective deals that light her fire more than yours. This is the by-product of the capital gap — more deals than dollars means that the bar is very high to get funding given other compelling options — and it also has to do with risk mitigation. Every early-stage venture is loaded with risk, related to the market, management, finances or technology. Risk itself isn’t so much the issue; venture investors know they are in the game of accepting and managing risk. That said, there are deals with more significant risks than others. The greater the risk relative to the upside as perceived by the investor, the more likely the investor will move on to the next deal for a more compelling risk-reward equation.
Fit: Investors have preferences and biases toward certain sectors and business models. This has in part to do with the value an investor believes she can add that is often linked to her background, network and prior successes (or, conversely, her avoidance of similarities to prior failures). Fit also often involves all players in the venture partnership. Investment funds comprise a team of individuals who tend to work on consensus — if one partner really hates an opportunity, it’s unlikely to be supported even if the deal’s champion loves it.
Management, management, management: As location is to real estate, so management is to startups. Investors look for more than just a compelling market and product. We look for complete management teams that have relevant experience in growing a business in a given sector. If the team is lacking the right kind of experience, many investors will pass rather than take a chance on a first-time team or lead executive. There’s also the issue of chemistry. Investors recognize that the venture partnership created by investment is much like a marriage. So, if the chemistry ain’t there, you’re not likely to start dating with an eye toward consummating that relationship. While there are a good number of funds that will take on the challenge of recreating or re-forming the starting team (often a painful experience for the founder who’d assumed founding a company translated to running the company), many would prefer to manage other risks than the sensitive and complicated management issue.
Blame it on the rain
In the context of the current down economy, many investors withdraw from new opportunities for a couple of good reasons: They want to preserve their capital to follow-up on their committed investments, because investors are as afraid of their portfolio exhausting their capital as entrepreneurs are; and investors who back ventures whose prospective customers are corporations are rightly concerned about the negative impact of a slow economy on corporate buying decisions. Advertising-based businesses are also likely to be out of favor, as advertising spending correlates closely with the economy.
So is all hope lost in a down economy? Not necessarily. Many businesses are resistant to the effects of recession. For example, a fund that I manage involves a mix of technology and consumer products; our food portfolio is holding up, in large part because our commitments were made to companies that produce and market products in large popular categories like pizza and pasta, which are less volatile in a down economy. And on the technology front, opportunities that have very quick payback periods (e.g. less than six months) are more compelling to corporate buyers focused on taking cost out of their operations to compensate for the drop in their company’s revenue.
Even in good economies, entrepreneurs often find that it takes several nos to get to a yes in the venture market. In today’s economy, you can assume more nos to get to that yes, if you’ve got the right business model for the current and projected environment. Remember, in the venture community, higher risk requires higher return. If your company scores poorly on the risk-to-return scale, you’ll likely have to give up more of your business for venture capital than you might have a year ago. Not fun, but potentially a lot better than the alternative.
Michael Gurau, managing general partner of Clear Venture Partners in Portland, can be reached at mg@clearvcs.com.
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