I visited the entrepreneurs week at Stanford this week, where many MBAs were walking around with new business ideas. From my conversations with them, it became clear they have a lot to learn. Since we raised a fair amount of money ourselves in the last ten years in Silicon Valley, I wanted to give some advice that may be helpful to any first-time entrepreneur:
1) Define the objective of the company in a new world order
The determination of pre-money valuation, even for the first round, should be based on the impact of the disruption of the company when it grows up. And like you evaluate the potential of your children, with a valuation not based on whether they can walk coming out of the womb. The goal is to find the investor who can comprehend and envision the path to that goal and whether you prove to be the best person to traverse that path. A valuation not defined by the bottom-up assessment of the infant crawl if you catch my drift. The starting valuation then becomes a reverse inference from that goal, correlated to the upside of a new normalization of truth.
2) Don’t set a valuation, but have one in mind
The investor usually suggests the valuation, but of course, you don’t have to take it. Ask your potential investor to value the company – first – after you give them the pitch, the outcome of that tells you whether the investor truly understands your unique proposition. If it is too low, it may be because of the clarity of your pitch. If not: walk away. Valuations inspire both parties to cement their alignment to foresight, from which there is no viable crawl back.
3) Have an operating plan ready
An operating plan defines how you turn technology into a business; without it, there is too much wiggle room for debate and depreciation. Show investors you know how to run the business. The more you do, the easier it is to cement your use-of-proceeds by which you prognosticate and validate the growth inflection points. It tells investors how you think over what you think, an important barometer shaping their confidence.
4) Find an investor you truly like
Every entrepreneur deserves to be treated with respect. Waste no time talking with awful personalities with nevertheless deep pockets, but don’t be afraid to receive some straight talk either if warranted. Check TheFunded.com for war stories and ask around, VC reputations invariably precede them. When the business gets tough, bad attitudes usually get a lot worse. And just as in relationships, a bad start makes for a terrible ending. So, pay close attention to how the honeymoon phase, in the words of Maya Angelou, get over what happened yet pay attention to how it made you feel. Listen to your compass of intuition.
5) Define business disruption
Building technology is one thing, but yielding disruptive business value is even more relevant. The latter is defined by a root-causal connection to a new normalization of truth enabled by technology, not by technology for technology’s sake. The difference is the validity of your unprecedented and best normalization of said truth, and how it intends to improve our world.
6) Take passion over domain expertise any-day
Find a lead investor who has a passion for the problem you are about to solve. An investor who claims to have domain expertise is usually the one who doesn’t understand disruption within or across that domain, let alone can imagine a new normalization of its existence. It is difficult to free fools from the chains they revere (Voltaire), and thus do not seek consensus from those within the domain. Changing the name of the game makes the prior domain expertise rapidly irrelevant. Seek like-minded passion and well-founded yet not commoditized criticism of the current status quo, over the pageantry of positivity that by definition, will fail to improve our world significantly. Critical thinking is what spurs the innovation to spawn a brave new world.
7) Don’t get squeezed
Investors like to put investments into past investment categories and make an assessment of how much it costs to build your business, your downside. Don’t let them stray too much from what is in your operating plan, your trajectory to the upside. If you do, you will get punished for it later, both on the execution side as well as in excessive dilution. An outlier knows no precedent, and thus avoid investors correlating your proposition to a precedent, with your valuation and upside soon becoming a deplorable derivative thereof.
8) Know the investment allocation
Generally, experienced VCs should have a total investment runway allocated to the business. Ask them for the overall allocation upfront, so you know when you need to go shopping somewhere else. Also, don’t be afraid to ask who else needs to sign off on this deal within the VC firm; in most cases, it is a very democratic process internally with a primary sponsor. Avoid talking to associates at the VC firm; they are like HR people, producing nothing but debilitating false positives and false negatives. Get in front of a General Partner quickly, spawn a meeting of the minds of upside, and engage in talking terms soon after that to gauge their real cognition and interest.
9) Control your eco-system
Investors like to wiggle around and determine how much money should go into R&D, Sales, Marketing, Business Development, Support, and G&A. Too much money in marketing is usually an indication the product or service is not ready, does not change the norm, and lacks real viral adoption, which must be avoided. If the balance of the ecosystem of expenditures, the infinite loop, is not guarded heavily by the entrepreneurs, the result is excessive bleeding and further dilution in subsequent rounds.
10) Balance your board
A board without a balance of technical and business expertise can quickly bring a company down to its knees when the going gets tough. Technical board members will spend too much time validating deep technology progress without real affinity for the bottom-line. On the flip side, demand for too early revenues can have disastrous effects on product or service readiness, disruptive value, and customer experience. Keep them both in check.
Be honest and transparent about the propensity of achieving macro from the meticulous execution of micro. A prospective investor who cannot distinguish between the two must be avoided at all costs. Paint a realistic risk-management picture through all the projected stages of growth through an operating plan, from which you illuminate sensible trade-offs.
Use the same method by which VCs sell their risk diversification to limited partners in a Private Placement Memorandum (PPM). Understand the language and hot buttons of investors. Aim to meet their goals by meeting or exceeding yours.