I met an entrepreneur who filed a patent for a pretty interesting technology and he was willing to get some funding for his business. He came to me as I was participating in panel for the launch of the UC Berkeley Business plan competition 2010. He was very convincing about his technology and really felt that his idea could get funded quickly.
After his first presentation to a VC firm that turned him down we had a long conversation about the most probable reasons why he had been turned down. This is when I realized that some people (probably more that I think) actually have a misperception of VC funding. The influence of the Bubble era pre-2001 are still deeply rooted in many people’s mind,making them think they can get funding with “just an idea”, but the scares of the burst after 2001, are also deeply rooted in the VC’s mind.
Here are a few myths about VC funding that I think should be well understood by wannabe entrepreneurs:
A good technology is enough for a VC: Technology is good but not sufficient. A VC firm is here to invest and make fast returns on their investments. A company at the technology stage has a lot of work to go by to prove the market opportunity, define a business model and acquire customers. A VC would rather invest a bit later in a proven business than earlier in a technology.
VC have so much money they’ll finance everything: It is true that VC do have a lot of money and they do need to invest it. But make no mistakes, VC bet on big wins for most of their investments. A big bet is a Google, a VMWare or similar company for which the return is astronomical. Out of 10 companies in which a VC invest, One will be a big win, 2 or 3 will make money and the rest might barely make it or lose money. (BACKUP WITH NUMBERS) If you think about the fact that all of those were thought to be potential big wins, imagine how much a VC can be wrong.. Just a little less wrong that others (hopefully).
Asking for a low amount is equivalent to low risk for a VC: I have seen a incredible amount of entrepreneurs taking that stand: asking for $100K, or $250K to make the VC feel it’s so low that they are not taking much risk. This attitude clearly shows that the entrepreneur doesn’t understand how a VC works. There is two component when looking at how a VC works in terms of investment decision. To make it brief:
If a VC has several millions to invest and a very limited number of partners to take care of their portfolio. if a $300M fund invest in $250K deals they will need to find and finance 1200 deals.. knowing that most of the time those VCs have 2 to 10 general partners, is their something wrong in the equation? VC are willing to invest from $5M to $30M or more in one venture if the return is good enough. A few deals a year is perfect for each General Partner and their is no time for very small deals.
if your venture requires only a few hundred thousands dollars to start and explode to the level a VC is interested in, it certainly means that their is a very low barrier to entry and competition will be very quick to come by and hinder the growth. Some competitive edge must be present to explain how you can produce so much value with such a little amount of cash to start with. I’m not saying it is impossible, but it’s doubtful.
Any VC will do for my Venture: This is a very common mistakes made by Entrepreneurs as they pitch to VCs. A VC is here not only for the money they invest, but for the network they provide, their experience, and their capacity to execute a good exit. The Track record of previous funds and of the general partners as well as the composition of the VC’s portfolio are very important in choosing the VC you want to work with. I might be naive, but I feel that a VC-Venture deal has to be a match for both sides otherwise it is doomed to fail. Pick your VC carefully because if it makes sense for you to work with them, the reciprocal might very well be true.
I’m digging up some numbers and will post them very shortly..