By Frank Demmler
Note: I’ve known and worked with Steve Czetli for 20 years. I am an admirer of TechyVent as an important and respected communications vehicle to the entrepreneurial/high technology/funding communities. In a recent conversation, he and I agreed that fund raising remains a largely mysterious process for first-time entrepreneurs and angel investors. We thought readers would benefit from a regular column with the goal of showing how capital gets raised in the real world.
I hope to explain how entrepreneurs and investors go through the courtship and mating process, shedding a little light on important aspects and dispelling some myths along the way. This column is the first of several, and perhaps many, on this subject, depending upon the level of interest expressed by you, the reader.
After 20 years of working with early stage businesses, from both the company and investor sides, it never ceases to amaze me how many myths and misperceptions exist about raising capital among first-time entrepreneurs.
One of the most common mistakes is the entrepreneur’s belief that raising money for a venture is a linear process with defined steps, and if he takes each of those steps, he deserves to be funded.
Let’s get things straight from the get-go – investors never have to invest in a deal (other than as follow on investments to their existing deals that require investment if certain milestones are met, but that’s a whole other can of worms, and happens after initial investments have been made.)
In fact, most investors who look at an entrepreneur’s deal look for a reason to say, “No.” They look for a flaw, any flaw, so they can place the plan in the circular file and move on. Why is this? Aren’t they in the business of investing? Why would they want to reject a “great” plan?
Look at it from their perspective. If they’re sophisticated investors who have done many deals, some have failed miserably. Being professionals, they know statistics like the fact that 80% of all new businesses don’t exist after five years. They know that typical venture capitalists only invest in 0.5% – 2.0% of the deals they see (and still with that level of screening, well over half of venture capital-backed companies fail, or do not provide a path to liquidity).
These investors probably have stacks of 25 “great” business plans sitting on their desks or in their briefcases. The goal of their initial screenings is to weed out as many of those plans as possible. A more-or-less constant inflow of new plans seems to keep their stacks at 25 regardless of how quickly the current plans are processed.
This raises another important point that the first-time entrepreneur must understand. Investors know that there’s always another deal coming. They can pass and pass and pass on deals, and there will always be another one to invest in. Occasionally, one of those plans won’t be rejected, and maybe they’ll do that deal.
Being active investors, they know that they will “miss” some good deals. That comes with the territory. They may learn something by revisiting why they rejected the deals and what the companies did to overcame their concerns, but they don’t dwell on that. They mostly focus only on how the deals they did do have fared.
So much for the investing mindset.
The language of rejection
A not-so-obvious, but critical element of fund raising is understanding the communication that goes on between an entrepreneur and a potential investor. The preceding has painted a bleak picture of the nasty investor dashing the dreams of entrepreneurs on a daily basis. Yet, few entrepreneurs would characterize their experience with investors so harshly.
Does that negate all of the preceding? Absolutely not. Investors often come to “No” conclusions, but rarely phrase it that way to the entrepreneur. The following phrases all mean, “No.”
- “Your opportunity does not meet our investment criteria.”
- “Our plate is really full right now, so we can’t devote the time to your plan that it deserves.”
- “We might be interested in co-investing when you get a lead investor.”
- “We might be interested once you’ve made a sale to a big company.”
Translated, read these responses as: “We are not inclined to want to do your deal, and we don’t think that you’ve got ‘a snowball’s chance in hell’ of [getting a lead investor or closing a major sale.] But just in case you do, we want to leave the door open. After all, maybe we missed something.”
Also, if they flat out say, “No,” the entrepreneurs may push for explanations that will lead to time-consuming, and probably unpleasant, confrontations. Meanwhile, their backlog of plans is piling up.
With all of this said, deals do get done. Entrepreneurs do attract value-added investors. Great outcomes are achieved. In future weeks, we’ll take a look at the dynamics that create these winners.