Don’t get discouraged

So the pitch went great, lots of good discussion and Q&A, but still no $...what happens now? Firstly, don’t be put off by a VC not investing in your idea--there are many, many reasons why this happens. Please don’t assume your idea sucks; at the same time, also don’t assume they don’t get it--the fact is, you can’t kiss every girl. VCs (should) only invest in things they can really add value to--so if they don’t understand your technology or haven’t personally built a business in that space, chances are they wont want to fund it because they cant add anything beyond mere $.

A little known fact, VCs love to learn--why did they listen to your pitch if they didn’t really understand the space? Because you can teach them--in return, they will teach you. They will spend some time with you helping you find the right VC through their network, if you seem to have a solid idea. Furthermore, if they do understand the space generally, they will often spend a long period of time helping you iron out the kinks in your plan. I know of one company that Dado spent almost 18 months with before ultimately funding. Some companies take a lot of work before they are investible. This is a really good piece of the ecosystem--now, many entrepreneurs from other places don’t realize or believe how much time a valley VC may be willing to spend to nurture a potentially great idea. So, here is a story--some chip guys came up with a very high risk concept pushing the chip performance envelope almost to its theoretical limits. They were pretty well qualified to do so but while their chip design knowledge was great, their market knowledge was poor. So a very well known chip investor spent about 9 months working with the team, almost turning them into EIRs and letting them work closely with the rest of his team to flesh out their concept. The company was probably 3 months away from being investible, but at that point they secured a term sheet from one of the top 3 firms on Sandhill rd, not well known for syndication of deals--they took the money & ran (per good advice ;-) but failed to get the original VC dialed into the deal--very, very bad...). One of my own companies in the optical space had a similar history where one of the founders had leveraged actually 3 different, small VC firms for almost a year before getting funded. I found out about the history about a year after that and set about mending fences, but hard as it is to believe entrepreneurs are stupid enough to leverage this help and then dump the VCs in favor of another, the emotion is a lot likely being dumped for a prettier girl, and it leaves pretty nasty scars, too. Now, this ususually is a byproduct of heady times of rapid market growth--in poor economic climates, it's far more common for VCs to band together and prefer more people at the table to share the risk.

Getting turned down isn't the end of the world--in fact, let's turn it around to the VC getting jilted by the entrepreneur. In the case of the chip company, the dumped VC now had a very clear perspective of the space and knew what he felt was wrong with the team’s original idea, so was in a great position to evaluate the next 4 groups that pitched him for the same concept and thereby selected the optimal competitor who is now making the original team’s life hell...fun, isn’t it. Every no from a VC is an opportunity to learn. Make sure you ask for a debrief--VCs are optimists and they live by relationships. They want to invest the $ they have; they will work with you to make you investible if you are patient, honest, and have fundamentally a good idea. The more honest they are the more it can hurt, but make it easy for them to be honest; otherwise, all you’ll get is “love the deal, but we are not doing any more in this space.”

Life is too short

Larry Ellison has known this for years, as he tries to extend his years ;-), but also in the sense, I mean. I had breakfast with a friend at Kleiner last week and he was bemoaning wasting 3 months on a deal and having to drop it. He was doing a deal with a foreign company in a region known for tough negotiations--and great falafels. So he had done all his diligence, reworked the plan with the team 5 times, secured his tier 1 co-investor (yes, even Kleiner likes to have a co sometimes), and had signed the term sheet. But there was a slight problem: There was a local angel investor who wanted to renegotiate the deal. He wanted blocking rights, veto rights, and the more they talked, the worse it got. Worse, the CEO clearly couldn’t manage the negotiation, and my friend had been negotiating with the wrong person and quickly decided 3 things:

1. If the CEO couldn’t manage his investor, then he couldn’t run the company.
2. The angel investor added no value to the company, and would jeopardize its success.
3. Life is just too short; he had seen this movie before and knew the ending.

There are very few negotiations you will do in your life that are transactions without some form or ongoing relationship. Even when you buy a car--a negotiation that is very adversarial complete with appeal to authority, missing man scenario, even ignoratio allenchi, and all 7 of the classic gambits--there is still a relationship to worry about post-transaction: Someone has to service your car and deal with your warranty.

Someone who takes a transactional approach to a deal with you is a great example of life’s too short--you should politely bow out and forget the deal, no matter how good it seems. Entrepeneurs have been often been advised to tell the VC that they don’t need or want the money--don’t play this game--you will get "great, then come see me when you do." If it's going to be all about price, go to a bank, a strategic investor, or an angel--the price will inevitably be better, but the value-add will likewise be less. And if it's just a transaction, why would you expect any value after the transaction?

Another classic tell is assignment of blame--in its worst form, the entrepreneur blames you when things go wrong, but generally it's their team or the economy, or the weather. Life is simply too short to work with anyone who won't accept personal responsibility for what they do. This tell usually comes out in the first Q&A session.

First impressions from engineers are difficult because they are almost always geeky--a good friend here in the valley created the first impression with some foreign investors that he would make a lousy CEO. Too much of a techie and a geek--kind of a gangly, dorky guy. Now, he is that, but if you have ever worked with, say, Intel, you will find that they are all a bit that way, but if you listen to what they are saying, you will quickly realize that they are really exceptional business people as well. The culture of semi people is quite unique--to be good, they have to be quirky, and only the paranoid survive. :-) So, I am not talking about superficial first impression--you have to see deeper than that. As dorky as my friend can be, his integrity is without question and his dedication focus and passion for what he does are compelling. He also built 4 tech companies and turned a zero-revenue tech acquisition into a division on Intel generating 100s of millions in revenue--so his business skills aren’t too shabby, either.

A young guy in Sydney caught my admiration dramtically when he argued passionately on a panel of older, more experienced investors, a very controversial point--but he showed passion and belief, and some serious cojones to take the position he did. (And, by the way, against my point of view as well--yet as a first impression--I’ve gotta find a way to work with this guy!)

It's really hard to practice what you preach in this regard. I am working on a project at present where we are literally founding the company around the entrepreneur--which any good VC should do. In this case, it’s the opposite of the first impression--my first impression was "there is something here; this guy is good, but he needs a lot of help." In working with him I have since seen many red flags, but can't get past my first impression--we’ll see if it works out. :-)

Ideas are Cheap

I know the guys that invented the Internet--no really, and he wasn’t even the Vice President--but seriously, in 1980 a good friend made the observation that the intranet at our university should be the basis of a global communication system. After a few more beers, he had painted a vision of IP telephony, e-commerce, and many of the other innovations we now take for granted. He had a brilliant vision, but limited ability to execute on it; in fact, no real desire to do the work necessary to execute on it. Not to criticize Dave; after all, I was renowned in my University days for always saying "Just shut up and do it"--imagine if I'd bothered to TM that. ;-)

I also spent a lot of time in my first company writing my own patents because I couldn't afford to pay an attorney--I highly value IP, but it's a love-hate relationship because IP fools you into thinking you have invented something. To me, invention, or rather innovation, is all about executing on the vision and delivering the change. Now, clearly, there are instances where someone invents something clever, tries to commercialize it, and another company does it better and a IP lawsuit results. Ultimately, products must be born of innovation, but unfortunately IP is more often used by Trolls to stifle innovation and competition. Sure, there are times when a company refuses a fair license agreement and get what they deserve as a result, but as an investor it's rare to find an inventor, especially in a university that has a realistic perspective on the value of an idea. If you have ever negotiated with a university to license IP, you will likely share this feeling about IP.

I had an interesting experience recently with a university outside the valley; the meeting started with reading the riot act about what the university wouldn't put up with, and then went into a diatribe around knowing all about how VCs operate. Now I admit my brethren in other countries to operate quite differently to those in the valley, and there is probably justification for considerable negativity. Anyway, it was an interesting opening negotiating position. It stemmed from a bunch of things--but recognizing that I had already spent a lot of time with the inventors and worked with them in arranging investor meetings, customer meetings, diligence, getting market data, and creating the plan, the assumption was that I was already half-pregnant so I had a lot to lose.

The problem with this adversarial approach, aside from the fact that life is just too short (see earlier blog), is that early-stage investing is a partnership--if it's being done right, the VC is part of the founding team and gets their hands dirty in the trenches alongside the founders. When someone starts trying to use the work you did to help them against you, it's indicative of a zero-sum gain mindset--clearly, it's one form of business leverage, but it's a transactional view that burns the relationship for short-term gain. You don't ever want to work with people like that--even if you are just doing a transaction. Many, many people live and thrive in zero-sum gain ecosystems, but they rarely create anything, so why bother?

Having walked away from the deal I had helped create, I then experienced the irony of having a series of players from the original investors, independent BoD members, and some of the founders come back over the next year and pitch me my idea It still sounded pretty good, but they were so busy competing with each other to steal the idea that none of them actually delivered it. Lawsuits were threatened, sabers rattled, and ultimately everyone walked and the original company died. Which is the other problem with a zero-sum gain mindset--there isn’t anything left to go around. :-)

Is venture capital better than VISA?

My first company had phenomenal investors--VISA, Mastercard, Bank of America ... Actually 37 credit cards in all, and it was great because you got sweetheart rates for 6 months as you swapped balances ... no really ;-)

Why was that? Well, I had no idea how to raise money, I had never heard of venture capital, and I certainly had no idea what an investor would want to see to fund me. Actually, I also had no idea who would buy my product, but I was certain I had invented something revolutionary ... if I could just figure out who cared?

Now I wasn’t stupid, I had searched for and found a smart partner who understood the laser business and we co-founded the company. He dealt with all the business crap, and I focused on solving the technology and building the product. The problem is, that neither of us really understood what the market was for our product. So as the number of credit cards increased, and the credit card debt scaled up towards $250,000, I realized that the problems weren’t technical per se, but rather financial ;-)

We ended up selling stock to some friends and family, and that helped but also increased the stress and worry around not losing their money in addition to personal bankruptcy. As things were getting worse, we had a visit from Milton Chang, and he gave us an epiphany about our business.

He spent time in my basement in DC surrounded by used lab equipment and even more used furniture, and spent the day talking about what was missing in the business, which included the fact that we didn’t actually have a business. Milton saw several things he liked, and I came to learn that these were his classic tells for a good investment (Milton went on to invest in 27 companies, generating 5 IPOs, 10 great trade sales, and no losses – his stats are off the charts even compared to the best Silicon Valley VCs).

He saw a passionate engineer, focus on putting every available penny into making the product, cheap rent (my basement), no salaries (everyone worked for equity), and a genuinely revolutionary piece of technology in the solid-state green laser, or the "green diode" as we called it (because its beam quality was about as crappy as a diode).

It took Milton about a week to come back to me with an idea to merge our company with one in California called Iris Medical. It took a year, me taking over as CEO, a lot of stress and angst for a lot of people. But when we put great engineers and inventors together with great sales and marketing, we got a great result: Iridex and a NASDAQ IPO.

We literally went from bankruptcy to success (albeit over a couple more years), and the original investors in Light Solutions got their cash back and also kept their stock, so a nice double return. VISA and the other cards got their money back, plus interest, and everyone was happy.

So was VISA better than VC? Well, it certainly attracted Milton. He couldn’t believe we were committed enough (read stupid) to take this level of risk to back our idea but it clearly showed we believed in it passionately. He didn’t like our idea of skin in the game, because it was too distracting and made us make short term tactical decisions rather than strategic ones, but it wasn’t a bad place to start.

VISA gave some good advice: pay your bills on time or we’ll screw you--perhaps some similarities to VCs with respect to milestones ;-) What amazed me most about Milton was despite not really understanding our market specifically, he understood it well enough generally, and 80% of our issues were common to all startups and he understood those better than anyone I have ever met then or since. The power of a committed investor/partner who is aligned with you and willing to give you the time and advice you need is invaluable--it's worth far more than the money, which as you have seen can be gotten almost anywhere.

A lot of us worry about giving up too much equity for investment, but old school entrepreneurs worry about losing the money, and old school investors get their hands dirty standing shoulder to shoulder with the entrepreneurs to help them not only not lose the money, but to use it to make more. If you are worried about dilution, VISA is much better, no dilution, but for God's sake don’t lose the money ;-(