A fellow SoCal VC and friend of mine, Peter Lee, recently joined Baroda Ventures and has just launched his own blog as well. Please visit it here and support him in his efforts.
As you might imagine, I am constantly asked out to raise capital from VCs and what VCs are looking for. In fact, I am asked so often that I wrote a piece about it awhile back titled Hope is Not a Strategy simply to be able to point folks to the post. Well, I recently had an “epiphany for a post” while at D7 this week and spent the short drive home thinking about it some more.
Let me first set the stage. We were at lunch and sitting at a table of 8. To my left was an entrepreneur (to his left was Rupert Murdoch) and to my right was a VC friend of mine. The entrepreneur and Rupert were in a discussion and, at one point, the entrepreneur leans over and asked my friend what he will invest in. My friend’s response: “whatever I happen to be interested in.” The response may seem flippant at first, but let me explain why it isn’t and why more entrepreneurs should pay attention to what VCs are interested in and only target those with an expressed interest in companies in their areas of interest.
One of the frustrations entrepreneurs commonly lament is that it is so hard to get a meeting with a VC. Well, we VCs are extremely busy and very sensitive to the “return on time” factor as to how we allocate the hours of any given day. Here in SoCal, there are so few of us (by comparison to Silicon Valley and New England and despite the population of SoCal), that the matter is further exacerbated. So, what does this mean? It simply means that we allocate our time towards areas of interest. We are all looking for the companies that meet the general criteria I list in the above referenced post so it is even more important to learn what we are interested in…and understand that our areas of interest may (and likely will) change over time based on numerous considerations. As I was thinking about this matter, I called a friend/entrepreneur I know and discussed the matter a bit with him and he quickly suggested that while my thoughts here were solid, I overlooked the fact that it can be very difficult for entrepreneurs to determine which VCs are interested in what and that their websites can provide clues but tend to be deficient to the degree that I’m talking about here. Good point. In fact, I’m hereby declaring to make some changes to this blog to clarify my interests and will also make some changes to our fund’s website in the coming weeks that hopefully helps explain a bit more about what I/we are interested in…so stay tuned.
Hi, my name is Marc… and I’m a recovering attorney. Well, maybe I should say “reformed” instead. Actually, while I like to make jokes at my former profession’s expense, a good number of my friends are attorneys (or ex-attorneys) and I am privileged to work closely enough with some of them on a weekly basis so please don’t misconstrue any animosity here. I thought I’d re-post a popular piece I wrote in early 2007 about choosing legal counsel after being inspired by a recent piece by Jason Mendelson titled: Quick Ways to Get Fired as a Lawyer. I strongly encourage you to read Jason’s piece in addition to my spiel below.
I’ve had the good fortune to work with some really great attorneys over the past fifteen or so years and would like to spend a few minutes explaining just how important they are to the VC ecosystem and, in particular, to entrepreneurs given the number of questions I’ve fielded of late as to whom to go to for legal service in OC. Rather than try to address each situation that I was presented with here, I’ll answer generally like any good (reformed) attorney and simply say it depends…and then provide you some general considerations when choosing an attorney.
First, I strongly believe that having one or more good attorneys in your corner can really help you at the inception of your new business endeavor and you should get them involved early and often (once you’ve decided on who you want) as they can truly help you avoid the frequent initial mistakes at a minimum. Some will tell you that a good attorney can be worth his or her weight in gold, but I prefer to think in terms of diamonds; namely, the right one can shine as brightly under the right light and should also be chosen based on the “4 Cs”. So, what are they? Simply put, they’re Competence, Chemistry, Collaboration, and Cost and I’ll take each in order.
Competence: You should retain the right attorney for the job based on the job at hand and the attorney’s competence in performing such job. This may seem like common sense, but you’d be amazed at how many people simply use their friend, neighbor, [fill in the blank], regardless of his or her specialty, out of convenience rather hire a domain expert. Doing so can be extremely detrimental to an entrepreneur, especially one in a sector where intellectual property truly matters. For the record, I’m not suggesting you don’t confer with your friend, neighbor, etc that is a litigator or maritime lawyer, I’m simply pointing out that (in my humble opinion) you should consult an expert in the subject matter you need help in. For example, you should consult with a corporate finance attorney with experience in representing start-ups in company formation and financings rather than a general practice attorney who dabble in a number of areas of law. Most good attorneys will be more than willing to refer you to an expert in a particular field when the matter is one off their proverbial reservation. Fortunately, there is a number of competent attorneys right here in OC with a vast array of specialties and extensive experience.
Chemistry: Bottom-line, you need to be able to work with your attorney and to trust him or her implicitly given the nature of the business you will likely be conducting with him or her. If you’re constantly at odds with your attorney, it can hinder your progress as a start-up. Spend some time upfront getting to know each other to see if he or she is someone you can work with. A good attorney will be rowing the boat right along side you and become a true team member. Again, it may seem like common sense but I’ve seen the uglier side of this relationship and it’s a very big distraction at a minimum.
Collaboration: This is similar to chemistry. You need to retain an attorney that not only understands your issues, but can dynamically work well with you to resolve the issues and get the work done. It is also a good idea to choose a local attorney as working with someone from afar on the litany of start-up legal issues can be a challenge and, in my opinion, deprives you from getting the most bang for your buck. It’s much better to be able to pop into your attorney’s office and chat, review docs, etc. than to attempt to do so by electronic means. Choosing a local attorney may also come with the fringe benefit of utilizing his or her offices and conference rooms for meetings with your team, investors, and the like (you know, when you don’t have an office yet and/or are trying to keep your burn down like a good entrepreneur). The other thing to consider here is whether your attorney is part of a larger firm that has a diverse set of practices to grow with you as your company grows. Having said that, I’m reminded of a plaque my father (a career pilot) had on his desk that read something like: “It’s hard to soar with eagles when you’re surrounded by a bunch of turkeys...” so I feel compelled to point out that it’s not always a good idea to rely on a single firm for all your matters just because you like and work well with one particular attorney. Make sure you’re getting the expert advice you need and will be presumably paying for rather than deal with a bunch of turkeys just because they share a nest with your legal eagle.
Cost: Before all you big-firm attorneys panic and think that I’m going to suggest that entrepreneurs simply get the cheapest attorney they can to preserve their much needed cash, relax…that isn’t even remotely close to what I have to say here. I use the term “cost” here but I just as easily could have used the phrase “value exchange”…but it wouldn’t have started with a “C” and would have therefore thrown off my analogy. The value exchange I’m talking about here is simply making sure you receive appropriate value for the money you spend on your attorney (which goes to the other 3 Cs). It can actually be, and often is, more expensive to go with a particular attorney just because he or she is cheaper. How? Simple. A good attorney brings more to the table than just basic legal service. He or she has presumably worked with a number of companies you might want to work with but are unaware of, know a variety of capital sources, know a number of potential employees that you’d be interested in hiring, etc. Additionally, a really good attorney will help you avoid some common mistakes with respect to incorporation, patent prosecution, equity/debt financing, etc. that a lesser attorney may inadequately do. Avoiding such initial mistakes can save you money in the long run and ultimately prove to be cheaper for you overall. So go forth you brave entrepreneurs, lawyer-up, and build great companies here in OC.
I thought I’d re-post on due diligence given how much more of it we VCs tend to do during economic downturns. For the uninitiated, due diligence is the process in which a fund decides whether it will make an investment in a particular company and I will include some generic items for consideration later in this post. The earlier the stage of company, the more “art” than “science” there is in analyzing whether to make an investment but most early-stage funds follow the guidelines below to one degree or another. The other aspect of due diligence is often left unsaid, despite the fact it is equally important — the due diligence entrepreneurs SHOULD perform when deciding which fund they would like to work with and whether they want to partner with a particular fund that may have expressed interest in investing in them. It is, after all, a two-way street and both VC and entrepreneur will be essentially “marrying” for the next few years (exceptions/divorces aside).
Deal Due Diligence
Most VCs generally break this down to 1) market; 2) technology; 3) financial; and 4) “operations”. Performing due diligence on a particular market should result in the VC being very familiar (and comfortable) with the size of the market(s) the particular company is targeting with its product(s)/service(s), the direction the market seems to be heading based on historical statistics and the forecast rate of growth (e.g., most funds don’t necessarily like investing in markets that are dying…), the typical sales cycles for the product(s)/serivice(s), and who the players are in a given market (i.e., both the real and potential competition). Technical due diligence depends on what is being offered for sale by the company and whether their success depends on any particular competitive technological advantage (i.e. intellectual property). During technical due diligence, VCs attempt to determine the defensibility of the company’s business, any differentiation, whether the company will have the necessary freedom to operate (i.e., potential patent infringement issues), and any product life-cycle issues. Financial due diligence is essentially two parts: one part is determining how much capital the company will require and whether that fits with the fund’s model and the other part has to do with analyzing the company’s financials (e.g., how much cash they have, their cap table, whether they have any debt, etc.). A part of financial due diligence may also involve determining whether the VC and/or company will be able to pull together a syndicate for larger and/or later rounds of financing. Finally, performing “operational” due diligence involves background checks on the folks involved to determine whether they are the right folks to be able to take the company to the next level based on their past experience and personal characteristics. Operational due diligence also involves making sure the business model is sound, the company doesn’t have any pending or potential legal issues, and the that the general logistics of making the investment make sense. The entire due diligence exercise serves, at a minimum, to identify and mitigate the risks associated with the deal to the extent necessary honor the VC’s fiduciary duties to its LPs. For more information about the types of risks VCs attempt to identify/mitigate, see my Arbiters of Risk post by clicking here.
Fund Due Diligence
A far too often overlooked aspect of the start-up / VC deal consumation is the diligence the start-up should perform on its prospective VCs. You would be amazed at how much “spaghetti” I get wherein folks are simply looking for funding from anyone and everyone regardless of whether their deal would be a good fit given the stage, size, and investment model of my fund. So, before I provide more specifics here, do I have all your entrepreneurs’ and would-be-entrepreneurs’ undivided attention??? I thought so… As sites like The Funded take root, I think you’ll see more transparency in the venture capital industry. In the interim, here is a short list to get you started. I started with a list that one of my attorneys, Craig Dauchy, provided for me and added my own items based on my experience as a VC and someone that has raised “OPM”. So here we go… Here’s a laundry list of questions you should be asking yourself and/or the VC to determine whether the fund in question is a good fit.:
For more on fund due diligence and general entrepreneurial advice, I recommend you see my VCs Circle of Life post and spend $45 to pick up a copy of Craig’s book, The Entrepreneur’s Guide to Business Law. Of the two, his book is better and maybe you can convince him to autograph it for you — just tell him I suggested it ;-) With that, all you entrepreneurs do your own homework and pick the right partner for the deal at hand and happy venturing.
As for why due diligence seem to take longer these days, there are a number of reasons but they merit their own post so stay tuned…
