Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.


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Breaking Through The Broken is an absolute “MUST READ” for every entrepreneur or investor trying to get ahead in today's down economy. To accelerate economic growth, the time is now to focus on creating sustainable new ventures faster and with more efficiency than ever before. This newly published paper offers up 30+ pages of insight, inspiration, and rarefied honesty on how entrepreneurs and investors can work together to achieve their common goal: a significant return on both invested time and capital.

North is a boutique private equity advisory firm providing forward-thinking entrepreneurs and investors with world-class due diligence and analysis services.

If you’re interested in learning more about how a Venture 360 Report can make you a more effective and efficient investor or entrepreneur, please contact us by sending a short email introduction to and we’ll set up some time to talk shop.

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Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital.

  1. 1. Breaking Through The Broken: The Transparent Guide To Overcoming The Inefficiencies In Early Stage Venture Capital. So you’ve done the work, assembled the team, of plans in front of them. Say what? That’s right, written the business plan...Now what? For most most investors don’t read business plans. They entrepreneurs, successfully raising capital is a simply don’t have the time or resources to read daunting task. After spending countless hours at thousands of highly subjective business plans networking events and collecting a shoebox full that all say pretty much the same thing. If that’s of business cards from people who can’t really seem the case, how do investors find, filter, and fund to offer any help or guidance, what is one to do? the most promising new venture opportunities in a You start blasting out your business plan to anyone deep ocean of possibilities? The truth is, they can’t. with a working email address or a “submit a plan” link on their website. But after hearing nothing but This current process for fostering early stage crickets from all your proactive efforts, you may innovation is broken, and it needs to be fixed. even begin to second-guess your big idea, your The problem isn’t with the number of opportunities entrepreneurial abilities, and your chosen career investors are presented with, but is rather a lack path. How can an entrepreneur break through and of an efficient means of filtering the options. The get venture funding when most investors don’t innovation system is constrained by throughput, even read business plans? not supply, but how can we solve this problem to make the process of creating new companies more It’s true. Most VCs and Angel investment groups are efficient and generate the returns investors, completely buried in submissions from entrepreneurs entrepreneurs, and ultimately the global economy who have “remarkable products, stellar financials, need so desperately? and a world-class management team,” or at least that is what their business plan would say if they actually had the resources to read the thousands 1 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  2. 2. Cont’d Breaking Through The Broken: Introduction Early stage investing will always be considered of the century, with the ability to create new jobs a high risk, high reward game. But what if there and even spawn entire new industries, where else were smarter, more efficient tools that enabled both could we turn for game changing growth? investors and entrepreneurs to optimize the process by making the investment process “less gut” and But as promising as American innovation sounds, “more guided”? Could we eliminate some of the fear if we don’t step up now and collectively address and confusion surrounding early stage investing the inefficiencies in how new companies are being and begin to truly optimize entrepreneurship? created, our economic and social futures could be at serious risk… In case you’ve been living under a rock for the last six months, you know that our economy isn’t doing so hot. The system’s flaws have unfortunately come to a head in recent times, leading to the near peril of once esteemed industries (goodbye Lehman Brothers and Merrill Lynch), a staggering unemployment rate not felt since the 1970s, and a socialistic-like bailout of our cherished laissez- faire markets. With crumbling credit markets and an over-hyped housing bubble sparking the recent Wall and Main Street economic meltdowns, American innovation is now being trumpeted as the last best chance to lead the impending economic recovery. With Financial Markets in turmoil, and real estate in a downward spiral, innovation is logically the economic game plan for the comeback 2 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  3. 3. Change We Can Must Believe In Fortunately, the timing for fixing this problem couldn’t contrary to popular belief, more money is not the be more ideal. With the new administration comes a only answer. promise of support in the creation of small businesses. Change will come with policies like President Obama’s The central issue is not with the quantity of ideas or “Innovation Agenda” which “leverages technology number of willing investors, but rather in properly to grow the economy, create jobs, and solves our pairing the two. There are plenty of investors willing country’s most pressing problems.” to provide the capital needed by the entrepreneurs working to change the world, but there is often a “Right now, somewhere in America,” believes Obama, communication breakdown between the two parties. “a small business is at work with the next big idea… On one side there are the mysterious “deal mak- an entrepreneur is sketching plans for the start-up ers” who might seem easy to reach with the click that will revolutionize an industry.” What Obama of a mouse, but in reality are incredibly difficult to forgot to mention, though, is that one garage down engage with meaningful dialogue. On the flip side, from the next Facebook, an entrepreneur is working there are the passionate entrepreneurs who are eager on the next big flop. Along with the many brilliant to find out what an experienced investor thinks of and world-changing ideas seeking capital, there are their “big idea,” but usually hear back nothing at all also plenty of terrible ones. How can an investor after submitting their materials for consideration. possibly know the difference between the two at such an early stage? How is an entrepreneur to know So what’s the rub? that the time (and capital) they are spending taking their project down a certain path may be much better Well, there are a number of problems that are spent directing it in an entirely different direction? holding us back. For one thing, the process for With today’s one in ten success rate for creating new raising venture capital is shrouded in secrecy. Isn’t ventures, we don’t have time to just “bet more”; it strange that in an industry hell-bent on building we need to bet smarter because what matters most new companies and “inspiring innovation”, most is the output that these invested dollars return. investors aren’t even willing to take the time to give entrepreneurs some valuable feedback; specifically This all raises the question; what is the early stage telling what they’re looking for, and guiding investor community currently doing to optimize entrepreneurs to focus on certain areas of a business entrepreneurship and increase the success rate of if they want a legitimate shot at raising investment their investments? capital? Don’t you think if entrepreneurs built their businesses around the actual criteria they were being evaluated on, they’d have a much better shot Support Beyond Dollar Signs at connecting with investors? Of course both parties have to be judicious with time and energy, Let’s not forget that entrepreneurs, and the investors but the complete lack of communication is beneficial that support them, need all the help they can get to to no one. turn these ideas into world-changing realities, and 3 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  4. 4. Cont’d Support Beyond Dollar Signs What is so frustrating is that both parties really need an era of collaboration and transparency isn’t just each other; the future of the world (seriously people) a nice idea; right now it’s an imperative. can be very positively affected if this communication gap is bridged. Bottom line, while investment capital injected into a handful of new ventures is great, most early stage companies need much more than money. Raising Capital: Pick Your Path To an entrepreneur, fundraising is scary stuff, The benefits of transparency, guidance, and mentor- and rightfully so. Make no mistake about it; ing that an experienced investor can provide can FUNDRAISING IS HARD, and even harder during ultimately prove to be the difference between success leaner times. However, those working on the next and failure. If an investor has wisdom to share, they big idea shouldn’t lose their faith. They should keep should be generous with it, not hold it so close to plugging away, stay inspired, and conduct careful their vest. As Ronald Reagan might say, “Tear down research on the options available to them. this black box and start to educate entrepreneurs and other investors about what works and what doesn’t.” Besides the current recession, most of the fear After all, neither investors nor entrepreneurs (or around raising money comes simply from a lack our economic recovery) are well served by spending of understanding. The world of start-up capital is a weeks or months to move a venture forward if it’s foreign one to most entrepreneurs, partly because fundamentally flawed in its infancy. investors are so unlike them (deal makers vs. creators), and partly because they don’t have an With the number of new small businesses expected intimate understanding of how the world of capital to rise in 2009 (with job losses high and traditional operates. Well, let’s try to straighten out some of employment options limited), many will take the the confusion. opportunity to test their entrepreneurial chops. Start-ups are now cheaper to launch than ever before, There are two main types of investors: Angels and as $500K has become the new $5 million. Primar- Venture Capitalists. Angels invest their own money ily because basic software that was once absurdly and VCs invest other people’s. The other main expensive is now free (open source), and astonish- options for funding are to solicit your friends and ingly good hardware (or virtual processing power) is family, or to just do it yourself. Given our current now very affordable. But before an entrepreneur will economic climate, and the fact that innovation by be able to transform an innovative idea into a real entrepreneurs is essential to right this economic ship operating company, they’ll most likely need to seek and restore the confidence in our global economy, a credible outside source of capital (and counsel- all options are on the table. So read up, welcome to ing). While the choices are abundant, the routes for business financing 101. depositing a round of funding in your bank account still remain challenging to navigate. The benefits of The VC Route secrecy are far too one sided. To change our future Venture capital is the most highly regarded form we need to re-think the past. Moving forward into of funding, but it’s also the most misunderstood. 4 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  5. 5. Cont’d The VC Route Venture Capital (VC) is funding that comes from returns on their investment over a set period of time. professionally managed funds that have roughly The fastest and biggest way to do this is for their $25 million to $1 billon to invest in promising new portfolio companies to either get bought out or go businesses. Because there are so few of them, and public, so you can expect them to push for unnatural they have control of the money, VCs are extremely things to happen. $5M to break the space-time choosy on who they decide to fund. continuum usually looks better on paper than it turns out in practice. VC funding is certainly not for every company, and timing is critical, but if you’re a high-growth In addition, VCs almost never look at a business plan company capable of generating significant revenue or listen to a pitch if a trusted individual didn’t refer in the short term (or already have a nice revenue you. While this practice certainly limits the amount growth curve), funding from an institutional of junk plans (i.e. cubic zirconia?) on their desks, it venture fund provides a fantastic opportunity for also leaves out the possibility of discovering a true accelerated growth. Such acceleration, however, gem. Yes, the old boys networks is a great thing if does not come cheap. you are part of the in-crowd, but both parties could benefit from a more open and efficient approach to Most VC firms offer a few other undesirable finding and filtering investment opportunities. “benefits” in addition to their money. In many cases they will require the addition of a few senior “VCs do initiate on their own when they see management roles (of their choosing) to your team. a bright startup. But it’s so rare that you seldom Remember, VCs are usually bankers at heart, so don’t hear such stories. And when it does happen, expect them to be able to help with or understand your technology or target consumer’s emotional it becomes legend.” - Vikas Rana, entrepreneur needs. Go to them when money is all you need. A big name VC will look to own AT LEAST 25% of As funding becomes tighter and tighter (until the the company to cover their time and energy for a economy begins to bounce back) the rate of innova- particular investment. Venture capital is by far the tion will likely speed up; out of necessity to find new most expensive money you will ever raise both in ways to make portfolio companies profitable quickly. terms of equity and sanity. And, just as people always say it will be hard to get VC funding, the large VCs will have money to invest. The existing VC model centers around a short-term For those fortunate enough to stand out and make a focus on a big payout. VC firms do not typically favorable impression, funding will still be available, invest in businesses that have a promising long-term as it was after the dot com bubble; but it will just future but rather in ones that will likely see a take a little more work to get that cash in hand. liquidity event in 3-5 years. Because these investors aren’t putting up their own cash, they feel substan- It is important to have your priorities straight and tial pressure (it’s their job after all) to see significant your feet planted in reality. If you’re new to the game and have a very early stage venture that hasn’t yet 5 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  6. 6. Cont’d The VC Route figured out how to make the cash register ring, you Angels thrive in a space that VCs and banks often are probably better off working out the kinks and fear to tread (very early stage, pre-revenue ventures) creating value than you are putting on a silicon in hopes of generating impressive long-term returns. valley road show. Don’t fret, there are other options. One study cites a rate of return of about 127%, on average, or 2.6 times the investment in 3.5 years. These Angels Have Money…and Wings The risks, of course, are steep. Still, 258,200 angels Angel investors carry the heavenly name for a pumped $26 billion into 57,120 ventures last year, reason; most can (and are willing to) offer much according to the University of New Hampshire’s more to your venture than just money. They can Center for Venture Research. Combined with the provide experience and mentorship to carry your potential “financial returns” an Angel gets from business to the Promised Land. Angels are usually playing a role in building a successful business, the entrepreneurs themselves, successful ones who are “emotional returns” one gets from a playing a role looking to offer up help to the next generation of in building a successful business makes Angel fresh-thinkers. But don’t be fooled, just because investing that much more rewarding. these guys aren’t bankers, doesn’t mean that they don’t have serious skills. Traditionally, the problem with Angels was finding them. However, there’s recently been a proliferation Angels usually invest in spaces that they themselves of formal Angel investor groups and websites that have experience, a trend that can prove to be very screen investments and pool money on a local and helpful to an early stage company, especially one regional level (read more here in North Mindmeld whose founders lack experience. An Angel usually section). According to the Angel Capital Association, has the time to provide guidance, as many of them there are now over 330 Angel Groups in the U.S. and are no longer working full time and enjoy becoming Canada. Like most high net worth individuals, advisors to those companies in which they invest. Angels don’t walk around with a sign on their back Remember, Angels are entrepreneurs first, so of- that says “investor” so use your Google hunting skills fering them a hands-on investment provides them to track them down (psst…if you haven’t already with the opportunity to live vicariously through the mastered this craft, should you really be starting a founders and keep their skills sharp, without having company in the first place?). What this expansion of to take the heat. formal groups and Internet enabled “pitch farms” has created is a familiar problem to VCs, a deep ocean of “You make money in Angel investing by killing potential investments where quality yield is far more off your losses early, as quickly as possible. important than quantity of submissions. The entrepreneur really believes that success Friends & Family First? is just around the corner, and you’ll quickly go If you can’t finance your venture out of your own broke investing for ‘just-around-the-corner’.” pocket, you’ll most likely turn to those in your close - Houston-based Angel, Richard Holdren. personal circle. However, if you do go this route, you 6 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  7. 7. Cont’d Friends & Family First? better be damn sure you aren’t going to fail, because In addition, debt may be better than equity. If there’s nothing like the feeling of going back to your someone lends you money, you only have to pay Dad, Uncle Larry, or longtime family friend and it back with interest. If they insist on buying stock asking them for more money (or worse, telling them in your company, consider making it nonvoting stock that you just blew the $50,000 they just gave you). (so they can’t tell you how to run your company). Lastly, after you’ve taken their money, make it a When raising money from friends and family, it’s priority to fulfill their expectations by giving them important to understand that it can often create per- a maturity date for their invested money and do sonal and emotional issues that go well beyond your everything possible to pay them back in a timely business judgment. If you borrow and subsequently manner (with hopefully a solid ROI). Don’t discount burn through the thousands from Uncle Larry for constant communication either. Keeping all investors your innovative start-up, don’t kid yourself; he’s go- highly informed is very important, and it helps ing to want to see something besides your pretty face prevent angry phone calls and awkward moments at Thanksgiving dinner. Can you say awkward? Con- when things aren’t going exactly to plan. versely, if you have an informal agreement with him or someone else and you strike it rich, this could lead Kick-starting your dream by taking money from to some uncomfortable legal drama down the road. those who you trust can save a lot of time and energy looking for external investors. It can also “What’s money for anyway? It’s to make things be just the right motivation to keep your eye on the happen,” once said Auntie Joyce, maverick en- grand prize, because nothing feels better than being able to write your Dad (or Uncle Larry) a check for trepreneur Richard Branson’s aunt. In 1972, she ten times what he gave you to follow your dreams. lent $10,000 to Sir Richard so he could build a Besides, getting rich with your friends and family recording studio, which eventually became Virgin makes it that much better, because who are you Records, and decades later, a $20 billion empire. going to go on vacation with if you’re the only one who can pay for it? When picking this path, it’s important to exercise the same discipline as you would in dealing with a Take It To The Bank professional investor. Firstly, treat family and friends There is a common misconception that start-ups as if they were strangers, insist on some sort of can’t get traditional bank loans. Not true. Banks, official agreement between you and them. Secondly, do, however, require some sort of collateral. So you should only borrow from those who have a if you’re fresh out of college and your personal disposable amount to lend. Sounds like a duh, but balance sheet is the title to a beat up 1998 Honda many people don’t know how to say “no” to a loved Civic and no significant credit history, than you one and wind up leveraging their futures on your have very little chance of squeezing any kind of new “can’t fail” concept. money out of a bank. And in today’s market, forget it, financing is going to be tough to come by unless 7 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  8. 8. Cont’d Take It To The Bank you have a stellar credit rating and something that Time will tell whether the Obama administration the bank can use to offset the risk of the loan. is indeed going to be able to walk their talk. Accord- ing to all early indicators though, bank/loan capital Even if you do have some assets you should still be should start to become more available cheaper and realistic, don’t just expect a bank to fork over their easier than it has been in years. But with a credit cash unless you can prove to them that there is a crunchy market, this option still may prove to be high potential of generating enough revenue to repay just as challenging as the others. Is next year going that loan. If you can’t, you better be prepared for the to be the Year of Small Business Loan? Stay tuned. bank to take something of value if you default. (p.s. hiding from a repo man sucks, so think long and Bootstrapping: Plastic or Paper? hard before you get in deep with the banks). Ahh…credit cards. They can be very useful if you In this down economy, it’s become harder and harder are responsible and know how to work the system, for banks to lend out money. The Federal Reserve but if you’re a rookie, they’re like playing with recently reported that 75 percent of domestic banks matches and gasoline. You can easily rack up tre- have tightened lending standards to small firms, mendous debt, and with extremely high interest rates and about 95 percent (up from 70 percent just a few you may never catch up if your business stumbles months earlier) say they are charging more interest even once... You know those commercials with the for loans to small businesses. guy in the pirate hat singing a jingle in some sea- food restaurant because his credit score sucks and But there is some good news at the end of the dark he couldn’t get a loan? That’s based on a true story, tunnel. President Obama’s nominee of Karen Gordon so don’t be that guy who was naïve about the conse- Mills to lead the Small Business Administration is quences of over leveraging yourself with plastic cash. a positive step (btw – the SBA’s budget was cut in half over the past eight years of the Bush). Mills, a The term “bootstrapping” refers to much more than venture capitalist and successful entrepreneur from financing a venture through credit cards, though. Maine has promised to take some aggressive strides Working two jobs, doing consulting work, anything to foster economic development and the growth of you can do to alternatively finance a new business small businesses. Let’s all hope so. falls into this category. Consulting work is an interesting source of income, but be careful not “The small business sector in this country is the to let that “moonlighting” become your full time engine of economic growth, and we need to keep business (investors are weary of throwing money at the night shift entrepreneur who just turns out only the engine running during this financial crisis. The to be practicing for a full time consulting gig). best way to do that is through expedient, targeted Be prepared though, when you decide to bootstrap, and effective lending through the SBA.” you, the founder and a limited number of early Senator Chuck Schumer (D-N.Y.) employees will probably forgo steady paychecks and a good nights sleep for quite some time to make your dream a reality. 8 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  9. 9. Cont’d Bootstrapping: Plastic or Paper? “People need to look back at bootstrapping, at a trade show booth. Just because you shake hands the way the vast majority of businesses in the US with an investor doesn’t mean he’s ready to give you a giant check. This traditional process of finding are started, as a viable means to incubate during entrepreneurs needed to evolve, and in some senses slow times. I’m excited to see what comes out of it has. Thanks in large part to the Internet, investors this time as it is the ideas that were being planted are buried in new business plan submissions. As of during the last bust that have truly changed our this writing, there are over 37,000 business plans on world today. The bust made people reflect, be, over 100,000 plans on FundingPost. deliberate, and grow prudently.” com, and over 6,000 plans on Sounds great for investors, right? But let’s take a – Michael, entrepreneur & blogger closer look at the math: If you’re bootstrapping, you’re going to need If an investor tried to review all these plans for evaluate every expense of your start-up down to the 30 minutes each it would take over 34 years reading ballpoint pens. The trick is to come up with creative non stop for 8 hours a day, 5 days a week, for and inexpensive ways to get the job done. Remember, 52 weeks a year. especially in your early stages, the pennies you save are sometimes more important than the pennies you Where’s the Brita water filter for business plans when make. Start-up with what you need, not with what you need it? Out of those 143,000 plans described you want, or you could soon find yourself starring above, how many are actually high quality, better to in that aforementioned jingle after all. digest, “investor-ready” ideas? Investors are thirsty for exciting opportunities, but they’re not quite ready to wrap their mouths around a fire hose. As for the Investor Side: What’s Broken? entrepreneur looking for a leg up, blasting your Before the Internet, entire industries emerged that business plan out to several thousand investors with helped investors find “good” entrepreneurs; trade the click of a button is about as strategic as buying shows, print publications, and an army of investment a Powerball ticket. banking connectors who helped investors and entre- preneurs find each other (for a chunky fee of course). The Internet has created a massive pool of invest- You can spend half your career (and life savings) at ment opportunities, which has shifted the real trade shows and more often than not all you would problem from an issue of quantity to throughput and have to show for it would be extra airline miles and yield. Adding another 140,000 business plans to the a desk drawer full of name badges. un-harvested fields of internet “pitch farms” will not increase yield any more than it already has. Angel Today’s investors rely more than ever on their investors are already using this huge pool of business personal filter of trusted referrals and connections plans and their throughput has likely increased by with friends. Tip: trust is not earned swapping cards an additional 10 or more deals per month at most. 9 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  10. 10. Cont’d Investor Side: What’s Broken? But while this increase in reviewed applicants should member of a small Angel group that exposes you to lead to slightly stronger funding candidates, the “quality” investments usually costs money (annual overall problem is still NOT being solved. In fact, dues), and more often than not, you end up doing all the minimal gains from reading a few more plans the deal review work anyway. So, what are you really each month doesn’t actually increase the number paying for? If you’re going to pay to join a social of deals that an Angel group can seriously club, join the country version, at least you’re evaluate or fund. That number (based on their in guaranteed a good tee time and some exercise. house resources) remains constant no matter how many ventures are knocking on the door. Speed Pitching Produces Few Hits Nearly every major funding website boasts that in The cold fact is that most investors still won’t even addition to their “connecting” services, they also host glance at a business plan unless it’s gotten a refer- entrepreneur speed pitching events. Speed pitching? ral from a credible third party. It’s not only about It doesn’t work for finding a soul mate, so why would who you know, it’s also about how you know them. it work for finding a high quality venture invest- Entrepreneurs and business plans referred by others ment? Let’s face it, true understanding of a venture, who have proven to be good filters for garbage ideas, the management team, and the target market doesn’t often float to the top of the pile. How else do you happen during a frenetic 20 minute pitch over a expect investors to filter through 34 years of reading cheese danish. Investors need to make confident and material? Everything else usually gets dumped into educated decisions based on data, not just rely on the circular filing cabinet. Today most investment their intuition or how the entrepreneur dresses that deals come down to personal TRUST, which is pretty day. Listening to eager, money-hungry entrepreneurs hard to create in a virtual world. dial in their elevator pitch is exhausting. Seasoned investors are looking for thoroughbreds, not an inbox Websites like Linkedin are useful tools for examin- clogged with also-rans. ing a person’s work history and experience, but they are not a substitute for one on one interviews and Funding Universe has recently made a lot of noise the ability to make an objective investment decision. with their Live Pitch concept, which they outline as: Characteristics like work ethic, ability to “Businesses are allowed four uninterrupted minutes handle risk, verbal skills, and attention to detail to present their venture. They then have three min- are learned through personal interviews, not back utes to answer questions and bing bam boom they and forth emails. are done. Four minutes is not a lot of time to explain an entire business, so the pitches have to be precise, It does, after all, take the same amount of time to thorough and engaging.” Are you kidding? Four min- read a bad business plan as it does a good one, and utes is how much time it takes to ask a stranger for even on the top funding websites (though they’d directions, not convince them to forge a committed, probably dispute it) there’s still not an effective way long-term relationship. to filter out all the junk. As an investor, becoming a 10 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  11. 11. Cont’d Speed Pitching Produces Few Hits investors to be able to discover and fund fresh The chance that a good investment will surface opportunities based upon the actual strength of and ultimately be made in one of these speed pitch the venture, rather than the bells and whistles events is very low. For a Web 2.0 company to go of a rushed or expensive presentation. pitch alongside a clothing company and a biotech company to a roomful of investors with varying Following The Roar Not The Reasonable interests is inefficient for everyone. As an investor, Unfortunately, today’s early stage venture investing why would you want to hear four minute, spin-filled, market is a little bit like following Tiger Woods on “sunny sky” pitches from entrepreneurs focusing on the golf course. This trend makes it extremely a space in which you have no interest or knowledge? difficult for new innovative ideas to grab the atten- tion from their desired audience. While there are Many tech conferences today (like well-known hundreds of world-class golfers playing on any given DEMO) allow startups to pitch and demo their weekend (who are plenty entertaining to watch), products to their attendees, almost always for a once the crowd following Tiger roars, everyone turns hefty fee (up to $18,000!). their eyeballs to Mr. Woods (even when he’s 6 strokes back). Because of the inherent high risks involved, “While conferences like DEMO are extremely the investing community is so susceptible to this lucrative for the organizers, I’m not sure the herd mentality; when a top tier firm or individual invests in a space, it seems that everyone follows. startups or attendees attending get much out of it other than a great networking event. There are These “me too” investments lead to businesses, too many start-ups for press to give even passing which often are inferior to other start-up ventures, coverage to many of them, and attendees are lost receiving full funding simply because they operate in a sea of pitches that all begin to blur together.” in a space that has garnered some interest from the recognized big boys (i.e. Sequoia, Kleiner Perkins, - Michael Arrington. TechCrunch. Greylock, etc.). Is this playing it safe or just playing it stupid? If innovation is going to solve the problems In addition, when a large fee is involved, attendees of tomorrow, do we really need investor dollars don’t know if they’re really seeing the best start-ups going to yet another video streaming site with a or just the best start-ups that were willing to pony social networking component that’s primary revenue up the presentation fee. model revolves around advertising? While there is a need for young companies to Another problem with the industry is that it has showcase their innovative ventures to experienced become entirely too incestuous, with the top firms investors, and there is a natural fee based filter that and individuals pouring larger and larger amounts weeds out the dreamers, this tactic has been met with of money into only a very small percentage of the mixed results. With our economy in dire straights, companies that actually need it. As VC funds have the time to accelerate innovation is NOW, It’s time for 11 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  12. 12. Cont’d Following The Roar Not The Reasonable NORTH MINDMELD grown, so has the size of their investments, leading The scarcity of capital for early stage companies in recent to a “handful of big bets” mentality that leaves a lot years has lead to the creation of literally thousands of of promising early stage companies standing in the businesses focused on helping entrepreneurs raise money cold. Although placing large chunks of capital into for their start-ups. At North, this subject is close to our ventures with established traction is valuable (and hearts, as we’ve made it our mission to make the entire lower risk), it also means true innovation is being process for fostering, filtering, and funding entrepreneurial left on the sidelines when it should be cultivated in innovation more efficient. an efficient manner. We don’t need seven great new companies right now; we need seven hundred. Young While some individuals and companies are taking strides stars who are new to the game are being overlooked to optimize entrepreneurship and inspire innovation, for individuals with more experience, not necessarily others unfortunately seem to be falling into the all too because it’s the experience that makes their venture familiar trap of playing “follower,” when today’s economy better, but simply because they know someone who desperately needs leaders. While there’s certainly value to can get them money. extract from a few of these businesses, many unfortunately are coming up short of industry expectations, launching “The real issue is that getting financing is difficult the exact same set of features and functionality as those and inefficient for the investor. I’m having to create that came before them. a whole slew of personal relationships, networking, “They have taken their cue from the Gold Rush when etc… - just to get small amounts of money. While the truly crafty business-people made money not from I like being social and getting out there, it’s slow. prospecting but by selling shovels to the prospectors. We need a Wal-Mart model for “common’ money” Likewise, today’s money-raising services have found (i.e. under $500k using a typical business model). a low risk means to separate the cash-starved The real issue is that many people could be funded entrepreneur from any money he or she may have left.” so much more efficiently, with better returns, if the - industry was more transparent.” - Adam Nelson, Founder of In this section, we highlight a few of the emerging ideas, ventures, and individual brand names that either have While investor attention is being paid to the or are in the midst of trying to bring much-needed Tiger-like entrepreneurs and ideas of the world, efficiency to the early stage venture market. Are any the next great phenom is sitting on a hell of smart the long-awaited silver bullet that is going to help concept and still waiting to be discovered. How can accelerate economic growth when now we need to c this talented bunch break through and get some time reate innovation faster than ever before? on the field? You be the judge. 12 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  13. 13. Cont’d Following The Roar Not The Reasonable The Rise Of Pitch Farms Entrepreneur Side: What’s Broken? We’ve already spoken at length about the recent proliferation of the “Pitch Farms,” those online destinations Great Players Listen & Practice, A Lot. that promise to connect start-ups with the investor There’s no question that success comes through hard community. If you’re an entrepreneur, you’re probably very work and persistence. If that’s the case, why does the familiar with the usual suspects that offer up their virtual media focus only on those stories of achievement? cork board for some type of fee (usually a recurring Flip through the pages of Inc and Entrepreneur, or monthly one):,, watch Donny Deutsch on the Big Idea and you’d, to name just a few. think wild and immediate success is the norm for an entrepreneur. Well, the fact is, the majority of new businesses fail, but the learnings from these failures can be invaluable if an entrepreneur uses the setback as a chance to dig in and come back stronger. In order for innovation to take flight on a grand scale two things need to happen. First, we need to provide entrepreneurs with more honest and candid feed- David Rose, Founder and CEO of, back on what it takes to succeed. Currently, it seems considered one of the “smarter” pitch farms, outlines both that most investors still aren’t willing to roll up their the opportunity and the shortcomings of these destinations sleeves to help nurture and cultivate new entrepre- when he said, “…there are many, many web sites out there neurial talent. Read any entrepreneur blog these days which purport to connect, or ‘match’, entrepreneurs seeking and you get the feeling that investors are out to make funding with potential investors. By our own count, entrepreneurs feel unworthy of their money. While it’s there are probably three or four dozen, and that’s without not true, the best way to stunt innovation is to offer looking very hard. The reason there are so many is that no constructive feedback at all (positive or negative). it’s like shooting fish in a barrel: how many starving entrepreneurs wouldn’t want to come to a web site that The second necessary ingredient for innovation to promises them cash?!” expand is for entrepreneurs to make the personal investment it takes to be a success. In Malcolm Mr. Rose originally marketed Angelsoft to Angel groups Gladwell’s latest book Outliers, there is a chapter as a software that enabled submissions, file management, about what it takes to become a world-class talent. and group communication tools. It was a lot of the Gladwell quotes neurologist Daniel Levitin, “The infrastructure that traditional Angels needed to scale emerging picture from such studies is that ten and update their current submission processes, making thousand hours of practice is required to achieve them more “new economy ready.” However, Angelsoft has the level of mastery associated with being a world since morphed into another massive deal farm for the class expert - in everything. In study after study, start-up community. Perhaps pleasing their engineers on of composers, basketball players, fiction writers, staff, they now offer up a dizzying array of features and ice skaters, concert pianists, chess players, master 13 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  14. 14. Cont’d Great Players Listen & Practice, A Lot. Cont’d Rise of Pitch Farms criminals, and what have you, this number comes software updates. So many in fact, it makes an average up again and again.” Angel investor feel as though they’re playing around on their kid’s Facebook page. Entrepreneurs pay attention; success in business or sports isn’t based on luck or talent, but hard work. Even with the questionable, confusing, and clearly When asked to sacrifice their time, salary, or per- off-target features, it’s not hard to tell that Mr. Rose has sonal savings to make a business fly, far too many his sights on consolidating the entire early stage venture entrepreneurs walk off the practice field, refuse to market. With 442 Angel groups, over 14,000 investors, hire the high priced coach, or simply cut corners. The and a staggering 2,000 new venture applications per insight here is that there is no easy path to greatness; month, they now have an Open Deal pitch for $250 a pop to make it you have to pay your dues and commit that allows an entrepreneur to get their plan in front of completely. Could you imagine an amateur athlete all 14,000 investors with the click of a mouse (if those telling the New York Yankees that “after” they pay investors were actually logged on and could even find him millions of dollars, “then” he’ll go hire a batting their way to the Open Deal room…). coach and spend 10,000 hours to learn how to hit a 95 mph fast ball? “The odds aren’t that much different for start-ups. You are going to be embarrassed, ashamed, labeled as an idiot, shunned, ridiculed, and occasionally driven from the village with pitchforks. On average, YOU ARE GOING TO FAIL. MULTIPLE TIMES, in NEW & INTERESTING ways. GET USED TO IT. In fact, the more you are used to failing -- and failing fast, with data on how you “The sad reality, however, is that while it is extremely fail -- the better off you will be.” easy to get hungry entrepreneurs to list their plans, it is - start-up advisor Dave McClure. well-nigh IMPOSSIBLE to get investors to show up on the other side of the curtain...for the simple reason that (a) Remember, most investors are completely buried in the ratio of investors to entrepreneurs is about 1:1000, business plans and simply can’t dive deep into each and (b) investors are so deluged with opportunities that one on a personal coaching level. So, just because an they simply don’t go out LOOKING for plans; plans come individual is not willing to fully commit to funding to them!” says Mr. Rose who in his own words admits your venture does not mean your idea is a bad one. he’s got an efficiency problem on his hands. Perhaps it’s just not “investor ready” and what you really need is a nudge in the right direction. Even 14 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  15. 15. Cont’d Great Players Listen & Practice, A Lot. Cont’d Rise of Pitch Farms if it means no money (yet), an investor’s comments Recently Angelsoft started to actually push deals onto the and suggestions may prove to be the pivotal moment unsuspecting investors of all the third party Angel groups in the path to success for a young company. Insight; that use their software. This pushy intrusion comes in the don’t just make it your mission to get in front of form of a bi-weekly unsolicited email filled with recent people that will listen, but people that will also venture submissions. Angel groups that signed up for dole out generous portions of perspective. Angelsoft to help manage their Angel group now find themselves competing for their own investor members Make Sure You’re “Clear” For Takeoff attention with the unrequested (and often unwanted) deal While we’ve been talking about the deep ocean flow being shoveled onto their members by an Angelsoft of business plans that investors struggle to filter email server that seems to have its dial stuck on “spam.” through, entrepreneurs rarely do themselves any favors with their pitch materials. It’s sometimes “With Angelsoft, all of the personal aspects of Angel difficult for an entrepreneur to sell bleeding tech- investing seem to be removed from the equation. My nologies or culturally noteworthy ideas to traditional materials are submitted through Angelsoft forms, and investors. Why? Well, while many of these investors then disappear into some system that encourages a group were once successful entrepreneurs, technology has of busy angels to evaluate the opportunity in a black box. made the principles of creating businesses and the Do they like it? Do they hate it? Do they even read it? pace of the economy much, much faster. I have no idea, since I have never heard anything!” comments a disappointed entrepreneur. Instead of wasting time trying to teach the old dogs new tricks, let’s just be clearer when explaining your For all the aggressive email action and striking numbers concept to them. Some investors may be older than on this site, one has to wonder, is it really delivering on you, but that doesn’t mean they’re stupid and out of quality deal flow or just polluting the Internet with more touch. If you can’t explain your business concept in “not ready for prime time” quantity? As of this writing, one sentence, how do you seriously expect an inves- Angelsoft reports that just 1.32 percent of start-ups on tor (or a consumer) to spend money or time with their site have been funded, and that the average number you? Let’s take this point a few steps further, if your of “views” for each submission is only 5.3 (Which means presentation materials are confusing, lack clarity, an average submission is viewed by only 1 of every 3,000 compelling content, and look like they were pulled investors that Angelsoft claims to represent). For entrepre- together on a Commodore 64, why should an investor neurs and investors, the verdict is still out on whether this think that your company will offer up anything but site is more “soft” than true “Angel.”( a clunky and confusing product? Don’t pitch your business as the next “Apple” and then hand over documents that look like you’ve never opened up an Apple box in your lifetime. The Competitions For Capital This section wouldn’t be complete if we didn’t mention investor’s belief in your ability to brand and market the plethora of contests and competitions out there for 15 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  16. 16. Cont’d Make Sure You’re “Clear” For Takeoff Cont’d Competitions For Capital a product starts with the first time they look at your entrepreneurs. Most of these are business plan writing materials. Entrepreneurs could do themselves a world competitions that target upstart entrepreneurs to enter in of good by investing real time (and capital) into their hopes they are going to get in front of a panel of investors presentation materials. Yes, Apple has the benefit of who will then choose their venture and write them a big teams of graphic designers who work on everything fat check. they bring to market. While these resources aren’t cheap, they also aren’t too hard to mimic. There are For young entrepreneurs, it seems that every college with countless resources available on everything from an MBA program is promoting one of these. But again, if concise presentation structure to graphic design. you happen to enter one, don’t just fall under the spell of Take the time to do some research into what a dollar signs. Most of the competitions offer entrepreneurs successful pitch deck looks like and maybe investors the opportunity to: 1) help crystallize their thinking (and will believe you are the right person to play the making them more investor ready); 2) receive feedback and leading role. advice from forward-thinking entrepreneurs and investors; 3) network with fellow entrepreneurs and distinguished Entrepreneurs may also want to take heed from investors; and 4) sharpen their skills in analyzing, writing, Hollywood. In the late 80s, the Bruce Willis and presenting their business plan. Again, the more value blockbuster Die Hard became the industry standard one of these contests provides back, the better it makes the for describing the plot of many of the screenplays entire process for starting and funding a company. and films that came in its wake. For example, 1994’s Speed was called Die Hard on a bus, and 1996’s The Rock was dubbed Die Hard on an island. If an investor is going to have a hard time understanding your new school idea, find a successful, well-known venture to compare it to. You may be proud of and wildly impressed by the technical details of your product or service, but instead of explaining it and risk losing the attention of your audience, instead focus on the single sentence of your business that will connect with the audience in a simple and The Rice University Competition has become one of effective way. the premier collegiate competitions in the world; with over 35% of its entered teams (since 2001) going on to Remember, investors (like Hollywood studio execu- successfully launch their business. These impressive tives) see and hear of thousands of deals a year and numbers can be directly attributed to the counseling have very little time to spend on them. If your idea and feedback all of these teams received at the doesn’t fit into their “box of knowledge”, it’s going to competition. Now that’s entrepreneurial education be quite difficult to break through and earn a second done right. meeting. If you can’t narrow down your business to a 16 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  17. 17. Cont’d Make Sure You’re “Clear” For Takeoff Cont’d Competitions For Capital sticky single sentence, you’re probably not ready “The support of business leaders and successful to get in front of an investor anyway. Bonus Tip; entrepreneurs ensures that tomorrow’s leaders can You may want to check out the book Made to Stick, pursue their dreams by utilizing such an investment to Why Some Ideas Survive While Others Die by Chip and Dan Heath. refine their business plan and presentation, potentially develop a prototype or begin the patent process, and Funny exercise, but play along; look at the top build the foundations of a viable business - ultimately start-up company names and logos funded after attracting additional capital and fostering the spirit of 2000 versus those started before 1980. While the entrepreneurship in the US,” explains Steven C. Currall, color palettes have changed and billion dollar PhD, and Founding Director of the Rice Alliance companies can now be started out of garages, the principles of what makes a sound business for Technology and Entrepreneurship. have not. When meeting with investors, don’t lose them by talking about how cool and complex your Alternatively, many VCs and Angel Groups are now venture is, break it down, simplify, and wow them holding “segment specific” competitions to generate with “how” and “why” you’re going to make fistfuls quality deal flow in hopes of surfacing the next big thing. of money. They like that. Entrepreneurs submit their innovative ideas on everything from gaming to green energy to senior products & services Working In A Black Box to social media. The winner can usually drive home with as Okay, we’ve already established that new entrepre- much as $100,000K of start-up capital in their front seat. neurs have very little visibility into the process of raising capital. Sure, one can grab some business plan writing software and piece something together, but are they filling in that plan with the right data? What exactly are investors looking for in a venture investment? Because of this cloud of mystery that exists over the venture capital world, entrepreneurial resources like and have recently been launched to give entrepreneurs more of an even (and sometimes upper) hand when it comes to dealing with investors. Paul Graham, a One interesting newbie on the competition front is Ideablob. prominent Silicon Valley entrepreneur and Angel com. Run by Advanta, one of the largest credit card com- investor sums up the feeling of many entrepreneurs panies in the States, Ideablob is a place for entrepreneurs to when he said, “VCs that suck less are all about post their ideas and get real-time feedback from their peers. disclosure and transparency.” To truly produce The site was developed around the premise that there are tens of millions of entrepreneurs and small business owners 17 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  18. 18. Cont’d Working In A Black Box Cont’d Competitions For Capital fundamental change and foster innovation it’s in the United States, but no real way for them to network time for investors to allow entrepreneurs to see and bounce ideas off of each other. Eligible individuals the world from their side of the table. can submit their business ideas to, and based on votes from the online community; which Entrepreneurs like to chalk up the lack of transpar- includes other innovators as well as friends, family, ency in this industry to the arrogance of a typical colleagues, associates, teachers and mentors – one idea investor, who thinks that simply because they have every month will win $10,000. Here’s to growing the blob the money they are in some way better. Bear in mind and mentoring entrepreneurs in the process! ( though, it takes a successful entrepreneur to turn the money that goes into their venture into a larger amount on the way out, so the relationship between investor and entrepreneur is a truly symbiotic one; without one, the other will not survive. Is it time for investors to reverse this perception of them? Then they should actually do something to innovate and push the industry forward instead of relying on norms and practices that have begun to stifle the Looking for something a little more unconventional? As of ease in which innovation is actually nurtured. We this writing there were already 16 announced teams regis- advocate full disclosure of all investment criteria tered for the Google Lunar X Prize competition. The Google to level the playing field, strengthen the market, Lunar X Prize will reward the first privately-funded team improve the quality of submissions, and build trust. to land a rover on the moon (and travel at least 500 meters across its surface) with the $20 million purse. If no one A Crime Or Worth Your Time? is able to complete the mission and send video, data, and Many new gimmicks and stunts marketed at images back to Earth by December 31, 2012, the first prize entrepreneurs now exist as ways to rise to the top of drops to $15 million. The big challenge for these braniacs the sea of investment opportunities. While we have will be to do it affordably. Many are already raising money to admit there is an intoxicating rush from pitching and even turning to corporate sponsorship to help get their your innovative venture in front of an audience, the idea on the launch pad. Let the countdown to liftoff begin. end result usually feels more like a hangover. Inves- ( tors leave with more questions than answers, and entrepreneurs are left wondering if their choice of wardrobe sealed the fate of their company. Whether it’s a trade show, mixer, or conference, these events are usually marketed around the emotional value New School Number Crunchers Adeo Ressi, the founder of the has joined proposition of “meet real investors.” a long list of entrepreneurs and investors that say that the venture capital industry is broken. However, Ressi Just in case you weren’t paying attention, any decided to put his (didn’t use outsider funds) money where investor worth his salt is already plugged in to a 18 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  19. 19. Cont’d A Crime Or Worth Your Time? Cont’d New School Number Crunchers complex social network from which he or she plucks his mouth was and built a site that allows entrepreneurs prospective deals. What makes you think you’ll critique and rate the actual audience that was evaluating actually find a reputable investor or advisor at one them…the investors. of these events? Oh, and you think that entry fee is paying only for the catering service? These events Ressi argues that airing the venture industry’s dirty are run by businesses looking to make money. They laundry will ultimately improve the efficiency of the don’t necessarily care if you close a deal while you’re funding process as well as the rocky relationships that there, only if your registration check clears. And exist between investors and entrepreneurs. TheFunded this just in, handing a spiral bound PowerPoint to an also allows entrepreneurs to view and share term sheets, investor in an elevator is about as effective as a guy to assist one another finding good investors, and to discuss throwing himself at a female bartender in a packed the many facets of operating a business. While many club on a Friday night. entrepreneurs applaud Ressi for clearing out the cloud of smoke that surrounds the VC world, many simply You should also know by now that the Internet is see as only an arena for disgruntled full of charlatans, scam artists, spammers and a entrepreneurs to vent. myriad of other people with questionable morals. And because there’s not a lot known about the inves- tor process, entrepreneurs don’t really know whom to trust when they scour the web looking for funding. They’re always suspicious of something that’s offered for free (like a new online business plan farm) and “The problem with sites like, or any site are just waiting for the hidden fee to rear its ugly with user reviews is that the reviewed product will always head. Free usually means you need to put in a credit be at a disadvantage. For every unhappy customer, they card and spend the rest of your life trying to cancel a recurring charge for $19.99 a month. If you’re going tell 9 of their friends, and for every happy one they tell to invest in outsourcing your capital raising work 3. The odds are against the VC’s here. Of course the (which is not unreasonable) try to make sure that majority of turned away entrepreneurs will put a negative the approach is smart, that you are going to get the review - it’s a form of vengeance. But those that did have feedback you need to improve over time, and try to a happy experience will have little reason to post any- save the fantasy of a lottery ticket for the check out counter at 7-Eleven. thing. They have already researched for information from the site, got what they were looking for and will not likely And lastly, if you happen to be sitting on the couch return without proper incentive.” Ian Bell, Entrepreneur in the early am, with your computer in your lap, watching TV and one of those “We’ll Pay Money Because of this lack of positive reviews, many entrepre- For Your Idea” infomercials comes on, you should neurs accuse the VCs of gaming the system where they’ve probably view it the same way you do a fake ad on asked entrepreneurs they’ve backed to submit a favorable 19 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  20. 20. Cont’d A Crime Or Worth Your Time? Cont’d New School Number Crunchers Saturday Night Live. Of course not every “invention” commentary about them and their fundraising experience. firm has bad intentions, but let’s just say there are a This boosts the firm’s rankings on TheFunded’s leader- larger number of scam companies than those actu- board, and has resulted in many in the industry to question ally helping the entrepreneur. So do your homework the sites credibility. and background checks. If after submitting your materials for consideration you’re having trouble For example, if a disproportionate number of members making contact with a live and knowledgeable voice, enter the site to provide a single comment on a given it’s probably not worth your time. firm’s profile, this sends a red flag to TheFunded’s system. TheFunded looks for other behavior, too, for example, unusual semantic characteristics of the written fund How Do We Fix It? reviews, such as excessive use of exclamation points and superlatives. It also looks at how many entrepreneurs Due Diligence: A Brief History voluntarily admit they were asked by their VC to submit a Smart, wealthy, and very successful men and women review (entrepreneurs are asked this when they provide a lose billions of dollars every year investing in new comment, and they check a box to say they’ve been asked). ventures. Why? Recent research shows investors are often investing without first conducting their Before this site can truly becomes a quality resource for own thorough due diligence. Just how powerful is the start-up community, they’ll need to become more the connection between due diligence and investor respected (from both sides) by attracting additional traffic returns? A recent three-year study of 539 Angel and even more helpful reviews to their site (Psst…a led investments conducted by the Angel Capital new Toyota Prius has over 158 consumer reviews on Education Foundation and the Kauffman Foundation, compared to just 30 entrepreneur reviews found an extraordinary correlation between of Kleiner Perkins on Unless these due diligence and significantly greater returns. numbers pick up, it’s hard to look at this site without ome real bias. At the end of the day tough, the TheFunded “Spending time on due diligence is significantly has definitely made Investors way more aware of their related to better outcomes…investors who spent perceptions in the venture marketplace, and if that’s the less than the median 20 hours of due diligence nudge they needed to become more transparent and helpful and investors who spent more, shows an overall to entrepreneurs; they deserve some applause, but not quite a standing “O” just yet. multiple difference of 5.9X for those with high due diligence compared to only 1.1X for those with low due diligence.” - “Returns to Angel Investors in Groups”, a comprehensive study of 539 Angel led investments. Robert Wiltbank, Ph.D. and Warren Boeker, Ph.D.,11/2007 20 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  21. 21. Cont’d Due Diligence: A Brief History Cont’d New School Number Crunchers Those numbers are staggering, not only in terms of “If their tool did such a good job, they’d raise a fund the difference thorough due diligence makes, but the themselves and beat the tar out of us.” fact that the median of the study was only 20 hours, and that people are actually spending less time on - Paul Kedrosky, investor & entrepreneur due diligence than that! While this seems to support both the “follow the roar” and the “trusted refer- “It’s a wantrepreneur focused product. Real VCs and real ral” methods for selecting investments, this amount companies with a legit shot at VC money wont use it.” of due diligence is far less than most people would – Jeff Martens, strategic consultant spend researching a major purchase. If you take a step back and think about situations in which an individual is preparing to spend a significant amount The above quotes are referring to the highly controversial of money you see in each situation a unique stan-, an online platform for start-ups and early dardized form of due diligence, and that spending a stage ventures. The feature that has sparked a lot of debate good deal of time on them is the norm. The goal of in the investment community is their YouNoodle Start-Up these efforts is to reveal any potentially damaging Predictor that analyzes data on early stage ventures and information regarding the item to be purchased as generates a report on what that start-up will be worth in soon as possible. Or as Richard Drake of business three years. For real? Yes, they’ve developed a software law firm Womble Carlyle Sandridge & Rice explains, program that claims it can predict the valuation of early- “a thorough review of what you are buying before stage start up companies (yes, companies that haven’t come it’s yours is the best insurance against any unwanted within a whiff of a dollar in revenue…). The model relies on surprises down the road.” basically four areas: 1) the team; 2) financial factors; 3) the concept; and 4) advisors. How’s it work? The entrepreneur It’s time the early-stage private equity industry takes fills out the survey and provides a little detail, and like some notes and follows the models of other industries pulling a rabbit out of a hat, presto…YouNoodle spits out in which thorough due diligence is the norm. Each a valuation. Smells about as real as the future predicting example boils down to the basic, easy to remember information Miss Cleo (the famous TV psychic and motto: cover your ass before you spend your shaman), provided after calling her “900” hotline. hard-earned cash. It’s hard for us to look at this with a straight face. Seri- Love The Location, But How’s The Roof? ously. Has the venture community been Punk’d? After all, Now ask yourself, would you buy a new home on a a “noodle” is defined in the dictionary as a fool or simple- gut feeling or simply because the guy selling it says ton. Can you really believe that two teenagers working on it’s a great deal? Probably not. A sensible real estate a few lines of code in the basement have developed a $2.75 investor would probably evaluate every aspect of million dollar idea? Ridiculous. Be very afraid of this tool, the property; from the foundation to the roof, the looking at some number on the screen followed by a huge plumbing, the electrical, the lot size, the appliances, string of zeroes right next to the name and your start-up the paint, and of course the neighborhood. Even feeds the entrepreneurs ego like nothing else can. Think more likely, you’d probably pay for a professional about the Far Side cartoon where the kids are all eating 21 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  22. 22. Cont’d Love The Location, But How’s The Roof? The Influential and Informative home inspector (who sees thousands of homes ice cream in front of the windows of a gym filled with every year) to come over, take a look, and give you overweight people sweating on treadmills. It’s pretty sick. a written report before you would sign the deed. We think it’s nothing more than a way to grow their real ambition - - yet another social network for entrepreneurs. “A home inspection is perhaps the most important If it isn’t, then why haven’t their own founding members chapter in the home-buying process and can run themselves through their magical predictor? benefit both the buyer in understanding the With all of the hype and hyperbole currently swarming condition of the house and the seller who wants the early stage venture community, it sometimes makes to provide accurate disclosure information.” it hard to hear, let alone focus. But within the chaos, - Lynette Wyrick, PC from RE/MAX Equity Group. we believe there are a few refreshing voices that manage to rise above all the noise and break through; offering Because buying a new home is most likely the single up a steady serving of insightful nuggets to entrepreneurs largest investment an individual will make in his or and investors. her life, it is difficult to remain completely objective and unemotional about a home that is seemingly per- fect. Flaws get overlooked as judgment is affected. “Think you’ve found the home of your dreams? So did Hansel and Gretel. The fact is, every prop- Matt Marshall founded VentureBeat in 2006 to provide news and information about private companies and the erty has its dirty little secrets that only the owner venture capital that fuels them. Marshall and co. have knows about. In a perfect world, owners would done a good job delivering “insider” news across innovative come clean about the quirks and glitches in the old sectors like: digital media, life sciences clean tech, homestead when they fill out the property condi- and mobile. It’s their mission to act as a megaphone for tion disclosure form that many states require. But as the entrepreneurial and venture community, ultimately Hansel and Gretel found out, real estate is fraught connecting decision makers with information they can use to grow their brains. One of our favorite features of the with subterfuge.” - Jay MacDonald, site is their guest columnist link, where a compelling mix of successful entrepreneurs and investors are invited to For accurate information, it is best to obtain an im- spread their wisdom on a weekly basis. ( partial, third party opinion by a professional in the field of home inspection. From a seller’s perspective, How can you really go wrong with a site that calls an objective inspection will provide valuable infor- themselves “Hamburger Helper for entrepreneurs”? mation and the opportunity to make repairs that will This enthusiastic and candid bunch of experienced make the house more attractive to prospective buy- entrepreneurs and investors feed off helping other ers. A third-party objective inspection is therefore entrepreneurs succeed. And after reading the words of beneficial to both parties. their Advisor Brian Norgard, you can’t help but wish 22 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital
  23. 23. Cont’d Love The Location, But How’s The Roof? Cont’d The Influential and Informative What’s interesting is that in some markets it’s stan- these guys well, “Nivi and team dard for the seller to provide a detailed third party are creating the premiere inspection to prospective buyers, while in other destination for top tier start- markets the buyer is the one who needs to invest in ups to raise money, hire and the inspection if they want to remove contingen- get attention. Raining money cies in their offer letter. The responsibility of who shouldn’t be a pain. Getting pays for the inspection tends to shift to the side of a meeting in The Valley the market that has the upper hand at that particular shouldn’t be like getting tapped moment. In the recent housing boom it was the sell- for the Skull & Bones. Good ers who got to push buyers with a “take it or leave it” companies should rise to the top attitude, today sellers are doing everything they can without friction. VCs should get to make their property more attractive and they are access to these deals. We’re now shouldering all sorts of costs, effort, and conces- working on it.” Give them a visit to hear some straight sions that weren’t even on the table two years ago. talk and be sure to give their “Recommended” sub-site a What does that mean for raising investment capital? spin. While the Internet clearly doesn’t need another social In today’s investing market the available capital is network, maybe these guys can create one with less friction constricting while at the same time the pool of and more efficiency, so we can all win. ( available deals is expanding. Will this shift some pressure (and costs) onto the sell side of the venture market like it has in the real estate market? Note: one other insight that can be pulled from the real estate market is the standardization of deal documents and terms. The liquidity of real estate hinges upon the simplicity of the standardized paperwork. Just imagine the efficiencies that could be gained from standardized deal terms in early stage venture investing. Are They Ready For Prime Time? Professional sports franchises spend thousands of dollars on scouting, background checks, and running TechCrunch is a must-read weblog for anyone that has draft prospects through a series of mental and interest in web-related information, products, and services. physical tests before they decide to invest millions In addition to covering new companies, TechCrunch also of dollars. General Managers look at everything profiles existing companies that are making an impact before risking their pick on an expensive draft pick. (commercially or culturally) in cyberspace. Be careful This is even truer when it comes to making a first though, you can kill a good chunk of your morning round selection. 23 Breaking Through The Broken: The Transparent Guide © 2009 North Venture Partners, LLC To Overcoming The Inefficiencies In Early Stage Venture Capital