How to Get the Most Out of Your Money

Wrong - not when it comes to seeking an equity investment. Many entrepreneurs today believe that the company's business model valuation and/or concept is validated by a successful capital raise. After all, "if you raise $5 million at a $20 million pre-money valuation, it just shows that the market is validating your story, right?" I don't even care to tell you how many times I hear this argument. My answer is "are you kidding?" In today's economy, raising capital is not the problem. However, raising "smart capital" is.

I will probably receive countless counter arguments to this editorial, since most entrepreneurs feel a sense of joy and a sense of superiority when raising any money, regardless of source. Nevertheless, it is my job to speak from experience, and I will tell you that source of capital is just as important as the valuation that is attributed to that amount.

Before you start arguing with me, let me paint you the picture with a series of Q&A:

Question: Would you trust a general practitioner to prescribe certain medication to you?
Answer: Sure - all physicians, regardless of specialty, are experts in the treatment of common colds.

Question: Would you trust a general practitioner to deliver your baby?
Answer: Maybe, maybe not. But I made you think, didn't I?

Think of the company as your child (as most of the entrepreneurs I meet do). Think of the physicians as funding sources - I think you get the picture. Never take someone's experience and expertise for granted. "Cash is king." In today's markets, a company needs cash or it needs a bankruptcy attorney. However, never lose sight of the fact that smart money - one that comes from experienced sources with knowledge of your particular space - is crucial to the existence and the prosperity of a company, regardless of stage.

~ To address the "smart" in "smart money," let me just say that selling stock at a gain and having a few million to "play with" does not necessarily give someone a degree in venture capital. I am referring to the increasing number of "Angel" investors that seemed to be "competing" with venture firms for deals. Most of them do not have a clue about venture investing and what it takes to grow a company. I am not talking about the likes of Ron Conway or Hans Severens - these ex-entrepreneurs are arguably more suited than some venture firms to make investments. They have been in the trenches and have experienced first hand (often not on a positive note) the hardships of making something out of nothing. Nor am I referring to corporate venture funds that add strategic value to a company. My argument is against those that think money alone is the answer to all problems being faced by emerging growth companies.

Having argued for the VCs, you are probably asking yourself: "How do I distinguish the right venture partner for me?" Believe it or not, I recommend using the same method venture firms do when they evaluate prospecting companies.

When choosing an investor, you must be able to understand their strengths in four key areas: Magic, Management, Market, and Money - what we call the "4 Ms."

Magic
The investor must visualize and be committed to your dream. Most of the VCs however will tell you this if they like the opportunity that you have presented to them. Your goal is to find out what makes the investors in front of you special. What is it about the venture firm that separates them from the rest (i.e. what is their competitive advantage)? Is it their relationships with other venture firms? Is it their stellar management team? Is it their history and/or work ethic with previous portfolio companies?

Management
Just as the management is the most important indicator of a potentially successful venture capital investment, it is also the most important indicator of a potentially successful venture firm. In fact, limited partners (e.g. endowment, pension and fund of funds professionals) spent considerable amount of time doing due diligence on the venture firms' management prior to committing capital for a specific venture fund. Ask yourself these questions: Can you work with the team that is in front of you? Do they have experience in your particular industry? Do they have enough personnel (senior and junior) to provide value to your venture? What do some of the other portfolio CEOs say about this firm? Do these VCs have relationships and contacts within your industry? Just like the entrepreneurs, the VCs should convince you that its management team is passionate, paranoid, prepared, able to persevere, always has a plan B, and maintains plenty of attitude.

~ Market
The appropriate research, comprehension, and selection of a target industry, market, and portfolio companies are critical to the potential success of a venture firm. Venture firms must understand the market that you are in. They must convince you that they understand the dynamics of a particular market and the players that are in it. They must be able to tell you how you will compete with your adversaries and how you will win the game. The last thing you want is someone who has no clue what drives your market. This is where money is not as important as knowledge. Furthermore, success in one market does not necessarily imply success in another. For example, having been a successful venture fund in the health care & life science industry does not guarantee success in the telecommunication industry. Venture firms specialize by industry for a reason.

Money
At the end of the day, you want to ensure that the venture firm has enough capital to ensure that your company will receive several rounds of financing, or that it will find you other "smart" money within its rolodex. Key questions to ask are: How much capital is currently under management? What is the dollar amount usually invested by this venture fund? What other investors does this particular venture firm invest with? How many follow-on (second, third, or mezzanine) rounds of capital does this firm do? What has been this firm's exit strategy?

Although today's successful VCs usually find time to play a round of golf, their schedule is often filled with countless responsibilities, which are often fiduciary to their limited partners and to the portfolio companies they support.

Remember, venture capital is not about just giving cash for an equity stake. It's about adding a partner to your existing team, having access to distribution channels, having a rolodex of managerial talent, and someone giving you more capital when things are not exactly going as planned. In short, its about having a professional, who has years of experience, with companies that are similar to yours assisting you in the delivery of your baby - the company.