Last October, I skyped into an entrepreneur meetup in Milan and talked for 30 minutes. This was arranged by AVC community member David Semeria.
The main topics were building a tech community outside of the main startup hubs, raising angel and venture capital in a market where there isn't much of that, and the differences between US and european investors.
When I watched this video this morning, the audio and video were out of sync which made it hard for me to watch. I ended up listening more than watching. I hope you all don't have that same problem.
Holger Luedorf has been doing business development in the web/tech/mobile sectors for almost 15 years. He currently leads Business Development (BD) for our portfolio company foursquare. Holger has contributed a guest post with a bunch of great advice for startups that are just getting around to BD and what they should do and what they should not do. His views and opinions are his own and not those of foursquare. —————————————————————————————-
The Beginner’s Guide to Start-up BD: 15 Basic Rules
A lot of the rules below will seem like no-brainers to any seasoned business development manager, but I think it is worth putting them together in one list. I hope that they will be useful for teams that are building up BD teams from scratch or to those start-ups without a dedicated BD team and in which for example the founders or others take on BD as an additional responsibility. I don’t think this list is complete and I am planning to add additional rules over time. If you have any direct feedback, please tweet me at @holger.
Create clear BD targets – This goes without saying, but it is worth repeating. Without clear targets, a BD team will aimlessly chase deals and in the worst case have a distracting effect on the rest of the organization by creating deals that are not core to the company but take up valuable executive, product, and engineering resources. Ideally, BD targets are a subset of the overall company goals (e.g. grow the user base, expand internationally, outsource a critical technology etc.) but they could also be outside the core company goals, like exploring alternative business opportunities, seeking M&A opportunities etc.
Structure your approach – Don’t just run off and randomly approach partners. Once the goals are set, the first thing the BD team or person should do is set priorities in terms of who your ideal partners are. This includes market sizing, market and competitive analysis, and a clear timeline. If you are new to the industry you better start researching yesterday. There is nothing worse than being pitched by someone who did not make the effort to understand your business and the challenges you are facing. Secondly, you need to put a lot of work into figuring out how to approach these partners (more to that in point 3). Finally, you have to make sure you have all the necessary contacts to approach your target partners. If not, work your network. Cold calls are rarely effective. Unless you come recommended by a trusted source, chances are very low that you will get someone’s attention. Ideally, you have built up a ton of what I call “good karma” by helping out others friends in the industry in previous situation so that you can call in some favors and ask for introductions.
Solve problems, help partners reach their goals – This is one of the most critical business development tasks. Partnerships never work when the benefits are one-sided. In addition to helping you reach your own targets, you really have to figure out how your proposal helps the potential partner reach their goals. Again, you would think this is a total no-brainer, but this does not seem to be the case judging by the large amounts of proposals that I get that are not really solving any of my company’s problems, or are so obviously mass-emails without any direct relation to myself or my organization. I consider these proposals to be spam and will refuse even reading those emails once I realize what they are.
Be prepared, research the companies you want to partner with – In addition to a well thought out, mutually beneficial proposal, it is important to research your target partners. To me this is like prepping for an interview. Nothing worse than realizing that the person you are interviewing knows nothing about your company or the issues you are facing but at the same time tells you how “passionate” s/he is about your business. Try to figure out what is top of mind for your potential partner. Is it facing a particular competitive thread, has it had a major product launch failure, has the team that you are speaking to experienced a recent change of executives etc. There are so many possible reasons that might make you want to tweak your approach, change your timing, etc. It is always hard to know for sure what matters most, but I am a firm believer that solid preparation will help you produce better partnerships. I am literally spending 15-20% of my work time researching the mobile, location, advertising space etc. to understand what our partners are most likely thinking of our product and our company. This means scanning a lot of industry press and frequently meeting with peers to share information.
Understand the partner organization – This is related to the previous point, but focuses on a different aspect. Especially when trying to partner with a large company, you want to make sure you have as complete of an understanding of the organizational structure as possible. Who are the decision-makers, which teams or managers are heavily weighing in, who is responsible for the long-term execution of the partnership etc. This organizational understanding will help you address the right people in the partner organization and help you identify additional contacts you might want to connect or back-channel with.
Build a hierarchy of touch points – Ideally, a start-up BD team does not act in a vacuum but is able to tap into various levels of its own managers and executives. I am fortunate that our CEO and other execs realize the value we can drive via partnerships and that they support the BD efforts in building additional touch points between our company and that of certain partners. For high-value partnerships, I always try to build a relationship on multiple levels, e.g. between the two day-to-day partnership managers, between the two VP-level managers responsible for those partnership, and ideally also between two or more C-level execs. Having these multi-level relationships gives you more flexibility in dealing with your partners. In certain scenarios bottoms-up approaches might work better and you want to convince the ground-level partner managers first but in other cases it might be better to pitch top-down knowing that an executive is passionate about certain topics and will strongly influence the decision making process of her organization.
Always be responsive – A pet peeve of mine. I think it is disrespectful not to respond to companies or people reaching out for various reasons. The only things I usually do not respond to are blatantly obvious sales pitches. But if people are reaching out asking for jobs, with a partnership proposal, or some simple user feedback, I will always try to reply within 48 hours, sometimes much faster. In many cases my answers are a short but polite “No”, but at least I acknowledge their message or request. This is how I expect to be treated, and that is why I tend to spend a good amount of time responding to incoming email, twitter, and Linkedin messages, etc. I am pretty sure that there are a lot of people who disagree with me on this, but that is my personal modus operandi, which I think this also creates “good karma”. (side note: I do not connect with people on Linkedin unless I had at least a few minutes of personal interaction).
Don’t rush, don’t annoy – Always remember that you are working in a dynamic start-up while some of the bigger organizations you are trying to partner with have heaps of processes and check-points that decisions have to go through. I remember from my time at two of those large organizations, in my case Deutsche Telekom and Yahoo!, that people in those organizations could get frustrated with impatient partners banging on their doors all the time. My mantra: Pitch, have a solid follow-up providing additional data points or whatever else were the action points, but then let it sit for a period of time, before sending a reminder. There might be legitimate deadlines that you want to be clear about but otherwise give your partners enough time to make their decision, at their own pace. Appearing over-eager never helps from my experience.
Can’t close? Regroup, analyze, and adapt if possible – Don’t beat a dead horse. If a deal cannot get done, and there might be many good reasons, regroup and think why the partnership did not make sense for the potential partner. Did you have the right partnership concept in the first place, were you talking to the right potential partners, did you talk to the right people in the organization, did the business model make sense for both parties etc. There can be hundreds of reasons why a deal did not work out and it is important to really try to understand why and come up with an alternative approach.
Own your partners, not just deals – There is a fundamental difference between Business Development and Partner Management. In many large organizations you have a dedicated BD team that flies in to negotiate and close a deal and then moves on to the next deal with another partner. On the other hand you have Partner/Account Management that identifies potential deals, brings in BD for potential negotiations, and then takes over full responsibility for the deal implementation and on-going partnership. In a start-up with potentially no dedicated BD team or at best a very small one, you have to double-up and take responsibility for both the deal making and on-going partner management. This can be tricky as in the BD negotiations you want to be able to get the best possible deal for your company and this can create friction with your partners, while as a partner manager you want to be as close to your partner as possible to understand what is going on and in order to smoothly execute the partnership. When BD is a separate function from Partner Management, it is easy to play good cop, bad cop. The BD guys are the bad cops haggling over the best possible deal while the partner manger is the good cop back-channeling with the partner organization trying to create a positive, productive setting for the partnership. In a start-up you really have to bridge those attitudes, which takes some experience. In the end solid knowledge about the partner’s organization and goals will help you find that right balance.
Don’t over-commit, internally or externally – With many partnership opportunities, you only have a few potentially only one shot at getting it right, so it is critical that what you commit to towards the partner is actually something that your company can deliver. This might be in the form of a product feature, launch timeline, support function etc. Do not over commit as you run the risk of killing the short-term opportunity and long term relationship. The same is true for internal commitment. Make sure that deals are signed off by and have commitment from all internal parties involved. This includes the management team, which has to ensure that a deal is in line with the overall company objectives.
Build strong relationships with key partners over time – What goes around, comes around. A strong working relationship with partners will help you build trust over time. Don’t forget that industries tend to be very small so having a solid reputation for being a trustworthy, proactive interface and partner will help you when partners research you and your company. Also keep in mind that many times, people will stay involved in a single industry over decades, so how good your relationship with someone 5 or 10 years ago was does matter in a new setting, maybe after that person joined a new company that is a potential partner of yours. Strong relationships with business partners will help getting deals done and in some cases can be the deciding factor that a decision-maker on the partner side chooses your company over another. Following many of the points above is what creates such strong relationships.
Be present as a company – In some cases your start-up is doing so great that you are getting a ton of positive press and interest from companies who want to partner with you. But these scenarios are rare and can change. One factor that will support your BD efforts is that your company has a positive image in the market. In addition to your start-up’s marketing & PR functions, BD can play an important role to represent the company to the outside world. Participation in conferences or other speaking engagements, hosting university student visits, or providing quotes and insights to journalists are all things that can help your company and your efforts as a BD team. Of course this should never become a time-suck for you and others on the BD team, but especially when it can be done mainly locally and without much travel involved, it can be a good way to make your company be “part of the conversation”, gain valuable market insights, and network with other people and companies in the industry.
Relay partner feedback back into your own organization – The BD team is usually one of the most outward facing teams in a start-up and as such you will be able to collect a ton of valuable feedback for company. A lot of partner meetings generate a lot of information like product critique, observation of what the competition is doing, insights into what partners would like to see in terms of product innovation etc. Make it a point to regularly pass this knowledge on to the respective teams in the organization as it will help educating the organization and making more informed decisions.
Make sure you have solid legal support – I have been fortunate to have had outstanding, dedicated lawyers to work with on deals in all of my past jobs and as well as in my current role at foursquare. Having experienced legal support that really understands the big picture and has a good balance of risk-averseness and business acumen will help getting better deals done faster. Weak legal support can kill or create weak deals.
Investing in startups is risky. If you make just one investment, you are likely going to lose everything. If you make two, you are still likely to lose money. If you make five, you might get all your money back across all five investments. If you make ten, you might start making money on the aggregate set of investments.
The math behind this is pretty simple. If you assume that the average startup has a 33% chance of making money for the investors, a 33% chance of returning capital, and a 33% chance of losing everything and that only 10% will make a big return (>10x), then you can model this out.
All the profit in that ten investment portfolio comes from the big winner. If you don't make that investment, you would have made nine investments for a total of $450,000 and you would have gotten back $450,000. You would have been better keeping the money in the bank.
So you need to make enough investments to be confident that you will get at least one big winner. And so that means making enough bets.
There's another important aspect of this. You should invest roughly the same amount in every investment. Don't try to pick the winners at the time of investment by putting more in the ones that are "sure things" and less in the ones you are less sure about. The only sure thing about startup investing is that there are no "sure things."
Let's look at the same portfolio with a set of random initial investment amounts.
You can see that even with the same set of outcomes for each investment, the amount invested in each one has a big impact on the total return of the portfolio. It really all comes down to how much you have invested in your big winner. And since I do not believe you can predict which one will be your big winner, my view is you want to be as consistent as possible with your investment amounts.
When you are an investor, there are days when some of your investments are doing great and some are doing badly. If you are broadly diversified, those days are easier to take. If you are all in on one investment, then those days are brutal. Entrepreneurs go all in and are rewarded accordingly when they hit it. Investors should not go all in. They should be diversified.
When a blockbuster deal happens, a lot of people get excited. The press is all over it, money comes pouring into startups in search of the next one, people quit jobs and school to get in the game. It's a gold rush.
But there's another reaction that I have heard a lot in the past few weeks that is quite different. It is "why not me?" The title of this post is from an email between me and an entrepreneur I know who will go nameless.
It sums up the emotion so well for me.
Startups are hard. They require great sacrifice from everyone. They are stressful and fail more often than they succeed.
And when you've been toiling away month after month, year after year, with no pot of gold in sight, it can be hard to watch that billion dollar deal go down. It's a punch to the gut. It hurts.
I'd love to say to all of you who are feeling that pain that your time will come. But most likely it will not. That's the way this game is played.
Over the history of the institutional VC business (the past 40 years) the number of companies started every year that turn out to be worth billions sustainably is in the tens not the hundreds. If you are looking for a billion dollar check in the startup game, you are playing for lottery odds.
So if you are doing the startup game for money, and lots of it, you are in for a plate full of frustration. It must be for more than that. It must be for the love of the game, a passion for what you are bringing to market, and for the chance that you will hit paydirt. But it is a lot more likely that you will watch someone else hit the big payday than hitting it yourself. And that sucks.
This past thursday, the Senate voted 73-26 to approve its version of the JOBS bill. The House had previsiously approved a similar bill and the process will now go back to the House to come up with a modified bill that can be approved by both the House and Senate. I hope they make quick work of that and present the bill for signature to Obama who has committed to sign it.
I suspect most readers of this blog know a bit about this bill. The three provisions that are most meaningful are the crowdfunding provision, the increase in shareholder ceiling for private companies from 500 to 2,000, and the "sub $1bn revenue IPO" provision that we discussed previously here at AVC.
I had held off blogging about the crowdfunding provision because frankly I had some reservations that I had privately discussed with friends, colleagues, and elected officials. I did not want to publicly throw cold water on this provision, but I privately hoped that the provision would be modified to help insure that equity crowdfunding of startups doesn't become a fraud infested sector of the capital markets.
Under the Senate amendments, any company using crowd-funding methods must still file some basic information with the S.E.C., including the names of directors, officers and holders of more than 20 percent of the company’s shares, plus a description of the business and its financial condition.
Companies seeking to raise $100,000 or less must also provide tax returns and a financial statement certified by a company principal; those raising up to $500,000 must provide financial statements that are reviewed by an independent public accountant. Companies raising more than that must provide audited financial statements.
The Senate also inserted requirements that intermediaries seeking to help companies raise money through crowd-funding must register with the S.E.C., make sure investors are advised of the risks they are taking, and take measures to prevent fraud.
I am a huge fan of allowing every person, not the just super wealthy and institutions, to participate in the funding of startups. Frankly its a shame that the average Facebook user has not been able to own shares in Facebook during its increase in value from zero to $100bn. The same kind of thing can be said about Twitter and many other of our portfolio companies. The changes to securities regulations in the JOBS bill are fundamental and important and very much needed.
But it is also true that investors are due some basic disclosure when parting with their capital. If they choose to ignore the disclosures, then that's fine. But the disclosures should be there for them when they want it and/or need it. The Senate was wise to add some basic disclosure requirements to the crowdfunding bill. I suspect the disclosure requirements might get toned down a bit in the final bill and that is probably a good thing. Requiring an audit for a $500k seed round seems a bit nuts to me.
As for the changes to the shareholder number rule (increase from 500 to 2,000) and the regulatory relief for "sub $1bn revenue IPOs", I am ecstatic about these new rules. Our portfolio companies have spent countless hours handwringing about the existing rules. They have made important decisions based on the current rules which are unnecessarily stringent and have hampered their access to capital. These new rules are much needed regulatory relief for startup companies.
Finally, I'd like to thank our elected officials for coming together in a non-partisan way to address an important set of issues and deal with them sensibly and corrrectly. This doesn't happen enough in Washington and we need more of this. I know that the majority leadership in the Senate, particularly Harry Reid and Chuck Schumer, fought back a mini revolt among the left wing of its party to get this bill passed. I applaud them for doing that and standing up for something that was not popular in their caucus. That is leadership and I appreciate it and I am sure the readers of this blog do too.
Steve Blank has a great post up on his blog suggesting that VCs should require startup CEO experience in their partners' resumes. He quotes from me in that post but I'm not going to state which one came from me. You can guess if you want.
You might be surprised to know that I agree with Steve. I have never run a startup company. By Steve's measure, that is a weakness in my background and experience. And I agree that it is. I've managed to overcome that weakness, but it is a weakness nevertheless.
I particularly like this paragraph in Steve's post:
What running a company would do is give early-stage VC’s a benchmark for reality, something most newly-minted partners sorely lack. They would learn how a founding CEO turns their money into a company which becomes a learning, execution and delivery engine. They would learn that a CEO does it through the people – the day-to-day of who is going to do what, how you hold people accountable, how teams communicate, and more importantly, who you hire, how you motivate and get people to accomplish the seemingly impossible. Further, they’d experience first hand how, in a startup, the devil is in the details of execution and deliverables.
Newly-minted partners are a big problem for entrepreneurs (and VCs too). And Steve's suggestion that they get a dose of reality before opining on stuff in board rooms is great. If a super talented young person in our firm shows an interest in a partner track, I would strongly consider Steve's approach.
John Doerr famously said that it takes $30mm of losses to train a VC. I am proof of that theory. But as Steve points out, you can start a company and operate it for a year for less than $500k these days. That sure sounds like a less expensive way to learn how to be a VC.
I wrote in an earlier post in this series that friends and family is the most common form of startup financing. If you are talking explicitly equity investments, then that is probably true. But the most common way that startup businesses get money to get going is they sell something to someone. In this context, someone means customers.
Customers are a great way to finance a business for many reasons. First, customer financing is typically non dilutive. They want something from you other than equity in your business. Customers also help you fit your product to the market. And customers will help debug and improve the quality of the product. An early customer will give you credibility with other customers. And an early customer may spend more with your company down the road.
The most common way customer financing is done is you sell the customer on the product before you've built it or before you've finished it. The customer puts up the money to build the product or finish the product and becomes your first customer. Usually the customer simply wants the product and nothing more. At times an early customer might ask for some exclusivity on the product or even some free equity in the business, but most of the time the early customer simply wants the product from you and nothing more.
So why not take this approach with every startup? Well, it isn't always possible to find a customer who will put up money in advance of the product being complete and ready to use. It takes great salesmanship to convince a customer to buy something from you that isn't built or isn't finished. But even if you can convince a customer to do this, there are some negatives.
First and foremost, building a product explicity for one customer often makes it less applicable to the market as a whole. An early customer who provides funding to build your product will want the product tailored specifically for its needs. And a highly tailored product is often not well suited to a broader market.
Second, you risk building a "fee for services culture" in your company with this approach. Some companies build products for customers for a fee. Other companies build products and sell them "as is" to customers. The latter is the scalable model for building valuable companies. If you use customer financing, you risk being pulled into the former.
And customer financing is much more difficult, if not impossible, in consumer facing services. It is much more applicable in business facing services.
Those are the pros and cons of customer financing. If you can convince a customer to put up significant capital in advance so you can build or finish your product, you should consider it very seriously. Many great companies got their start this way.
Governments will provide capital for startups and I've seen many entrepreneurs over the years take advantage of this form of financing. The grants are usually "free money" in the sense that they do not need to be paid back and they don't cost any equity.
But nothing in life is free. You do pay for this money in ways that may not be in your interest. The application process is usually long, involved, and distracting. And sometimes the grants come with strings attached; you can't move, you have to use it for a specific purpose, you have to hire a certain number of people with it, etc, etc.
I've seen states provide grants to do "economic development." I've seen all sorts of US Federal Government grants. The most common are Small Business Innovation Research (SBIR) Grants. But there are also grants available from various departments related to energy, health, defense, and many more. Internationally, I've seen Canada, Israel, and Slovenia provide "free capital" to startups.
In Canada, startups can get a portion of their headcount funded by the government. In Israel, the government provides grants to startups but they need to keep their IP in country. I am sure that many countries around the world provide funding of this sort. And I suspect we will see more of this sort of thing as technology based economic development becomes more important.
I'm not a fan of this form of financing. First, in principle I think that government ought to stay out of the business of picking winners and let the market do that. But more practically, I've never seen an entrepreneur change the outcome of their startup with government money. It is never enough to really move the needle and the strings that are attached usually make it uninteresting to me.
But if you would like to look into this sort of thing, contact your state and national government and ask about grants for high technology, research, and startups. I suspect you'll find some programs out there that you can tap into.
This is the first in a series of posts about financing options for startups. By "financing" I mean obtaining cash to fund your business. There are all sorts of strategies to avoid needing funding, but this series is not about them.
Many entrepreneurs turn to friends and family for their first funding needs. In fact, it is common for non-tech startups to raise all the capital they need from friends and family. I don't know for sure, but I would suspect that friends and family make up the largest source of funding for entrepreneurs and startups.
Friends and family financing is popular because it is easy to get a hearing from the people who know you best and they are positively inclined to say yes. But there are some negatives as well. It's tough to know how to price and structure an investment where the investors are close friends or family. You don't want to take advantage of them and they may not be sophisticated enough to know what is a good deal and what is a bad deal.
And friends and family often cannot come up with a lot of capital so unless your business doesn't need much funding, this will not be the only round you do. But friends and family can get you into business and give you some time to create value that other investors will recognize and value.
Probably the most tricky part of friends and family financing is that you really don't want to lose money that friends and family have invested with you. And most startups fail so the chances that will happen are high. I would encourage entrepreneurs who take funding from friends and family to be very clear about the risks and downside. I would also suggest only taking capital from friends and family members who can afford to lose the investment. That way, if the investment does turn out to be bad, at least you won't lose valuable relationships. Even so, it is easier on the mind to be doing a startup when your capital comes from professional investors than your loved ones.
I would recommend doing friends and family financings as convertible notes with a discount and a cap on the valuation. That way you don't have to worry about how to price the investment. A 20-25% discount from the next round is appropriate. The valuation cap is going to vary depending on the size of the raise and the size of the opportunity. I'd suggest a cap that gives the friends and family around 10% of the business if things work out. But that is just a suggestion. A 10% interest will not be appropriate for every friends and family investment.
Friends and family funding is the most common form of startup financing but also the most tricky in many ways. Be careful to do it right because there's a reason why these people will back you when nobody else will.
This list is roughly in chronological order of how a small company might avail itself of the various financing options, but there are always exceptions. Starting a company is more art than science.
I want to do each financing option as its own dedicated post so I’m not going to start today. I will start next week with friends and family.
If you are looking for some meaty MBA Monday reading this week, I point you to Brad Feld and Jason Mendelson’s awesome venture capital term sheet series, which is required reading for anyone seeking to raise venture capital.