Raising money is hard. And when you’re relatively new to the process it’s easy to be confused by the process. There is all sorts of advice on the Internet about how to raise capital. Of course much of it is conflicting.

I’ve raised money as a “hot company” and I’ve raised capital when no one would return my phone calls. I’ve raised in boom markets and when everybody thought the Internet was a fraud. I’ve raised seed rounds and A-D rounds. I raised money as an entrepreneur, like you, in 1999, 2000, 2001, 2003 and 2005 for two different companies.

And of course I’ve sat on the other side of the table: As a VC. I now observes the fund raising process as a profession. And I also now have to raise money myself, but this time from bigger institutions that our industry calls LPs (limited partners).

I’ve tried to make this advice as well-rounded and biased free as I can. This is not just the perspective of a VC although I can’t say I have zero VC bias. This is the fund raising perspective from both sides of the table.

Executive Summary
For those that want the answer without reading a long post – here it is. Fund raising (as is much of life) is a sale – pure and simple. The sooner you understand that the sooner you can plan your campaign.

As with any sales campaign you need to:

• Qualify your buyers early so you focus your scarce resources on people likely to buy your product
• Spend time researching your buyers and not just pitching them
• Call high. Partners make investment decisions.
• Meet in person. They’re not buying a book on Amazon or shoes on Zappos. They’re buying you. And that doesn’t work remotely.
• Build a relationship with your investors over time. “People buy from people they like, trust, respect and … believe.” (Zig Ziglar). Trust doesn’t come from one 45-minute Powerpoint pitch or 30-minute demo.
• Create scarcity. Three rules in sales: Why buy anything? Why buy me? Why buy now? If you haven’t read my post about that, you should. The hardest is the last: Why Buy Now. People avoid difficult decisions until they have to make them.

Every company is different so it’s hard to listen to advice from the uber-successful fund raisers. Their story will likely be very different from yours. Fund raising is bloody hard. It takes a lot of work. Don’t believe otherwise.

If you want to watch the video version summary of my advice on fund raising it’s here. It’s an hour and has tons of insights on the process. Tell a friend!

And now, the details …

1. Identify the right target investors
Every investor is different. I never suggest that entrepreneurs just randomly pitch VCs. Start by trying to narrowing the list of total prospective VCs. Create a spreadsheet or list them in a CRM. The total universe of VCs are what we call in sales “suspects” – otherwise known as “the top end of your funnel.” But focusing on too many is a mistake. You want to narrow the suspects into a group called “prospects.” These are people with whom there is a likely match for your product or service. This narrowing follows the three golden rules of sales: qualify, qualify, qualify.

Remember again that the three major steps to a sale are: Why buy anything? Why buy me? Why buy now? If you can solve these three major questions you’ll sell. The first step in the qualification is “why buy anything?”

In VC terms that means the key questions you need to answer are, is this investor:

• Geographically focused and have they invested in my geography before? (most Seed or A round deals will be done by an investor in your region so that should help you to focus. Other investors have national practices. Know which one you’re talking with)
• Right for my stage? (approaching an investor who normally does $20 million C rounds for your $2 million funding round is a waste).
• Focused on my industry? (I get approached about clean tech or biotech periodically – I don’t focus on these. You’re wasting your time with me).
• Already invested in one of my key competitors? VCs are unlikely to invest in direct competitors so you will normally be qualified out.
• Do they have money to invest? (look at how many deals the firm has done in the past 12 months. If it isn’t many (or any) that should tell you something. You can also find out when they raised their last fund. If it was more than 5 years ago you probably want to ask around a bit to see whether they’re still investing).

Also recognize that WITHIN a VC you have partners who focus on different areas. For example, if you’re looking to approach Kleiner Perkins it’s worth knowing that my friend Matt Murphy runs their iFund and therefore is the in-house expert on all things mobile. I’m sure there are many partners at KP that know the mobile space but if you’re a “mobile first” company you’d be well served by focusing on Matt. In Accel that’s Rich Wong. At GRP that’s largely me.

If you’re raising money in Financial Services I’ve never met a more knowledgeable investor than my partner, Brian McLoughlin. He’s focused on that sector (not exclusively but predominantly) and therefore has an amazing network at large financial services firms to help you with business development. He knows the history of all of the payment gateways, mobile payment platforms, credit offerings, remittance companies, etc. Others that are experts in this field include Matt Harris at Village Ventures and Jim Robinson at RRE. Approaching random VCs who aren’t experts in FS makes little sense.

In ad tech there’s Seth Levine at Foundry Group and both Dana Settle & Ian Sigalow at Greycroft.

And so on. Not trying to be comprehensive here – just making sure you know that partners & firms are often focused. Fred Wilson likes, “large networks of socially connected people” while Foundry lists its 5 key themes on its website. Do your homework.

I do the same. When raising money for GRP, I look at my suspect list and say, “Do they like VC versus buy-out funds? Have they invested in new VC relationships versus just doing investments in firms in which they have long-standing investments? Do they invest in funds that are $200-300 million versus $50 million or $500 million.” I use the same methodology I am advocating to you.

2. Determine how to get access to them
In the era of social networks, LinkedIn, Facebook messaging, Quora and email addresses that are easily guessable, it’s easy to think that maybe you should just approach a VC directly. They seem so reachable. Yet this approach in my mind is the equivalent of spam. I get many Tweets directed at me that say, “come check out my product.” Even if I wanted to be this accessible, I could never find enough time in the day to evaluate every single person who approached me. Neither can any VC. So they develop short-hand ways to qualify things better. The main way they qualify is to determine who introduced them and the veracity of the introduction.

As I like to say, in the era of social networks and transparency if you can’t figure out how to get introduced to a VC then hang up your cleats now. You’ll never make a great entrepreneur. I wrote a longer post on how to access VCs that you should read.

But the short answer is that the best intro is from a portfolio company of that VC or by other entrepreneurs whom that VC respects. So your journey to fund raising begins by strengthening your relationships with other entrepreneurs. You need to build genuine relationships with these portfolio startup founders as well as trust with them and the rest will follow. Earn the right to the intro. I often recommend that entrepreneurs try to focus on building relationships with younger companies that aren’t already “big time” because they’ll have more time and willingness to help.

Approaching Dennis Crowley to figure out how to get access to his earliest investor, Bryce Roberts? Not so much. And trust me, if you’re early stage you DO want to meet Bryce. He’s awesome for early-stage entrepreneurs.

3. Meet early
There is much controversy on this topic. I have laid out my philosophy in, “I Invest in Lines, Not Dots.” If you haven’t read that you should – it’s one of my most re-tweeted posts. There is the school of people who tell you that you should only meet with VCs when you’re ready to raise. Their arguments are:

a. Fund raising is too time consuming and meeting early is wasting time
b. The VC will get a bad impression of you and you should wait until you’re on your best footing to raise.

Both of these arguments are logical and thus many entrepreneurs buy them. They’re both flawed, though.

“Fund raising is too time consuming” … yes, fund raising takes time. If you save it all for some mythical 6-week period every 18 months where you hit up all the VCs at once – sure, it will consume much of those six weeks. But as I’ve argued before, you need to ABR (always be raising). By constantly taking focused VC meetings you’ll have relationships established for when you are ready to raise. As the CEO you have many tasks you need to do on a regular basis. Call it your functional pie chart. These include building products, recruiting, managing your finances, marketing, selling, getting feedback from customers and … fund raising.

It will be at least 5% of your week so if you work a 60-hour week (I know, I know, you work more) then you should dedicate 3 hours per week to fund raising. Maybe up to 6 hours.

Remember that if you’re meeting with targeted investors you’re meeting people who can challenge your thinking. You’re meeting with people who can help you with introductions. You’re meeting people who can give you market insights and information. REAL information. Not what you read in the press. And of course you’re meeting people who can give you money. It takes money to grow a business.

Most VC partners do 2-3 deals per year max (except for the higher volume shops). So the odds are never great for you. But VCs want to be helpful – even when they can’t invest. So they go out of their way to offer advice and introductions. The shortest path to meeting hard-to-meet entrepreneurs or senior executives at a big company is to have a VC who likes you, but isn’t yet ready to invest in your company, introduce you.

“VCs will get a bad impression of you” … also logical but slightly misleading. So let me be clear. DO NOT show up at a VC meeting unprepared. Do not “wing it” and see how the meeting goes. Know your plan in advance. Know what you’re going to discuss. Know how much information you’re going to give. Know that it is HUGELY important to make a good impression.

What I advocate is letting the VC know that, “you’re not yet fund raising but you’re building early relationships because you’re going to be fund raising in the near future and you want to start determining where there are good matches in the industry for your firm.” All VCs want early access. If they see you when you’ve already got your first term sheet and they’ve got 3 weeks to decide then by definition they have no relationship with you. So winning means they’re paying the highest price.

Sure, some people work this way. I think it’s a terrible way to work. When I get these inevitable emails or calls I respond the same way, “It’s a shame for me that I’m too late to your process. Why don’t we meet right after you raise your money so we can start a relationship early for your next round.” And I mean it.

Fab wrote a popular post on fund raising in which they advocated a very different approach to mine. Their approach worked for them because their business is super hot and on fire. I introduced one of my dearest friends and one of the most talented guys I have worked with, David Lapter, to the company and he became CFO. So I know how first-hand how awesome Fab is. And the CEO is experienced. If your business is totally killing it please follow Fab’s advice. It’s ideal for people who have VCs all chasing them.

For everybody else I would encourage you to meet early and often.

4. Press the flesh
It’s tempting to want to stay in your offices and fund raise via email or web conferencing. But fund raising is a contact sport. You’ve got to get out there and shake hands and kiss babies. If you’re in the Bay Area this may be easier. If you’re not you’re going to have to put in some miles and some time away from home. Raising money is a “direct sale” not a telephone sale. They are buying YOU. So interacting with you in person is paramount. Many VCs don’t like to tell people to travel to them. They may even suggest phone calls. This is part out of guilt of not wanting to make you travel and part because they know they can have shorter meetings on the phone – it’s harder to cut a meeting short if you have traveled.

Always do your important meetings in person. I can’t over state the importance of the human connection in being able to develop a relationship. If you have to travel tell the VC you’re already planning to be in town. They feel less obligation to you and therefore are more likely to say yes to an in-person meeting.

5. Avoid the two big “donuts” in the year
There are two times every year where raising VC from partnerships with more than two partners is exceedingly hard. July 15-Aug 31 and Thanksgiving to New Years. I’m not saying VCs are lazy. They are not. But they are highly likely to be in the age bracket of 35-55 and often have kids. That means that they take their holidays with their families and these are the big seasons.

Most VCs I know these days answer emails on vacation. Good or bad – it just is. But there is a different reason not to raise in those periods. In order to get a VC to agree to fund you, you need to get the entire partnership on board. And so while your VC partner may not be gone the entire month of August, you can bet that at any time at least a few of their partners will be gone.

And because all sales processes rely on momentum, you don’t want to have a process that has a “dead spot” in the middle of it. I call these “fund raising donuts.” Plan your timing accordingly. If you’re concerned about this issue I wrote a longer post on the topic.

6. Have a narrative / make it simple
Nobody will buy what they don’t understand. It’s your job to take the complexity of your company & industry and develop a “narrative” that helps investors better understand the context. It’s basically story telling. Don’t under-estimate the power of stories. When I was reading the Fab.com website I noticed that the CEO refers to Fab’s “one thing” as being design. By talking in this way, he can create a storyline that investors can say, “oh, Fab.com. They’re the place focused on design. They think design wins. They think there’s any underserved market for young urban professionals who care about quality design and don’t want to buy cookie-cutter, Idea furniture and accessories” (or whatever their pitch is).

Investors can agree or disagree but they know what they’re evaluating. As do journalists.

The best company pitches are those that have this narrative. Why does the world need another X? Or why are the market conditions ripe for a new entrant who does Y when Y hasn’t existed in the past 20 years? I spoke at length about the narrative here.

Trust me when I say that the narrative is vital to your business. It’s important in aligning internal strategy, communicating with others, talking with partner, recruiting and, yes, raising VC.

7. Create a sustained campaign
Many people equate a great pitch meeting with success. They then lament the fact that the process died shortly thereafter. All sales campaigns are processes that occur over time. It’s your job to find a continued way to stay on the radar screen of the VC.

You had your great meeting. If it felt great it probably was. But in the three weeks since your meeting that VC has seen 12 other companies, had 3 board (bored) meetings and had to deal with some enquiries from his own investors. So when you’re wondering what they’re thinking about – unfortunately it’s not likely you.

Think about it this way. Let’s say you have a product in which the CMO of a company is your buyer. You wouldn’t imagine they’re sitting around 3 weeks after your meeting daydreaming about you. They’re under pressure to do tons of stuff. You were a priority when they agreed to meet you but since then they’ve been putting out other fires. If you start to think of VCs as a person who might buy your product like this CMO then you can plan your sales campaign accordingly.

Some relevant posts to help you on this topic:
I met a VC, what happens next?
How do you build long-term relationships with VCs

But the summary for you is:
- get an intro
- create materials for your first partner meeting. This is a demo + a high-level deck
- create materials that would be used in a follow-up meeting. This includes stuff like detailed financial plans, product roadmaps, etc.
- prepare a list of reference clients and a reference list of people they could call to ask about you

Then make sure to send out VERY high-level summary emails to update key investors on your company progress. Ask for 30-minute update meetings from time-to-time. Stick to your time slot unless they say they want longer.

Investors back companies where they see traction. What better way to show traction than to meet a VC early, baseline your performance and then update them on your positive achievements?

8. Lobby
If it were a sales campaign to a CMO you would naturally think about having customer references. You’d even probably go as far as to ask your best customers if they wouldn’t mind proactively reaching out to your prospects to subtly tell them how great you are. I call it “marketing heroes” and I wrote about it here.

So why would raising venture capital be any different. If the best intros to VCs come through qualified referrals from people they trust, then it follows that the best way to keep VCs interested in you is to have similar people tell them how great you are. So determine the VCs you want to influence, identify who influences them, figure out how you’re going to get these people loving your product, your company and you.

And then ask for their help in reminding the VC how great you are. And remember my golden rule, “you don’t ask, you don’t get.” Nobody proactively bugs a VC to tell them how great you are. You have to ask for it.

Will the VC know you asked them? Who cares. Any great VC will know that’s how the world works and if that’s how you influence them it’s probably the tool you use to influence journalists, customers, prospective employees and corporate suitors for M&A one day.

The only people you don’t need to lobby are people whom you don’t want to invest.

9. Recognize that fund raising is a part of your ongoing duties
As I’ve said before, ABR. Always be fund raising. It’s just a part of your ongoing activities as a founder. Sure, you might not like it. It might not seem “core” to your business success. It is. Building a business is not about only building a product and seeing if customers like it. You can’t just do those things in business that you enjoy. Make fund raising a habit. Don’t only engage every 18 months.

10. Test interest
One of the best sales coaches I ever worked with used to talk to me about “testing prospects.” What he meant was that since your scarcest resource as a manager or sales rep is your time you need to qualify better. Most people are afraid of asking the tough questions because they prefer to imagine that you might be a buyer than to know that you’re 100% not. I prefer the latter. I once did a project with Carly Fiorina when she was president at Lucent. Her quote that always stuck with me was,

“I’d rather get a firm no then a muddy yes.”

So true. At least you can move on and focus your time on energy on people who might say yes.

So how do you test a VC?

It’s actually OK to say something at the end of your meeting such as, “I know that you’re not likely to give me a strong indication at this meeting, but I’d love to know if this is the sort of opportunity you could imagine doing if I was able to persuade you over time or would I be best off focusing my attention on other VCs?”

Said politely and I promise you people will appreciate it.

Similarly, it’s OK to email a non-responsive VC by saying, “I’ve email you a couple of times and left a voicemail. I know we all get busy. I just wanted to confirm whether you were super busy or whether this was a sign that maybe I’m not a good fit for your firm? If that’s the situation – I’d understand. But if so I’d love to know so that I can focus my limited time on other VCs. (if you are still open, I’d love the chance for a 30-minute meeting to give you a status update. I think you’ll be impressed.)

Other ways of testing a VC?
- if they show interest and have spent time with you, why not ask if you can set up a customer call for them so they can hear directly what they think of your product? Willingness = they are engaged. Not willing either equals, “not now” or “not ever.” Better that you know. A firm no is better than a muddy yes.
- how about setting them up to use your product? (if it’s possible). Then you have a reason to check in every couple of weeks, “I noticed you didn’t yet get a chance to log in to the product. Would you mind if I had a senior training rep call you for 30-minutes to give you a quick demo to get you up to speed?

There are a million ways to test. And a million more to drive engagement. I’d say <5% of people ever do. These are people who are more likely to raise VC. People who manage processes make more sales. As I articulated here.

11. Take appropriate risks
I always encourage people to take risks in sales and fund raising is no different. Remember those three rules of sales?

• why buy anything?
• why buy me?
• why buy now?

Well if the “why buy anything” is testing whether you’re even compatible with a VC, the “why buy me” has got to be extreme differentiation. VCs see companies all the time. They all start to sound the same. Be bold. Make your positioning strong. Stand out. It may turn off some VCs but for others it may be a positive.

I’ll give you an example from my own fund raising.

Conventional wisdom says that you can only build big businesses in Silicon Valley so as a VC you need to be there. But of course that’s horse puckey.  Some of the biggest wins of the past 5 years were built outside of the Valley. GroupOn, Living Social, AdMeld, Gilt Group, Demand Media, ShoeDazzle, Tumblr, FourSquare, etc. And the great monetization engines of the Internet were built in LA – Overture (AdWords) & Applied Semantics (AdSense).

But many VCs outside of Silicon Valley are afraid to raise against this conventional wisdom so they say, “yeah, I’m in the Valley all the time. And I went to Stanford so my network is there.”

We went the opposite way. Our biggest returns were outside Silicon Valley: Overture (LA), CitySearch (LA), BillMeLater (Baltimore), Ulta (Chicago), Envestnet (Chicago), HDI (Las Vegas), PF Changs (Arizona), TrueCar (LA).
So I argued with my partners we should stand firm. Our fund has always made money mostly outside the Valley. So my standard pitch is:

“If you’re looking for another Sand Hill Road firm we’re not for you. There’s 80 firms there – have your pick. But if you’re looking for something differentiated in your portfolio I think we’d be a great fit. We’re the largest fund in Southern California.

We were found to be the 5th most consistently performing fund in the country over the past 20 years by Prequin. Our 2000 fund is the single best fund of its vintage. Our 2008 fund looks spectacular.

We have followed this strategy for 15 years. And now it’s even easier to build a big business outside of the Valley. Our next fund will follow the same strategy. We invest in the Bay Area but more than 50% of it will be outside of Silicon Valley.”

So if I take a pool of investors I might turn off 8 with this positioning. But they were never going to be convinced anyways once they did due diligence and realized we’re not a SV-focused fund. And with these hard positioning I might get 3/20 into the “yes column” because they understand the “why buy me” better. Take risks.

12. Understand the important of marketing
Nobody thinks they are influenced by marketing. Everybody is. Even if it’s subconscious. We tend to be more excited about things that we read in the press and/or articles being forwarded to us by our peers. It’s human nature. So make sure you have a solid PR strategy.

I have two articles on the topic:
1. Understanding PR & Crisis Management
2. How to Work with PR Firms

Make sure good PR is underpinning your fund raising efforts. The articles about you create great collateral that you can email out in your VC update emails and they create collateral for your contacts to mail to your VC prospects on your behalf. And PR also has a way of generating inbound funding opportunities.

And trust me if they’re thinking about investing in you and an investor Googles you and gets “bagel” – so, too, will you.

13. Create urgency
The final rule of why buy anything, why by me is … why buy NOW! It’s the hardest rule of sales. Why should I buy a new TV when my current one works well? I know I want one but I can always buy it next year. In fact, there will be a newer, fancier model. Same with a new car. Same with an investment. Why invest now when I can see how your company develops? Or see the next company that rolls through.

The only way to get VCs to move is to make sure subtly that they feel a deal is or may become competitive. Life works the way it did in high school. A guy has three options to ask to the prom. He waits as long as possible. Why ask a girl today when I can decide tomorrow? Then the rumor mill starts and he hears his rival is going to ask one of his top picks today. Guaranteed that he’ll ask her before lunch.

Maybe life shouldn’t work this way. It does. You need to create a sense of competition.

That is best done through back channeling, where possible. I know some VCs will tell you this isn’t necessary or a good idea. They are probably “book smart” VCs who don’t even understand themselves the psychology of buying.

Conclusion
Fund raising is hard business. And perhaps it should be. Too many competitors getting funded leads to incrementalism and me-too competitors. There are some wildly successful companies out there that also become hot. It’s hard to take advice from them because the process one goes through when you’re the belle of the ball is different than when you’re having to sneak your way into the party.

I once had an LP tell me that when Sequoia fund raises they place the first call and say “we’re closing in 6 weeks – you need to decide quickly if you want an allocation.” I don’t know if that’s true, but it wouldn’t surprise me. When you’ve had the consistent success of Sequoia (or similar) over so many decades I guess you earn that right.

But when I fund raise I’ll be right out there with you.

• Plotting out where I think I have a strong fit between my prospects & my product
• Shaking hands and kissing babies
• Following through with email, phone call, follow-on meetings and lobbying
• Always pushing forward but never taking things for granted
• Always raising, even when I’m not.
• And praying like hell there’s no “Black Swan” event like the Greeks defaulting on their debt, the Italians pulling out of the Euro, a Lehman-like bankruptcy or a devastating terror attack that screws up fund raising timing for everybody. Damn you, Black Swans!

Like you I’d want to get it done as early as I could. Never taking a day for granted. Knowing that “time is the enemy of all deals.”

And then waking up one day many months later and seeing whether all of the hard fund-raising effort paid off.

ABR.

** post script **
Yes, I’m sure there were many typos. No, I’m not stupid. My grammar is generally quite good. But I hope you enjoyed the content enough to forgive my lack of time for editing. And anyways, you’re still reading, aren’t you? thanks for your understanding

Image courtesy of Fotolia

This post originally ran on TechCrunch.

I recently spoke at the Founder Showcase at the request of Adeo Ressi.  I asked what the audience most needed to hear.

He said, “They need an unbiased view of the fund raising environment because there is too much misinformation and everything seems to be changing fast.”

This was an audience of mostly first-time entrepreneurs. They have seen one side of a market where many of us have seen the ebb and flow multiple times. Still, market amnesia by ordinarily rational actors always surprises me.

I spoke about a lot of things during the keynote. If you are interested the Vimeo is here. I spoke about whom to raise capital from (funding options), how much I thought they should consider raising (18-24 months), how fast they should spend it (lean until product/market fit, then fat when they’re ready to scale), how fast they should raise it (now, now, now) and at what valuation (at a fair price that I call “the top end of normal“).

I spoke about how Amazon Web Services deserves far more credit for the last 5 years of innovation than it gets credit for and how I believe they spawned the micro-VC category. I said that I felt that Micro-VCs were the most important change in our industry. I believe that. It is great for entrepreneurs and great for VCs.  I will write more about this in the next 2 weeks.

I also spoke about why I believe we’re in a “localized” bubble. I suppose I should have imagined that this line would get more press than all other comments combined. Fair enough.

But a certain amount gets lost in the headlines – especially when not everybody actually heard the video and knows the nuance of the message.

So here is what I have been telling entrepreneurs privately for the past 6 months.

1. Why I believe we’re in a bubble
People get too worked up over the word. I’m no great scholar on bubbles – I have more interesting things to spend my time worrying about than the exact definition, but having been around a few I have at least given them intellectual consideration. I know that most people who are close to them tend to deny their existence, as we saw in the great housing bubble of 2002-2007 and the dot com bubble of 1997-2000.

I believe a bubble occurs when a market is willing to pay greater than intrinsic value for an asset class. That asset class need not represent the broader market. As any historian of bubbles will tell you – there were periods of bubbles in assets as arcane as tulips, South American trading companies, dot-com bubbles & housing bubbles. They are often bound by geographies and asset classes. But they also often have a rippling effect on broader markets as all of our economies seem to be intertwined these days. I said that at the Founder Showcase, too.

The fact that today’s Internet bubble does not represent all companies does not disprove its existence.

Ah, but today’s Internet companies have real revenue! and profits! Sure, that makes them better companies than those of 12 years ago. But that doesn’t mean that people are paying rational prices as investors based on intrinsic value. Rational people can disagree and some may argue that today’s prices are rational and under-pinned by economic drivers. That’s fine. It’s just not my judgment based on the data I see.

In the past I have publicly commented on some specific companies that seemed over valued. Responses ranged from, “hey, they’re in a HUGE market” to “it is an amazing company and their technology rocks.” Sure. But everything has intrinsic value. And you may choose to overpay hoping that the future value will be worth your while. That doesn’t mean it’s not a bubble. It’s like people arguing that there’s a beautiful beach house in 2006 that represents great long-term value due to scarcity of similar property. All of that might be true, but the 2006 price might still be over-valued

What I believe is happening is that private-market investors are getting ahead of themselves for fear of FOMO: fear of missing out. If you are an early investor in Facebook, Twitter, Zynga, Tumblr, GroupOn, LivingSocial, etc. – you’re very well positioned as a fund. I guess that makes USV, Spark Capital, Foundry Group, Accel, Benchmark, Revolution (along with several others) pretty happy right now. And well they should be.

But this mania to not miss out on the next big thing is driving some investors to pay growth-equity prices for traditional market risk (as in, they’re paying up before it is clear there is product / market fit). And so on down then line.

In addition to FOMO it is partly driven by massive increase in valuations for earlier-stage companies who raised money at bit seed prices but who still have product risk. If a company that would traditionally raise $500k at a $3.5 million pre-money valuation is now raising $1 million at a $12 million valuation the next investor has nowhere to go but up (or sit out the investment). Just because the valuation in absolute terms isn’t a big difference does not mean that people aren’t paying higher than intrinsic value for these investments.

And this is happening in mezzanine (pre-IPO) deals as well. And post IPO deals, although these tend to correct more quickly.

Why does all this matter?

2. There are fewer big deals than people imagine
If everybody is over-paying for early-to-mid stage deals you’d imagine that these all need to feed into a frenzied M&A and IPO market that will garner big returns for these risks investors are taking. Perhaps this will trend up massively but historical data doesn’t bode well.

source: Capital IQ

In any given year there are about 50 venture-backed companies or so that are bought for $100 million or more. And for many of these they were (over) funded 7-10 years ago and don’t necessarily all represent great returns for investors or founders. I would guess (I don’t have the data) that less than 5 companies / year are purchased above $100 million that have been funded within 5 years of the being started and have raised less than $10-15 million in capital.

And as you probably guessed the data aren’t any better on IPOs with less than 20 / year average for the past 10 years. Yes, everybody expects a continued uptick given the euphoria of  LinkedIn & Pandora and long anticipated Facebook, Zynga, GroupOn and one day, Twitter. But it’s not enough to justify over-paying for deals.

source: Capital IQ

3. What a bubble means for each entrepreneur
To anybody who asks my advice I repeat the same line, “I don’t know whether this party will last 6 weeks, 6 months or 18 months. But it will end. And when it does the market will shut off immediately. Investors will focus only on protecting existing deals. They will enter the “triage phase” of the market where they figure out which of their existing deals will survive. Many good companies will not get funded. New investors hate down rounds. Vultures will start circling looking for deals. Get funded now, if you can.”

Note: I did not say, “funding is easy” as some people have quoted me. I said, “It’s much easier now than it was in 2008/09.” That’s a fact. And for some it is actually easy. For others it feels like a two-speed economy, where rules apply to hot tech startups that don’t apply elsewhere. Huge structural under-employment in much of the country and full employment in some niche tech markets where it’s impossible to hire developers, designers or sales professionals. You know what I’m talking about. You feel it, too. It’s surreal.

So I’m not advocating panic or a need to rush your funding round. I just think that some entrepreneurs try to “optimize” too much for short-term prices. They hope to delay fund raising (or only raise small amounts now) so that they can raise at a much bigger price later. That may happen.

That’s the problem – you never know when the party’s over. And time is the enemy of all deals so start sooner rather than later, as anybody who was planning to raise in October 2008 will tell you.

And for some that means that despite waiting they may see worse valuations in the future than now. Or worse yet they may never get financed. That happened a lot in 2002 and again in 2008.

I tell people to raise money when you can, but don’t ramp up your spending in a crazy way afterward. Have a cushion. Raise at “the top end of normal” but not so high that future financings in a corrected market become impossible.

4. Bubbles are inevitable
I guess it’s an inevitable process that we seem to go through where markets heat up, get euphoric & irrational and then external market drivers remind us all at once that we were being irrational as a market. We go through our “Bear Stearns moment.” I learned long ago at the University of Chicago where I got my MBA that investors tend to want to invest when markets become over-valued and sell when they become undervalued. Exactly the opposite of what a rational investment strategy would advise.

Why?

In a booming market your investment is worth more than you paid almost instantly. You come in at a $10 million price and somebody else invests at $50 million 6 months later. Feels good.

In contrast, when the market is falling, by definition your investment is worth less THE DAY AFTER you have invested. In a public market this is measured immediately. You are “catching a falling knife.” You have to have patience, which is hard when you see red. So people sell or at least don’t invest.

Some people argue that we’re not in a bubble because the prices are not as crazy or as inflated as they were in the late 90′s. That may be. It may also be that this lasts another 18 months. But when it’s all over and they define the era of this mini run up in stock prices I suspect they’ll include 2011 in the “over valued” category.

5. Good things may come out of bubbles
Bubbles are not all bad. There are great societal benefits that sometimes come out of bubbles. One example is that the telecom bubble of the late 90′s left both the US and the international markets with a greatly expanded footprint of fiber-optic cables laid at the expense of many an over-zealous investor and entrepreneur. I can’t argue that this is better than slow, rational growth. I only point out that there are side benefits of the bursts of energy, enthusiasm and investment dollars.

And the bursting of bubbles isn’t bad for everybody. Those with strong business models suddenly stand out when the tide goes out. An obvious example is Google who may have gotten less market attention if there would have been 8 well-financed competitors during the 2001-2005 timeframe. Or Salesforce.com who rose to prominence in this same period where they were ramping up PR and shouting from mountain tops when everybody else in the market was mute.

6. Why the bad side of bubbles affects entrepreneurs & investors alike
Another misconception of bubbles is that they only hurt investors. That’s not true. When you’re building a startup and can’t hire the engineers you need, can’t retain staff, can’t get press coverage and can’t hire sales people – it certainly affects you. When your competition does irrational things to grow fueled by low-cost capital it makes it harder for you to compete by playing by the conventional rules.

I remember in the late 90′s trying to charge fair prices for software when my well-financed competitors were giving things away for free.

7. Why the bursting of bubbles also affects more than investors
I also point out that bursting of bubbles also affects us all. Sometimes callous observers say, “Who cares if some VCs lose money in a bubble?”

Um …

• many people also lose their jobs when bubbles burst
• some founders lose their life savings
• people who poured their hearts into projects see their efforts vanish over night
• customers who paid for services often get burned
• many ancillary businesses (legal, real estate, services) are affected
• and those VCs are actually investing money from places like state pension funds & university endowments

Trust me, we’re all hurt when bubbles burst. Just think about how you felt the impact of the real estate bust even if you didn’t own property or if you bought well before 2006/07. This market will be the same.

8. The road ahead

I’m not an alarmist person, I’m rational. The sky isn’t falling. There are many things to be encouraged about.

I see opportunities for disruption all around me and am meeting amazingly talented entrepreneurs. I’m looking for ones that understand that in order to build huge, meaningful companies they’ll need to likely build through these boom years and some lean ones. When I find people like that it’s great chemistry.

When I look at the headwinds we face as a country and as a society they are also big. This concerns me about the growth rates we can anticipate for the next 5 years.

I’ve wrote about this 9 months ago. If you want a more detailed analysis see that post. Nothing has changed in my mind since then but it does go to show how difficult it can be to predict the timing of economic impacts. In economics we call these “exogenous events” and if they happen (Greek debt crisis, problems raising the US debt ceiling, trouble in Saudi Arabia) – you will not be shielded.

That said, for every set of global challenges there are entrepreneurs dreaming of solutions, solving big problems and ready to lead us into the next 20 years. It’s what I love about entrepreneurship and about venture capital. We get the opportunity to serve these amazing talents that hold our futures in their hands & minds.

9. Why I will still be investing
I know prices are higher than the norm right now. I am confident they will be lower at some point on a relative basis. But as an investor you cannot simply sit out period of great innovation. As Fred Wilson once pointed out to me, he invested in both Twitter & Tumblr during a high-valuation period.

So at GRP Partners we’re very active now. We’re just conscious to invest in realistic entrepreneurs who know that it will take years of hard work, who are committed to building large businesses over time, who have exceptional skills & passionate about the disruption they’re causing and who are cost-conscious enough to be around for the long haul. Building billion-dollar businesses requires 7-10 years which means operating through at least one full economic cycle, if not two.

We may invest at the “top end of normal” but not at such a high price that we create future problems. We’re not cheap, but we’re disciplined. We are definitely still open for business.

Bubble image courtesy of Fotolia.

I had the privilege of keynoting at the Founder Showcase tonight in San Francisco.

Adeo asked me to speak about fund raising. I generally don’t like to speak about fund raising in a frothy market. If you’re bullish you seem like a Cramer-esque cheerleader and if you’re bearish you sound like a party pooper.

But Adeo asked so I obliged. I don’t know whether they shot video. If they do I’ll post it. I think you can get the gist of it from my presentation although some slides don’t quite tell the full story.

Enjoy. See you in the comments section for our debate.

VC Funding in a Frothy Market

This article originally appeared on TechCrunch.

2 preamble issues having read the comments on TC today:
1: I know that the prices of startup companies is much great in Silicon Valley than in smaller towns / less tech focused areas in the US and the US prices higher than many foreign markets. I acknowledged this in the article. You can be pissed off, but I don’t set prices. I’m just making the commentary.
2: As expected at least one person accused me of writing this post because I want to see lower valuations. That’s stupid. I can’t control the market. When prices are too high I just pass. Simple. I wrote this because over the last decade I’ve seen a destructive cycle where otherwise interesting companies have been screwed by raising too much money at too high of prices and gotten caught in a trap when the markets correct and they got ahead of themselves.

I said both in the article but felt compelled to provide a statement up front for the skimmers.

I have conversations with entrepreneurs and other VCs on a daily basis about fund raising, the prices of deals, how much companies should raise, etc. I’ve stopped talking about this as much publicly because it’s such a heated, emotional topic where the points-of-view are strictly subjective and for which the answers will only be revealed in the future.

I’ve decided to take all of my private conversations and subjective points-of-view on the topic and make them public in a keynote speech at the Founder Showcase in San Francisco on June 15th.

I thought I’d post on one of the topics before hand. It’s the one bit of advice I find myself giving most frequently these days, “raise money at the top end of normal.”

Huh?

Here’s what I mean. There is an inherent value that any company has. On a public stock market that is the value that investors place on future free cash flows of the business discounted to today’s date to account for the time value of money. The more mature the company and industry, the easier it is to predict its future. When investors are feeling confident about the future they tend to bid up the value of public companies due to an increased perception that the future cash generated by the company will appreciate. The price of public stocks change instantly in reaction to news that is perceived to affect the future value of that company.

Every day shareholders vote on the value of the company by buying or selling shares. There is no price movement without one person agreeing to sell the stock and other agreeing to buy it. Stocks that have a lot of people trading are said to have a lot of liquidity, which basically means it’s really easy to get into (buy) or get out of (sell) the stock.

Private markets for stocks are the opposite. They are pretty illiquid. If you invested in the first angel round of a startup company it is usually very hard to sell your stock – usually for many years if ever at all. So how exactly are prices determined?

There is no great science to it. The earlier you invest the higher the chances the company won’t work out and thus you pay a lower price than later-stage investors. As an investor you’re trying to pay the appropriate price for your perceived risks of the company succeeding and protect yourself in the event that it isn’t quite as valuable as you had hoped. As the risks below get eliminated the higher the valuation investors are prepared to pay.

Over time some “norms” have emerged in pricing based on investors risk / return profile. The obvious thing that investors think about is making a financial return on the investment they made in your company. Early-stage investors in technology startups are only looking for growth-oriented companies that can achieve an “exit” someday – either via selling your company to a larger company or via an IPO. The former is much more likely than the latter. So investors have to have some general sense of what companies that are similar to yours ultimately sell for in the private market place via an M&A transaction and they have to have some sense of valuations on public stock markets to be able to back into what their potential returns on your investment might be in the event of an IPO.

For example: If you were to invest $41 million into a company (and one could assume that you owned between 33-50%) then the company is worth $82-123 million at funding. As an early stage investor you’re often planning around 10x your investment at the time your write your first check so in this case you’d be going into your investment expecting an exit of $800 – $1.2 billion. Then you can do a little bit of research and find out that very few companies ever achieve this valuation in a trade sale so you’re clearly gunning for an IPO. You’re unlikely to want to make this sort of investment with the product or the market not yet validated. The risk wouldn’t be appropriate.

Ah, but you say that for a normal-sized angel check or A round check one shouldn’t worry about the ultimate exit because he or she is getting in really early and at a cheap enough price so who cares whether one pays $5 million pre-money or $15 million pre-money – you just have to make sure you back really big companies. Well, obviously if you knew that in advance it would be big of course that would be true. But the reality is that you’re faced with two problems: 1) the earlier the stage the riskier and thus more write-offs so you need to have enough ownership percentage in your winners to make up for the losers and 2) the earlier stage your check the more likely the company will need many more funding rounds behind you and thus you face dilution.

So rounds tend to be “range bound” where the top end of the valuation spectrum often being done in boom markets (i.e. 2007, 2011) and for the hottest of companies and in bad markets for fund raising (2003, 2008) prices test the bottom end of the range.

There is no such thing as a uniform price. It is highly dependent upon many factors: experience of the team, type of opportunity (a big biotech or semi-conductor A round is likely to look different from an Internet A round), geography, etc. So the ranges you would expect can be highly imprecise. But to help with the explanation I’d like to put down some markers of typical Internet pre-money valuations done in major US markets (San Fran, NY, LA, etc.) while acknowledging that San Fran deals are often higher valuations due to increased competition amongst investors.

There is no value judgment in my putting up these numbers nor am I negotiating with anybody. I’m just pointing out my gut feel for approximate ranges of deals that I’ve seen with Silicon Valley having the highest valuations, NY / LA / Boston / Boulder / Seattle having valuations in a slightly lower range but comparable and sometimes significantly lower prices in markets that don’t have a healthy venture market. These are not scientific, just anecdotal and just trying to provide some transparency for entrepreneurs on what I’ve seen the market. And of course there are always outliers.

Prices have definitely gone up in 2011 as depicted in the anecdotal chart below. Again, prices are expressed as pre-money valuations.

For me I think that investors have got to accept the new reality in pricing if they want to remain competitive in markets like we’re seeing now. As ever, prices still determined by: quality of team, quality of product / market and competitiveness of the deal.

So when I advise entrepreneurs on fund raising I often say that it’s OK to try and shoot for the “top end of normal” for the market conditions. So in 2011 as a startup company if you can generate lots of demand you can definitely raise an A round of capital (say $3 million) at a $7 or 8 million pre-money valuation or slightly higher whereas just two years ago you would have struggled. That’s fine. That’s the deal you get when you’re raising in a good market for startup financing.

What I caution entrepreneurs from doing is raising money at significantly ABOVE market valuations. I’m a VC so I have an obvious bias. But that’s not where this is coming from. I’ve been preaching the “don’t get ahead of your inherent valuation” message for nearly 10 years. I raised my A round at a $31.5 million post-money valuation with no revenue. It was early 2000. That was market. I saw this kind of pricing when I first entered the VC market in 2007. We had companies pitching us that had almost no revenue at all and they were raising $10-15 million in capital at a $40-50 million pre-money valuation. I should also point out that while they had built their products they had limited market traction.

We passed on all of these deals and often tried to discuss the possibility of more modest amounts of capital raised and at more realistic prices. It’s hard to stop a train. One company which was raising at $40 million pre-money wrote a comment about me in a public forum saying something along the lines of “Mark worked really hard to understand our business and was very detail-oriented. But he and his firm were just too cheap on valuation.” Fair enough. But he sold within 3 years for not a huge price after having raised more than $20 million. Another firm we saw tried to raise $15 million at a $60 million pre-money with similar metrics. They did an inside round, spent a bunch of money and then went through a fire sale of the business less than 2 years later.

Here’s the problem. If you haven’t figured out product / market fit and therefore still have a highly risky business you run great risks for getting too far ahead of yourself on valuation. If you raise at a $40 million pre-money on what would in normal times have been a $15 million valuation you’re fawked if the market corrects and you need another round. To any prospective investor you look like you’ve failed even before your first pitch. Even if you have an interesting story to tell most investors won’t want to go through the brain damage of doing a “down round,” which creates tension between them and early investors.

Finally, even if they could bring themselves to offer you a major down round, the more sophisticated investors know it’s fool’s gold. They get a cheaper price, they wipe out much founder stock value and they reissue you new options. You’ll take the money – what choice do you have? But 6 months later you’re not working past 10pm. 1 year in you stop catching early morning flights. Within 2 years your evenings & weekends are spent planning your next business. And the CEO they would hire to come in and run the business when you go would always be a mercenary.

So my advice: go ahead and ask for a valuation that 2 years ago wouldn’t have been likely. Use competition to make sure you get a fair price. Raise a slightly higher round than you would have previously but keep some amount as a strategic reserve. Make sure that when you need to raise your next round of funding that you are able to show an uptick in valuation that is important for new investor confidence and to maintain great relations with your early investors.

Increase price. But unless you’re already a well-known technology heavyweight be careful about raising above the range of prices that are normal for a bull market. If you’re hot, don’t raise above normal. Raise at the top end of normal.

Other topics I’m going to cover at the Founder Showcase on June 15th:

• Why I believe convertible debt with no cap is wrong for your investors
• Why convertible debt WITH a cap is wrong for you
• How much money should you raise?
• When should you start talking with investors?
• Why you shouldn’t stack too many brand names into a round
• Are we in a bubble?
• and more.

Hope to see you there.

This is part of my ongoing Raising Venture Capital (VC) series

Yesterday I had lunch with a really interesting and capable serial entrepreneur who is raising his A round.  The topic of  ”strategic” investors came up.  It felt like Groundhog Day because I have this conversation again and again – literally dozens of times each year.  And I had 2 “strategic” investors in my first company.

So I thought I’d try to lay out a framework for how you should think about it as many you will inevitably be faced with this experience.

What is a “strategic” investor and why do you keep putting the word “strategic” in quotes?

When people refer to a strategic investor they are usually talking about an investor that comes from the industry you serve as opposed to an independent venture capital investor.  I put strategic in quotes because they are often anything but “strategic” and thus the term can be an oxymoron.   Many serial entrepreneurs who have been burned would use something less kind than quotes.

But they’re promising to massively increase my uptake, they’ll give me huge legitimacy and maybe they’ll buy me some day?

Yeah, I know.  And Microsoft always convinces me that their next version of Windows won’t be slow and I get fooled every time.  When they promise to help you with marketing, sales, distribution, integrated product development, etc. it sure is tempting.  And they probably have every intent of helping you.  But the venture guys don’t make the calls on what the product / business guys  do.  The reality is that their core business is not venture capital.  So push comes to shove they will be driven by their core business (as they should be) – not the $5 million they put into your company.  You are the tail, not the dog.

OK, so maybe they won’t be helpful. Most VCs aren’t either?  What’s the difference?

Great question.  It’s true that many VCs over promise how helpful they’ll be with introductions / strategic advice / recruiting, etc.  But this is benign.  Strategics can have some negative impacts:

1. You’re not their core business – their interest will swing more wildly with the markets

When times are good “strategics” want in.  They’ll pay up for it and promise much.  When times are bad many cease investment activity all together.  OK, I know this is true with VC also, but to a lesser extent.  Investing is our core business.  We have nothing else to revert to.

2. They value their core business more than your success – and they should!

I saw this directly.  I had two strategics in my first company.  One was the hardest working guy on our board and the biggest mensch.  He was also chairman of a $6 billion company!  I loved working with him and learned much from him.  He tried his best to balance his needs and ours.  He was a needle in a haystack in that I think he really cared about my success.  He also wasn’t the venture guy – he was the big cheese.  But even he would feel conflicted when I had to cut the engineering team because he valued our product more than his investment.  When we wanted to sell the company he was very hesitant because he didn’t want somebody to buy us who might not be a good steward of the product going forward.

The other strategic was a train wreck.  One month after investing the guy who invested left his firm.  The guy who took over said, “I never believed we should invest in dot com’s.  I will be on your board but don’t ask me for anything.”  He literally said it that bluntly.  His words were an understatement.  He fought me for 3 years and actively worked against our interests – I think to spite the guy who put in the money.  I struggled to get every signature or consent.  The market knew he was an investor yet he wouldn’t promote us within his own company.  You can imagine how that made us look in the German market where his company is a big deal.

In retrospect he was right for his business but it sucked for me.  Keep that in mind when you’re thinking about ‘strategic’ money.

3. Many strategics have less experience in helping entrepreneurs

Another big question you’ll want to answer is whether your strategic investor has a long history in investing in startups.  How have they behaved in good times and bad?  Make sure to reference check with other portfolio companies.  I often talk about why you want “smart” money (yes, I use quotes because I know it’s not always as smart as it promises to be).  But working with VCs means you’re working with people who deal with entrepreneurs as their career.  When you deal with doctors or dentists for angel money, for example, you’re dealing with people who don’t.  The same can be true with strategics.  So make sure you know what the team and what the individual is made of.

4. Many strategics have bureaucratic decision-making processes

One of the problems in working with corporate entities is that the venture arm doesn’t always have an autonomous decision-making ability.  As a VC I need to get buy-in from my partners when tough stuff comes up.   But I only have 3 of them and they spend every day dealing with these kinds of situations.  Imagine your investor has to call the CEO of a $20 billion company for approval for your merger or sale.  Fun.

5. You may struggle to land their competitors as your clients

So you took money from the largest player in your industry.  That’s awesome because you now have credibility.  But guess what – number 2-10 in the sector now you view as an agent for the evil empire.  It will be much harder to get deals done there and may drive people to your competitors.  I know that you’ll tell them that BigCo owns less than 20% of your company.  Remember, they’re not venture investors.  They don’t see it that way.  They see you as an extension of their competitor and that all information will flow to the corporate parent.

6. You may find that when you want to sell your company it is harder to get a fair price

See point 5 above.  If you thought it was hard to sell your product to the competition try selling your company.  Yeah, I know it happens all the time.  But for an M&A department that is already super busy they don’t want to be seen as a stalking horse for the company that owns 20% of you so sometimes they don’t even want to bother.  Plus, many acquisitions happen when you are already partnered with the company so you may have to get beyond the hurdle in point 5 before getting to this step.  So if you ask many bankers they’ll tell you that there’s a “discount premium” that you’ll get at the time of the sale as a result of having a strategic.

So should I ever consider taking money from strategic investors?

There are times where strategic money makes sense.  I personally recommend it in the following situation: When you have your A round and/or B round done, the business is progressing well and you’re not early stage.  That way the strategic isn’t as involved in the early-stage messy stuff when you need to quickly change direction when your strategy isn’t working and need to get more funding rounds done.

There is a second reason I recommend this.  You can often get 3 or 4 strategics to invest alongside each other and then nobody sees you as an extension of another company.  You may not get fierce competitors to co-invest but perhaps you can get enough closely related companies that you don’t have the branding problem I’ve spoken about.  Also, you have more leverage to not take them all on as full board members.

You may also do your due diligence on the firm you’re talking to and find that they’re an outlier.  You may find that they’ve been investing for 15 years, their entrepreneurs love them and they’re entrepreneur friendly.  So if you get good feedback just make sure that you understand the framework above to think about how to best mitigate your risks.

Are any strategic investors better than others?

Yes.  There are many funds that are associated with corporation that are structured as proper VCs.  Three examples where I know the teams personally, respect them and have heard great feedback are: Steamboat (Disney), Comcast Interactive Capital (CIC) and Intel Capital.  I’m sure there are many more.  What I’d point out in all of these firms is that they have had a long view of the VC market, they are pretty independent from company decision making, they aspire to make money on the fund rather than fuel their core business, they are structured like VCs and therefore attract A-quality people and none of them over promise that their company will ‘make you.’  As a result the market knows this about them and doesn’t view them in the same way.  They are strategic with no quotes

Where can I go for help?

Try VentureHacks, The Funded or OnStartups- three great communities to tap into other entrepreneurs and ask them for their experiences.  Oh, and maybe a few of you will meet me in the comments section to discuss your experiences.  I’d love to get the debate going.  And if you know any great strategics please list them.  I’d love to give them some recognition.

Handling PR with VCs

This is part of my series on How to Raise VC but could equally be filed under Startup Advice more generally.

I recently got a phone call from an entrepreneur whom I respect and who runs a company that I hope will do great things one day.  He had pitched me in the past and I told him that for a variety of reasons his company was too early stage for me but that I would happily keep track of their progress.

He started the call by telling me he had exciting news.  He was about to be featured in a major US news magazine as one of their “hot” picks.  I think my response surprised him, “Really?  Is that why you called?  To update me on your PR?  That’s what you’ve got?  PR?  Save it for someone who cares!   What progress have you made in your business?”

I don’t think that’s what he was expecting.  Entrepreneurs get so used to friends and family congratulating them on their press coverage that they forget sometimes that this isn’t real.  A positive news story means NOTHING about the core performance of your business.  A good friend of mine was features on the front cover of the LA Times business section with a glowing article.  He had 2 weeks’ cash left in the bank and was facing massive layoffs or potentially bankruptcy.

Press doesn’t mean anything other than free advertising.  Don’t get me wrong, I’m very pro PR but please see it for what it is and don’t think that smart or experienced people are going to see it as any more than it is either.

Our call recovered and we spent the rest of the time talking about the development of their management team and their product.  But it got me thinking about how often entrepreneurs overplay their PR so I thought I’d try to offer some advice and how to play PR with VCs (or more broadly with customers or business development partners)

1. Press coverage really matters – The good news – your press coverage really does matter.  I know that most people will tell you that they aren’t influenced by what they read on TechCrunch but the reality is that people are way more influenced by what they read in the press than they even admit to themselves.  Just notice how many VC emails you get after your TechCrunch article or after you were on stage at TC50.  Please don’t take my post as meaning you shouldn’t have PR as an important part of your company’s strategy.

In another post I’ll talk about how PR has changed dramatically in the past 10 years or you can just read Brian Solis’s blog or buy his book on the subject.  Most notably you need to understand Earned Media and how blogging, public speaking and social media play an important role in the new PR landscape.

2. In your VC pitch your PR page should take no longer than 30 seconds – Wait.  If press coverage matters so much then why shouldn’t I talk it up more in my VC pitch?

Many entrepreneurs have a PR page in the PowerPoint deck.  It has logos of the 5-6 most prominent places they’ve been covered with a paragraph from each article.  They proceed to read these paragraphs out loud to the VCs in the meeting.

PR is subtle.  When I read an article about you I’m influenced.  When you sit and walk me through it for 4 minutes on a page I’m reminded of what it is – press coverage.  It shows nothing more than you have the ability to get coverage for yourself.  Again, I reiterate, it IS important.  Press coverage helps you to recruit team members, it helps add legitimacy to your customers who often do Google searches on you before buying and it helps influence biz dev (partners), corp dev (acquirers) and investors.

So what is the right way to pitch your PR page – either in a VC meeting or in a biz dev meeting?  Put up your slide with the 5-6 logos of journals that have covered you.  Reduce any quotes to a few key words and make them large.

When the page comes up say,

“I guess every entrepreneur needs to put in the obligatory PR page.  We feel honored that we’ve gotten such good press coverage.  Most notably we loved that ReadWriteWeb referred to us as ‘a next generation TripAdvisor” because that’s exactly how we want to be positioned.  PR has helped us to drive our numbers faster than we had planned and has gotten us to our 300,000 registered users.  We plan to continue to use PR as an ongoing part of our customer acquisition strategy.”

End.  Next page.  And only go back if you’re asked to.  Leave them wanting more.  You’ve accomplished two things.  One – you’ve shown that you understand how PR plays an important role in customer acquisition and more broadly in your company’s success strategy.  Two – you’ve been subtle about your PR achievements so the VC is left with a positive impression of your press coverage rather than becoming cynical.

3. In an email you can have curated links - So at the risk of sounding contradictory, I still think press coverage is important to VCs.  The best way to handle your press coverage is to send a series of links in an email to the VC you’re getting back in touch with.  It can be a simple email on any topic and toward the end say, “I’ve included some links to the most important (or most recent) articles covering us in case it helps with your research.”

I’ll close this story down with the one I started – the entrepreneur who called me to tell me he was about to be profiled in a major news magazine.  How could he have turned this into a positive?  After the article was written he could have sent me a short email with a one paragraph intro saying, “Just wanted to let you know we got this great coverage in ABC magazine: (link to article).  We’ve been making progress in bringing together our management team and our next release is about to ship.  I’d love to do a 30 minute call just to update you on our exciting news.”

9 times out of 10 I’ll click on the link and peruse the article.  If it’s positive it will probably have some minor impact on my perception of you – whether I acknowledge it to myself or not.  Strike one up for subtlety.

This is part of my series with Advice on Raising Venture Capital.

I recently wrote a post on how to Deal with your Elephants in the Room during your VC meetings.  Elephants being big issues that the VC will be thinking whether you bring it to his/her attention or not. My advice with Elephants was that you need to take them head on in your first VC meeting because the VC is already thinking about the issue whether you bring it up or not.

But what about issues that might have a slightly negative connotation that the VC couldn’t know in advance?  Skeletons in the Closet are these types of issues.  They are issues, though, that your VC would certainly find out during due diligence or at a minimum you’d be ethically obliged to tell them.

Some examples:

• A large company has told you that you need to change your brand name or they’ll sue you for trademark infringement (this is a real world, recent example)
• A company has just filed suit against you for product patent infringement (obviously more serious)
• Your CTO and leading technology visionary has just announced he’s quitting
• You’re not happy with your existing investors
• Your largest customer just cancelled its order
• Large parts of your tech system are going to need to be rearchitected
• You have a prior record as a felon (yes, this has happened)

These are all things that you know you’ll eventually need to tell your VC and ethically you must tell them before they fund you.  But when in the process should you tell them?

I’ve had this debate several times with VCs – sometimes they agree with me and sometimes they violently disagree.  In this particular case – I’m right.  Here’s my advice: Don’t reveal your “skeletons” in the first meeting but you need to tell your sponsoring partner before the full partner meeting.

Why shouldn’t you tell them up front?  Is it displaying a lack of ethics to avoid some of these facts?  I don’t think so.  I have often said that fund raising (like any sales process) can be related back to human instincts and therefore explained via dating analogies.  All prospective partners say that they don’t like to “play games” yet it is human instinct to do so.

Some VCs would tell you that you need to lead with all of your dirty laundry – but in reality this way they won’t fund you (whether they admit it to themselves or not).  So here’s my analogy:

Let’s say you’re in your late 20′s and you’re in a bar trying to meet your prospective future partner.  You wouldn’t reveal the first night you meet girl / boy of your dreams that you snore like a bear, would you?  I guarantee the night would stop there.  It is important that he/she sees your positive attributes first.  She loves a man with a great sense of humor.  That smile!  He’s so kind to people.  He likes kids! Did you hear that he was an entrepreneur?

So eventually it will be known that you snore.  By then she has at least seen your good points for what they are rather than being biased by some smaller issue that she eventually would realize isn’t that big of a deal.  Or if it’s a big deal to her, she’ll abort just as a VC would.

BUT (and there’s always a but) … you need to reveal your snoring habits to your sponsoring partner before the full partner meeting.  Why?  Because that individual is your champion within the VC firm and is going to bat for you with his/her partners telling them how great you are.  You can’t send them into battle without the full details or you’ll lose a supporter.

It’s ok to not admit to snoring on the first meeting but it’s not okay to ask somebody to champion you without complete information.  If they back you in the full partner meeting and then later have to reveal your secrets to his/her partners you’ll not only lose the deal but you’ll lose a friend and contact (along with your reputation).

UPDATE: @BSierakowski wrote to me on Twitter and pointed out that I didn’t really deal with how to begin to reveal your Skeletons in the Closet.  This is a tough one because every VC process will go differently depending on how hot your deal is perceived to be, what the general market conditions are and whether that partner has other deals in his pipelines.

But let’s assume a standard pace.  Let’s say it takes you 3-4 weeks to get from your first meeting with a single partner to get to the full partner meeting.  Let’s assume that you have 2-3 one-on-one meetings with the partner and several phone calls.  My suggestion is that you get through the first 2-3 meetings and feel out whether the partner is comfortable at some point putting you in front of his/her partnership.  If the answer is “yes” then before the full partner meeting is scheduled I suggest the following process:

• Call the partner to say you want to sit down to go through some final details before the full partner meeting is scheduled to be sure you’re all on the same page
• Ask that this meeting be 1-on-1 (e.g. no principals, associates or analysts) because you have some sensitive stuff you’d like to go through before the partners’ meeting
• ALWAYS have this discussion in person – even if it means jumping on a plane and flying 5 hours
• Sit down and have a 1-on-1 discussion.  Lead with the information early in that meeting.  Make it clear that you wanted to reveal the information before asking that partner to sponsor you in front of his other partners
• Make sure you walk the partner through the details of how and why you believe you’ll be able to overcome this issue
• If the partner grills you on why you didn’t tell him sooner you can answer in two ways.  A) you can explain that you felt it was important that people judge your business for its positive attributes that you are passionate about and your commited to making sure your Elephant won’t harm the company – OR – B) tell them you read this post and followed my advice and you won’t let that happen again

This is part of my series on Raising Venture Capital.

There’s an old saying that if I’m talking with you and I start the conversation by saying, “whatever you do, DO NOT think about Elephants” then you can’t help but thinking about elephants while we’re speaking.  There’s a lot of truth in this adage. It’s sometimes called “The Elephant in the Room” because even when you don’t mention not to think about an Elephant there are certain issues that you just can’t stop thinking about whether they are brought up or not.

Many businesses that pitch to me have Elephant issues and I’d like to tell you how to deal with these when you’re raising venture capital.  Elephant issues are those things that the VC would automatically be thinking about when you’re speaking but he/she may not immediately ask you about either for legal reasons or out of courtesy.

But the VC is thinking about the issue whether you address it or not.  I’d like to separate these from “skeletons in your closet” which are issues that the VC would have no idea about when you’re meeting but might discover later during due diligence.  I  talk about how to deal with skeletons in my next post, which is linked to above.   Today’s post only covers issues that the VC will for sure be thinking in your first meeting.

Let me give you some (real) examples:

- You were an EIR at a VC firm who isn’t funding your current company

- You have a “strategic investor” who wants to invest in your B round as long as a financial investor will lead. Your A round investors are not stepping up

- You raised $1.5 million for a social networking site 18 months ago.  Today you have 2,000 users.

- You haven’t been able to resolve who’s going to run the company so you’re raising money as “co-CEO’s”

- The person who founded the company is no longer working for the company

- Google has announced that they are planning to compete with you

- You’re raising money but the CEO is not in the room (e.g. you’re the ex CEO, VP Biz Dev or some other title)

Each of these scenarios are real-life situations I’ve seen where no matter what the person across the table from me is saying that thought – that Elephant – is hard to completely get out of my mind.  I’m not saying that they can’t be overcome – but avoid them at your peril.

There is only one way to deal with your Elephants – head on.  Don’t pretend it isn’t in the room.  Know in advance what you’re going to say and don’t wait for the VC to bring it up.  When VC’s bring up Elephants they feel like they’re “catching you out” and you’ve lost the high ground.  When you bring them up you take the issue off the table.  I can’t say that they’ll get over the issue, but they won’t hold it against you for not bringing it up.

Small story.  I used to work in the UK.  It was 2003 and I was training for a marathon so I was in great shape (yes, I know this was YEARS ago but I did complete it in 3:57).  I was looking for a person to head up my UK sales team.  I hired an executive recruiter and had 7 finalist candidates that I interviewed.

One of the people who came to see me was named Nick.  I don’t know exactly how much he weighed but it had to be at least 350+ pounds – maybe more (I’m a bad judge).  Anyone who knows me well knows that not only am I not “weight-ist” (or whatever the right term would be) but also that I will quickly reprimand people who talk in a derogatory way about people who are overweight.

In this scenario, there was NO WAY I could sit across from this individual without noticing that he was larger than even a normally overweight person.

Within the first 5 minutes of the meeting we had discussed that I was training for a marathon.  He made several jokes about how he wasn’t running a marathon any time soon.  But he also used to opportunity to emphasize that he is full of stamina, works late and hard and had always performed well in his previous sales leadership roles for which he’s be happy to provide pay slips as proof.

He took the issue off the table.  He disarmed me.  He got his talking points in.  And in the end I hired him.  I would like to think that this would have been the outcome regardless.  I’ll never know.  But as a sales person you have to be able to build rapport.

I recently met with a firm that raised $4 million in an angel round (some friends & family this guy had!).  But they didn’t have any revenue or enough traction to show for it.  Instead of BS’ing me he said, “we spent 18 months building out our product and a set of graphic editing tools when we realized we had developed in the wrong platform.  We rebuilt everything in Flash and now have a better product.  So we know that our valuation will be lower than others who would have already raised $4 million.”  He then went on to describe a phenomenal set of biz dev partnerships that they had signed and showed me a very cool product.  Issue off the table.  Elephant out of the room.

Elephants also exist in normal everyday business.  If you’re in front of a customer and you had some very public bad press that week don’t pretend it didn’t exist.  Many people Google you before meetings.  If you’re going to see a client and somebody else in their organization is having big customer service issues, don’t sweep in under the rug.  Deal with your Elephants.

From the VC perspective, before you go out to raise money think about whether you have Elephants.  If you do, make sure you write them out and think about what you’re answers will be.  Make sure everyone on your team who will attend the meeting knows the script.  When you’re dealing with Elephants you can’t waiver.

Also remember, Elephants are things that would (or could) easily be known about your company.  Issues that couldn’t possibly be known without “discovery” I call “skeletons in your clost” and I’ll deal with those in the next post.  The rules above don’t apply.

This is part of my series on Raising Venture Capital.

I’m sure I’ll spark the ire of some VC’s for saying so, but there is certainly such a thing as black-out days in venture capital.  It’s worth you knowing this so you don’t waste your time.  It’s also very important to understand so that you can properly plan when you raise money.

Let me first tell you the black-out periods and then I’ll explain why.  It is very difficult to raising venture capital between November 15 – January 7th.  It is also very hard to raise VC from July 15 – September 7th.  (you need to have had your first meeting even earlier.)  If you’re thinking about raising VC and have not yet started the process, you’ve probably already missed the boat for 2009.

If you’ve had your first partner meeting but haven’t had the full partner meeting then you had better schedule it for Monday, November 23rd.  Full partner meetings are almost always on Mondays and if it isn’t already booked yet for Monday, November 16th (e.g. this coming Monday) obviously that’s not going to happen.  If your VC is reluctant to schedule the partner meeting by the 23rd it’s a clear signal that they want to wait until the new year (or they aren’t committed to your deal).

So why is Funding Season over for the rest of the year?  The VC process is almost universal in how it works across firms.  You meet an initial person from a firm – an associate, a principal or a partner.  If it’s one of the first two you’ll probably meet a single partner before coming into a full partner meeting where (by definition) all of the partners will be in attendance.

It’s true that some VC’s will work a few days of Thanksgiving week and many will work the first 2 weeks of December.  But the problem is that trying to get enough of the partners to be at a full partners meeting during  Thanksgiving week or in December is very difficult.  Because almost all VC’s know this, many are reluctant to even start the process with you.

The same thing happens beginning in the middle of July.  Many VC partners take 2-3 (4?) weeks off in August.  I know that many VCs also work in August so I’m not making any commentary about work ethics.  But enough take vacation that organizing full partner meetings proves difficult.

Maybe it’s partially because many entrepreneurs are pre-kids and many VC’s are post kids that VCs take off large blocks of time in the Summer?  Who knows – but trust me (regardless of what anyone tells you) it’s a true phenomenon.

Note that Jeff Bussgang says that VC’s work in August and he’s right.  VC’s are never really “off.”  Just like entrepreneurs they take calls from vacations, do board calls, handle company emergencies and urgent financings.  Jeff argues that his firm has done the most deals in August in the 7 years since he’s been a VC.  I’m betting these processes started much earlier and his firm was just finalizing what had been previously agreed during Funding Season.  Maybe I’m wrong but if I am I’m telling you in my experience his firm is the exception.

One carve out to the “Funding Season” rule – if you’re raising money from angels or small VCs (2-3 partners) maybe you can get something done as you don’t have the same scheduling conflicts.

But by and large I encourage entrepreneurs who are raising money to focus on the following time periods to START your process:

- January 6 – May 15th (green zone)

- May 16th – June 30th (yellow zone)

- July 1st – September 7th (red zone)

- September 8th – October 15th (green zone)

- October 16th – October 31st (yellow zone)

- November 1st – January 7th (red zone)

Please don’t shoot the messenger in the comments, I’m just tellin’ it how it is.  And if VC’s are telling you otherwise, when they’re done with your funding documents I’m sure they’ll also tell you, “the check is in the mail.”

UPDATE: As accurately pointed out in the comments, I advocate building relationships with VCs year round.  It is always best to know your VC well before you really need money (in the same way you’d historically want to know your local banker).  My guide to VC relationships if you haven’t read it.

UPDATE 2: Yes, this is US centric.  In Europe funding season is longer into November but much, much shorter in the Summer! (I know, I lived there for 11 years).  Any views on funding season in Asia?

This is part of my Startup Advice series of posts.

I heard Bruce Dunlevie of Benchmark Capital say these words at a conference in London nearly 10 years ago.  I jotted the words down (I normally pay little attention to anything said at conferences.  Most of it is BS) and thought about them much over the years.  I later learned that the quote was taken from somewhere else (perhaps as early as the 13th century!) but whoever is responsible I just want to help spread it.

There is a folklore in Silicon Valley that you should fund first-time entrepreneurs.  When you see the successes of Mark Zuckerberg, Bill Gates, Steve Jobs, Larry & Sergey, Marc Andreessen and Marc Benioff it is easy to see the allure (either that or invest in people named Mark

But it’s not my strategy.  I definitely don’t rule out first timers – I just invested in one to be announced soon who I am really excited about – but I greatly prefer experience. It’s easy to say you’d back a great team that has previously been successful – that’s a no brainer.  Fred Wilson outlines why in his piece “Swinging For the Fences.” He outlines that Union Square has overwhelmingly had success with either first-timers or serial succeeders.

I can’t argue with Fred.  He has a great track record and I’m a newbie.  But I was asked recently whether I would prefer to back a first-time team or a team that had failed once before.  Obviously it depends on the team and the idea but holding all else constant I would personally back the team that had previously failed.

I’m fond of saying that I F’d up everything as a first time entrepreneur.  Actually, we got much right, too.  We corrected mid flight.  I believe great entrepreneurs do that.  They do what VC’s like to call “pivot.”  Boy did I pivot.  I went from 92 staff members + 30 contractors (e.g. 122 in total) to 38 people in one day and then down to 33 immediately after that.  I went from managing a team to “flipping burgers.”

So in my case, I believe that I acquired good judgment from my previous bad judgment. We eventually got a successful exit but I can’t say it was a Google like exit!  I believe that it helped me succeed in my second company.

Seeing how entrepreneurs handled adversity and difficult decisions tells me a lot about who I’m going to be working with if I invest.  I learn much from hearing whether they have humility, understanding what they learned from their failure (or success), gauging the speed of decision-making and willingness to admit when they were wrong.  I also look to see whether they can make the really difficult decisions (like firing all of your friends – this is no fun.)

The way I like to make my point about the quote is with something that all of us know innately.  When your parents told you at 15 not to feel so heart-broken when your girlfriend or boyfriend broke up with you because you’d meet many more people in life you probably remember feeling like the only special person you’d ever meet just got away.  They couldn’t tell you this – you had to learn it.

For many of us we had warnings about not drinking too much and yet we still found ourselves “praying to the porcelin G-d” on prom night or at a frat party.  Instructing people can’t create wisdon, experience will.

Which is why I recently wrote a post called, “Is it Time to Earn or to Learn” asking people to think about what they hope to attain from their current job or from the job for which they’re currently interviewing.  I wasn’t trying to encourage everybody to become a CEO tomorrow – I was encouraging them to learn.

Every day I talk with entrepreneurs in my office.  I’ve been a VC for 2.5 years now (an entrepreneur for nearly a decade before that) and as a result I’ve gotten to see many first-timers progress over time.  It amazes me the pattern spotting you can pick up from all these meetings.  I had so many discussions with people when they launched their companies about what each of us thought would happen and now it’s enlightening to have those conversations 18 months later.

Some of these people are people I wasn’t ready to back but I said, “I’d love to find a way to work with you on your next company.”  I think this quote would resonate with most of them.

I prefer second time (or more) entrepreneurs.  Sure, I would love to work with people who have had multiple successes.  But I’m not afraid of entrepreneurs that didn’t succeed the first time.  I want to work with talented people with good judgment.  And so I’m out to spread the word, “Good Judgment Comes from Experience, but Experience Comes from Bad Judgment.”  Go out and learn.