I’ve been seeing a lot of emails from friends on various lists that contain the question, “how are we supposed to raise money in this economic climate?” Or, “are we going to make it through this crisis?” Or, “shit, I need a drink.”
Okay, that last one wasn’t a question, but I am seeing it a lot.
So, I did what I always do when I have a question, I ask really smart people for their opinions. As entrepreneurs worry about investment dollars drying up, it makes sense to ask those who are sitting on some of those dollars. After all, who’s ridden out the bubbles and pops, watched the ebb and flow of investment capital and seen companies flourish and perish more than those in the VC community? So I asked a couple VC’s for their insight on raising money and running lean in this chaotic economic climate.
There are a LOT of great VC’s in Seattle, but today’s answers are courtesy of
Greg Gottesman from
Madrona and
Jan Hendrickson of
Denny Hill Capital. They both just happen to be super smart, visionary, compassionate and creative – and I just like them. To me, they serve as a great reminder that a good VC has more than money to offer; they have insight, ideas and genuinely love to help out good companies. These two fit the bill.
1. Times are tough, but investors are still investing. How do you think that this economic climate has changed what investors are looking for?
Greg: The current economic climate (and the panic of the last couple weeks specifically) has clearly changed the start-up investing environment. Venture funding is not immune to the overall market unfortunately. When there is no IPO market and the perception of a weakened and weakening M&A market, later-stage investing and follow-on funding dry up. I don't think this cycle will mean just lower valuations; as investors become more conservative, follow-on financing of any kind will be tougher to find. Moving to the other end of the funding spectrum, my sense is that it will be more difficult to get angel funding. Like everybody else, angels have taken a beating the last couple weeks in the stock market. Angels are the critical funding source for early-stage start-ups, so I hope that I am wrong that they will stay on the sidelines, with a few exceptions, until the economic picture clears up a bit. Venture firms also will be more conservative. I don't think you will see as many out-of-town firms investing aggressively in Seattle. I have spoken with several Valley VCs who told me that, like they did when the last bubble burst, they are now focusing on issues in their own portfolio and will be less likely to hop on a plane. There will be significant exceptions, of course, but it will be harder to attract funding from outside the region. With that said, many businesses will still get funded. Investors will be looking for businesses that are not burning much cash and have a clear path to profitability. The general consensus is that this downturn will continue for years, not months, so investors will prefer businesses that they believe can survive over the long term. The old criteria still apply: top-notch team, big opportunity, good timing. I would still spend most of my time pitching on those basics, but also be sensitive to showing how you can stretch every dollar.
Jan: I think investors will be most attracted to those opportunities that can demonstrate they will be cash-flow positive in a relatively short time period and without multiple rounds of financing—as Greg points out, later stage and follow on investing will dry up without exit opportunities. Raising money for business model that doesn’t reach cash-flow positive before 2 years if not sooner will be all but impossible to raise capital for. Only companies with proven sales models will be acquired. Investors will be looking for CEOs who are: completely realistic regarding valuation; understand what they can and can’t control; know how to make each dollar scream. Angels are already on the side-lines. Those business plans that receive funding will be those that emphasize and can deliver the fundamentals, and can do business better, cheaper, more efficient operations.
2. Savvy startups know that they may need to do more with less right now. Besides giving up the vintage Donkey Kong console for the employee break room, what kinds of cost saving measures can startups make in order to make progress (and as such be more invest-in-able) to weather out the storm.
Greg: People are the biggest cost for any start-up. Is everyone on your team either building the product or selling it? Don't hire ahead of revenues. Monitor every expense. Avoid luxuries like new office space, new furniture, new anything. Reward frugality. During the last downturn, Intrepid Learning Solutions used to give "Scrappy Awards" to the employees who demonstrated acts of extreme frugality, and the winning stories were often humorous and fun to share with other employees. Frugality starts at the top.
Jan: Greg has great advice: don’t hire ahead of revenues. With marketing dollars, invest only what can be measured and cut everything else; but now is time to be aggressive with company’s messaging—so PR and communications strategy important (can do a lot these days with relatively low investment). Focus on building out only the essential features of your product, forget the nice to haves; make certain that the features you build are what your customers actually want.
3. Typically it seems like startups are always trying to paint the rosiest picture possible, but a lot of the mess we are in now has to do with people painting unnaturally rosy pictures. Given that, how do we communicate our potential without sounding like we're delusional or worse, cooking the books?
Greg: Getting funding is still a marketing exercise, but one that has to be done with integrity. As investors become more conservative, they will take more time to dig into your business. Nothing will send investors running faster than a sense that a founder/CEO has not been 100% truthful. I think the key is to get an investor to come over to your side of the table. Ask for advice. Don't shy away from talking about challenges and issues. If an investor is truly interested in putting money to work in your business, he or she will want to engage at that level.
Jan: I think transparency is key; being clear about what you can control and what you can’t. Inviting help and then following up to share how you executed or incorporated the help. Part of the integrity question comes from “truth in advertising”—don’t make the obvious dumb mistakes, like claiming “we have no competition” or “no one else does what we do”. This is common sense that holds true in any environment but I think founders/CEOs will be held to even higher standards in this environment.
4. Looking specifically at Seattle, is there a particular market sector that you think investors are considering safer than others?
Greg: Generally, I think businesses that are directly tied to the money flow will be easier to fund than ones that are indirectly tied through means such as advertising. Selling into the enterprise will be difficult unless your company is delivering a product or service that is one of the top three priorities of a large number of buyers.
Jan: Business plans that lower costs; create efficiencies; create savings. I also think about this instead in terms of my answer to #1: what business plans can scale to cash-flow positive without round upon round of financing?
5. I'm a firm believer that tough times are when we do our best learning and growing. What's the best lesson that you think we can learn as we try to raise money and grow businesses in a time when everyone else thinks it's impossible?
Greg: Many great businesses are built during challenging times. If you can survive and build a sustainable culture in a tough environment, you are more likely to prosper when the economy improves. This economic cycle will be like other difficult economic cycles, and ultimately we will climb out of it. It takes several years for a start-up to mature. I think we will look back and say now was actually a very good time to be starting a business. Many mature businesses will find it difficult to cut back and compete in a recession. Start-ups with low burn rates, new technology, and a lack of legacy issues are better positioned in many ways than those with much longer histories.
Jan: I think Greg is spot on: this is a good time to be starting, building a company—it will more likely succeed in better economic times. I’d emphasize the need for low burn rate, problem-addressing business plan; proven sales model, lean and flexible, with a sheer refusal to accept defeat = ability to navigate and be more competitive than, as Greg points out, legacy companies.
And on that note, hold on, we are probably in for a bumpy ride, and it may well shake off some companies….. But not only is failure a great teacher, those left standing will be leaner, meaner and stronger. Hunker down. Oh, and now is a great time for Happy Hour. Revel in the irony and seek the company of friends.