On Tuesday evening Jason Mendelson, Managing Director of the Foundry Group, conducted a Crash Course on “Raising Venture Capital” to over two hundred gathered in the Wolf Law building. After being introduced by Brad Bernthal, Director of Entrepreneurial Initiatives for Silicon Flatirons, Mendelson took the stage to explain how the venture capital industry works, what an entrepreneur can expect when engaging with VCs, and how the current economic downturn is impacting a firm’s ability to raise money.
Venture capitalists, explained Mendelson, are professional investors who raise a pool of money (a fund) from institutions and well-heeled individuals and proceed to invest this capital in seed, early, or late stage companies over a period of eight to ten years. A venture capital group can specialize in a certain industry or it can focus on a specific stage of investment, such as only taking positions in seed-stage companies (defined by Mendelson as “a couple of folks and a power point slide”). A VC shop can have a number of funds operating at once, as it tends to invest the majority of a fund early to allow a five to seven year period for the companies to mature. The venture capitalist will receive a management fee of 2-3% of fund, as well as participate in whatever profits (usually around 20%) are harvested from the portfolio companies upon exit. So, for example, the Foundry Group closed its current fund of $230 million in November of 2007. It primarily invests in IT companies at a seed or early stage, and has done thirteen deals in the last fourteen months. A third of its portfolio companies are located in Colorado, slightly over a third are found in California, and the rest are spread around the United States.
There is some subtlety required in engaging venture capitalists, as these professionals witness an enormous amount of deal flow: Mendelson reports that his firm looked at 1400 companies in the last fourteen months and spent “meaningful time” with 210 of these prospects. It thus comes as no surprise that VCs tend to value “short communications,” prefer emails to phone calls, and favor an executive summary over a voluminous business plan. Once in the door, Mendelson urges the entrepreneur to “know the rules,” meaning there should be no discussion of non-disclosure agreements, and the candidate should “know the market, know the competition, and be original.” Under no circumstances should an entrepreneur tell a VC that there is no competition for her intended firm, as that’s a clear indication she hasn’t done her homework. Mendelson also counsels that whatever the business, the entrepreneur should be compelling and offer a transformative idea, instead of a “next best” business idea such as creating a new social network.
Another necessity to raise capital– at least for Mendelson – is a team over a single founder. First, there is the “hit by a bus problem,” whereby the prospects of the firm are tied to the health and safety of a single individual. Second, if the sole founder needs to be removed over the life of the business the firm will likely die. And finally, having a partners or partners signals buy-in to the VC: “If you can’t attract somebody to be your partner, that ought to be a big warning sign to you that maybe your business isn’t quite as attractive as you thought it was … if you’re on Match.com and Jdate and still can’t get a date, that might tell you something.”
In choosing a venture capitalist to speak with, the entrepreneur should take a number of things into consideration. First, the founder needs to ascertain if the VC is the right fit from an industry and investment stage perspective, and whether or not the VC is invested in any potential competitors. Second, the entrepreneur should investigate where the VC group is in the life of the fund, as there might not be money to invest in new startups. Next, the business owner needs to understand if the VC has the power to get a deal done, or if this specific VC is lower on the ladder and thus has a reduced ability to get to a term sheet. Finally, Mendelson would have the entrepreneur ask, “Would I rather have a beer with this person or my mother-in-law?” If the answer is the latter, he counsels to find another firm given the need for a basis of likability in a relationship potentially lasting years.
Mendelson then offered his insight on what types of companies are currently getting funded during the economic downturn. First and foremost are “capital efficient businesses,” meaning firms with a low burn rate not likely to require continuing large injections of capital. Mendelson also looks for experienced management teams in this type of environment, as such managers have likely been seasoned in hardship. While preferring not to do a deep dive on specific industry groups, he did offer the Clean Tech environment is “hot,” Life Science is “OK,” Mobile Applications are “hot to warm,” Gaming is “great,” while the Retail Space is “tough all over.”
Over the course of the presentation, Mendelson offered numerous online resources that can be helpful to entrepreneurs preparing to meet with venture capitalists. For legal documents he cited resources freely available at the Techstars website. For answers to frequently asked questions related to the industry, he pointed to Ask The VC as well as the blog of his partner, Brad Feld. Finally, there is his own blog, Mendelson’s Musings, where he frequently comments on venture capital, music, and the staggering hourly fees of the lawyering class.
Silicon Flatirons, in administering the CU New Venture Challenge (CUNVC), will be hosting a number of programs, crash courses and workshops leading up to the final competition, held the week of April 13-17. The next event, entitled “Financing Startup: Friends, Family and Beyond” will be held on March 5th. Application for competition must be submitted by March 2nd, and every team must include at least one member with a CU ID.
