Part 1: VC's role and back to basics

What is a venture capitalist's role and how has it changed since the downturn?
The venture capitalists are somewhat returning to the old role they were in prior to two or three years ago when they were looking at business basics. A lot of them right now are working out problems in their portfolios and spending a much higher percentage of the time making sure they add value and keep value in old investments and are less focused on new investments.

I think they're turning back to the basics of what makes businesses go: a good management team and the product that meets the need of the consumer, whoever your customers are for your products or services.

What's the biggest hurdle for someone to get over when they are pitching an idea to a venture capitalist?
The more things change, the more they stay the same. It's really just being able to trigger that spark where the venture capitalist says, "I get what you're saying, I understand why this is of value to your software engineers, your consumer, your semiconductor chip manufacturers, whoever your target customer is." The venture capitalists need to feel as though they get what the problem is, that it's a huge market and that your specific company is the solution to it. That's what I mean by back to basics.

So, from the venture capitalist perspective, everything centers on "What's the problem and what's your solution?"
Exactly. The way they look at every pitch is: First, is this a strong management team who knows what they're doing and can do what they're promising, second is there a problem that your company is solving, is the market big enough and why will they buy it from you rather than twenty-eight competitors.

And the hardest part for an entrepreneur is to trigger that first spark of interest, that "Aha, I get it and now I know why this is valuable. Now let's talk about the problems with it, or where the competitors are in this market and how to overcome them." If you never get to the first part of "Aha" or why it is valuable, they're just not going to spend any time with you.

And what about the case where venture capitalists look at a management team, love the idea, but don't think the management team will be able to pull it off?
Some will just say no, others will say "We think it's a great idea but you need a VP of Marketing experienced in the media industry" or "you need a better CEO" for example. And then the proposed CEO finds himself or herself in a very difficult dilemma.

Tell me that dilemma.
The dilemma is, let's say they go to five venture capitalists and they all say the same thing about needing a better CEO, then the dilemma is: Are your ego and being in charge of the thing more important, or is it more important to make the idea a success?

As Jon Nordmark of ebags likes to say, "There are missionaries and mercenaries. The missionaries are ones where it's not as much about the money, it's about building a company that's important and meets an important need." [see our interview with Jon]

And that's really the issue of one, whether they buy what the venture capitalists say and two, whether they can accept that and take a different role in the company.

And what about the remarkable and revolutionary idea that you propose for companies to have enough money to fund their own businesses for two years?
(Laughs.) Well, in a tight money environment it's not as easy to get the next rounds of money, and it's just a prudent business practice. What you would really like to do is to have enough money to get you to where your company breaks even. I think later stage companies, that is what everybody's focusing on. The term of art is "fully funded companies." That's a prudent thing to do where money is tight.

Two years is a rule of thumb, there are still areas that venture capitalists are very interested in. If you get the right venture capitalist, in the right market, you can take a risk that you're going to get funded a year or two out. It's all a trade-off vs. certainty, vs. valuation, and each situation is unique.

If you're fortunate enough to have a choice of venture capitalists, choose ones that are more long-term oriented, that want to build a company and know that's how they get their returns in the end, by building good companies, not chasing the "latest" thing, whatever that is.

You said on the venture capitalist panel that people should ask up front how many CEOs the venture capitalists have fired - why?
In my years of experience, the personality of the senior management team and the venture capitalist melding together is a very strong determinate of what success the company will have. And the CEO will sometimes hear bad news from the venture capitalist, so if they have a good relationship it will be more helpful.

Some venture capitalists are more mature and less volatile than others. If you have a choice, you need someone who is tough but fair. The CEOs change and management teams change and, if anything, you have to really go by human nature. Sometimes people within a company wait too long to make a change.

Can you talk about those entrepreneurs that have gone on record in stating that venture capitalists want to just come in and steal a company?
Great question. It's just not true. They're putting money on people and the company to succeed. There's no idea that's so good that it's going to succeed with a mediocre management team and vice versa. So there's no real incentive to take over companies. Now in the last two years, I think there have been people new to the venture business who sort of panicked and fired CEOs.

I've been in situations where companies have had five offers from five key venture capitalists. And this is dangerous to do as a lawyer, but I've told clients, "I'd take the lowest valuation." Because the venture capitalists that aren't quite as premier have to put a higher value on the company. It's like Mercedes Benz or Chrysler. My advice is: if you can get a particular venture capitalist to take the time and serve on your board and commit to spend time, then I'd take the lower valuation from that fund.

The best companies are the ones where the venture capitalists are on the board and the entrepreneurs running the company are in a true partnership.

And the venture capitalist's role is to help the person along the path to success?
Absolutely and it's in their self-interest to do that because the less time they have to spend with that company the more time they have to help build up other companies. And a key determinate of value, again, is quality of the management team and how the management team works with a venture capitalist. That's really all about human nature.

Continued...