Simply RFiD

What it really means when someone gets 'Venture Funding'

You've seen those press releases like: "Alien Technology Grabs $66 Million venture funding". Perhaps you thought, "Oh, someone believes in them to give them money?" Not exactly...

This is what really happened: The company was about to close its doors because it spent everything and needed more money to keep operating.

Here's what else happened and things to think about for your next startup (because if your taking venture money -- you're on life support...):

1. Dilution and failure cascade

A venture round is the beginning of a failure cascade. Any company that accepts or takes venture money effectively announced they went out of business and were rescued for 10 cents on the dollar. Most venture funding rounds are bets that the asset breakup value of the company are greater than the funding required. If you work at the company and own 10% of it, you would now, typically, own 1%. This isn't the VC's being unfair -- this is that the company spent all its money and rather than ceasing operations (and your stock going to 0%) a VC put in money to keep it operating.

Regardless, the morale hit for working at a company like this is nail-in-coffin #1. Though, frankly, it was doomed if it's gotten this far. The VC probably believes they can flip it (sell it) to a bigger company for 10 times return on investment. Either way, if you work there -- you'll be out of a job shortly...

2. The company over-spent

Rather than fixing the 'problem' (too high a burn rate also know as 'expenses') the company continues to operate and pay exorbitant salaries based on massive growth numbers. When they take the VC money, they will be forced to adjust. Why they didn't do that in the first place --that's covered in the bad planning bullet. But, expect layoffs or cutbacks or restructuring or whatever you might want to call it. It's coming...

3. Bad planning

This is really part of my 'how to not get screwed by VC's' -- but, when you take round 1 -- VC's know you'll be back for round 2. It's a given. There is no way to grow at the rate you predict and so you'll need more money. The difference is: In round 1 -- you were doing better and had a nice, profitable, growing company. In round 2 -- you'll be desperate because you expanded operations faster than you grew. You HAD to because it's what your business plan said to get round 1 financing. And, it's also in your performance contract to produce a certain growth rate. Essentially, it forces bad planning. 

This is where the VC's will have a major upper hand in deciding on and negotiating additional funding. Round 1 from VC's = good. Round 2 = not good. Whatever you do -- don't ever get round 2...

In summary...  If you see a company taking round 2 (or more) of financing / venture funding -- it means they are up for sale. They expect a bigger company to gobble them up within 12 months (or, an IPO) and their best talent is probably available for hire... Is 2nd round funding a sure sign of failure? I can't think of any case where it is not. Because if they were succeeding, 1) Their management would fight the equity loss by leveraging growth through debt (vs. equity), and 2) their previous investors would never let a dilution occur if the company was that valuable.

Six things you need to know about Venture Capitalists

Part 1 of Dealing with Venture Capitalists

A friend sent me a cover letter he was sending to VC's (Venture Capitalists) and asked what I thought of it. It suddenly occurred to me that there are a lot of guides that say "How to get funded" and people believe it. Just like 'Tim Ferris' selling the dream of being the new rich -- people are fooled into believing a book on VC funding will actually be truthful.

So... a little background. I've been through several VC funded companies. There are a number of cheerleader books dripping with honey and how-to-get-rich and funded. These books, too, prey on your basic desire to succeed without effort -- and, VC's hope you'll read them because it makes you an easier target. Most new companies are funded by overly optimistic entrepreneurs. Most of us don't get to do five or more startups and we believe the tenet that people are basically honest. With VC's, it's the opposite. VC's are dishonest until proven honest. VC's are the lawyers of the banking world -- they make money of other peoples misfortune. These tips are to prepare you for the majority of VC's so you aren't blinded by what you think they want, who they are, or what they can do for you. 

1.  Never believe a VC thinks you are a great leader for the company.

You may think you have an incredible skill set and VC's will want you to run the company.

VC's don't care about you and will replace you the moment you pause to breathe. They will say you've done an incredible job and they want you to lead the company. This is bullshit. They are stroking your ego. This is all 'how to win friends and influence people' to motivate you to get extra value from their money. If you work 100 hours per week, they save 2-3 extra hires and this gives them a higher ROI on their money.

Tip 1: If you think you are important, you need to check your ego before the VC's use it against you.

2. VC's don't care about your product.

You think you have a new technology that is unbeatable and everyone will want?  VC's absolutely don't want that...

They really don't. They have a very specific formula: P = S - E.  Profit = Sales Revenue minus Expenses. As long as you can grow P -- that's all they care about. VC's would rather see an established market than a new market. Established markets are proven and they can examine financials of existing companies to figure out how big the market is and how much money they will make.   

Tip 2: You need sales and profits before asking a VC for money.

3. VC's don't care about your people.

You think you have a great staff with lots of experience that would be irreplaceable?

Forget it... They may actually be a liability. VC's are not about long-term. They are about quick-turn. They don't want a great organization or stellar service or new products. New products = engineering costs = less profit. Existing people equal liabilities = higher pay = less enthusiasm for working 100 hour weeks.

TIP 3: If you take money from a VC -- expect to fire your friends.

4.  VC's don't care about your promises, hopes, or dreams.

You think the the idea for 'a pc on every desk' is the future you are building towards? That concept would scare off a VC. Don't dream... VC's don't want dreams. However, they will tell you how it's going to be a great future under your leadership and your dream is exactly what they want -- just as long as you sell more of those PC's!

Tip 4: Be prepared to break every promise -- unless it's in writing.

5. VC's don't add value and have no specific skill set of value.

In case you think a VC can help with your marketing or management or 'contact's -- you'd be mistaken. Yes, a VC will have all of these things. But, they will only divert your attention from succeeding.

How the VC contacts will help you: You make PC's and are showing great growth and profits. Too much profit! The VC's want to temper the growth figures so they have you buy a bunch of services from one of their failing companies (e.g. "A marketing design firm") that will make a new image for you. They pump the marketing firms balance sheet by having you spend your profits so they can show that the marketing firm is growing (so they can dump that turd on the unsuspecting stock market) -- while destroying your profit margin percentages. This is how VC's work...

Tip 5: Never talk to a VC if you think they can actually help you.

6. VC's will screw you.

Some day you'll report a stellar month. The VC's will say they want to explore new leadership because the company is growing fantastically but needs an experienced 'organization man'. What can you do? Nothing.

Tip 6: If you take VC money -- never sign anything and get all your cash up front because you'll likely never get another cent.

In the next blog, I'll cover how to keep from getting screwed...