People Define the Deals
Venture Capitalists Share the Formula for Funding Success

Copyright 1998,  Morino Institute. All rights reserved. Edited for length and clarity.  

(Falls Church, VA -- July 28, 1998) A panel of four venture capitalists delivered the low-down on what they look for in a potential investment at the July 29 Coffee & DoughNets at the Fairview Park Marriott. One investor called it "vision." Another "passion." But all agreed that at the top of their list in evaluating a technology start-up for funding is the CEO and his/her team’s personality and talent. Sponsored by the Mid-Atlantic Venture Association, the morning panel of investors provided the flip side of an earlier Coffee & DoughNets (May 21) at which five netpreneurs shared their recent experiences with obtaining early-stage capital.

More than 200 netpreneurs turned out for the program, which began with announcements of new funding and strategic partnerships from about a dozen regional netpreneurs. Their success stories were particularly inspiring to three high school students who attended the morning program with netpreneur Shelton Jewette, whose Computers 101, Inc.  provides summer internships for students to learn the basics of online technology and train each other, and others, in using the Internet.

The session was organized and introduced by Fran Witzel, Director of Investor Services with Morino Institute. Fran pointed out that although most new ventures will not be funded by venture capitalists, there are still many relevant ideas from these investors that all entrepreneurs can learn from and apply if they are interested in starting and staying in business in an increasingly competitive environment.

Moderated by Esther Smith of investor relations company, The Poretz Group, the panel featured Tom Smith of Mid-Atlantic Venture Funds (investor in Women's Connection Online); Gene Riechers, Managing Director of FBR Technology Venture Partners (an investor in WisdomWare); Kevin Burns, CEO of Intersolv and Managing Principal with Lazard Technology Partners (lead investor in Online Monitoring Services); and Will Dunbar of Vortech Equity Partners (angel investor in CrossMedia). They fielded questions from audience netpreneurs and questions sent by e-mail to the Netpreneur Program.

While drive and commitment topped the list for all four VC's, product barely made the list. According to Gene Riechers, "…At the end of the day, the race will be won by the team and the company that has the best distribution strategies. They may or may not have the best product." In describing the main ingredients for a hot prospect, Will Dunbar summed it up as "people, opportunity, and deal."

PEOPLE

Commitment to the product and to succeeding in the market are key traits of a good CEO, said all of the panelists. A track record in start-ups makes a big difference, as does a well-rounded team that can both create a product and sell it. An entrepreneur may have these skills or may have to recruit others who have them.

Mid-Atlantic Venture Funds even ascribes to "the Warren Buffet theory of investing in people, not in 'spaces,' " said Tom Smith. He cited Women's Connection Online as an example of a company with great leaders in whom they have invested. "I liked CEO Susan DeFife’s personality and sales skills," said Smith. "It’s not just the product; it’s selling the technology to the market."

Kevin Burns, whose firm is highly focused on Internet and telecom companies, said that the "people equation" is even more important than the business plan, and that he is seeking CEOs with "almost a religious fervor" in the companies in which he invests.

OPPORTUNITY

In addition to a company’s executive talent, the best candidates for investment are those that are ready to target and exploit a particular market niche. The panelists gave examples from their own experience: Gene Riechers pointed to WisdomWare, which created its own market. Tom Smith noted that Women's Connection Online exploited an existing, underserved market that the founder knew well -- women on the Internet. Kevin Burns spoke of companies that are targeting market opportunities that large, "entrenched" companies are overlooking or aren't fast enough to exploit.

Market opportunities take different forms, but the venture capitalists agreed that the companies that are poised to dominate small, focused markets -- rather reach a small percentage of a really large market -- are good candidates for venture capital. "I like to see defensible segments where we can be number one at something," said Burns.

DEALS

One of the touchiest subjects for entrepreneurs seeking funding is valuation, or what a venture capitalist says your company is worth. Sharing their thoughts from the other side of the negotiating table, the investors told it like it is:

The real job of venture capitalists is to make a handsome profit on their investment portfolio, ensuring a good return for their shareholders. Deal-making, therefore, means looking for opportunities for a very high return on investment. For early-stage funding, this often means employing simple "bar room math," as Kevin Burns described it, to figure out their initial investment and what percentage of the company they want to control in return.

Will Dunbar outlined the factors that went into his calculation of the potential of getting a good deal: "it encompasses everything on the right-hand side of the balance sheet, but also a lot more . . . the structure and terms and valuation of the investment, and the exit potential."

Gene Riechers said that he is usually looking to make three to ten times his original investment, over several years, depending on the level of risk associated with the deal. After accounting for companies that fail, he said that this enables him to bring a 30-40% compound annual return to his investors.

Kevin Burns said that most VCs recognize different "points of valuation," or points in a company's development that correspond to the company's likely worth. Entrepreneurs should assess their own point of valuation and adjust their funding expectations on that basis.

In response to a question from Rob Montgomery of Argosy Omnimedia about the importance of "anchor customers," Gene Riechers said that big contracts are less important to him than repeatable, sustainable products. He seeks out companies that are focused on developing products and services that can be re-sold many times, drastically reducing the cost over the long run and providing a product with a track record. Kevin Burns agreed, saying that you have to be careful not to let an anchor customer get you off of your main focus in fulfilling their contract.

Paul Lyons of Tesseract asked how a VC recognizes when a deal is going bad. Tom Smith replied that a market where there are competitors with more resources is a sign that the company won't be able to succeed. He added that investing is often a gamble since the market may or may not be ready for the company's technology at the time the company is able to deliver it. A bad deal can happen when the company is too early, or too late, to capitalize on a market need.

Putting perspective on the importance of venture capital, Gene Riechers emphasized that "99.9% of successful companies never received venture capital." He said that angel investors are another avenue. Kevin Burns also pointed out that entrepreneurs who want a lot of control and want to run a sole proprietorship would probably not be happy with a venture capital investment. Venture capitalists offer deep pockets and long-term investments, but the trade-off is losing some control of a company.

Talking about his experience as the founder of Intersolv, Burns said he thought the venture capital he received had been worth the trade-offs. "I sat in my living room with my software idea, and I owned 100 percent of nothing. When I went public, I owned 18 percent of a $75 million public company."