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Why Investors Say NO A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry. Something Ventured: October 1, 1999 By Brent Holliday Greenstone Venture Partners "All this rejection's got me so low... The more you suffer The more it shows you really care Right?" - Offspring, Self Esteem Hey, don't take it personally. Early stage investors say NO for a living. The exception is when they say YES. And investors are not perfect. In fact, far from it. Many companies get money when they shouldn't and many companies that could have made it won't get funded. Your challenge is to get what's right for you and to get the right people to say YES. Ahhhh, there lies the rub. How can you get custom-fit capital for your unique business opportunity? Well, for starters, it helps when there is some choice in the financial market. Without choice, how can you get the right money? In technology in BC we have a hell of lot more choice than we did even 5 years ago. And it's continuing to get better. Harry Jaako said last March that we need 10 times the amount of private equity than we have now. Well at least two times would be a huge improvement. My view is that capital supply leads, not lags, commercialization and innovation. (Up to a point. The Silicon Valley may be seeing the other side of this coin now with a capital supply glut). If I have a good idea and there are inadequate sources of money where I live, I leave to go where the money is. If there are adequate sources of money around, I shop here for the best capital fit and attempt to partner with them. Ask Glen Ballman at Onvia.com whether he found a capital fit in Vancouver. Or Terry Drayton at Homegrocer.com. They heard NO a whole lot, but eventually they heard a YES. Unfortunately for us, the YES was in the States… another big story in and of itself, but I digress. How many entrepreneurs are there out there that have heard NO a hundred times and are still trying. There is something to be said for perseverance, but when is enough really enough? When do you stop trying and go back to the drawing board? What about when you hear NO from the people you really think are the perfect capital fit and then you take money from a source that doesn't work for you and your company? Aren't you just prolonging the inevitable failure? {At this point in the story, our indomitable reader realizes that Brent is writing about the Capital Connector site just launched this week by T-Net. Without closing the browser window with disdain for such an obvious plug for the site, the reader sighs and reads on to see what treasures, well OK, kernels of knowledge can help them in their search for capital.} As an intrepid, exuberant, wide-eyed entrepreneur looking for OPM (other people's money) to fuel your rocketship to success, you should know ahead of time why you are going to hear NO and try and ascertain just what kind of NO you have been told. The reason I keep capitalizing NO is that I have a four year old and a two year old and to them no is not quite the same as NO. It's just for emphasis. Why NO? The very basic and guttural NO response comes from a bad idea. Sorry, but there are some pretty bad ideas out there. If I were to display some of these concepts to the entire general public and have them give the ability to democratically vote on whether the idea, on its own, merits further research, the polls would be overwhelmingly NO. These are the pencil biters. You know, you read the first few sentences and start biting hard on your pencil so as to not laugh out loud. Some of the bad ideas are actually quite thoughtful and would certainly be useful, but it is quite obvious that it can not be economically feasible. Example? How about an individual commuter rail car that zips you downtown in less than 20 minutes from Abbotsford? Nice idea, but… the hurdles to getting this done are a bit too high. The other sure way to get a NO fast is to fail the bozo test. Nothing gets a plan rejected faster than having it addressed to Ms. Brenda Holliday at Greenstone Venture Partners. I kid you not. It just happened a few weeks ago. Seriously, if a plan or executive summary arrives and it is unreadable or has spelling mistakes or is written in a style like Something Ventured… it's in the round file. Any external representation of you and your idea is an extension of you. If you cannot communicate in a simple manner, then you will definitely get a NO. Any sloppiness, like getting the sex of the investor wrong, is viewed as a red flag for stupidity or laziness or both. Proof read, proof read, prof read. A lot of bad ideas for companies are actually good ideas as individual, stand-alone products. There are many inventors out there that come up with wacky, but possibly useful new products. These people need to approach existing manufacturers or marketing companies rather than try to start a company on their own. This is quite important for you to understand: Big companies are built around product or service related competencies. And the competencies usually walk out the door every day in the management and employees. It's not the product or service itself. In order for an investor to get a meaningful return, the small one product company must grow into a larger entity. From the very beginning, you, the entrepreneur, must have (or quickly build) the competency to design, manufacture or service new products and capture more and more customers. I might say NO to your company idea, but your product may still work. Why? I don't see the competency or vision to build a family of products or to expand the service offering. If you have an invention and you can't build a big company, then you can probably license it. This requires some effort and ingenuity. In order to collect royalty cheques for the rest of your days, you need to find the right commercialization partner and write a solid legal agreement. There are many licensing agents around and many local law firms that specialize in licensing deals. Do your homework and get a deal done. There is custom fit capital for licensing plays. It is usually angel money, but is sometimes more formalized into a company. In biotech, there is Drug Royalty, a publicly traded company that specializes in licensing intellectual property for drug discovery. You can get some capital (usually less than $100,000) to go and form the right partnership. Unless you have a technology that you can build a series of products from or you can demonstrate a competency for commercializing products that are in demand, a NO from me might be a YES for licensing. One last point about the big company idea. Remember, early stage investors take the risk of losing all of their money because they see a chance for a big return. If you have a good idea for a small market, you still can be very successful and make lots of money. But your investor likely would not make a great return. So investors say NO when you have a perfectly good business opportunity that is just not going to be big enough. How big is big? If I invest $1, I want to see $10 in seven years or less. Without that potential, it ain't worth my time to even try. Other investors have different thresholds… make sure you find out what it is in each case. In the new economy, many new ideas are springing up for companies that have little or no advantage in the technology. This has made it very easy to say NO to a potential company. Take HomeGrocer.com in early 1997 when they approached me at Multiactive. I was living my own Internet start-up and trying to find business models that worked. They laid out their plan to deliver groceries from a Net site. They wanted to know if Multiactive would be interested in helping them start with some cash. Peapod and Netgrocer already existed at the time and I said, " You don't have the first mover advantage. You need tons of capital to buy trucks and market. It's going to take you a long time to create value. We're not interested." Of course, Multiactive was a company and had other areas of focus, so it wasn't really a fit. But HomeGrocer got the same response from investors at the time. I'm certainly not here to defend all investors, but selling books on the Net is a lot different than coming up with market changing technical innovation, like Creo, for instance. Most VCs come from a world of investing in protectible technology. One of the first columns I wrote was about investing in services companies. The excuse used to be that they don't scale and therefore can't grow fast enough. But new models were emerging and public market valuations had gone through the roof. This brand new world scared investors to death. It got to the point where Canadian VCs were heard to be saying there are no good dotcom deals left to be done. Why? No first mover advantage. Forget the past for a minute. Why do investors say NO to Internet related deals today? As some early painful lessons in creating Internet companies have revealed, the new economy is driven by people with old economy skills and connections that weren't common in technology companies of the past (and present, actually). In fact, the dotcom, Internet services and B2B companies are not about technology per se, but are about clever positioning, marketing and delivering customer satisfaction. And running like hell. The investors have had to get brand new Rolodexes with connections to people in department store chains, call centre organizations and PR consultants. You don't need a PhD in electrical engineering to manage your new bulk electrical parts on-line auction company. Investors say NO to Internet related deals today based on who it is that is going to run the company. Full stop. Excellent management has always been the most fundamentally important criteria for success. In pure play technology companies you often have a protectible technology asset that also has value. On the Internet, you have your team and its ability to build brand and satisfied customers. If an investor does not believe that the team can get to the next milestone, then they won't invest. The management capability is the toughest factor to directly pinpoint as the reason to say NO. It's a politeness thing. It's not hurting feelings. So, VC's and other investors have euphemisms for the times when they really want to say, "We don't believe you can do it. Not even with our help and connections. You just don't cut the mustard, in our opinion." Instead they say anything but that. They cite the market opportunity, they talk about first mover advantage, they say the competition is fierce. It's a lie. But it's not meant to be malicious. But you already knew that didn't you. So there are your reasons for NO. To recap: NO to plain bad ideas NO to people that don't do their homework on the investors and fail the bozo filter NO to products that should be licensed, not have a company built around them NO to good ideas that are probably too small for a meaningful return NO to any deal where the management doesn't have the competencies required to move ahead Make sure you understand what type of NO you have been told and take it as constructive feedback. Always seek a second opinion. When you've heard the same NO a few dozen times, maybe you should pack it in. How about saying something positive to end this column? Investors in early stage technology are looking for you to make them comfortable with your idea. Too often, entrepreneurs and investors bog down in what the opportunity is and what the technology is. These are important things. But it is incumbent upon any entrepreneur looking to inspire investors confidence to focus on the HOW. HOW does this technology/service capture this opportunity? That's the business of running a technology business. That's what separates the wheat from the chaff. Do you really understand how this business is going to market, operate and finance itself into a huge success? Go ahead… convince me to say YES. Random Thoughts - You've heard the notion that VCs travel in packs. I have mentioned the tendency of early stage investors to follow what the broader technology markets are doing, instead of lead. It makes sense to anticipate public market trends, rather than follow them when you consider that an investment today needs to find a hot IPO market in two to three years. That's one reason it is tough to invest at early stages... who knows how receptive the market will be to Justpeas.com in a year or two when they have sales. So, just to show you that some VCs are smart enough to invest where the trends go, look at the hottest IPOs of the past three weeks: Networking hardware companies. Alteon WebSystems (IPO at $18 went to $120 two days later for a 666% gain, Foundry Networks (IPO at $27 went to $156 on Tuesday for a one day 528% gain. Crosspoint Venture Partners held $840 MM worth of stock, after investing less than $6 MM in the company two and a half years ago) and a few months ago, Juniper Networks, Redback Networks and others. All of them were venture backed and all of them have a VC that you know by name in their history. The dotcom consumer plays are getting killed at IPO time right now. Many are backing off and postponing IPOs. Why are networking hardware companies so hot? A bunch of reasons, including a realization that these companies make gobs of money as networking standards change and bandwidth needs continue to grow at geometric rates. But the point here is that if you invested in redshoeswithwhitestripes.com a few months ago, then you better find other sources of capital other than an IPO. Do I need to make the following point? Yeah, what the heck. Those "smart" mining shell companies that have rolled consumer reliant Internet companies into their operations are going to be sucking wind big time (Christmas might save them for a while). Let's see how long it takes them to find some networking hardware companies. By then it'll be something else that's hot I'm sure. - Canadian Business (and local writer Ric Mazereeuw) wrote a story this month about HomeGrocer.com and its disdain for Canadian investors that said NO. Read it at http://www.canbus.com/magazine_items/ oct8_99_grocer.html Response From Last Week's Column: Brent, Enjoyed your last article. I also wanted to thank you for speaking at our UBC Internet Marketing Class a couple of weeks ago. Your commentary was very interesting. As an aspiring entrepreneur it was refreshing to receive an update on the VC community. I have been working with Stockgroup.com for the past three months, as Business Development Manager. I can honestly say I have been bitten by the bug and breathe the Internet day and night. I have just returned from the Internet Content conference in SF last week. My favorite quote came from Ted Barnett, founder of When.com (now sold to AOL). Ted offered his opinion of being successful on the Internet, as "going as fast as you can - without the wheels coming off!" The show was very good. Everyone in Silicon Valley appears to be flying by the seat of their pants - in the eye of the hurricane, always looking up. Regards, Craig Oliver Thanks Craig. The only way to fly is by the seat of your pants. It's a bigger rush. Congrats on your recent investment by the media mogul of Canada, Conrad Black and his Hollinger cronies. I do remain puzzled as to why he invested in both you and Stockhouse, when you both appear to be competitive in the same market. Hi, I've had a few more thoughts on your wireless/retail information idea. First, an article that might be interesting: http://www.inc.com/ incmagazine/archives/17991021.html The goal might be to help retailers compete with the e-commerce businesses. I propose a combination self- serve checkout and product information kiosk. The kiosk would be a small, stand-alone unit capable of being placed anywhere in a store. It would be wirelessly connected to a local server, connected to the internet, to master servers. The kiosk would provide both product info & serve as a self-serve check-out. It would also be accessible to anyone - no special consumer hardware needed. Ian Johnson Ian actually sent an entire spec for such a device. Anyone interested can e-mail me and then we can negotiate the rights with Ian...   What Do You Think? Talk Back To Brent Holliday   Something Ventured is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks). Something Ventured Archive Online Venture Capital Guide