It's August 2008, and I'm leading a team of 10 in the creation of something special. We called it the Innovation Grapevine: A sort of Quora (before Quora) that crowd-sourced business brainstorming. We had hot technology, a great team, a fist full of patents pending, and a growing roster of satisfied customers.
I strut into our annual investment meeting where my boss's bosses warmly congratulate me on my team's progress to date. We spend the better part of the next hour talking about our journey to the current product, its current features, and our current customers. I ask for another big chunk of dough to keep the ball rolling. After smiles, handshakes, and atta-boys, I leave the room confident that it's a sure thing. I literally take my family to Disney World. Everything is awesome.
I return a week later to learn that while I was away, my funding request was denied, and the Innovation Grapevine itself had been put to pasture. Oh, and the Great Recession just started. What the...? Everything is awful.
I spent a chunk of that next year feeling pretty cranky. Here I was, building this business that was, by most measures, exactly the kind of specimen that my leadership had been asking for, and they go and kill it off. I was convinced that I was the victim of a conspiracy; some shadowy anti-me sentiment. Grumble.
It wasn't until recently, finding myself on the other side of the table as an investor, that I've come to realize what actually happened. I went into that meeting expecting to be recognized and rewarded for my accomplishments to date. I believed that focusing on our successes would result in my being rewarded with more investment dollars.
This is not how it works.
Investment funding isn't a reward for what you've already accomplished.
It's fuel for what you plan to accomplish next.
Looking back at C:projectsfailuresgrapevinefunding2009.ppt, I spent 90% of the pitch celebrating the past and present, and only 10% of the time detailing future plans. The folks in the room were impressed with what we'd accomplished to date, and they were genuinely proud of us. As investors, however, they simply couldn't see how incremental dollars spent on my team were going to generate more value than money spent on their alternative investment options.
From our earliest days, we're acclimated to this simple scheme:
Do Well > Get Reward.
Use Potty > Get Cookie.
Pass Test > Get Diploma.
Ace Interview > Get Job.
So it comes as no surprise that most founders, not unlike me back in '08, hope to be handed candy from strangers as a reward for prior jobs done well. Truth is, investors, unlike employers, have little to no incentive to reward you for your past performance. Investors are looking to share in your future success, and in order to feel good about your prospects for future success, we need to see that you have a concrete plan in place to create value, and precisely how our money, skills, and network can best fit into that plan. Betting on someone's past is a faith-based investment, and even if you're betting on a "courageous genius", as Marc Andreessen likes to say, faith-based investments are more akin to gambling than investing.
"How much money are you looking to raise, and what do you intend to do with it?"
This is, understandably, one of the key questions we always ask our investment candidates. It may seem like a rote, even softball, question, but the founders' answers always shine a bright light on the state of their business. Responses understandably run the gamut, but they break down into three broad classes that I'll explain here as Time, Team & Tactics.
Buying Time - The Bronze Medal Use of Proceeds
"$250k gets us the runway we need to..."
Ah, ye olde runway. When an entrepreneur doesn't yet have a winning business model, and doesn't yet have the team in place to execute against it, she'll tend to talk in terms of "buying time". Thing is, the longest runway in the world isn't going to help a plane take off if it doesn't yet have wings.
Every young business starts out on the tarmac. The trick is to show your investors that you intend to use their money to build better wings, not a better runway.
There's nothing wrong with experimentation, but there's everything wrong with making it needlessly more expensive. This is precisely why I don't like to throw money at "runway extension" absent a concrete plan for altitude increase.
Buying Team - The Silver Medal Use of Proceeds
"$250k lets us beef up both technology and business development, as well as marketing..."
This request, while thoughtful and articulate, is essentially the founder's way of saying: "I'd like to pay some salaries to folks who actually know what they're doing." Not that this is necessarily a bad thing. Any founder would be foolish to think they could do it all, let alone all of the time.
The watch-out here, though: Salaries Are Not Strategies. Adding salaried positions to a startup without an airtight strategic rationale is like adding a flight crew to our aforementioned wing-less plane. If anything, it just makes the plane heavier.
You might want to bring on Sales, Marketing, and Development talent, but don't hire these people in the hopes that they'll magically figure out how to get you airborne. Strategy sits with you, boss, and every single hire should be in direct response to your concrete, strategic...
Tactics - The Gold Medal Use of Proceeds
"$250k lets us test hypothesis X, and penetrate these two markets..."
Winner Winner Chicken Dinner! We want to invest in strategies and tactics aimed at getting your business to positive cash flow, or failing that, to a critical learning that shortens your path to positive cash flow. If you start with that end in mind, you're already well ahead of the game. I can tell when an entrepreneur is thinking strategically because they tend to talk in terms of probabilistic outcomes, learnings, and numbers. If this, then that. Failing this, then that. Logical. Deliberate. Investable.
Tactics (and a few Red Bulls, or so I've been told) give you wings.
As the inimitable Steve Blank says: "A startup is an organization formed to search for a repeatable and scalable business model." And so: Focus on your search algorithm. Explain why your proposed approach best stamps out ambiguity en route to your company's growth and profitability. Only then can we reasonably begin to appreciate the thoughtful composition of your proposed team, timing, and capital request. Only then can we compare you, apples-to-apples, against our competing investment alternatives.
If only I realized this back in '08.