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Today’s interview is with Peter Ireland, entrepreneur,
investor, consultant, and author of the AVC Smart Startup
Guide. Peter’s website,
www.antiventurecapital.com , offers a wealth of
information on many facets of raising capital and startup. I
hope that after you’ve read this interview you’ll take a few
moments to check out both his website and Guide.
Anthony: Peter, what brought
about the Anti-Venture Capital Smart Startup Guide?
Peter: It was my very first
venture capital deal many years ago that provided the
motivation to research and write a manual on alternative
financing strategies. Our company got badly burned in what I
have now come to call The Classic Venture Capital Trap.
Let me explain what I mean by this as it’s a very
important point.
When a venture capital firm starts conducting due
diligence on your company as a preamble to investing, you
are forced to go “open kimono” with it. All of your secrets
are exposed. And with the loss of your secrets goes your
negotiating power as well. Face it, successful negotiating
calls for holding your cards close to your chest. If your
opponent is free to come around the table and peer over your
shoulder anytime he wants to, you don’t have much of a
chance of winning the game, do you?
To make a long story short: when it came time to “talk
numbers” in my first ever venture capital deal, our team
said that we were willing to give up 33% of the company for
the $500,000 needed. The VCs then told us they needed to
think about it. A few days later they called and offered us
the money in return for 50% of our company. We were not very
happy with this offer, to say the least, and let them know.
They then said they would re-evaluate their offer and call
back the following week. At this point our optimism started
to return. We thought that we would probably “saw off” the
difference in half and do a deal at 41.5%.
Well, when they finally called back their offer had not
“gone North” as we had expected. It had “gone South”. This
time they gave us a “take it or leave it” offer of 66% for
the $500,000.
Being rookies at the venture capital game, we were
utterly horrified. This was a reputable, established, top
tier venture capital firm by all accounts. How could they
treat us this way?
What had caused the hardball offer was the fact that in
the course of the due diligence they had discovered that we
were no longer covering our burnrate and were going to run
out of cash within thirty days.
In other words, they made us an offer we couldn’t refuse.
So, we reluctantly accepted it. It was either that or shut
it down. It was not a pleasant transaction to put it mildly.
Actually, it felt like a mugging.
In fairness, I will point out that the venture capital
firm did nothing unethical or illegal. They simply used the
information made available to them to negotiate the best
possible deal.
I really can’t blame them for acting that way. But the
66% stake that they took left little for future financings.
Indeed, the first round made us very unattractive to other
potential investors.
To make a long story short, the company grew slowly but
steadily for the next 5 years, at which point it was able to
buy out the original venture capitalists. You never saw such
a happy team as on that day those VCs left. The company
really prospered after that.
So, it was that experience that got me thinking that
there had to be a better way to launch companies. By
the way, this situation is very common. If an investor sees
that you are in dire straights financially, he’ll be
inclined to use this information against you to varying
degrees.
Now you can understand where the title “Anti-Venture
Capital” comes from.
Anthony: What lessons can
you share with our readers from this experience?
Peter: When you start looking
for investor capital you have to make an important decision
beforehand on how to avoid this trap. Basically, you have
two choices for avoiding getting caught up in it.
One, you can decide to go with a zero burnrate until you
have the funding in place. When there’s no burnrate there’s
no financial pressure on you to accept a lowball offer. You
are free to walk away from bad offers. The downside with
this approach is the lack of tangible progress being made
while you shop your plan around. There’s just you, your
business plan, and your kitchen table office at home. You
have nothing to sell. There’s nothing with which to create
cashflow. If the financing doesn’t come through, you simply
drop the idea and move on to something else. This is the way
to go when your commitment level is low to moderate. It’s
basically a low risk fishing expedition.
Two, you can devise a startup strategy that creates
enough cashflow to cover any necessary overhead associated
with creating some traction. This allows you to start making
some progress before the big funding comes in. The keys to
success are to have a means of generating revenue while
keeping a tight rein on expenses. With this approach you
take the attitude that you are open to the right deal if it
comes along, but you will find a means to succeed even
without funding. You will make it happen or die trying. This
is the approach you take when your commitment level is high.
Anthony: Peter, you don’t
seem to have much use for business plans. Why is that?
Peter: Back in the mid 1980s I
became a business plan wizard. I had just come out of
college and was on fire to start up successful technology
companies. The key to doing this was the business plan—or so
it seemed to me at the time. So I read every book on the
subject and started writing plans for my own ventures and
other entrepreneurs. I have always had a knack for selling
deals to investors, the media, acquirers, etc. So the plans
and associated collateral materials were very good, if I do
say so myself.
But I quickly came to realize that no one actually reads
business plans. We’d be doing a “dog & pony show” for a VC
or angel investor after they had allegedly read the plan,
and they’d be asking questions that were clearly answered by
the document. We’d remain smiling as we answered the
question while thinking, “You really didn’t read it, did
you?” Most would eventually confess that they hadn’t had the
time to “really” read them.
So why don’t people read business plans in most cases?
Here are a few reasons.
The vast majority of business plans for startups have as
much connection to reality as an online dating profile. They
are pure hype. As an entrepreneur myself, I know with the
benefit of hindsight that we first pump ourselves up with
hype when taking on a new project. We tell ourselves, “This
is the greatest product since sliced bread! Everyone will
want to have one!” Then all that hype works its way into the
business plan and sales projections.
People who have built companies from scratch and who
invest in new ones want to see some proof first that there’s
actual market demand and that you’re the entrepreneur to
make it happen. This proof goes by names such as “traction”
or “cashflow”. As I state repeatedly on my site, folks with
just a business plan and no traction tend to not get the
respect they think is owed them.
Let’s be real. In the very best business plans the cost
side of the equation may bear some resemblance to reality
while the revenue side will invariably be wildly optimistic.
In most cases, you can accurately estimate the cost of
producing your widgets but forecasting sales accurately is
impossible. However, no one will invest if you tell them
sales will peak at $10 million in 10 years. So the pressure
to exaggerate is great.
Here’s another downside about business plans. Being asked
for one is frequently a polite means of getting rid of you.
If after speaking with a potential investor for just a few
minutes he or she asks for a copy, you are probably being
brushed off. When you follow up a week or two later, you
will invariably hear that they haven’t had a chance to read
it.
Investors who are serious about your company are willing
to make the time for you and your team to do a full-blown
dog & pony show, after which they will bombard you with what
salesmen call “buying questions." So, don’t make the rookie
mistake of getting excited over merely being asked for a
copy of your plan.
Bottom-line: be really sure that the ROI from writing a
full blown business plan is really there before sinking two
or three months into writing it. In most cases, it’s not.
However, if you’re a first time entrepreneur it won’t hurt
to go through the learning process of writing one.
Anthony: Peter, why is there
so much emphasis placed on writing a business plan?
Peter: Because most people
have no understanding of what’s involved in being a
successful startup entrepreneur. Only a tiny fraction of the
population is able to pull it off. So when asked people
resort to trite and clichéd advice, “You need to write a
good business plan first!” There’s also a substantial
“business plan industry” pushing this idea. It consists of
writers and publishers of business plan books, business plan
software companies, and the business plan consultants and
writers. They all tell you that the key to funding is a good
business plan. They ignore the reality that investors are
really only interested in the qualifications of the
management team and actual traction.
Anthony: So what can you
share with us about the right way to start up?
Peter: I mentioned that after
my first venture capital deal I felt that there had to be a
better way to launch a company. Then when I started looking
at the startups around me, I noticed that they could be
divided into two separate groups.
One group, the bigger one by far, is led by founders who
choose situations where nothing—and I mean nothing—can
happen until some kind and trusting stranger first drops
$500,000 or $5 million into their laps. So they place all of
their faith into writing the perfect business plan which
will miraculously compensate for their lack of a track
record in the industry as well as the complete lack of any
proof of market demand. Over time I’d see the members of
this group grow bitter and disillusioned. In private some
would accuse the venture capitalists and angel investors of
being “too stupid” to understand the potential of their
startups. Others would blame their business plan and fall
into the trap of revisunum ad infinitum. That’s a
Latin phrase I coined for perpetual rewrites based on
shallow and often contradictory feedback from people who
have only skimmed your plan at best.
In most cases, this group will pull the plug on the
venture after 6 to 12 months of a futile capital quest.
The other, much smaller group consists of entrepreneurs
who pick startup situations where they can start achieving
traction from the get-go. These are the entrepreneurs whose
startups populate the annual lists of fastest growing
companies compiled by several magazines. While they think
that an injection of outside capital would be nice, they do
not wait for it to happen. They know that only one in 500
startups seeking capital is successful in raising it. So
they avoid these long odds by devising a startup strategy
that focuses on traction rather than on chasing investors.
They intuitively grasp that investor capital will come later
if warranted.
This is a key point. Savvy entrepreneurs understand that
investors want tangible proof that the concept is viable.
They want to see that the team has been able to generate
some sales first on their own. Most investors these days
want to see at least a million dollars in upward trending
sales over the previous 12 months.
Anthony: But don’t some
projects require a large cash injection immediately if they
are to get off the ground?
Peter: Good point. Two
examples that spring to mind are FedEx and the Segway. When
launching FedEx, Fred Smith needed to have this huge
infrastructure in place on Day One. This involved a fleet of
aircraft plus facilities and staff in about a dozen cities.
He raised about $60 or $70 million in venture capital after
first putting in well over $20 million of family money into
the startup. The VCs then knew he was committed.
With regards to Dean Kamen, he already had a reputation
as a creative and successful inventor when he approached the
VC community to fund the Segway, so there was a satisfactory
level of investor confidence to begin with.
The lesson here is that if you don’t have substantial
personal funds committed, or at least a reputation as an
“industry star”, investors are highly unlikely to back you
initially. Therefore, you must avoid this type of “no-win”
situation. Otherwise it will consume 6 to 18 months of your
life and, in most cases, you’ll have nothing to show for it
in the end.
This means that you need to get creative like that
smaller second group of entrepreneurs I mentioned and find a
means of generating cashflow without outside funding.
Anthony: What can you tell
us about the funding techniques employed by savvy
entrepreneurs?
Peter: Well, there’s more to a
successful startup than just solving the funding problem.
First, those savvy entrepreneurs understand that you need
to find your “sweet spot." By this I mean a situation where
your chances of success are highest. Some opportunities are
far better than others for cash-strapped entrepreneurs. They
offer the promise of quick traction with minimal capital
requirements. The first time entrepreneur can dramatically
improve his or her chances of success by knowing how to
avoid the long shot opportunities described earlier.
Second, smart entrepreneurs know how to create a business
model that's a cash engine and not a cash sinkhole. There’s
an arcane art to this involving optimal matching of revenue
models with cost structures. Part of this involves the
utilization of cashfloats in lieu of equity capital. If we
explore the startup financing strategies of the
entrepreneurial greats from Henry Ford to Michael Dell to
Jeff Bezos, we see the use of cashfloats as a common funding
element early on. The Smart Startup Guide goes into
great detail on this topic.
Finally, successful entrepreneurs understand that writing
a business plan and spending 6 to 12 months pestering
strangers for money is a recipe for failure in the vast
majority of cases. So they focus on achieving traction,
which places them in the “stream of opportunities” that
operating companies enjoy. When you’re in this situation,
opportunities for further growth and profits start opening
up to you because with cashflow you have respect from
investors, customers, suppliers, employees, and potential
partners.
Anthony: What’s the secret
to raising venture or angel capital?
Peter: Well, if you’re not
already an industry star your best bet by far is to be
flexible in your startup approach and look for means of
generating cashflow as Job #1. Spend 90% of your time on
this and only 10% on the business plan and chasing
investors. Most people do the exact opposite. This approach
may require a transitional business model whose sole purpose
is cashflow generation. Once positive cashflow is achieved
you can start tacking back towards your original concept. At
this point investors will take you far more seriously. Maybe
you won’t even need them…?
Let me wrap it up with this example. I managed a small
venture fund for almost four years and have been an active
angel investor for over a decade. Now suppose two
entrepreneurs approach me for money.
The first one tells me that he’s come across a big market
opportunity but has nothing beyond a 50 page business plan
to inspire my confidence in both the idea and him.
The second entrepreneur comes in with a 20-slide
Powerpoint presentation, 2-page executive summary, and a
stack of purchase orders. When asked if he has a business
plan, he answers that he’s been so busy filling rapidly
growing sales orders that he hasn’t had time to write one.
Which one do you think I, or any investor, will want to
spend the afternoon with?
If you enjoyed Peter’s interview and would like to get
his full story on the subject of the Smart Startup, consider
ordering the
AVC Smart Startup Guide, a 200 page guide downloadable
in PDF.
Bio
Peter has held executive positions with a number of
corporations both private- and publicly-held. His early
career includes working for an investment bank where he
learned capital formation techniques for small and medium
sized businesses. In 1986 Peter became a partner in
Ashton Montana & Company, a performance-based
consultancy providing mission critical financial and
marketing services to high technology entrepreneurs.
Consequently he served for over three years as CEO of
Leisuretech Corp., a publicly-traded company, then spent
another four years managing CalWest, an innovative
venture fund geared towards start-up companies.
In addition to his entrepreneurial forays, Peter has
assisted numerous technology companies in selling themselves
to individual investors via private placements, and the
public via IPOs.
He appears regularly on television, radio, and in print
media as an expert on entrepreneurship and small business. A
graduate of Simon Fraser University, one of Canada's
top business schools, he also happens to have a knack for
generating media coverage for projects he feels passionately
about. In addition to running a rapidly growing network of
online businesses, Peter devotes five hours per week serving
as venture advisor to rookie entrepreneurs. He is also an
active early stage investor.
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