How to Get Venture Capital: Secrets of Sand Hill Road

VENTURE CAPITAL is not right for every business. But if you determine that it is right for you, you should read Secrets of Sand Hill Road by Scott Kupor, the managing partner at Andreessen Horowitz. It is a book for those with big ideas.

Beginning in the 2000s, capital became more abundant due in large part to the costs required to start a new company. Consequently, the amount of money a start-up needs to raise has declined significantly. Beyond that, there are more angel investors to provide early-stage funding. And the size of the funds has increased as institutions have contributed to VC funds allowing them to fund growth throughout a startup’s life cycle.

VC firms stay with their investments longer (upwards of ten years), often providing advice, support, a network of relationships, and coaching to improve the odds of success. Of course, most investments don’t work out. 50 percent don’t. 20 to 30 percent of businesses invested in make a return over the investment. 10 to 20 percent are home runs where an investment returns ten to one hundred times the investment.

It’s those home runs that make the whole thing work. Understanding those economics will help you to align your objectives with the sources of the funds you need. VCs don’t always get it right because, at the beginning, there are really no hard numbers to go on. To determine if funding your venture is right for them, they look for three things:

1. People and Team

If the idea is a good one, we have to assume that there are others thinking about doing the same thing. “So what matters most is, why do I as a VC want to back this particular team versus any number of the x-number of other teams that might show up to execute this idea? A decision to invest means that the VC cannot invest in a different team that may come along and ultimately be better equipped to pursue the opportunity.”

VCs are trying to determine whether this founder will be able to create a compelling story around the company mission in order to attract great engineers, executives, sales and marketing people, etc.

2. Product

Because the original idea is not likely the idea or product that will ultimately go to market, the VC wants to know how the founder came up with the idea. They want to know the process. They like founders that “have strong opinions but ones that are weakly held, that is, the ability to incorporate compelling market data and allow it to evolve your product thinking.” In other words, “they want to be comfortable that your process of evaluating the market needs to date is robust enough to enable you to adapt appropriately to changing market demands.”

The idea or product also must be significantly different to move people. Great illustration of this point:

Ben Horowitz uses the difference between a vitamin and an aspirin to articulate this point. Vitamins are nice to have; they offer some potential health benefits, but you probably don’t interrupt your commute when you are halfway to the office to return home for the vitamin you neglected to take before you left the house. It also takes a very, very long time to know if your vitamins are even working for you. If you have a headache, though, you’ll do just about anything to get an aspirin! They solve your problem and they are fast acting. Similarly, products that often have massive advantages over the status quo are aspirins. VC want to fund aspirins.

3. Market Size

What matters most is the size of the market you’re going after because the bigger the market the better the odds of a home run.

Kupor delves into how VCs are funded and why it matters to the entrepreneur. Specifically, ask how old the fund is from which you are receiving payment. If it is generally towards the end of its life cycle, there is will be additional pressure on you to return capital or exit. Also, at the beginning of the life cycle there are generally funds reserved for additional rounds of funding.

Importantly, he covers what form your company should take (C Corp), stock vesting, up-front agreements, intellectual property, and employee option pools.

How much money should you raise? This is something founders often get wrong. The simple answer is: “to raise as much money as you can that enables you to safely achieve the key milestones you will need for the next fund-raising.” Raise the first round with the second round in mind.

Thus, if you are raising your first round of financing (typically called the Series A round), you will want to raise an amount of money that gives you enough runway to get to the milestones you will need to hit to be able to successfully raise he next round of financing (the Series B) at (hopefully) a higher valuation than the A round.

The other consideration regarding the amount of capital to raise is the desire to maintain focus for the company by forcing real economic trade-offs during the most formative stages of company development. Scarcity is indeed the mother of invention. Believe it or not, having too much money can be the death knell for early-stage startups.

In the discussion of the art of the pitch, Kupor notes that VCs aren’t expecting you to be clairvoyant, but “you do need to demonstrate to the VCs that you are the master of the domain you are proposing to attack and that you have thought about every important detail of your business in a way that shows depth of preparation and conviction.”

Kupor also covers the less exiting—but critical—legal and financial aspects of funding like term sheets, valuation, voting rights, the board, stock, insurance, vesting, and founder issues. Actually, he covers it in the most straight-forward manner I’ve ever read.

Secrets of Sand Hill Road is a must-read for anyone considering entrepreneurship. Kupor takes the mystery out of funding and clearly explains why things work the way they do. You will discover the inner workings of the VC-Founder partnership. If you are an entrepreneur, this book will help you get to know your partner.

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Posted by Michael McKinney at 08:13 AM
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