Finagling the Funding

SAN MATEO (06/12/2000) - Venture capitalists still have plenty of money to invest in new technology companies, but they're getting a whole lot pickier about what sort of ventures they'll invest in and what they expect in return.

Even with the recent stock market gyrations, venture capitalists are on the lookout for new investment opportunities. Some investors, however, are reserving their capital for jackpot ventures that might become the next Cisco Systems Inc. or Amazon.com Inc., promising the highest potential returns in the least amount of time.

Geoffrey Yang, heavyweight Silicon Valley venture capitalist at Redpoint Ventures, in Menlo Park, California, puts it plainly when he says, "For us, it is now a home-run business. We expect returns of 20-to 50-fold in a period of less than four years."

In other words, if you can't draw a hockey-stick growth curve for potential revenues that reach into the billions, Redpoint isn't interested.

Yang wasn't always so shy of long-shot risks. In early 1995, he funded a group of six college kids with no track record who worked out of a garage. The result was a portal Web site that became Excite, and Yang reaped significant rewards from his early involvement. Finding those untapped, unrecognized business opportunities is getting harder, however, and investors such as Yang have much higher expectations for how much, and how soon, startups should pay off.

Although the days of garage glory may be gone, things are far from hopeless. It just means that today's entrepreneurs need to be better prepared to establish their credibility with investors and demonstrate a clear vision of what their venture hopes to accomplish. And they need to articulate the upside potential for investors in the rosiest of terms.

Credibility test

Establishing credibility is key, especially if you have never run your own business. VCs are taking a leap of faith that your business can succeed, and having a record of success in other areas helps. Furthermore, CTOs, CIOs, and other technology professionals need to demonstrate how their experience will apply to the startup environment.

"Managing an IT department and building a company from scratch are two very different things," says Curt Pabst, general partner at San Francisco-based VC firm Platform Ventures. "This doesn't mean we won't listen to someone who has been primarily a technologist in an IT shop, but we will definitely ask some questions."

Here's what Pabst wants to know: Who on your team has built a product, launched a product, and acquired new customers? He does not expect to find all three skills in a single person. "The person who can do all these things is not likely to walk through my door asking for help, because that person will already be fabulously wealthy," Pabst says.

Pabst also advises IT professionals to come to the table with more than just a concept. Investors want to see that a new venture has a development team in place, and, if possible, a demonstrable vision of a viable product or service.

"These days you have to have more than just a good idea," says Marc Sokol, executive member at J K & B Capital, a Chicago venture firm. "You need to come to the VC community with a team in place that can execute."

Sokol has spent most of his career creating or evaluating new ideas and innovative technology. He founded software developer Realia in 1978, which ultimately was acquired by software giant Computer Associates International Inc. in 1991. By 1996, Sokol was senior vice president of advanced technology at CA. Because Sokol went from managing a small startup to working at one of the largest software companies in the world, he has seen how acquisitive companies operate from the inside out.

The lesson, Sokol says, can be easily summarized: "As an entrepreneur, don't try to go it alone. The more you bring to the table when you approach a VC -- a solid team, good technology, a prototype, etc. -- the more likely it is you will be funded. And, just as important, you will be able to keep more equity for yourself."

Powerful friends

The founders of WebPRN.com, a startup in Palo Alto, California, learned through experience that the better you can articulate your idea, the better your chances are of getting funded. In May 1999, Thomas Yeh and two of his colleagues at Questra, an IT consulting firm in Rochester, New York, thought they had the perfect idea for a collaborative business-to-business site. "From our collective experience in consulting and managing IT projects, we saw that there is a tremendous amount of pain in designing and manufacturing products that use embedded electronics," Yeh says.

Yeh, together with Rick Seger and Larry Simpson, went to the venture capital offices of Hambrecht & Quist to present their idea for an online exchange for electronics manufacturers. "We pitched the concept," Yeh says, "but it was a long shot, since all we had was a PowerPoint presentation."

The team didn't get funding, but they did get valuable feedback about how to move their idea forward through the planning stages. "They told us that the model was sound, and we had a unique opportunity," Yeh says. "But we needed to proceed from the high-level concept to a documented business plan."

The team kept their day jobs as they fleshed out their idea, and by June felt confident enough to leave their jobs at Questra to begin working full-time on WebPRN. But before doing so, they began a dialogue with Questra that vastly improved their chances of success.

"We first approached Questra to see if they would be interested in funding us," Yeh says. "They liked the idea, but told us it wasn't really their business model."

Instead of funding, Questra offered the team free office space in a basement conference room, and the more mature company provided consulting services. In return, Questra took an equity position in the fledgling company.

Questra was not the only previous employer Yeh approached successfully. Before joining Questra, Yeh managed a team of engineers at Motorola Inc., one of the large suppliers WebPRN hoped to work with. It didn't take much to sell Motorola on the business-to-business hub idea.

"They saw us as a much more efficient way to get their products to market.

Motorola liked the idea so much they took a significant equity position in us," Yeh says.

With Questra and Motorola on board, it was easier to get other large players interested. Motorola's investment got the attention of suppliers such as AMD, Hitachi, and LSI Logic, who embraced the new company as an important business partner.

With business partnerships in place, Yeh and his team found that obtaining funding was much easier. "The VCs got excited when they heard that Motorola wanted to fund us," Seger says. Platform Ventures' Pabst took the lead and pumped $1 million into WebPRN.

Seed yourself

If you are on the venture trail for the first time, you will probably cover some of the same ground trekked by Yeh and his team. But there are always exceptions. Jogen Shah, a former CIO of General Motors' Truck Engineering organization, created an innovative new venture on his own terms. In 1998, Shah founded IntraGlobe, in Pleasanton, California, as a professional services and IT consulting firm. Shah also had ideas about targeting more specific markets, so he put together a business plan based on e-business supply-chain automation.

At the time, he was indifferent to venture money. "We wanted independence, and our consulting business was already profitable, so we funded the new venture, -- also called IntraGlobe -- ourselves," Shah says.

The new IntraGlobe has attracted some prospective clients, including Owens Corning and Sears, and having those deals in play makes it easier to seek additional cash. "I have four different proposals from top VC firms," Shah says. "I plan to pick only one."

It was Shah's good fortune that he was able to seed his own startup, but his story is the exception, not the rule. It is far more likely that as an entrepreneur you will find yourself, hat in hand, in the offices of those who control the purse strings sooner rather than later.

Sell the concept

Tasha Seitz, principal member at J K & B Capital, has some advice for those who take the plunge. "Try to pitch your product as a 'must-have,' not just something that would be 'nice to have,' " she says.

Seitz agrees with Pabst and Sokol that having a good team in place is key to getting funded. "We really look at the strength of the individual and the team that person brings," Seitz says. Passion never hurts, either.

"You really need to believe very strongly in what you have to offer and in your ability to compete in the long run," Seitz says, "because it is going to become a much tougher environment."

Send comments about this article to Mark Leon at mark_leon@infoworld.com.

What do VCs look for?

Curt Pabst, general partner at Platform Ventures, in San Francisco:

"I like to see a team with a strong leader who can say with confidence, 'Here is the problem. This is how we will fix it. This is how much money we will save customers. This is how much money we will keep. This is how much we will return to the market.' "Marc Sokol, executive member at J K & B Capital, in Chicago:

"I look for someone who is confident and technically very knowledgeable. And I want that person to be open, to show a willingness to learn from everyone."

Tasha Seitz, principal member at J K & B Capital:

"I look for depth in the team. The rule in our industry is that A-plus talent attracts more A-plus talent. So I want to make sure that the technical skills are there to begin with."

Vinod Khosla, partner at Kleiner Perkins Caufield & Byers, in Menlo Park, Calif.:

"Asera, one of my current startups, is a good example of what I look for in a new product: No one else is doing it. It fills a massive market need. Customers don't have the expertise to do it themselves. There is a big barrier to entry -- this is hard stuff to do."

The inside scoop on pitching your idea

At InfoWorld's CTO Forum in San Francisco last month, Geoffrey Yang, a founding partner at Redpoint Ventures, a venture capital (VC) firm in Menlo Park, California, gave an audience of leading CTOs an inside look at how his company incubates startup businesses. Some of Yang's more successful ventures include Excite and Tivo. InfoWorld Senior Editor Mark Leon spoke with Yang about the changing nature of the venture game, and what it takes to be a successful entrepreneur.

InfoWorld: How has the process of funding startups changed for you over the last few years?

Yang: It has become a home-run business. This means we are expecting returns of in multiples of 20 or 50 -- and this in a period of only two to three years.

InfoWorld: What does this mean for the entrepreneur who has a good idea without home-run potential? Is that person out of luck now?

Yang: Not necessarily. There are other venture firms, other sources of funding.

If it isn't for us, that doesn't mean it isn't for other people.

InfoWorld: VCs often cite "barriers to entry" as critical. Is it important to you to look for business plans with high barriers to entry?

Yang: Barriers to entry are nice, but not a 'must-have.' There are really two things that I identify as must-haves: a big market and great people.

InfoWorld: How do you identify great people?

Yang: I look for visionaries and executors. And I want people who have a great track record, people who have succeeded in everything they have done. I look for that light in the eye.

InfoWorld: What advice would you give to a CTO or corporate IT professional who is convinced that he or she has a great idea and the experience to turn it into a great company?

Yang: Someone here will always look at a new idea. But it is always best if you can come to us through a referral. Then, if you do get a chance to make your pitch, keep it short. Plan on a 45-minute presentation, focus on the big picture. Bring other members of your team with you. ... Don't exaggerate. If you are about to enter into a relationship with a venture firm, make sure it is the right one. This is really not a simple partnership. It is much more like a marriage, and you don't want to get stuck in a bad one.

InfoWorld: You also do incubations. You will work closely with entrepreneurs to craft a business plan and technical strategy. Tell us about that process.

Yang: This is like creating a company out of pure ether. We do about five to seven a year. This creative phase can be very exciting.

InfoWorld: What kind of people do you like to work with on these incubations?

Yang: The ideal person here is a CTO with real marketing vision.

InfoWorld: What other qualities would help make a CTO or other IT professional a good entrepreneur?

Yang: Entrepreneurs are people who see the big picture and develop unique insights. A successful entrepreneur then uses these insights to differentiate himself or herself from the rest of the crowd. One way to summarize this is as follows: Entrepreneurs see patterns where other people see chaos.

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