It is axiomatic that startup founders in search of investors are anxious to tell the best story they are capable of to secure funding. And why not? First time founders are classically running against the clock to secure funding before their own meager resources are totally consumed, and they are typically unsophisticated and inexperienced in negotiating with VC’s. VC’s on the other hand, by their very nature are sitting on relatively large amounts of capital and employ experts in the field of funding businesses. It is – by definition – the VC’s game that founders are playing, so the conditions are ripe for founders to be tempted to put the best possible spin on their story, the better to wow the VC’s with. The VC’s are quite literally examining the investment opportunity – as presented by the founders – from the aspects of upside and downside risks. The more the upside and the less the downside, the higher the likelihood of investment. Therefore, it is a no brainer to say that one of the founders’ key jobs is to speak as clearly and thoroughly to those risks as they possibly can. The challenge is that every business is steeped in a myriad of interlocking risks, and risks have a strange way of behaving like bubbles in wallpaper.
I recently had a very nice chat with a mentor of mine, who has spent a long career helping VC’s repair struggling funded companies. He also founded a software company and raised $6M in capital early in his career, so he has seen this from both sides (with a successful exit to boot!). He observes that VC’s factor in founders’ over-optimism when considering startups’ performance projections, and that a nominal adjustment multiplier that typically gets applied is 60%, i.e., if the pitching founder projects revenues of X at the end of year 1, the VC’s will mark that down to X*0.6 in their own analyses to make the revenue projection more realistic. They are artificially – but prudently in their eyes – adjusting the story to assume the most likely outcomes, which are then used as the basis of their fund/don’t fund decisions; this is a tactic for factoring in risk, in this example dampening the risk that the founder was overly optimistic.
My friend also says that pitching founders are often short on the “here’s why we believe this” aspect of supporting their projections. Ultimately, the more a founder can do to proactively address risk in an orderly fashion, the better and cleaner the picture he will leave with the prospective investors, thus improving the odds of a deal being struck in a timely fashion.
Two simple but powerful elements can be built into the brief to help instill investor confidence in the business seeking funding.
First, give a three-dimensional performance projection, not just a one-dimensional, rosy, hopeful case. It is simple Human nature for an optimist to sincerely believe that the best case is eminently achievable and as good as done…and entrepreneurs, founders, and puppies are all born optimists. As outsiders though, VC’s suffer no such fantasies; they are inclined to be much more clinical about the whole enterprise and it is frankly proper that they exercise healthy skepticism during their due diligence. Recall here that the entire point of the Sprocket Blueprint is to groom invest-able startups through a thorough sequence of due diligence exercises…to enable the startups to progress easily and cleanly through the deal flow and secure funding.
Ultimately, it is better to under-promise and over-deliver than to over-promise and under-deliver.
The thoughtful startup’s projection series would include these three cases:
A. Worst Case (Easiest to Achieve) – This integrated strategic, operational, and financial plan set is 90% likely to be achievable with the team and resources given, considering assumptions and known facts included in the plan(s).
This is the foundational level of your funding case; it has the least amount of embedded downside risk for all parties.
B. Middle Case – This case is 50% likely to come to pass with the given team and resources. Some assumed downside don’t come to pass, some upside beats assumptions. It’s all gravy on top of the Worst Case scenario.
C. Best Case (Most Difficult to Achieve) – 5% – 10% likelihood of achievement; all or most optimistic objectives are met with given team and resources.
By presenting this three-dimensional laydown of projections, with its broader contextual terrain of possibilities, you give the prospective investor a range of potential ways to see a fit.
In the second element to work into your confidence-generating structure is the solid delivery of a coherent, well-integrated plan that addresses your Strategy, Financials, and Operations. A full-blown discussion of the ins and outs of planning is beyond the scope of this post; for our purposes here, the Operations plan is the founder’s ultimate expression of exactly “how” the Strategy will be carried out in conjunction with the Financial plan. The “business side” of the VC team of experts is most likely extremely strong on the Strategy and Financials; these are more generic across business models and technologies and so are the easiest to rapidly understand and digest. Operations, however, will vary more from business to business as there is more sensitivity to particular technologies, attendant processes, and relevant skill sets.
A solid plan clearly lays out the foreseeable work, skills, resources, and time it will take to reach Strategic objectives, broken down in to smaller goals and milestones. At the investor pitch level, the summary Strategic plan is overviewed, then each supporting, more detailed plan is briefed at its summary level, but the presenters should be able to speak to the next few levels of detail down in response to questions. The supporting plans are arranged however makes the most sense for the organization, but a simple way to arrange things is along functional area lines since it is a common way organize activities. For example:
• Software Development
• Customer Service
In order for operations (broadly, all the activities within the business) to be coherent, each necessary task must be feasible, every resource should be sufficiently available to the demands placed on it, only the activities necessary to the plan should be undertaken, and all activities must be in harmony.
In order to achieve this, each plan must be arranged to maximize its support of, and eliminate any interference with, other functional area plans. This means that the planners MUST cooperate with each other. The maximum positive effect of a good operations brief to investors is achieved when the primary briefer, the lead Founder, introduces each functional area lead in turn to present their plans. This is an opportunity to showcase each manager/leader’s competence and to demonstrate that the leadership team can work together.
It should go without saying that the startup team should rehearse this brief relentlessly… any gaps in the plan(s) will be spotted by the evaluating VC members involved, which will incline them to ascribe higher risk and/or further discount founders’ performance projections.
Some final tips on preparation: Murder Board the heck out of the Pitch brief. The pitching team should rehearse this relentlessly and conduct internal critiques and revisions. Find soft spots in the plans by having outsiders pick them apart for you, and find soft spots in the presentation by rehearsing in front of non-team members (Mentors, friendly experts, consultants, directors with domain expertise, etc.).
In the end, a solid investment up front in a coherent plan, hard practice, and relentless constructive criticism will put your investment pitch in its best light.