Be Careful about Paying Brokers to Raise Capital

There is a saying in Hollywood that “A good script gets found.” The same is true in sports — if you are a good enough basketball player, the NBA will find you, whether you are playing on a Division III team in Alaska or for Duke University. I think that generally the same is true in venture capital — if you are a good startup and you make an effort, you will get an audience with at least a few decent VCs.

Therefore, paying a consultant to find you investors is usually, not always, a waste of money. Brad Feld in his blog Ask the VC had a good post about this in December 2007. I recommend reading the comments to it as well.

Personally, I feel that outsourcing fundraising to people can be of great help to a startup BUT only when those hired have relevant experience and can truly help the company. I don’t agree with Brad that it is important that the founder do it themselves. I do believe, however, that the percentage of brokers/consultants that work in this area and REALLY add value is less than 10%.

Here is the major problem: almost all consultants/brokers are motivated to tell a startup that they can raise them money, regardless of whether the startup actually has a chance of successfully doing so. In other words, where the brokers/consultants really rip off the startup is in taking them on as a client when the company does not have a realistic chance of raising capital. Any fool can throw together an executive summary and email it to VCs. It takes an experienced, ethical player to make an objective appraisal and give an honest “go/no-go” to the startup before time and money is wasted. Many times the best advice to a startup is to focus on building the business and hitting milestones before looking for capital. If it is not possible to hit those milestones before raising venture capital, then the startup needs re-evaluate its business plan.

The best rule of thumb is to look at the background of someone offering these services and see if they have previously raised money for early-stage companies (perhaps for their own startup). It is not good enough just to have been in the financial services industry in general: in order to make an objective appraisal of the situation, they need experience in the early/growth stage world. Obviously, direct experience in the same vertical (e.g., consumer internet) also helps a lot, for obvious reasons, including that the broker/consultant presumably has relationships with investors in that space.

A final distinction – paying a success fee is one thing, paying a retainer is another. If someone finds you money, it is usually reasonable that they expect a finders fee or commission of some sort. Paying a retainer to a broker/consultant, however, drains critical funds from the startup and should be done only in the 10% of the cases where the broker will bring real value.

Failure is Good…

…or, more accurately, failure is okay.
I read a great post today called 10 Lessons from a Failed Startup.

It reminded me that one of the large differences between Brazilian and US venture capital is that, in the US, failure is accepted as part of the startup ecosystem. From an investor point of view, in a given mid-stage VC portfolio, it is understood that at least 1/3 of the companies will fail outright, another 1/3 will go sideways (0% gain) and the last third will provide the returns required. In early-stage funds, the number of companies expected to fail is higher — I would say 6 will fail outright, 2 will go sideways and 2 (one hopes) will provide outsized returns.

More important is how failed entrepreneurs are treated in different countries. In the US, an entrepreneur who has failed is not stigmatized and, depending on the situation, may even be more “backable” by VCs based on the experience he has had. Entrepreneurs in Brazil have communicated to me that starting a company that fails can be ruinous to a reputation and that angel investors in a failed startup feel a high level of shock and negativity.

Also, the regulatory burdens of starting a company in Brazil are very high, as are the burdens of shutting down one down: starting a company in Brazil can take 12 months and shutting down a company can take longer (no, I am not exaggerating). Given that, is it any wonder that, traditionally, joining a large bank or a government agency is the preferred option for young Brazilians?

The good news is that this is changing. As I wrote previously — entrepreneurialism is on the rise in Brazil, as is the respect they are accorded. Second, MANY other countries face the same cultural stigma against failed entrepreneurs/startups, i.e., Brazil is the rule, not the exception. I was at a conference in February where a young, talented tech transfer executive from Germany told me that the single biggest issue holding back the growth of a VC/startup ecosystem in Germany is the stigmatization of failure.

Lastly, when you count the chips stacked against the Brazilian entrepreneur: inflation (mostly under control), cost of capital, taxes, labor laws, lack of capital, culture, etc., the more respect you must have for them. I have met entrepreneurs in Brazil that I would put up against the best in the US, anytime, anyday. The average Brazilian entrepreneur has had to be resourceful in ways the average US hacker in a Stanford dorm room can’t begin to imagine.

As Brazil lifts (hopefully) the regulatory burdens on entrepreneurs and the VC ecosystem and culture evolves, the world will see how well Brazilian entrepreneurs perform.

Great interview with the found…

Great interview with the founders of Twitter in Saturday WSJ yesterday…

The Diaspora Issue

I heard from Randy Mitchell that the April Cleantech VC trip to Brazil is going to be postponed.  I will update when I have more info.

I wanted to share a very interesting point that Randy made when we had coffee.  It addressed the issue of why, of the BRIC countries, China and India have gotten so much attention from US VCs while Brazil has so little.  I assumed it had to do with technical training of workforces (among other reasons) but, given that Brazil’s universities are quite strong in technical trades, that’s not the (whole) answer.  Randy refers to it as the Diaspora issue.  The US has large populations of people of Chinese and Indian descent and, among these populations, there have been plenty of entrepreneurial success stories.  Combine this with the fact that US VC funds have numerous partners of Chinese and Indian descent, who provide a link of interest back to China and India, and you get VC activity in those countries.

No such diaspora of Brazilians exists in the US.   How to start generate that diaspora, or whether its needed, is the subject for another post.

Investor and Entrepreneur?

News came out last week that Marc Andreessen will start a VC fund.  Andreessen founded Netscape, Loudcloud and ning, among other companies and it rekindled some thoughts about the difference between an investor and entrepreneur.  In my opinion, it is all too often assumed that, if you are a good entrepreneur, then you will be a good investor (less often, the reverse is also assumed).  In Andreesen’s case, he’s invested in Digg and Twitter, so he certainly can do both but I think his case is quite rare.

I have had the good fortune to meet a lot of good entrepreneurs and I am fortunate to be working with some now.  In most cases, if you plucked them out of their companies and plopped them in a VC fund, the LPs’ money would be lost very quickly. 

Why?  By definition, entrepreneurs view their endeavor optimistically — admirably, stubbornly and, often, fatally optimistically.  Why would they pursue it if they thought it would fail?  In order to succeed, they must pursue that vision persistently (maniacally), usually past the point at which everyone else — spouses, friends, co-workers — thinks they should quit.  Entrepreneurs focus relentlessly on what can go right in the future.

Good investors focus on what can go wrong.  Venture capital investing is a terribly risky enterprise — the road from investment to liquidity event is much longer and more difficult than other types of investing.  A VC investor must wrack their brains to think about all the things that can go wrong along that road and then assess whether the company will be able to overcome.  If they take an optimistic viewpoint, they are fools and will lose their money quickly.  Good VCs won’t invest unless 1) management has credible answers for all known risks to the business and 2) the VC believes that management can overcome the inevitable challenges that will arise in the future.  (That is why as time goes by I increasingly value the entrepreneur as the most important piece of the puzzle — more on that later.)