Brooks-Keret VP Nimrod Elmish on avoiding pitfalls in dealing with venture capital funds.
“Almost every entrepreneur I meet tells me, ‘Just arrange a meeting for me with investors, just open the door, and I’ll charm them. My product will win them over,”
says Brooks-Keret VP marketing and business development Nimrod Elmish. Brooks-Keret provides financial management and business development services for companies from seed-stage start-ups to large publicly traded corporations; its services include making introductions, managing financing rounds, and preparing financial reports. It replaces a company’s need for a full-time financial management and business development manager.
Many companies meet Elmish after preliminary meetings with venture capital funds. Logically, it is never too soon to make contact with a venture capital fund. After all, even if you’re not interested in an immediate investment in your product, the fund will at least get to know you, give your direction, and maybe recommend you to someone else. But Elmish claims that this logic is wrong.
“Entrepreneurs claim that they send their material to everyone around. Usually, what happens is that an analyst, who conducts a preliminary screening for funds, concludes that the company is too new or too unfocused. The analyst is liable to send the documents to an affiliated fund for consultancy. The next time you contact that fund or one of its affiliated funds, even if you’ve done good work since then, the fund is liable to pull out that earlier document, and say, ‘No’, without taking the company’s updated circumstances into account. As a result, someone who contacts funds too soon is liable to be blocked in the future,”
Elmish recommends that start-ups initially rely as much possible on private capital and grants from the Office of the Chief Scientist, which he says can finance up to 40% of R&D costs, without diluting holdings at all. “First of all, work quietly, in secret. Investors like to see who manages alone for a while, or who did the impossible with a negligible budget, those who fought. They don’t want those people who want a ride on someone else’s money.
“If an entrepreneur is able to raise $50,000-100,000 from someone who believes in him, the first thing he must do with the money is to establish his intellectual property and set a clear business direction for the company. Afterwards, some technical work and a little market research as part of a business plan should be carried out, in order to spot in advance the big problems liable to affect the company. This should be done before seeking financing. A fund should be approached when you’re a real company with an organized team and the beginnings of a product, not when you’re a group of guys with a nice idea.”
Elmish also quashes the entrepreneurs’ natural impulse to approach large companies to interest them in buying their technology or product. “If you haven’t signed a confidentiality agreement with them, you’re not sufficiently protected, and if you’re relying on such an agreement, know that large companies are deterred by them. The functionary you contact in Israel doesn’t know whether his company’s R&D department in New Jersey isn’t right now working on an idea similar to yours. If he signs a confidentiality agreement with you, you’re liable to sue him when the product comes on the market, even if no crime was committed. The added value they give at this stage is low. The stage at which your company becomes an important market player and an acquisition target, is the stage at which you must prepare a strategy for meeting with that large company.”
Elmish recommends holding the first meeting with an investor after you’ve done the basic work. This is a dry run in which the entrepreneur undergoes a reality check. During this meeting, the investor will flood the entrepreneur will pertinent comments, and bring the dream back to reality. Money rarely results from this meeting, but if you’ve ensured confidentiality in advance, and chosen the right investor for your first meeting, you can learn a lot without burning any bridges.
One pitfall an entrepreneur has to face is appointing a CEO for his company. Elmish says a CEO with no prior experience in senior management, or in founding and running a start-up in a comparable field to the company’s business, will not last long in the job after a venture capital fund invests in the company.
It is not easy hiring a CEO who meets all the requirements. If you cannot find a CEO, Elmish recommends a surprising tactic: don’t hire one. “Tell the fund that you believe that the entrepreneur can run the company for a year or two, but can’t be the CEO, and that you’re willing to let the fund appoint one. As far as you’re concerned, this is an opportunity to get an excellent CEO through the fund’s connections.”
Elmish says you should contact a venture capital fund not only with an excellent CEO in hand, but also with proven and experienced operations and business development managers, if possible. “The team is the first thing a fund looks at,” he says. An entrepreneur often wants to continue managing the project forever, even though his or her natural place is usually as CTO or business development manager. Elmish warns that funds who suspect that the entrepreneur will not vacate the CEO chair, or fire an existing CEO, will hesitate to invest in the company, and all the work will go to waste.
When arriving for the really critical meeting with a venture capital fund, it’s important to be well prepared. Elmish recommends that a company arrive with a two-page synopsis of the company and its product, and a one-page summary of the team. “When you’re talking about the product and the company, let the facts do the talking,” he says. “But don’t be modest when describing the team. Present the team in their best light.”
Before the first meeting with a venture capital fund, it’s important to find out exactly who you’re meeting with, and gather intelligence about all the participants. What are they interested in? What questions do they tend to ask? Will they ask about your business plan, or about the US Food and Drug Administration (FDA)? Are they nice guys, or rude or arrogant? Why did other companies fail to obtain investment? Elmish also recommends for the company to have its technical expert at this meeting, who can answer any technical questions.
Correctly reading the meeting’s participants makes it possible to correct errors. “If you feel that you’ve suddenly said something problematical, immediately say, ‘but we’ve not yet settled this matter, we’ll examine it later.’ This will allow you to recover from almost any mistake,” says Elmish.
Let’s assume we’ve passed all the stages and get an offer to invest. Sometimes you now have two choices: a small investment for a small stake in the company; or a large investment for a large stake, even control. Usually, an entrepreneur will hesitate diluting too much of his or her stake and ceding control to a venture capital fund, and will opt for a smaller financing round. Elmish says this is a mistake. “A fund wants to be at least an equal partner in the company, which is good. After all, you’ll probably have to hold more financing rounds, and again face dilution. If the fund acquires the controlling interest, you’ll have more money until the next round, but more importantly, in the next round, the fund will have want to keep its proportional stake and will handle most of the negotiations.”
Another mistake is to tell a venture capital fund, “We want to hold a financing round at a minimum company value of X.” This usually results in a counter-proposal at a much lower company value, one that does not always reflect a company’s true value. Elmish believes that every company is worth what investors are willing to pay for it, and when a venture capital fund makes the first offer, the initial value is usually higher. “If you mention a company value during the presentation, all the interaction with the fund, assuming it wants to invest, it’ll be trying to persuade you that you’re not worth what you think you are.
“Private investors or funds are influenced by their surroundings, and their decision are influenced by calculations about how they will appear in three years: as the village idiot, or prescient savant who was the first to discover and invest in the next big thing.”