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July 03, 2008

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Or...

1) The usual suspects

2) We're in the value creation business and focus on aligning a valuation commensurate with the terms and conditions - a win - win for both of us.

(It's critical that the entrepreneur have an "anchor" value in mind and also if he/she's done their homework, a sample term sheet already worked out). The process is about creating value for both sides and that ultimately comes from transparency and visibility around the process).

3) Absolutely you can talk with customers - customers mean traction and a business model.
(You've funded start up's without customers (Tungle) so to me it's a moot point.)

1) Sure. Entrepreneurs don't need to answer. However, saying the usual suspects would not get you any credibility.

2)What do you mean you don't have to answer pre-money valuation? Are you saying entrepreneurs should just take VC's valuation without having discussed what's in entrepreneur's mind? This is just nuts.

3)No customer reference calls during pre-term sheet diligence? This is just plain crazy? Why would any VC invest in companies without doing reference checks? What are you investing in?

I disagree. During your first meeting with a VC, you are under no obligation to tell people who else you are talking to. All VCs will respect that. Most will ask, tho, I ask and happy if you tell me. You don't need to answer it as you might be getting two different term sheets with better terms in one over the other.

Pre-Money. Unless you are not taking anything less than a billion dollars, again, why negotiate against yourself? Yes, I'm going to ask and, yes if you tell me 100 million for a seed start up the conversation will be short but, in my opinion, generally speaking, you are far better served by letting the process play out a bit before you offer up a number. It is not different then you asking somebody how much they want in terms of salary. Avoid, if you negotiating against yourself.

On item three, again, this is incorrect. In my opinion, it is a very risky thing to do until you are further down the process. I can do personal reference checks, check out the product myself, ask industry people, etc, without putting your customer relationships at risk. And I can get enough information to determine if I want to proceed.

If I call a customer and say hi, I'm looking to invest in the company, that customer now knows something about your financial state that you may not want them to know. In addition, what happens if I don't invest? The customers usually (after two calls) will be following up to you wanting to know if you got the money. The farther down the path you are before the customers gets those calls, the more likely you will close which in turn makes your customers happy.

(no harm in using real names when you disagree, btw)

Totally agree; particularly the bit about customer reference calls. This is one of the few areas where entrepreneurs have some leverage and you can use it to move the ball forward.

Agree with (1) and (2) ... but it is in the entrepreneur's best interest to allow customer refs before a term sheet. Why? A clean term sheet means no contingencies other than "standard legal due diligence". However, that absolutely requires us to make customer reference calls ahead of time. If you want a meaningless termsheet, allow a VC to put "subject to satisfactory completion of customer reference calls". That is a clause big enough to drive a truck through... and meanwhile, because you wouldn't let us do customer refs ahead of time we would require a no-shop in the term sheet. Net, net: customer refs ahead of the term sheet gives the entrepreneur a much better shot at clean, no-contingency terms.
Yes, you have to frame this properly with your customers so they know the expected timing (extended) and your alternatives (organic growth).

Richard,
I don't disagree with your opinion with the big qualifier being that you can get the customers to sign up for this and understand. I believe you can go way down the path with DD before having to call customers.

For example, if an enterprise solutions company walks in for financing and has, say, 20 customers, I'm going to assume a few of them are going to say the product is good. Naturally, I will want to speak to as many customers as I can. I can, tho, get comfort with the investment and, yes, offer the company a term sheet subject to less or more based on what you've already said.

I think, by the way, attempting to get a 'clean' term sheet which basically says, we are good so long as we can close legals is the best thing a company can get.

Thank you for stopping by the blog.

>R<

1. I agree with. In my experience even asking that question really makes you look like a high school girl figuring out if you are in the "cool" club or not (no disrespect to high school girls)

2. Is always a tough one. You're the one asking for money...so its like when the car salesman asks me "how much do you want to pay?" $1 is my response....I think there should be some ballpark.

3. I think can happen right before or after the term sheet but I want to be damn sure we're not just kicking the tires. And MORE importantly I want to know who is going to call and what they are going to ask. It better be a respected principal with well thought out questions. The LAST thing I want to have happen is have some junior birdman with no dignity mucking about trying to find dirt. (that's a lesson learned the hard way)

Rick,

Its ok for you to say this speaking from the other side of the table (VC side). But for entrepreneurs like us who want to be thorough both on the business apects as well as the technology, we have a real hard time understanding the true intent behind such questions.
We feel that your suggestions of;
1: "The Usual Suspects" answer may be looked upon as arrogance or ignorance.
2: "We are looking for a deal that provides great returns for all of us" may be looked upon as not having a clue about the financials of the business.
&
3: Why does it matter if customer calls are post term sheet due diligence. You as a VC can always pull the plug anytime before the check is cashed. So why should an entrepreneur be worried about the fact that you will try to reach a customer before or after term sheet!?

Nice article and advice, but only adds to the confusion for entrepreneurs.

regards,

-D

Deepak,
I think you and others are taking the answers in the extreme literal. You shouldn't. There is a larger point that I'm trying to get across and that is that you simply don't have to create these self-inflicted wounds because we (the VC community are not demanding it).

There is no confusion here. All ethical and straight VCs will agree that it is not in your best interest for me (the VC) to know who you are talking to. There is no upside in you telling me and you are under no obligation to do so. It isn't arrogant rather prudent.

If I know you are talking to three guys, those three guys and I discuss together. The only possible outcome from that is a lower valuation for you. Sorry, that's the raw fact and, as I said, most ethical and professional VCs won't get in a snit if you don't tell them. If you are in demand and a 'hot' property, let each VC talk to you about what they will do for you. You keep control of the process.

On valuation. Same thing. If I know you will take 3 pre when I would do 5 pre, guess what you are going to get. Let the VC do the work and make you an offer.

On customers, yes, we can pull any time. Totally. However, it's an odds game. No ethical and professional VC is going to go all the way to max DD, etc, flip you a term sheet with the intent to punt it. And no ethical and professional VC is going to objective to customer calls at the end for the reasons I've previously mentioned.

Thanks for stopping by the blog.

>R<

#2 is the #1 mistake in most sales situations. When selling a large-ticket item (like enterprise software) in the past I was often asked "how much?" long before we had won over the tech influencers, etc. My typical response was "how much have you budgeted?" Since they often don't want to give that up, you're in a stalemate until a clear decision needs to be made (e.g. the product sucks or it's exactly what they need). To be clear - I need to know that they've budgeted reasonably before wasting my time, and any customer should have some idea of your pricing model. After the need and fit are established, it's easy (and since they want you you're in a strong negotiating position).

If your company (team, idea, strategy, etc.) sucks the pre-money valuation could be $100.00 and nobody would invest. If the business is attractive, the team great and the opportunity large, there will be a number - but that's all only known AFTER a bit of due diligence. Term sheets are just indications of interest - not fully baked commitments. Don't answer the price question - just let it play out until the investor is either hot for the deal or takes a walk.

#2 is the #1 mistake in most sales situations. When selling a large-ticket item (like enterprise software) in the past I was often asked "how much?" long before we had won over the tech influencers, etc. My typical response was "how much have you budgeted?" Since they often don't want to give that up, you're in a stalemate until a clear decision needs to be made (e.g. the product sucks or it's exactly what they need). To be clear - I need to know that they've budgeted reasonably before wasting my time, and any customer should have some idea of your pricing model. After the need and fit are established, it's easy (and since they want you you're in a strong negotiating position).

If your company (team, idea, strategy, etc.) sucks the pre-money valuation could be $100.00 and nobody would invest. If the business is attractive, the team great and the opportunity large, there will be a number - but that's all only known AFTER a bit of due diligence. Term sheets are just indications of interest - not fully baked commitments. Don't answer the price question - just let it play out until the investor is either hot for the deal or takes a walk.

If somebody can't tell me their pricing model (not the final price) I walk instantly.

Many more customers are adopting this stance after having dealt with people like Oracle sales guys.

And if your competitor like a Salesforce can post the model to the web it breaks that model.

Interesting.

1) I had been thinking that without a term sheet on the table, naming other interested "suspects" might create a syndication, but I now think that names should not come out until it is clear that syndication is necessary. While I don't love the phrase "ususal suspects", your point is well taken about them getting together and driving the price down.

2) Tough call. Exact numbers are bad, ballparks can be useful in setting expectations. But reviewing my recent experience, I think you may be right. However,

THE QUESTION IS: Will that answer cut you out early in the screening process when any excuse to narrow the field of deal flow will do?

3) Agreed, talk to customers later in the process (near term sheet time, if not after) and set ground work: no "junior birdmen" looking for dirt.

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