Inside the process

Starting the day at 4a on a Sunday, having to roll out of a toasty warm bed into the Canadian winter, is not something I’m all that excited about. Unfortunately, duty calls with this, the beginning of a busy week of meetings, travel, and checking out some new companies. 

Over the past several weeks, I’ve been packing in the meetings with new companies. I’ve been impressed with the quality of the management and the opportunities being created.  It’s also nice to see folks doing some homework on our firm.  Many entrepreneurs read this blog, check out our web site and, in general, are doing a good job knowing a bit more about our firm.  Well done. And Albert’s been back all focused and ready to ship stuff, go get em Albert.

One question that comes up is about the VC process and what to expect, timing, process, etc.  I’ve put together this long entry in an attempt to give you our process in the hopes it can help with your expectations. Keep in mind every firm is different and we all have our particular quirks, so your mileage may vary.

WARNING: This post is very very long

Probably way more information then you’d ever need but I did it this way to try and give you as much behind the scenes, so to speak, because there isn’t really much detail to all the checklist and ‘tip’ stuff we VC types like to throw around. 

So, in advance, I apologize to those of you who fall asleep, don’t hit your head on the desk.

Step One: No Harm No Foul

The first step I recommend, if you’ve never done the VC bit before, is to come by for a 30 minute no harm, no foul meeting. You can tell me the general story, give me an idea of what you, your idea, your company, etc, is all about, while getting feedback, suggestions, and a free drink. This meeting typically doesn’t count against you so if the demo blows up, you forget stuff, mess up the names of whatever, etc.  The idea is to lower the stress levels so we can have a great conversation that is valuable to both of us. We can also establish, right up front, if we’d be a target financial solution for you.  

Step Two: The pre-meeting activities

Send me electronic materials to read. This is probably where lots of other VCs will give you different opinions. I like data from a market perspective. I want to understand the problem set, the people who will pay, etc. This can take many forms besides the standard Gartner or whomever stuff. I met a women last week who hit upon a really interesting way to solve a particular problem while she was digging through some PhD thesis documents for an unrelated project. Paper was written in 1974, 30 years before the technology even existed to solve this problem.  It was a fascinating read and she just might be onto something.  When it comes to JLA and my bookworm partners, we will read the stuff you send us. The smarter we can be ahead of time, the better.

Step Three: Face to Face (1)

This is the first meeting where the meter starts running. Up until this point, it really doesn’t count. It is this meeting where we’ve agreed you are starting the process to raise capital from my firm.  This meeting will usually last an hour or so. I say, or so, because I try to leave enough room for the unexpected as well as making sure you feel comfortable that when it b done, it b done, you don’t have to stick around.  You are going to tell the story and I’m going to listen. Really. It is not that complicated. You talk, I listen and then we have some dialog with questions, give -n- take, etc.

Don’t put up with these cocky jerks who think they know more then you because they get to be in the VC office. Don’t accept rude, condescending, treatment. You are working hard on growing a company and that fact alone, affords you respect.  I try to follow my partner, John, who has a great habit. During a presentation, he asks if it is okay to ask questions. Simple, polite behavior and, more often then not, it blows people away. 

Just tell me the story and let’s talk about it.

There are common questions that will always come up so you might want to consider doing a first (i.e. I’ve never seen it); create an Investor FAQ. It could consist of these (and probably other) questions:

• Are you the founder?
• How many founders are still in the company?
• How many full time employees in the company?
• Do you have any revenue today?
• What has been the amount of capital gone into the company to date?
• What is the current capital structure of the company?
• What do you think the total investment is required in order to have the business begin to generate net income?
• What are the key milestones you will use to measure the company’s success/progress?
• What keeps you up at night?
• What factors, outside your control, will have to be in place (or have to happen) in order for this business to be successful?

This isn’t a long, painful, power point deck, rather a simple list of the obvious questions that pretty much everybody is going to ask.

At the end of this meeting, I am likely to tell you that I will speak to my partners and get back to you with a go forward yes or no, typically, within 48hrs.  If I know for a fact that this isn’t for us, I will tell you on the spot.  If you’ve read the web site, asked around about me, know what we do, etc, you’ve probably got a good shot at peaking my interest. I’m new, like you, am growing a brand, like you, and work hard, like you, to make my business successful. Hopefully, we can do it together.

Step Four: The Huddle (1)

At JLA, we have an open office concept. Cubicles, if you will. We do that to insure we all know what’s going on as well as keeping a good buzz around the office. Nothing kills cooperation and teams faster then private offices with doors. Leaving that debate for another day and moving on; we will chat about your idea during that 48hr period. We think about the market, the space, our collective expertise, the docket of pending deals, and the general first pass, collective gut check. 

Assuming nobody reaches for a barf bag and the partner driving the deal is still keen, we move on to step five. If it dies at this point, you will get a phone call or email.  The jury is out on which style is better. I think a rapid response phone call is more personal then email while others thing getting out the email quickly beats telephone tag every time. In the end, speed is the issue. I try hard not to waste your time. It’s just a bad thing for everybody.

I take it as a supreme compliment when an entrepreneur recommends me to another entrepreneur after I’ve said no to their idea. This tells me, loud and clear, that respect for you and your time is appreciated.

Step Five: More info (1)

I try to do as much work as I possibly can before issuing a term sheet. It’s the worst thing in the world you can do or have done to you, it being having a term sheet pulled. I’ve been on both sides of that table and nothing, regardless of the reasons, hurts more then having that paper killed.  To combat this, we try hard to get as much information as we can so that when we give you a term sheet, it is as far down to the legals and reference checks as possible. We’ve made the call to do it, now it’s the pesky details.  Others toss term sheets with no shop clauses, break fees, and other silly things and that’s fine for them but not for my partners and I.

During this phase, we provide a checklist of the items we’d like to see before making the call on a term sheet and valuation, etc, etc.  The checklist we provide list the materials you will likely have to have regardless of who funds you so we try to make this request work you will do anyway and work you only have to do once.  You are, of course, free to decline on some or all of those things and we will make the call on what we have.  A term sheet with less data is likely to have issues with valuation, structure, etc, but we can serve the customer as best we can.  If you are interested in what those checklists look like, drop me a line or come by; I’ll be happy to share this data with you. 

It’s important to note that we will say no as fast as we can if there is something that doesn’t check out or there is a serious problem which impacts our basic thesis. This is the place where “good business but not for us” is reasonable so long as we get you that feedback quickly and with a minimum of pain.

It’s also important to note that we will issue a term sheet if we think something is interesting/good before completing all the work.  I just strongly recommend you think twice about insisting on a term sheet before you know if the party is really interested in your business. Get all your materials together, let them review what they need and make that term sheet count.

Step Six: Face to Face (2)

You and your team will be invited back to our office to meet our entire team. This is basically an opportunity for you to present to our whole group and give everyone a chance to meet and greet.  We are pretty laid back about this but we want you to know everybody. It’s the best part of the process, actually. You get to meet some really smart people who, by this point, are really interested in you, your team, and your ideas.

Step Seven: The Huddle (2)

The JLA team huddles and we spend time going over what you’ve presented. The lead partner on the deal, along with an analyst, will present the basic thesis again, opportunities, a standard SWOT (Strengths Weakness Opportunities Threats) chart, and we will debate the deal to determine the value and structure of a deal.  We usually will make the term sheet call at this point and begin the process of getting a term sheet out the door or somebody will have found a major flaw/problem that, if not resolvable, will kill the deal. Either way, we communicate this to you quickly.

Step Eight: The Term Sheet

At Last! We will issue you a term sheet with fairly standard terms and one that matches what we’ve talked about prior to the paper being transmitted.  The single more important suggestion I can give you is to negotiate this document and take your time! Do not fall into this silly trap of being told, aww hell, its non-binding, don’t worry about it.  Get that term sheet as detailed as you possibly can and have every business term that matters to you spelled out and agreed to before you sign it. Why? Money. You will save a small, well large, fortune in legal bills if you get the business terms clearly spelled out now, before the lawyers go at it.

In addition, you will get a very very clear feel for your ‘partner’ and how they act.  Don’t let the lure of a term sheet cloud your judgment. Don’t be afraid and don’t listen to ‘we don’t do that’, ‘it’s standard’ or any other stuff we toss at you.  Dilution might very well be the solution but make darn sure that it is on business terms that make sense to you.

Again, take your time. Work out your employment agreement. Work out the option plan. Work out shareholder rights, minority shareholder rights, etc, etc.  Read Brad Feld’s term sheet series if for no other reason then he gets standing ovations for showing up late to dinner parties, in jeans and a t-shirt. Plus he is all old now, you know, 40, yowsa.

Step Nine: Validation

It’s numbers and crunching time. We ensure there is agreement on the plan, agree on what will need to be spent, the basic metrics, and where we can add the most value quickly.  During this time we are also continuing to refine the business terms we’ve collectively laid out in the term sheet so we can turn a business list over to lawyers for legal language not a legal debate on our mutual objectives.  This is additional face time between you and I as another checkpoint for both of us to get to know each other.

Step Ten: The Huddle (3)

Our team gets together for a third time to talk about our findings with respect to the final plan, milestones, people, terms negotiated, etc. It’s the time where we ‘sign off’ internally before we head to serious legals. At this point, my partners have had lots of time to review the opportunity, maybe play with the service/app, look at the competition, etc, and just continue to get smarter about the space. It should be noted that along the way, we usually provide the feedback to you. You will notice we forward items of interest from blogs, news clippings, etc, just to make sure we are on the same page and seeing the things you see.  Hopefully, we are already adding value to your team by seeing things you may be missing.

Step Eleven: Legals

Crank up the lawyers and roll out the paperwork. By this point, we should be ‘there’ from the perspective of ironing out legal points that have been translated from the business issues we have agreed upon.  The smoothest part of the transaction or the nightmare from hell with no middle ground is how this step gets classified by me. Nothing kills a deal faster then both sides going off track with respect to legals. Actually, nothing kills the working relationship faster, is probably the more accurate statement.

On the VC side, there are many things which you can assume are going to be required prior to closing. A no material change clause, for example, or a rep and warranty with respect to ownership of intellectual property is likely going to pop up.  On the start up side, you are going to be looking for things to be defined like “for cause” or “best efforts” or “to the company’s knowledge”, etc.  All of these things are in the domain where the lawyers look out for the client’s best interests.

My advice at this step is twofold.  First, common sense and reality rule the day.  This applies to both sides.  There is always a business agreement that is the basis for the legal translation. I find it very helpful that when a sticking point comes up, the business people (you and I) simply agree on the business principal and then, with both lawyers in the room, give instructions to ensure the translation is carried out, no free lancing.  Make the two lawyers work it out and do that as a team.

The second point is risk management. There is risk in everything. If you believe I’m going to steal your company, we shouldn’t be past step zero. If I believe we need eighty layers of protection because there is some question about you, again, we shouldn’t be past step zero.  We either want to do a deal or we don’t.  I know that sounds silly but, in the end, it really will be that simple. Give on points that, in the end, will be the least of your problems.

This applies to both sides of the equation.

Step Twelve: Final Approach

We have a last review of the details, the agreements, put some beer in the fridge, coin in the box, and get cracking!

If you’ve lasted this long, and I know it was painful, thank you.

I hope this long entry will help you get a feel for how at least one firm, ours, operates. Drop by. Canada is always open for business, we’ll keep a light on.

Comments

[Fergus Burns]

Great post Rick

I've shared it with our Entrepreneur group here in Ireland - http://itnorthwest.blogspot.com/2005/12/post-money-value-inside-process.html

regards
fergus

[Scott Converse]

Rick,

Excellent info for any startup. We're adding an "Investor FAQ" slide to our pitch as you read this. If every VC out there with a blog did this for their firm, all of our lives would be much easier.

Scott

[thinkjose]

Rick,

That is a fine blend of casual people-focused conversations and nailing down the details. Thanks for the look into your process. How many companies are you in process with at once?

thanks

Jose

[Stuart MacDonald]

Great post, Rick.

- Stuart

[Rick Segal]

Jose,
Thanks for the comments. I have about 20 companies at any given time, in my personal queue. Lots of those are in the first, no harm, no foul stage.

Rick

[Darren Fast]

Rick,

Great post detailing how to approach a VC. Everyone who is looking for financing should read this before approaching a VC. I've posted a link from my blog (dfast33.blogspot.com)