Book Summary: Mastering the VC Game

Important Points From Jeff Bussang’s Book

I just finished reading Mastering the VC game and it is the most insightful book I've read about the mysterious world of venture capital and the complexity of the relationship between venture capitalist and startup founders.

The bullets below summarize the most interesting information for startup founders that I extracted from the book:

Finding The Right VC Firms

• Venture capital is not a right fit for most new ventures. Of the 600,000 ventures started annually in the US, only about 0.5% actually received any VC funding. VCs specifically look to invest in companies that they think have potential for huge innovation and growth and that ultimately have the potential to grow to multi-billion dollar companies.
• Venture Capitalist need to hustle to get into the best deals. For founders, there might be value in waiting till your startup has significant leverage before trying to raise venture capital. It’s pure demand and supply at work. If you have no leverage, you would be effectively begging for money and might end up with the worst terms from the worst VCs, but with significant leverage, the best VCs will be fighting each other to get into your round and the ball would essentially be in your court.
• Get a good startup lawyer before getting involved with any complex legal documents. If money is a problem for you, some startup lawyers are willing to defer cost till after your startup has raised a venture round. Legal speak is generally different from regular speak, so trusting one’s independent interpretation of legal documents could lead to disasters in the long run.
• Avoid cold contacting VC firms. Getting a warm introduction shows that you can work your personal network to your advantage, a valuable trait to have when doing business development for your startup and closing early customers and strategic partners. Odds of receiving funding from a cold email are 50,000 to 1.
• A VC’s location should also be factored into the search process. The farther a VC is located from you, the less likely they are to be very useful for assistance with strategy, business development, recruiting and everything else VCs are meant to help their portfolio companies with. While location is not a show stopper, it should definitely be factored into decisions.
• Size matters. Bigger VC funds might not be interested in making small investments. Look for VC firms that invest in companies at your stage, it’s a waste of precious time trying to raise 500k from a firm that only invests in $10 million+ rounds.
• The sweet investment spot for VC firms at any point in time comes down to the size of a firm’s current investment fund and not the total assets under management listed on crunchbase. For instance, a firm’s current fund might be running out and they might be in the middle of raising a new round, in which case the partners might be too busy pitching LPs and might not be able to consider new investments even if you might otherwise be a right fit.
• Before pitching to a VC firm, make sure they invest in companies like yours. Some VC firms explicitly state opportunities they are not interested in, don’t be that startup that pitches a bitcoin startup to a VC firm that explicitly states on their homepage that they don’t invest in bitcoin startups.

The Pitch

• Pitch meetings can be intense, know all the details of your company and its competitors inside out before walking into the lion’s den.
• You typically don’t get very much time to state your case, be brief and try to get the most important messages across within the first 15 minutes of your pitch.
• Don’t try to hide the risks associated with your venture. Make it clear during your pitch that you have thought through all the risk and have strategies to reduce the chances of their occurrence. Hiding the risks comes could rub off as being unaware of all the variables in your startup’s arena.
• Successful entrepreneurs are passionate about their ideas, and VCs look for evidence of that passion during pitch meetings. Channel your passion in the way that feels most natural to you.
• Ideas are cool, but the people behind the idea are the most important element that most VCs look at. Make sure you clearly outline why the team you are working with is the best team to execute on the idea you are pitching. Ideas are cheap, execution is key.
• An advisory board is a very useful mechanism that entrepreneurs can use to build VC confidence around their startup idea even before a real product exists. The advisory board typically consists of acclaimed domain experts in the field that the startup is going after. If you have a good advisory board, point that out.
• VCs like to invest in ideas whose success or failure can be easily measured in the short term using clearly defined metrics. Make sure you clearly communicate the metrics you are interested in monitoring in the short and long term and why you think the metrics you choose are relevant to measuring the progress of your startup. Define clear milestones with regards to the metrics you choose.

After the Pitch + Choosing the Right VC to Partner With

• VC firms rarely ever explicitly say ‘no’ to founders. Some might tell you that they need more time to think over it, and might subsequently proceed to ignore any future correspondence from you when said you try to get a status update from them. Others might be somewhat interested but might not want to independently make a decision and might only decide to invest if you can get other VCs interested in your startup so they might hang around in the shadows until you can get a couple of other big name investors interested.
• VC firm need to do due diligence on deals and this can be anything from discussing the feasibility of your product behind closed doors with experts in your field to calling up your references — both the references you personally supply and additional references that they source for themselves. This process takes time.
• It is not unusual to go through dozens of rejections before you get a positive financial commitment from one firm.
• No matter how desperate your startup might be for cash, it is important never to rush into accepting an investment from any VC firm unless you are certain that your goals are aligned. Accepting an investor is like getting into a marriage that a founder can’t terminate at will, tread with caution.
• The fact that a specific venture capital firm might be the right fit for your startup doesn't necessarily mean that the partner who wants to lead the investment in your startup is the right fit. In addition to doing due diligence on the VC firms interested in investing in your company, you also need to do your research on the individual partner who plans to lead your round.
• A good place to start could be by getting feedback from other founders like you who that partner has worked with as an investor in the past. This person might end up taking a board seat in your company and might be very influential in key decisions such as deciding the right time for your company to exit, so you want to make sure that your goals are aligned.
• The more experience and connections the partner you are letting into your board has in your space, the more value they could bring to the table in both the short term and long term.
• Beyond the more generic due diligence, you also want to be sure that you and the investing partner have a shared chemistry. There is no hard and fast rule for evaluating chemistry, but on a high level you should ideally have aligned visions for your startups and your investor should be someone you feel that you can trust. When things hit the fan, you want to know that your VC partner would not immediately throw you under the bus.
• The more active VCs who come invest early and join the board only have bandwidth for 1–2 deals a year per partner, while the more passive later stage VCs can do 3–4 deals a year per partner. Make sure the VC partner leading your investment round has the bandwidth to be useful to your startup from an operational standpoint.
• Entrepreneurs should ask VC firms about how carry is divided among the firm’s investment partners, this might be useful in determining what the firm’s culture and division of decision making authority among partners. For instance, if the partner leading your round is a junior partner in a remote office, he/she might not necessarily have enough influence to secure funding allocation for future rounds in the unfortunate event that you ever run into problems and need emergency capital infusion.
• VCs could bring very important strategic relationships to the table and could connect portfolio companies to customers, strategic partners and potential acquirers by simply digging into their personal Rolodex for the appropriate connections. The quality of a VCs Rolodex as it relates to your specific startup’s needs is of utmost importance.
• Having two co-investors with vastly different fund sizes could yield tension because both firms might have vastly different goals and expectations.
• In some rare scenarios where a founder has an exceptional product/concept but is not a good executor e.g. scientists in academia, VCs might only want to make an investments contingent on bringing in strategic executive hires to help figure out how the turn the product into a business.

Closing the Deal

• Most VCs typically only issue a term sheet to an entrepreneur after the entire partnership has agreed that the business related due diligence is complete.
• Avoid jumping into 24 hour exploding term sheets at all costs, if a VC cannot give you enough time to think through a decision of this magnitude, this might be a sign that any marriage with said VC might be very rocky.
• Always get an experienced contract negotiation lawyer to help navigate this process, don’t try to do it on your own.
• Raising funds at really high valuations in early rounds might increase the pressure from VCs in the long run, because early VCs might have unrealistically high exit criteria.
• VCs need to be convinced that they can make 5–10x within five years, and this consideration is factored heavily into the proposed pre-money valuation they give your startup in the term sheet.
• Post-money valuation = Pre-money valuation + Amount raised.
• Many VCs will require that an option pool for new hires is created from the stock allocation of the management team. The options pool is included in the pre-money valuation.
• Founder’s final % ownership = Founder’s initial % ownership - % allocation for options pool - % given up to financial investors
• The ‘promote’ is a very important number for the founders to consider in evaluating term sheets. The ‘promote’, as it is defined in the book, is the percentage of the founders stake after dilution — by the combination of VCs and the employee option pool — multiplied by the post-money valuation. For example, a founding team with 40% ownership after an investment round and a post-money startup valuation of $10,000,000 has a promote of $4,000,000.
• Liquidation preference is another really important part of a term sheet that an entrepreneur needs to thoroughly understand as it ultimately determines the ordering of payouts in a liquidation event. VCs will typically always want at least 1x liquidation preference, This means that for instance in a $10 million exit event, a founder who owns 80% of a company could still have a $0 payout if the startup received $10 million in funding with 1x liquidation preference. In the above scenario, the VCs will need to take 1x of the initial investment i.e. all $10 million off the table after acquisition before any of the proceeds can be partitioned among shareholders.
• Liquidation preferences of more than 1x are rare in regular early stage investments and competitive deal, they are more common in distressed situations and recapitalization.
• The participation feature of preferred shares is another important thing entrepreneurs need to watch out for. There are 3 types of participation as follows: fully participating, non-participating and capped participation. The above classifications are too complex to explain clearly in a bullet, please read the following breakdown to get a clearer understanding of the implications of each term.
• Founders should be careful of having their ownership diluted up to a point whereby they don’t have enough skin in the game to care about the outcome. An unmotivated founder could be an early trigger for problems in any startup.
• Founders should be sure that they are comfortable with the compositions of the board of directors as outlined on the term sheet, because the board ultimately has veto power to fire the CEO and to decide on major transactions.
• Term sheets also have a list of protective provisions that require approval from VCs, and not just the board, this could be anything from accepting acquisition offer to decisions relating to making or accepting strategic investments in the future. Make sure your lawyer explains all the protective provisions included in the proposed term sheet to you.
• Ensure that you fully understand how control and voting rights are outlined in the term sheet.
• Explicitly ask firms for their policies on syndication. This is particularly important if you plan to raise from multiple investors.

After the Deal

• VC are mainly important for 4 things: Recruitment, business development, strategy and future funding.
• As far as executive recruiting goes, the best VCs are always thinking one step ahead. For instance, a good VC who understands the business he/she invests in thoroughly might know that an entrepreneur need a VP of sales without being explicitly told.
• VCs always gives tons of good strategic advice, it is up to the entrepreneur to aggregate and filter out only the relevant advice. Entrepreneurs should be open to all the advice from VCs, but should not blindly accept everything. Some advice is good feedback while some advice is just smoke.
• The best VCs have connections in big strategic companies and could open up executive-level doors in these companies for startups in their portfolios.
• Good early VCs should typically be able to either provide future financing when needed or be able to connect their portfolio companies to later stage investors with larger pockets.
• 80/20 Rule: It is OK to feel in command 80% of the time and to be confused about major decisions 20% of the time. If you are on the wrong side of this rule — confused 80% of the time — talk openly to your board and investors you trust about this. Investors are meant to provide help when you need it, don’t be afraid to ask.

The Exit

• Acquisition is the most common type of exit, IPOs are rare. Only about 2–3 percent of VC funded startups achieve an IPO.
• The average venture backed startups that go public are 10 years old according to the NVCA.
• The most passionate founders view IPOs as an avenue to raise capital needed to get to the next milestone and not purely as an avenue through which to cash out.
• In cases where IPOs do occur, they do not necessarily mean instant gratification for an entrepreneur, rather they expose a company’s metrics to scrutiny by brutal public market investors. Going public too early might have brutal consequences for a company, VCs are more understanding and forgiving than public market investors.
• In even rare cases, some companies get acquired after IPOs. Certain milestones are only attainable with the full backing of a much bigger organization.
• The best VCs with the strongest Rolodex can play a vital role in securing a soft landing in the form of an acqui-hire for struggling startups.
• Put your startup on the radar of relevant decision makers in potential acquirer companies as early as possible. This could be by anything from winning away some of their key customers, to networking with relevant executive from potential acquirer companies at industry events.
• Have early conversations with your investors with regard to their exit expectations. Would they try to rush you to sell at $100 million when you would rather wait to get to $10 billion? This conversation should be had throughout the lifeline of a company, because the decision to exit is probably the biggest decision an entrepreneur will have to make with investors.
• There is no explicit answer to the question, “when do I sell?”, this should be considered on a case by cases basis.
• Creating scarcity is one of the most powerful tools in exit negotiation. Acquirers who really want in might increase their hands if there are competing offers on the table. That said, you don’t want to make your price so high that you scare all the suitors away. Negotiate within reason.
• Only exit when you are done and you feel confident that you have achieved as much of your vision as you think you possibly can.

General/Miscellaneous Information

• While making loads of money is — more often than not — the ultimate goal of venture capitalist when they invest in startups, the best founders typically view wealth as a side-effect of following a dream to build a great company that has a huge impact. Money is a motivator, but should not be the primary motivator.
• A very important characteristic in the best entrepreneurs is a strong and infectious passion for an idea or phenomenon that they spread to everyone that they encounter. They believe that their ideas will change the world, so much so that they will break through steel walls with their heads in the quest to actualize their visionary ideas.
• One of the somewhat counter intuitive driving forces that keeps such entrepreneurs pushing extremely hard even during good times is the inherent fear that everything that can go wrong will go wrong.
• The most successful entrepreneurs tend to accept random meetings with interesting people for no clear reason. The aggregate of these random meetings often evolves into serendipitous opportunities.
• The best entrepreneurs are active users of their products. For instance, Christoph Westphal from Sirtris Pharmaceuticals showed great commitment by going as far as injecting himself with Sirtris’s experimental drugs and showed up to some VC pitch meetings with black and blue arms.
• Don’t be scared to completely change your idea if you think you are going in the wrong direction. One of the founders in the book, Eric Paley, abruptly switched off from fundraising mode and went underground for 6 months to research a potential idea pivot after an enlightening conversation with a potential customer made him realize that he might be pursuing the wrong opportunity.

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