The VC of You
The majority of startups fail, and this is a reality of life. In order to make investing into innovations a meaningful business, angels and VC-s follow the Law of Large Numbers. They make investments into many promising startups, with an expectation to have just one or two super-profitable exits at the end (the so called “home runs”). A serial angel usually builds a portfolio of at least 20 startups, and a venture fund typically builds a portfolio of at least 10 investments.
An entrepreneur is similar to angels and VC-s, but demonstrates two major differences:
- An entrepreneur invests their time, not money;
- An entrepreneur invests their time into just one startup (two at max, unless we are talking about Elon Musk).
A startup founder can’t do what the financial investors do: An entrepreneur can’t mitigate their risks by applying the Law of Large Numbers and putting many eggs each into a different basket. In a risk/reward game, an entrepreneur accepts higher risk but also has an opportunity to receive a higher reward compared to a financial investor. Theoretically, it means that the entrepreneurs should be even more rigorous than angels and VC-s in picking a startup. But the reality is often different. In this post, I am offering startup founders a piece of advice on what they should do to be able to treat their time, the same way as angels and VC-s treat their money.
1. Understand Investors’ World
Study a few textbooks for aspiring investors. In my list of “books to read before launching your first startup”, I’ve included two of these: One for angels and the other for VC-s. Please, go through them to understand the investors’ logic and be able to speak their language.
2. Enroll in Workshops and Classes for Investors
Not only you will get access to the most cutting-edge expertise by attending such classes, but it will also help you expand your network into the investment community. This exercise will substantially help you later when you start raising money.
- Available options might differ depending on where you are based. If you are in Silicon Valley, I recommend “Venture Capital Executive Program”, which Jerry Engel teaches at UC Berkeley a few times a year. It’s a workshop spanning over 5 full days from Monday to Friday. The workshop is rather expensive but, if you can afford it, it’s worth every dollar. Also, Carol Sands sometimes offers her “Angel Investment for Serious Investors” course at Stanford Continuing Studies, which is usually delivered over a course of three months, one late evening class per week.
3. Take Time to Contemplate Different Ideas Before Choosing the Final One
Don’t rush to start executing the very first idea which excites you. On average, serial angels invest in one out of about 25–75 companies that they see; venture investors review about 100–400 startups before pouring money into one of them. You, as well, should think about a substantial number of alternatives before making your choice.
- It’s easy to get lost while analyzing and comparing so many disparate ideas. You need to define a simple structured framework to think about them in a systematic way. You are about to become a seed fund with a portfolio of just one startup. What will be your investment thesis? What will be your investment criteria? You can use my 10¹⁰ framework as a starting point.
4. Do Due Diligence for Your Idea
When an investor decides they want to invest in a startup, they don’t sign an investment contract. Instead, they sign a term-sheet: a non-binding “contract to sign a contract”. Then the investor spends a few weeks to double-check everything (a process known as “due diligence”). Only if this verification is successful, the investor confirms they are ready to sign the final agreement (an act known as “closing a deal”). Ask yourself: What can you do to conduct similar checks for your idea? The most efficient approach: start with talking to people around you and asking for feedback.
- Talk to potential customers to validate that they really need your future product and will be willing to pay for it. Talk to experienced entrepreneurs to learn about unpleasant surprises which you should expect in your journey. Talk to future partners and distributors to calibrate your view on the market. Talk to potential members of your advisory board to check if they see a future for your product. Talk to as many people as you can.
- Sometimes entrepreneurs are afraid to do it. They see a risk of disclosing their idea in the fear that someone will steal it. But the reality is different. The largest risk at this point is that a soon-to-become-a-founder does not get enough feedback from the market.
- Depending upon your circumstances, there are many additional ways to get market feedback . Treat this process with utmost importance and you will figure out what else you can do.
5. Share Risks
When VC-s or angles invest, they almost always do it in syndicates with other investors. This is one of the ways they mitigate risks. Usually, it’s not only about sharing financial risks, but also about getting complementary expertise aboard. For example, suppose an African “AI-powered land irrigation” startup is about to get term-sheet from a California-based AI-focused VC. Most probably, this investor will want to build a syndicate with at least two other VC-s: One having expertise in agriculture and another with experience in the African market. The same approach works for startup founders: Find a co-founder or two to share your risks and access complimentary expertise.
6. Get Ready to Spend Way More Time than You Originally Planned
When a VC or a serial angel makes an investment into a startup, they always reserve almost the same amount of money for future follow-on investments into the company. In other words, investors allocate for a startup at least twice as much money as the startup is raising from them. You should do the same with your time. No matter what your plan says, expect it to take twice longer.
- For example, if you are quitting your job to found a company, and you plan to be able to start paying yourself salary in 6 months once you raise your first investment round, it means you should have enough money in a bank to sustain for at least a year.
7. Understand Your Fiduciary Duty
If you follow Silicon Valley playbook, you incorporate your startup in Delaware as a C-Corp. There is no such legal title as “founder”, you will be an officer or a Board member for your corporation, or most probably both. Your investors will also get Board seats. In their official capacity, Board members will be required to make decisions which are in the best interest for all the company’s shareholders. A failure to comply with specific fiduciary requirements might potentially get officers and Board directors into a court, or even into jail. Once a startup has more than one shareholder, its founder must learn what it means to be an officer and a Board member.
- Law firms in Silicon Valley frequently organize workshops (often — free) where they provide basic education on this subject, but you will have to specifically dedicate some time to master it. Of course, it does not replace a need to hire a corporate attorney to support your startup.
8. Keep an Exit in Mind
VC-s will buy your startup’s stock in order to sell it a few years later at a liquidity event, usually M&A or IPO. They typically expect to get at least 20X ROI from this speculation. VC-s have many companies in their portfolios. You, as a founder, have only one. To compensate for this difference, you should target a higher return for the cost of the time you invested. To make it work you need to learn and understand the logic and dynamics of an exit, your end game.
- If you are in the software industry, I highly recommend attending Corum’s “Selling Up, Selling Out” half-day workshop, which they organize frequently in various locations worldwide.
Final thought. Startup founders have a lot of hats in their companies: From a lead strategist to a chief janitor. This post aims to help you with wearing your “time investor” hat, but you also need to develop the skills needed for all the other roles you will play in your startup.
Good luck and may the venture force be with you.
