How to Avoid Mistakes When You're Looking for Money

August / September 2005 By: Dean Takahashi Volume 3 Number 4

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Silicon Valley is full of both seasoned investors and entrepreneurs. Everyone has hard-earned advice that they can peddle. Some of them write books about it and some charge for their advice. But we caught up with some entrepreneurs and investors who offered their advice out of a hope that those who follow in their footsteps can avoid the mistakes they've made. The investors and entrepreneurs quoted in this story have created billions of dollars in shareholder value during their careers in the high-tech industry. But they aren't hucksters.
There's no guarantee that if you follow what they say you will overcome all of the obstacles before you. But you can at least consider their advice with the knowledge that while these people have failed many times in their careers, they have become successes because they don't let failure stop them. Here are 10 things any serious entrepreneur should know about investors.

1. IT'S ALL ABOUT THE MONEY

Investors are in it for the money. They want a return on their investment. And they want that return to be bigger than the return they can get with other investments or keeping their money in the bank. To get that return, they will take the risk of hooking up with entrepreneurs who can move fast enough to stay ahead of other competitors. The investors have no patience for failure. George Haber is the founder of multimedia/graphics chip startups such as CompCore and GigaPixel. He sold both of those businesses for a handsome profit and he is currently former CEO and founding board member of cell phone video chip maker Mobilygen, He is contemplating becoming a venture capitalist himself because there are so many new technologies that deserve investments. But he offers this reminder about the reality of the business: "Venture capitalists are very hard-working people when they are with you. But they are very fast to discard you when something is not right with the idea, the team or the industry space where you are in. You should not forget that." All you can expect, Haber adds, is that the investor has to have a sense of fairness. The investor and entrepreneur are going to share in the risks, so they should also share in the rewards. If an investor takes too large an ownership stake, then the advice and money they offer is indeed expensive. Valuations hit unreasonable highs for both entrepreneurs and investors during the tech bubble. But now both sides have to make compromises. The investor who considers only his or her return, and not the entrepreneur's as well, could drive the company out of business.

2. IT'S NOT JUST ABOUT MONEY

Beyond just providing money, the investor should have the experience and relevant expertise and sources to provide the entrepreneur with a running start. This way the entrepreneur can have access to guidance, coaching and mentoring so that the founding team can reach its goal. Investors can provide a key introduction to a potential customer, or bring in other investors when it comes time to raise more money. Can they find support personnel such as auditors, accountants, lawyers and engineers quickly? Can they cut through red tape to avoid interminable delays? They see more companies than the entrepreneur sees so they can provide wisdom about the larger patterns in the market. "It's not just a transaction and it is better to think of it as a marriage," says Trip Hawkins, CEO of cell phone video game maker Digital Chocolate. "You need to know how the investor can contribute in addition to providing capital. Then you need to figure out who the investor is and whether they will be a good partner in supporting your goals." Given the choice between a green investor who offers a lot of money and no experience and a savvy one who doesn't offer as much, go for the latter.

3. DO THEY STICK BY THEIR COMPANIES?

Vinod Dham is known as the "father of the Pentium," the microprocessor that helped secure Intel's near-monopoly in microprocessor chips in the 1990s. He left the company in 1995 and joined microprocessor startup Nexgen, and then created networking chip startup Silicon Spice. He sold that company for a cool $1.2 billion to Broadcom in 2000. Now he is a partner at New Path Ventures in Fremont, Calif., which is investing in chip startups with engineering teams in India. He believes that an entrepreneur needs an investor who has a history of supporting a venture through thick and thin. A lot can go wrong in a startup. Product deadlines may slip, cash may run out sooner than anticipated, new hires could be stolen away, patent lawsuits might come out of nowhere. At Intel, Dham had to deal with criticism about a rare mathematical flaw in the flagship Pentium chip. Dham and those above him eventually turned the opportunity into a learning experience and came back stronger than ever against the competition.
The market for the product may tank in the short term and take a longer time to come to fruition. "Good investors should stick with their investments when the going gets tough," he says. "Investors need to have enough savvy to know that not everything will go as planned and that a startup will likely need more money."

4. DOES THE INVESTOR TRUST THE ENTREPRENEUR AND VISA VERSA?

This is a corollary to No. 3. Ramesh Singh, CEO of Nethra Imaging, a video chip startup, says investments aren't just a one-shot deal. The entrepreneur needs someone who believes in his or her capabilities and will support the company's biggest efforts. "The investors need to play the game from start to finish," he says. "It's easy to raise money, but if the investor doesn't understand the idea or business, then you can have trouble. You as an entrepreneur need an ally to help you. You need someone to have faith in your decisions. They help you as much as they can, and then they trust the rest to you."

The flip side of this is the entrepreneur should trust the investor for what the investor is good at. Haber says that it isn't always easy to listen to venture capitalists who decide not to fund your company. But he says that the entrepreneur should take such a pronouncement from a seasoned investor to heart.
Those investors listen to dozens of ideas a day and thousands a year. If your pitch hasn't hit home, ask the investor why, Haber says. If the investor can offer you a tiny tidbit that can improve your presentation, then you can integrate it with your next pitch. This way, you can refine your pitch until it hits home. If you can't raise money at all after doing all of this, then maybe you should trust the investors and abandon the idea.

5. GO FOR THE SMART MONEY, NOT THE DUMB MONEY

Mark Surfas was the founder of GameSpy, an online gaming service and portal for everything related to video games. He merged his business with IGN.com in 2003 and is now looking for investments. He suggests that entrepreneurs figure out the difference between experienced investors with patience and a hands-on attitude, and inexperienced, impatient investors. No entrepreneur should want an above-market valuation from "dumb money," he says. Much of the dumb money disappeared when the tech bubble burst. But there are always new bubbles forming, fueled by dumb money that hasn't learned lessons from the past failures. Dumb money only sets a company up for some kind of fall later. For instance, if the company runs out of money and then needs to go back to the well, new investors may refrain from investing because the valuation of the company has already been set much too high.

6. ENTREPRENEURS SHOULD KNOW AN INVESTOR'S REFERENCES

Check references. That's the brief suggestion that veteran venture capitalist Bill Gurley, a partner at Benchmark Capital in Menlo Park, believes every entrepreneur should know about investors. It follows that anyone starting a company should be as conscientious about checking the references of investors as they are about someone that they plan to hire. You can start by checking the investor's own web site about previous investments. You can find out from the words of other entrepreneurs whether the investors are as patient, helpful and supportive as they claim to be. This is the way that Silicon Valley has worked for decades. Many of the successful investors and entrepreneurs are part of a tight-knit club. They have strong opinions about the people they have worked with and are ready to share them in exchange for a lunch. Trip Hawkins adds, "You need an experienced lawyer advising you. Don't assume the lawyer knows everything and do your own homework, including a Google search on the investor and your own reference checks."

7. FIND AN INVESTOR WHOSE TIMING MATCHES YOUR OWN

Everyone professes to be patient, but the definition of the word means different things to different people. And all companies grow in stages but those stages are not always easy to discern. John Mashey, a Silicon Valley technology veteran and former partner at Sensei Partners venture capital, says, "Finding a good investor is like finding an adopted parent who has deep pockets, has successfully raised many kids, knows the neighborhood well, has lots of friends but practices —€˜tough love.'" He notes that timing is very important. An entrepreneur wants an investor who is very familiar with the stage that the company is in. A certain kind of CEO is necessary for a stage such as technology development, while another type of CEO is necessary during market expansion. The investor who understands how to recognize these stages and what the entrepreneur should do during them is invaluable. "It is well worth finding at least one investor with lots of experience helping companies in this stage," Mashey says.

8. DOES THE INVESTOR HAVE MONEY FOR A RAINY DAY?

Make sure that the investor has plenty of "dry powder." Dham says this means that the investor should have enough money to invest in subsequent rounds of funding if the startup's plans don't go as expected and it needs to go back to raise more money. Some venture capitalists have committed themselves so broadly that they don't have enough money to finance later rounds for each of their companies. The entrepreneur might take note of which investors are actually doing fewer deals with the same-size funds, rather than more deals. The former is more likely to have cash on hand for a follow-up round that might not be expected.

9. DOES THE INVESTOR HAVE A TRACK RECORD AT SPOTTING GOOD IDEAS?

Check to see if the investor has put money into a company in the same or similar industry. "Everybody wants to go after megatrends," says Haber. "It's a self-fulling prophecy for either something big or BS. Some have an ability to foresee and create a megatrend. Then the second and third-tier investors jump in." If you've found an investor that is good at spotting a trend first, that's a good thing. If you've found an investor that always trails the pack, then you're likely to have a lot of problems later on. If you're only attracting second or third-tier investors, maybe you have a second or third-rate idea.

10. DON'T SWEAT IT IF YOUR INVESTOR ISN'T PERFECT

If you can't find investors who live up to all of these high expectations, don't feel that bad. Nick Tredennick, a Silicon Valley chip design expert and longtime technology investor, says that investors are typically "so scarce in the early rounds that entrepreneurs take anything they can get. There's no good and bad to it, only whether someone will write a check." The earliest seed round investors are getting harder to find because they get squeezed out of their percentage ownership stakes by follow-on investors who put in much larger amounts of money.
"This has happened enough that the well of angels is running dry," Tredennick says. Don't be surprised if the one you wind up with is a pain in the butt. And that might be a good thing, says Mashey. "A good investor asks tough questions, probes hard for weaknesses, holds feet to the fire, makes people make tough decisions, and then publicly supports the entrepreneur as best they can," he says. "During the bubble, there was plenty of love. But many investors forgot the tough part, to the cost of money. Hopefully, we'll remember this for a while, until the next one."

Dean Takahashi is a reporter for the San Jose Mercury News. He wrote this article for TechComm.