Bill Reichert, a partner at early stage venture fund Garage Technology Ventures, gave a talk recently at Dublin SmartCamp 2010 in which he offered some thoughts on how entrepreneurs often get themselves into trouble with investors with ten lies that they often tell in pitch meetings. Personally, I would say “lies” is a strong term. More accurately, these are statements that are either unknowable or that lack foundation or sufficient evidence to support them.
While the statements are largely self-explanatory, I thought it helpful to provide some additional commentary in the interest of helping entrepreneurs understand why investors have a difficult hard time finding these arguments credible and why, in most cases, it’s best to simply avoid making them altogether.
1. Our projections are conservative
This kind of argument typically lacks foundation. What is a conservative estimate in a new industry where much is unknown about the growth path of companies in this space? Are there reasonable comps to reference? A better approach is to build sensible, data-driven financial assumptions and make sure they are supportable.
To be clear, making aggressive growth forecasts in a financial model is not a deal-killer. Indeed, venture investors want to see the potential for explosive growth in the business and will likely not invest if they are not convinced that the business can become a juggernaut. That said, whatever growth assumptions are made should be grounded in some logic and consistent with how the industry functions.
2. Our target market is $56 billion
Are there $56 billion markets? Of course there are. That’s not the issue. Having a large market is one of those necessary but not sufficient components to securing funding. An entrepreneur must also make a compelling case for what portion(s) of that large market are truly addressable, how the company intends to attack those addressable segments of the market, and, once a beach head has been secured and early validation has been achieved, how the company intends to roll out its solution more broadly.
3. We have a world-class team.
Sounds terrific. Based upon what, exactly? How are we defining world-class? This is just sloppy semantics. Like the word “genius”, “world-class” is one of those phrases that is bandied about cavalierly in the start-up community.
Let the investor be the one to judge how impressive the team is. Insisting that the team is world-class at the outset won’t impress investors to suddenly embrace it as gospel.
4. Our average sales cycle is 90 days.
There are few sales cycles this short, so insisting a company can enjoy that privilege will strain credibility. Entrepreneurs should shy away from making this kind of statement. As in #1 above, making this argument is not necessarily a deal-killer nor entirely wrong if it is indeed the case for this company and this market. However, if this argument is made then the entrepreneurs need to be prepared for a lot of collective eye-rolling and some pointed questions demanding data to support it.
5. We have no direct competitor.
This is perhaps the one comment that is most likely to persuade me to end a pitch meeting early and abruptly. There is always competition. Before pitching any investor, an entrepreneur should have thoroughly investigated the entire competitive landscape and identified not only current competitors (direct or tangential), but also developed an understanding of all the potential competitors that could enter the space at any moment. Like any good chess player, an entrepreneur must be thinking several moves ahead. She should ask, ‘Who could easily get into this space? Are there incumbents in tangential markets that could extend their reach into the market? How would our company compete with those better-financed, more established incumbents and their competitive solutions? What is defensible in our solution and our approach?’
If the start-up is fortunate enough to obtain funding and if the company executes well, one thing is sure to happen: if there wasn’t much competition previously, there will certainly be fierce competition now. A market entry plan should incorporate not only the thinking around how to enter the market but also how to stay competitive once new entrants emerge—both other start-ups and incumbents extending their reach.
6. No one else can do what we do.
This statement strains credibility because it assumes that the management team has hit upon something no one else has actively considered nor has the capabilities to successfully execute. In reality, this is very very rare.
7. All we need is 2% of the market.
Investors are not interested in a company that can be content with 2% of the market. As I like to say, “You are either in the lead, in the hunt, or in the way.” Venture investors aren’t just interested in backing potential market leaders; they must be backing potential market leaders. There is little room for ventures that can, at best, be a nice little business. There is nothing wrong with “nice little businesses,” mind you. Most small business in this country would fall into that category, but that does not make them appropriate venture investments.
8. We’ll be cash positive in 12 months.
This argument is problematic on a number of levels. First, it strains credibility. Few businesses can achieve cash flow positive one year after launch. Second, if the company hits this milestone this quickly it raises a lot of uncomfortable questions about whether this business is really that attractive, whether this market is that substantial, and whether the management team is being penny wise and pound foolish by focusing on achieving this at the expense of investing in growing the business.
While it may appear counter-intuitive, most investors are not primarily focused on getting a company to achieve cash flow positive in a narrow time frame. Their primary interest is in building a substantial company. This usually means embarking upon a torrid growth path which, in turn, often means that a great deal of capital will be necessary to fuel and sustain that growth which will, in turn, often push out the timeline of becoming cash flow positive.
9. I’ll be happy to hand over the reins to a new CEO
This is one of those ‘live by the sword, die by the sword’ dilemmas for entrepreneurs. Typically, one of things that influenced the investors to consider investing in the entrepreneur’s business was the entrepreneur’s sheer determination and tenacity. Investors love vigor and drive in a start-up CEO. However, that zeal also often comes in a personality not easily persuaded to step aside in the face of challenges and outside pressures. A CEO who is so invested in the business and considers it her baby is not likely to readily hand over the reins once investors feel a change is necessary at the top. That said, a good chief executive must grasp the effectiveness of everyone on the team and when that team member may no longer be the right fit for the company’s needs at that time. This is best communicated through actions over time, not through empty pronouncements.
10. Our contract with [Big Company] will be signed in two weeks.
Investors who have been involved in partnership agreements will agree that when it comes to large companies nothing takes two weeks.
The real danger in raising this argument, and many of the previous ones, is that it signals to the investor that the entrepreneur is naïve. This is, perhaps, the greatest risk to the entrepreneur. Investors are quite forgiving. They understand that there are many unknowables; that market conditions can change at any moment; that exogenous factors can creep in and fundamentally alter a business’ prospects. This is par for the course. However, what is critical for the investors is for them to feel supremely confident that the management team is capable enough to be nimble and to navigate through the speed bumps as they occur. What truly alarms investors is the sense that an entrepreneur is not savvy nor experienced enough to know how to react to these headwinds nor how to think about sales cycles, nor what typical growth expectations should be for a company in this market, etc. Gaffes such as these can effectively kill a financing because they can have the effect of undermining the investor’s faith in how the entrepreneur will manage the business post-financing.