VC P.S.: Ten Myths
and Realities of VC
by Lawrence Aragon
Part 1: June 14, 2000
Part 2: June 21, 2000
Bill Reichert’s brother is a doctor. His father also was a doc. So were his grandfather and his great-great grandfather. So how could it be that Mr. Reichert is sitting and talking about venture capital over a plate of bacon and eggs at the Peninsula Creamery coffee shop in downtown Palo Alto? As I join him in the high-cholesterol meal, I can almost see the family of physicians staring down, wagging their fingers. “I’m the first Reichert male not to be doctor,” he says, munching on a piece of bacon. “We figure it was my other grandfather’s genes that sent me on this path.”
Not the path to the coffee shop. The entrepreneurial path. His mother’s father, Robert McElroy, built two companies — one that eventually became the multibillion dollar American Hospital Supply. Following in granddad’s footsteps, Mr. Reichert founded five companies of his own, including a software company while he was getting his MBA at Stanford, and he was instrumental in helping turn around The Learning Company (now part of Mattel (NYSE: MAT)). Now, as president of Garage.com, he helps seed- and early-stage companies raise money from angels and VCs. Along his entrepreneurial journey, the lean 46-year-old picked up a lot of Roy Rogers-style wisdom about the venture capital business. He distilled it into a top ten list of myths and realities that are guaranteed to raise someone’s ire.
Myth No. 10: The Internet changes everything.
The reality: The Internet touches everything but doesn’t necessarily change it.
“Conventional wisdom is that the Internet is the biggest technological phenomenon in the history of mankind,” Mr. Reichert says, clicking on a Powerpoint presentation to prove it wrong. The computer screen shows a big ski slope and a smaller one. The big slope? I guessed television. Wrong. It’s actually radio. In its first seven years on the planet, radio was adopted by 45 percent of the U.S. public. In that same time frame the Internet has penetrated just 25 percent of American households.
Slide shows aside, Mr. Reichert makes an excellent point for would-be entrepreneurs: “Just because you’re part of the Net doesn’t mean that the laws of economics have been repealed. You’ve got to have a real business.”
Careful not to alienate Vint Cerf, Mr. Reichert notes that he “would never want to come across as someone who doesn’t think the Internet is important. The Internet clearly can have a dramatic effect on the way business is done, but it’s still business. That means it’s still about creating value and creating profits.”
Myth No. 9: Venture capitalists fund startups.
The reality: Venture capitalists fund established companies. Angel investors fund startups.
OK, this one’s self-serving. Garage.com, which Mr. Reichert dubs a “venture gapitalist,” hooks up seed- and early-stage startups with angel investors. Still, I must agree that early-stage companies are much more likely to find backing from angels than even those VCs who say they focus on early-stage deals.
“There is a whole bunch of mythology that has evolved that says, ‘You find a couple of grad students, have a clever idea, go to Benchmark Capital, and get $15 million,'” Mr. Reichert says. “If you’re serious about starting a company, you’ve got to be realistic. You scrape together a little money from friends, fools, and family and then when you’re ready to go for outside money, there’s a one in a thousand shot that you’re going to get name-brand VC even at that stage.”
Mr. Reichert’s main point, which I think is dead on, is that too many startups have unrealistic expectations, setting them up for discouragement. “Don’t limit your vision to getting your series A funding from a Sand Hill Road venture capital fund,” he says. “There’s this assumption that if, gee, I don’t get Sequoia Capital in my first round, then I’ll never make it with the big boys. There’s a chance, but it’s really unlikely that you’ll get that funding. So, you need to expand your horizons and understand what you’re looking for. Don’t compromise on quality, but be realistic in terms of who is the right investor for you at this point in time.”
Mr. Reichert speaks from experience. In his last company, Academic Systems, he didn’t seek VC initially. It made more sense to get corporate cash. Academic raised $400,000 in smart money from Jostens (NYSE: JOS), which later brought in brand-name Accel Partners. It wasn’t long before Kleiner Perkins Caufield & Byers was on board, bringing along two little companies named Microsoft (Nasdaq: MSFT) and TCI. “There was a very nice food chain effect that happened,” he says.
Myth No. 8: I’ve got to perfect my business plan.
Reality: No one is going to read it. You only have a few seconds to attract the attention of an investor.
Mr. Reichert cops to the fact that Garage.com is just as guilty as other VC advice gurus. It has a 12-slide template that it encourages entrepreneurs to use instead of a business plan. “But even at that I’m very anti-template and very anti-cookie cutter,” he says. “Every business has a different story to tell, and in each business the story has different points of emphasis.” In other words, you need to understand your audience and tell them exactly what they want to hear.
Mr. Reichert advises entrepreneurs to focus on the four or five key questions an angel or VC will ask so that they can “preempt” them. How do you do that? Simple. Find three smart people at a cocktail party or some other schmoozefest and give your elevator pitch. “I bet you that each of them will have three or four questions in common,” he says.
One other piece of advice: don’t give VCs history lessons. “Story trumps history,” Mr. Reichert says. “Don’t spend your time recounting the history of the Internet or enterprise software. Tell your audience the two or three compelling things that are unique about you, and then answer all the first-tier questions.” Be prepared to give concise answers when asked about your team, technology, size of your market, competitors, financial milestones, and so forth. Mr. Reichert isn’t telling you to skip the fundamentals. “You need to do the work, but don’t lead with that,” he says. “Don’t lead with 50 pages of stuff. Have good crisp answers as questions get asked.” Having heard countless horror stories from VCs about entrepreneurs who needlessly try to impress investors with their knowledge of the industry, I must concur.
Myth No. 7: VCs back teams.
The reality: VCs back future returns. As one prominent VC once said: “I support my management team 1,000 percent until the day I fire them.”
The main point here is to understand that your VC is your investor, not your friend or the parent you never had. Too often an entrepreneur hears a VC say he or she is completely behind the team and “there is a disconnect in an entrepreneur’s head that the VC now feels as though there is this emotional bond between them,” Mr. Reichert says. “And then they feel betrayed at the first board meeting when the VC pushes back on what they say.”
While you may feel like your VC is betraying you, there is little doubt that your fundamental interests are aligned: “The alignment is around building a hugely valuable company,” Mr. Reichert continues. “It’s not aligned around your inner visions about how to craft a company. While the VCs buy into your economics, they don’t necessarily buy into your philosophy of management. They’ll be tolerant to a certain degree as long as you deliver the economics. But understand that it’s about the economics.”
A related pet peeve: entrepreneurs who say that VCs have given them money. “What you’ve got to understand is that they’re not giving you anything,” he says. “They’re buying a percentage of your company. They’re buyers, not givers.”
Myth No. 6: There is more money out there than good ideas.
The reality: There are more good ideas than money.
Finally, one for the entrepreneurs. Of course, you know this is right from experience. You hear VCs time and again talk about how there is plenty of money in the market for great ideas. What they don’t tell you is that you need to know the right people to get that cash.
The fact is, money isn’t a commodity. There are lots and lots of good entrepreneurs with good ideas who can’t get funded to save their lives. But don’t despair. The real issue is that you need to get backing. That’s what matters, not whose name is on the check. “Don’t feel as though you’re a failure just because you don’t have Sequoia’s money,” Mr. Reichert counsels. “Very, very few successful companies started out with Sequoia’s money. Now, that’s not exactly the way Sequoia pitches it [he laughs], but understand the way the numbers ultimately work out.”
Myth No. 5: Find a need and fill it.
The reality: Anticipate a need and invent a market. As the great hockey pro Wayne Gretzky said, “Skate to where the puck is going to be.”
Mr. Reichert calls it his “anti-MBA business model.” Too often, entrepreneurs get caught in the standard “gap analysis” they’re taught in business school. That framework urges business people to research a market, identify gaps between what customers want and what the market provides, and then fill the gaps. Seems like a reasonable approach. The problem is that in today’s high-speed Internet economy, gap analysis doesn’t go far enough.
You must look beyond the gaps to where that puck is headed. Getting trapped by “gap analysis” won’t get you there. “The gap in the market right now isn’t going to be a business opportunity in 18 months,” Mr. Reichert says. “If the gap is that visible or that important, someone is going to address it faster than you or leapfrog it altogether.”
Remember that the problems of gap analysis may emerge later in the development of a company, not just at the business-plan stage. Mr. Reichert recalls a board member who came back from a tradeshow and was high as a kite about interactive TV and wanted the company to change its strategy. “There was huge pressure on us to shift the model to interactive TV, but fortunately we resisted,” he says.
Myth No. 4: If you build it, they will come.
The reality: Anyone can build, but can you execute?
“As opposed to the MBA-driven business model, this is the engineer-driven business model,” he says.
This may sound old hat, but don’t get caught up in gee-whiz technology. Mr. Reichert says the problem still is very much with us. Even when it isn’t readily apparent, it’s bubbling below the surface. Based on my correspondence with entrepreneurs, I agree.
“Entrepreneurs are trained well enough so that they say, ‘No, no, no. We’re not technology driven,’ or ‘this isn’t a field of dreams,'” he says. “But deep down in their heart of hearts, they feel that if their idea sees the light of day, the world will beat a path to their door.”
The bottom line — as you’ve heard time and time again — great technology isn’t enough. Steve Jobs has a great technical mind, but he’s also a hell of a salesman. Too often Mr. Reichert sees entrepreneurial teams that lack the person or people who can sell ideas to new employees, business partners, customers, and investors. “You’ve got to sell all the time, and that’s what makes the difference between a success and a failure.”
As Garage.com cofounder Bill Joos says, “It’s not enough to build a better mouse trap. You must really want to kill mice.”
Myth No. 3: Someone will steal my idea.
Reality: They already have your idea — and the next one.
Entrepreneurs keep making the same mistake on this count. I usually get at least one email from an entrepreneur every one or two weeks asking how he or she can protect his or her killer idea when VCs won’t agree to a nondisclosure agreement. That’s the risk you take. If you pitch your idea to a VC, you’re right to be concerned about someone ripping it off — or the VC distilling the information and passing it along to a company he or she already funds in your space. However, if you don’t pitch the idea, you’re never going to get funded, and your company will forever be a bunch of words scribbled on napkins.
Mr. Reichert laughs when he recounts a “favorite” story underscoring his point. A bright-eyed entrepreneur approached him at a conference. She said she had an amazing idea and was recruiting a team. “That’s great,” he replied. “Why don’t you send along your executive summary.” She wouldn’t do that unless he signed a nondisclosure agreement. So he said, “OK, then just tell me the name of your company so I can keep an eye out for it if you decide to pitch it.” She wouldn’t do that either, explaining: “If I told you, it would give it away.” (Rim shot!)
It’s not enough to have a great idea. You need some kind of “unfair advantage.” “You should be able to articulate a compelling business idea that you can win, even if the entire world knows you’ve got this idea,” he says. “You’ve got to have some unfair advantage — domain expertise, a relationship, a technology, or something else other than the uniqueness of your idea.”
In a previous gig at The Learning Company, Mr. Reichert’s unfair advantage was the company’s backing by Josten’s Learning. It wasn’t enough that The Learning Company had a great idea to develop online instructional materials for colleges and universities.
Myth No. 2: VCs don’t get it.
The reality: Unfortunately, they do. Make sure you understand their feedback.
“Generally, VCs are pretty smart people,” he says. “They know a lot more about certain things than you do. So you should take advantage of the opportunity to learn and not just dismiss them as bozos.”
The main point here is that it’s too easy to blame VCs if they take a pass on your idea. “Oh, they just don’t get it,” is a frequent refrain. I won’t go so far as Mr. Reichert to say that all VCs get it, especially these days when starting a VC firm is as trendy as Regis Philbin’s monochrome shirts and ties. You need to do your homework and know who you’re talking to.
I agree with Mr. Reichert’s advice: When you’re going to pitch a VC, take someone with you whose sole purpose is to observe and take notes. That person should write down the exact questions that were asked, the body language of the VCs, what piques their interest, and any other clues about the concerns of a business plan. Even if you don’t get funded, you have invaluable information that you can use when you pitch to the next VC.
Myth No. 1: Our projections are conservative.
The reality: “Lies, damn lies, and business plans.”
This is just a short piece of advice to keep entrepreneurs from embarrassing themselves or losing credibility with investors. Mr. Reichert has a lengthy list of things you should never say to a VC, including “our projections are conservative,” “there is no competition,” “we’re going to sign a contract with XYZ company next week,” and “ABC competitor can’t move fast enough.”
VCs have heard these claims over and over again. “Entrepreneurs don’t realize that these are big red flags for investors,” he says. Do yourself a favor and don’t repeat them — even if you honestly believe they’re true. Just focus on the fundamentals of your company and how you’re going to win. Don’t make statements on which you can’t deliver. For example, if you don’t have a contract in hand, don’t suggest that your inches away from landing Cisco as a customer.