If you are going to buy something, it should be exactly what you want...it should be Custom Made

Today I am psyched to announce our investment in CustomMade.com. You can read about it here and here, but I wanted to give a little backstory on why this company and the marketplace they are building is so exciting.

I am addicted to sneakers and probably always will be. But, at the peak of my addiction, the recreational drug of mass produced kicks available at retail was not enough. In the deepest grips of my addiction, I took a deep dive into the hardcore world of custom shoes.

Working in the footwear industry, I became obsessed. I would seek out the craftsmen all over the world who could create the 1 of 1 custom footwear I needed to feed my addiction. There is magic in participating in the product creation process and getting something built just for you. The product says something about you, represents you, makes a statement that can only come as the result of a handcrafted project.  But, most people I know would never do this.  The process of creating these statement shoes was difficult to manage and very inefficient. I had to create a detailed description of what I wanted to some guy who would turn them into art. After a bunch of back and forth on the design, we would negotiate the price and I would cross my fingers and send full payment for the final product. Sometimes it worked out, sometimes it didn’t, but it was always a difficult process.

They don’t do sneakers (yet), but when I met the team from CustomMade, I fell in love. The team is building the first online peer-to-peer marketplace connecting shoppers with skilled artisans who create unique, luxury custom goods including furniture, cabinetry and jewelry.

It is a hard problem to solve, but if you can take friction out of the system and make it as easy to discover or create a custom item as it is to shop the generic stuff online, I think a large audience will never shop retail again – not just for shoes, but for all the products in our lives from tables and chairs to engagement rings, pool tables and picture frames. When a consumer can get better quality and personalization for the same price as big box retail, it becomes an IQ test, not a decision.

We were joined in this investment by a great group of syndicate partners including Google Ventures, Founder Collective, Launch Capital, NextView Ventures, Andrew McCollum and David Tisch.

The power of managing a complex transaction and creating trust for a consumer is obvious when you look at Uber and TaskRabbit, ReadyForce and Docracy. We have also seen the brand value that is built when you deliver unprecedented access to curated, high quality, personalized goods and services in Birchbox, Modcloth, KiwiCrate, Fab and Chloe + Isabel. I think the CustomMade marketplace will leverage these themes and we are excited to help the team build a leading brand in this space.

I have been on one side or the other of thousands of pitches and get asked about what makes a good pitch all the time. This is my attempt to answer that question. At AND 1 we pitched athletes to sign with us and pitched retailers to buy our product. We got pitched by agencies, potential partners and a few acquirers along the way. At my video game company I had to pitch investors, potential employees, retailers and partners from Microsoft and Sony to P&G and McDonald’s. We got pitched by distribution partners and content creators looking for placement in the game. Now, at First Round, entrepreneurs pitch their businesses and I pitch our platform and approach.

The Architect: Sketch something that will still be visionary in 100 years

Thousands and thousands of pitches over 13 years, some good, some bad, but none perfect…none that combined the ideal mix of clarity of vision, obsession with the problem and evangelical passion for their solution, until yesterday.

The sketch– Architectural clarity of vision

This team had a strong idea and clear vision for the brand rather than just the product, business model or distribution mechanism. Just like in design, the best ideas are things that can be drawn on a napkin. When someone asks what you are starting up, you should be able to sketch the business for them in a sentence or two. The perfect pitch starts with this sketch and gets everyone in the room leaning forward to learn more.

Psycho Killer: An obsession that lets you run through walls

The obsession – Psychotic depth of understanding

It was clear that the team had a medical grade compulsion to solve the problem and that this obsession with the consumer and the details of their experience were the foundation for every decision. As you describe your product and your vision, describe the insight that motivated the decision. The perfect pitch shows everyone that you know more about your consumer, your competition and the dependencies in your model than any sane person should and more than anyone competitor ever could.

The Evangelism– Religious passion

The Evangelical: Can I get an Amen? AMEN!

As the meeting went on, I could see the excitement in the room rising. The team was weaving emotion into the narrative and their passion for their solution was tangible. Every pitch should describe the innovations in product, distribution and business model, but as you build momentum, the best switch from pitching to preaching. The perfect pitch is not an objective business meeting but a baptism: a true believer working to convert the unwashed masses and at the end they get an amen!

Love to know if you all agree and if there are other characters that play a role in the performance that is the perfect pitch.

People not resumés

It got me thinking about initial meetings and how recently I have seen a couple initial meetings go horribly wrong when an entrepreneur spent more than 50% of the meeting on resume review. Narrating a resume and the background of the team bullet point by bullet point is what I call Biohazard and I am sharing this in hopes of helping others avoid it.

I know investors created the biohazard both by being over scheduled, initial meetings are often as short as 30 minutes, and by endlessly repeating the mantra of investing in people, not just ideas. In my experience it is absolutely true that investments are made in people, not just ideas, especially at the seed stage. In fact, the best thing about moving from my role as an entrepreneur to my role as an investor is the people I get to meet. Everyday I sit down and learn from brilliant people who are about to set off and build amazing things. Josh calls the best entrepreneurs heat seeking missiles. Floodgate calls them Thunder Lizards. Whatever you call them, you cannot typically identify them with a written bio (even if it is read out loud in a meeting).

The problem is Initial meetings are kind of like a first date. Conversation can be a little awkward at first, but you both work through it to lean as much as you can and see if you feel a spark. In the end, both people come to the meeting with the hope of finding a deeper connection that evolves into a great relationship. First meetings are optimistic places where each person knew enough about the other to want to meet in the first place.

As an investor, I think it makes sense to learn as much as I can about the team I am meeting so that by the time we sit down or talk on the phone, I am familiar with the past, on paper at least. I try to find connections between the team’s professional past and what they are currently working on both in terms of expertise, but also in terms of potential sources of inspiration. For me, the team bios are like the outside pieces of a jigsaw puzzle: they are informative and easy to find but never really give you the whole picture.

In a first meeting, I think a quick review of the past is worthwhile, but what is most important is how the past has informed the current vision. The best narratives I have seen at First Round weave the background of the team into more than the “team” slide. The best meetings illustrate the team’s background in the story of how the company came to be, in the initial insight that lead to the proposed product or service and in the explanation of the hypothesis and beliefs about the key risks.

Ultimately, if you can weave your collective history into why this team is ideal to attack this problem with this unique solution you will avoid the biohazard. Done right, you can surface the most meaningful experiences and personal characteristics that do not appear in your LinkedIn history but do qualify you as a heat seeking missile that any investor would be crazy not to engage.

trying them out is the only way to know what to buy

When you picked up a shoe at Tony’s, a sales guys would give an approving nod and mention the story of the shoe, the design, the athlete or artist endorsing the product. When you asked to try it on, he would head to the back, and not only bring your size in that shoe, but also an arm-full of matching shirts and other gear. During your try-on session, a couple other pairs of shoes that you didn’t ask for, but that the staff thought you should try would show up in your size.

This process would repeat trip after trip and I always walked out with more than I needed and less than I wanted.  Finally, Tony let me in on his secret:

If they smile when they try, they WILL buy.

At First Round we have e-commerce in our blood and have been active investors in the space. We continue to look for the next wave in e-commerce innovation and hope some of the companies we partner with will play a role in changing the current e-commerce landscape . When we had the opportunity to meet the team from Birchbox their vision resonated with our experience and view of the opportunity in the e-commerce space.

As they described the Birchbox service I could hear Tony in the back of my head,

If they smile when they try, they will buy.

A subscription to Birchbox elevates product discovery and brand experience to the top of the consumer purchase decision process. For $10 a month Birchbox members discover and experience premium beauty products in the form of specially selected deluxe samples delivered to their door. The monthly discovery package is accompanied by a fully integrated editorial and e-commerce platform offering instructional videos, news about the products and the opportunity to buy full size versions of the products that you try and then fall in love with.

Just like the “previum” model in the digital world, one of the most powerful ways to motivate purchase and long-term consumer loyalty in the physical goods space is to deliver a full product or brand experience. When this process includes new product discovery and unique items that surprise and delight the customer, and includes expert advice on the best use of the product and the stories that define the brand the impact is even deeper.

This is the Birchbox vision and we are excited to help them achieve this kind of consumer impact. We are also lucky to be joined in this effort by a great syndicate including Accel, Harrison Metal, Lerer Ventures, Gary Vaynerchuk and Consigliere.

If you are a beauty product connoisseur I hope you will join Birchbox and if you know a beautiful person, an annual subscription makes a great holiday gift.

I'm not sad, I just need a walk...

I experienced this first hand a few years ago when my wife gave me a British Bulldog for our fifth wedding anniversary. I was in business school at the time and she was building her marketing and communications firm so we needed a dog walker. New to the city and with no friends who had similar K-9 responsibilities, we turned to Google and to Craig’s List.

We interviewed no fewer than 10 people for the honor of spending 30 minutes a day with our fat and friendly beast with no luck. The available information about each dog walker was so limited that we went into every interview almost blind. This lack of information increased the friction in the process and forced a much higher investment of time and energy than we anticipated. We also found that each service that did provide a reasonable amount of information expected rates that were 2-3 times the rates proposed by the overweight, chain smoking “dog walkers” who screamed and jumped away when our little guy tried to sniff their hand.

Eventually we took turns running home during the day to give Barclay his walk and with each dog he would meet, we would ask the owner if they had a dog walker they liked. Two days later we met a wonderful woman who took fantastic care of our boy for less money than any of the services we had learned about in our searches.

Today we are excited to announce our investment in SkillSlate because they will structure the mess that is local data and provide value to both buyers and sellers of local services.  SkillSlate allows consumers to easily filter through individual service providers based on detailed professional and personal information including pictures, fees, and reviews within a searchable, sortable directory that is far more efficient than the current process.

By reducing the friction inherent in the discovery and quality assessment process SkillSlate solves a real problem for both sides of this large and inefficient market.

If you are in New York and are in need of a tutor, a photographer, dog walker, a handyman or a personal trainer, head over to SkillSlate and give it a try. Also, if you have a great service provider and want to help them capture more business, encourage them to create a profile in the SkillSlate directory.

I know it would have helped me a ton and I hope you will find it valuable as well.

Here is why:

When I worked at AND 1 as the Creative Director for Footwear, I spent a lot of time in Asia at our development facility in Taiwan and our production facilities in China.

It was typical for us to exchange small gifts with our partners (books, plaques and other trinkets with meaning, but little monetary value) around holidays and business achievements. At some point along the way I was given a copy of the I Ching as a token of appreciation.  Upon leaving AND 1, I started a company and spent three years dealing with legal and other challenges that ultimately resulted in failure. In one of many moments of duress I began to read the I Ching and believe the writing describes a framework to support better decision making in a start-up environment.

There are 64 verses in the I Ching and over the next couple months I am going to try to publish (or re-publish) my interpretation of how each verse could have been written if it had been written for start-up founders.

The fist verse:

RESPOND. DO NOT REACT. You always have more time to make a decision than you think. Do not allow decision points to be forced upon you. When a decision is required, use your strength as a leader to create the time and space you need to gain perspective, to be thoughtful. Make a habit of consulting with people you respect and admire. Be a conscientious observer and a student of your craft. Take time to recall the advice of your mentors, to draw out their insight and evaluate your position. When you have settled on a decision, respond with confidence.

There is no honor in this deal

At a lunch with a friend who is running his own company and working to raise money, the topic of termsheets came up (First Round is not an investor in his company and he was not talking to me about an investment) but it got me thinking about deal terms. It is no secret that investment dollars are flowing and the number of deals being done is rising.  Along with this increase in the pace of funding, more termsheets are being put in front of entrepreneurs on each deal. In this environment, I encouraged him to look for simple terms that are easy to understand, straightforward to negotiate and that create long-term interest alignment. I told him to look for honorable terms.

My first experience with the value of simple terms came my freshman year in college. I went to Haverford College, a small Quaker school outside Philadelphia. The Haverford community is managed by a simple Honor Code that governs academic and social life at the college. It can be summarized as, “Be respectful. Be Honest.”

This sounds like utopia and I was skeptical until my first exam. The test was set for 90 minutes and was closed book, closed notes. I came to class prepared for the exam and was surprised as the professor began to teach a full lecture. At the end of class she asked us to pick up an exam, reminded us of the closed book, closed notes status and the time limit. She then asked us to return the exam by the end of the week.

With this responsibility, and the ability to take the exam in my room with the door closed, I experienced the value of simple terms and clear expectations. I took the exam with my book closed and without my notes. I did not finish in time and chose to stop. The lesson in that moment was far more valuable than anything I learned the rest of the semester. Honor is expected in governance by simple terms.

When I think about investment deal terms, I am convinced that no level of contract engineering can protect you as much as mutual respect and transparency. The simplest investment terms would be agreement on valuation based on the entrepreneur’s vision and the investor’s assessment of risk, a handshake and a check.

Any complexity beyond this represents protection in the event things go wrong. This protection is for both sides and is necessary, but the level of downside protection your investors ask for, embodied in the terms of the deal, tells you something about their approach to your business. Your level of comfort sitting across the table before an investment is made is the best indicator of the confidence you will have sitting on the same side of the table in the future. How investors (and entrepreneurs) negotiate terms is the way they will manage and advise the company.

This early interaction is signal, not noise. When you raise money you should look for signals that indicate a long-term partnership rather than a transaction, you should look for a partnership based on simple terms like, “Be respectful. Be Honest.”

Alignment with your investors is crucial. Adjustments are available if you ask questions before you sign the term sheet

When you are fund-raising, your job becomes getting cash into your company. However, the best entrepreneurs don’t just get funded, but find funding alignment with their investors in terms of values, vision and approach. Since joining First Round Capital I have met with hundreds of entrepreneurs and many of them never ask me any questions about our process or our approach to working with our portfolio.

I know the fund-raising process is really, really hard. It is an emotional roller-coaster. It demands 100% of your energy, your time and your heart but you should be asking questions, interviewing your potential investors, and choosing your investors.

It is important to know you have alignment in terms of financial interests and that you are not only working toward the same outcome but also have agreement on how to get there. If you do this, you will experience many of the commonly listed benefits of chiropractic treatment:

1. It is completely safe

There should be no penalty for asking questions and if there is, you probably don’t want to work with those guys anyway.

2. Allows better sleep

The fundraising process is hard for many reasons, but the thing I hated most was being evaluated over and over in a process where I felt I had little to no control. Asking questions about your investor’s expectations and approach put you in the driver’s seat and will help you feel comfortable when you accept the term sheet.

3. Corrects the cause of pain rather than treating the symptoms

Treating the symptoms of misaligned exit expectations or disagreements around strategic vision is always painful to you and to the company. Don’t set yourself up to suffer through the distraction and pain of on-going treatment of symptoms. Correct the cause of the problem by asking questions prior to accepting the investment.

4. Relieves stress and tension

Alignment with your investors on values, vision and approach allows you to build trust and treat your investors as partners with no hidden agenda. You will get much more strategic value as you work to build your business and steer your company to success if you are not fighting the people who backed you along the way. It will also be much more fun and probably more successful.

5. Improves posture

Your investors will become one of the most powerful signals about your position in a market, your prospects for the future and the overall quality of the operations of your business. Alignment of interests will create a powerful posture for your business and insure you are all pulling in the same direction when it becomes time to get back on the roller-coaster and raise your next round.

The benefits of Chiropractic treatment are touted by some and dismissed by others, but when it comes to raising money, I am a believer. Take your VC to the chiropractor and find alignment or keep looking for other sources of capital.

If you have benefited from alignment with your investors or have suffered through the opposite, I would love to discuss it in the comments.

there are always (at least) two paths...

The 20+ inches of snow outside have me remembering bits and pieces of Robert Frost and thinking about choices at 5:45am on a Sunday:

“Two roads diverged in a wood, and I–I took the one less traveled by,
And that has made all the difference.”

Recently I had the opportunity to introduce two current MBA students from top 3 schools to a company that is looking for smart people to help them do some market research. Each student spoke to the founder and then their paths diverged like the roads in the woods.

One student took the opportunity to respond with a thank you and an outline of the project already written-up as an independent study project. He also included the comments from the professor who would be sponsoring him in the research. He asked the founder to comment on the proposed project so he could make any required changes and expressed his excitement about the company. He concluded with an offer to do the work with or without the academic credit and mentioned his ability to engage full-time during school vacations. Compensation never came up.

The other responded as follows:

“The firm you are starting seems viable but I do have some questions and would like to
cover a few items. Most of the points are to clarify the agreement between us so we are both clear about how this could work…

My desire is to join the company as part of the founding team, not just an intern…

I can commit to a maximum of 15 hours per week, but to do so would require me dropping my other commitments that I have worked hard to cultivate…

I would want to be compensated $3,000 a month…

I truly believe that I can deliver real value to your venture and I think that you will find me to be a good team member that will help build your vision…

Let me know your thoughts…

The founder could have responded with this:

“The woods are lovely, dark and deep.
But I have promises to keep,
And miles to go before I sleep,
And miles to go before I sleep.”

To me, this is about knowing your audience and creating messages that will motivate the desired action from the targeted segment. I would appreciate links to other images/short clips that make this same point — if you have a favorite, leave it in the comments.

What's in a name?

I was talking with an entrepreneur today about messaging and his frustration with having a great product that some customers are struggling to understand reminded me of some kicks I built.

When I was the creative director for footwear at AND 1, Ballers were walking around in soccer slides with socks on before and after games, to the mall, to the B-B-Q and to school. Not a good look, not that functional and your socks get ruined. We wanted to create a slip-on shoe that could be worn before and after games and generally enter the casual athletic market. We built the shoe you see here and called it “the slide.”Comfortable, affordable and way better looking than soccer slides with socks.

I took it up to 155th and 8th to test it. Everyone hated it. I took it to West 4th, they hated it. At playgrounds and malls across the country, everyone hated “the slide.” We tested different colors and fabrics and nothing worked. Kids said we should stick to lace-ups or make a soccer slide.

The shoe was a failed experiment until our audience helped us with the messaging.

On my last testing stop before heading back to Asia to finalize the line I was at the Northline Mall in Houston, TX and didn’t notice the kid holding The Slide until the argument started. 30ish high school kids, boys and girls, surrounded the shoes and 29 of them were laughing at the one holding the shoe. He argued with them with no success until he said, “No, stupid. It’s not to hoop-in yo, it’s to-chill-in.” The other kids were silent. Then, one by one, they agreed. In this group “the slide” was the best shoe.

I delayed my trip to Asia by a week and went back to all the other places we tested product, but this time I did not bring “The Slide” I brought the “Tochillin.” It tested off the charts and we included it to the line. Within 12 months we had a $50M Tochillin business with multiple styles and the original Tochillin Low went on to sell over a million pairs in 3 years.

The name of a product or service or how it is positioned through marketing and customer messaging can determine its success or failure. Don’t assume to know your audience, listen to the market to discover the right message. If you have an example of messaging changes that drove significant changes in consumer acceptance I would love to read it in the comments. If you own a pair of ToChillin’s, post it here or on twitter with the #todayskicks tag.

Know what you are fishing for...

Following the recent meme on sources of seed funds with contributions from Chris Dixon, Charlie O’Donnell, Mark Suster and Brad Feld and the related topic of We need to own baloney from Fred Wilson and Josh Kopelman has reminded me of some advice I got after my first company failed.

A good friend and the founder of AND 1 told me you get to make three choices as an entrepreneur:

1. You get to choose your idea
2. You get to choose your business partners
3. You get to choose your investors

I happened to be one for three because I did not invest the time to do more than a cursory reference check on my business partner and my investors. Everything that I discovered as my business disintegrated, was discoverable prior to building and funding my business. I just didn’t ask the questions.

There is no recipe for success in these choices, but learning as much as you can about your prospects is a good start.

To be clear, when you decide to take on outside investment, you are bringing a new partner into your business. Their business model and approach will have a significant impact on your business, your strategies and your prospects for success. No matter how many times Fred “calls bullshit” on VC’s who say they “need to own x percent,” fund math is real and there will always be investors who push out value added syndicate partners in order to “own enough” even though they hurt the entrepreneur (and the business — including their investment) in the process.

Mark and Brad offer excellent perspective on seed investing in their posts (links above). The type of questions Brad encourages founders to ask of their investors and the diligence Mark recommends (including contacting existing portfolio CEO’s) are exactly right and I wish I had this advice years ago. This process is difficult, but crucial because for each entrepreneur, there is a different ideal investor. For some, taking seed money from a large fund and the “freedom” that comes with a passive investment may be ideal. For others an extremely active angel who does not plan to participate in later financing may be a perfect source of guidance and capital. For many the balance lies somewhere in between and future participation is based on meeting specific milestones that should be well understood by both sides of the table.

I don’t believe is possible to say one funding path is superior to another, but I do believe your choice of funding is one of the most important decisions you will make and you should know what you are signing up for prior to signing the term sheet. Investors should be chosen based on their alignment with your interests and vision for the company. It is critical to understand the investor’s expectations and ability to assist you in living up to these expectations prior to accepting funding and allowing them to join you as a partner. You should ask each investor you meet with to articulate their investment model, their ability to add value to your business and force them to pitch you on accepting their money and their advice. Similar to choosing your business partners, complete reference checks and look at their past actions in both successes and failures. If you sense that you do not share a vision or an approach to managing your business, as hard as it is, keep looking for other sources of funding.

a friend of mine captured the quote here

I jotted it down in my notebook and followed with an open question: “What does that say about how we should think about community?”

The same day Chris Dickson posted to NextNY and the NY Tech Meet-up communities about open office space for start-ups with the goal of “creating a vibrant, thriving start-up hub” with a “great motivating community everyone would benefit from.”  His post is available on Hacker News here.

The free-rider problem here is the reverse of social games — everyone who gets a desk is a paying customer, but how many will contribute and actually play the game? How do the members of the community motivate participation and create structure that encourages everyone to engage in each project within the community?

In my experience, community spaces succeed or fail based on the membership and the belief of each individual that they are stronger for contributing to the efforts of others. When you decide to take a desk in a space like this, it is important to recognize the opportunity to create a virtuous cycle. The more you invest in the value proposition offered by the community by giving your time, thoughts and creative efforts to the others working around you and the more you are open to constructive criticism from your peers, the stronger the community that supports you will be and the further you and your ideas will go.

This type of thinking applies to the broader tech community in the city and is part of why I love that Chris is doing this and will certainly be recommending his space to entrepreneurs I meet with in the city.

Who's the MVP?

On Wednesday night I had the opportunity to attend the Lean Start-up meet-up in NYC to talk about best practices in Minimum Viable Product development practices as described by Eric Ries. The iterative process of the MVP development cycle makes a ton of sense for early stage technology companies and I would encourage anyone building a web service or other product that can be updated with frequent releases to pursue the minimum viable product strategy.

Beyond my reading and my experience managing the development of websites and interactive media strategies and my reading about MVP, the conversation at the meet-up took me back to my roots in product development when I was carrying a bag of samples for AND 1 Basketball in 1998. I spent a lot of time in Footlockers and at playgrounds talking to kids about the shoes I had in the bag. I would lay the shoes out on a bench and watch the kids check them out. Some would talk and others would just look, but everyone had an opinion.

For me, this exercise became like a language study. I had to learn how to hear the meaning behind the words and find the common patterns and key themes that could inform our product development efforts. I would take my notes from these product testing sessions and head to Asia where I would work with the factories to build “what the kids want.” While samples were being built, I would spend time in Japan and Europe looking for trends and working with designers to sketch concepts based on what I saw. When the samples were complete, I would meet the Fed Ex truck at my hotel in NYC and head back up to 155^th and 8^th to talk to the kids again.

Soon these consumer conversations were allowing me to provide direction to the design team, to help the development team focus on the most relevant new processes to achieve new looks, support the factories in Asia with execution by limiting the sample requests through a more refined market perspective and elevate the brand by delivering more relevant products that were closer to the consumers’ needs and desires.

Looking outside your industry can be a source of inspiration and lead to real innovation and the tech world should learn from the best practices of consumer products companies that have been practicing MVP development for years. I have never had the handle to be the MVP at Rucker Park but if you are building technology and think my experience at AND 1 could help you implement the MVP process, I would love to talk.

There is no i in team, unless you are talking investment

There are two sections from Brad’s post that apply to the entire curve

a)    Team

b)   Fit with the fund

Team:

Once an investor understands the business and has formed conclusions about the biggest potential pit-falls, the next step is to identify the members of the team who have experienced similar challenges in the past and learned from them. When practicing your presentation around team, try to match the strengths of your team with the areas of concern or weakness in your plan. Your investor knows that you will need to adjust along the way. The strength of the team is the key to identifying the proper time to adjust and the new path to follow. The discussion of the team is also a time to show your prospective investor that you know what you do not know and a plan for the learning process.

WHO IS YOUR MANAGEMENT TEAM?

-Who is the management team?

-What is their experience?

-What pieces are missing and what is the plan for filling them?

The numbers may be a waste of time, but the calculations are not

Fit with the fund:

As a founder the most valuable resource you have is time and fundraising can be a massive drag on this resource. It is extremely important to maximize the efficiency of this process and select potential investors to target based on a sense of how well your company fits with the fund. This includes understanding the portfolio as a whole, the specific investments that a given investment professional is involved with and the expertise of a firm or specific investor. Understanding of the shape of your curve and a sense of how close it is to other investments that the firm has participated in historically is a good filter as well. This analysis starts (and often ends) with an answer to the question, “How much are you looking to raise?” Brad’s list on fit is below, and I have added one to the end.

HOW DO YOU FIT WITH THE PROSPECTIVE INVESTOR?
- How does this fit w/ the investor’s portfolio and expertise?
- What synergies, competition exist with the investor’s existing portfolio?

-**Does the shape of your curve match those of the investor’s existing portfolio?

Friends who read this blog have told me that this series is too wonky and that what is really important is great entrepreneurs with big ideas. It is also true that at the early stage where I focus my time at First Round, every number in a financial projection is going to be wrong – either high or low – and so detailed projections are often a waste of time for founders who could be focused on building cool product. While this is true, ultimately the investor is buying shares in a company, not the consumer product or service and must believe in your ability as an entrepreneur to deliver a shape that fits the fund by focusing your energy in the space you have chosen for your innovation.

The view is unknown, but understanding the possibilities can help you choose your path to the top

For the fifth entry in this series of posts about why investors ask the questions they ask I am focusing on competition and other things that could erode the value you have worked to create. To start from the begining, please go here.

The defensibility of your business speaks to its long-term value as a stand alone entity or as an acquisition target. As you are building a company, it is important to know what is on the other side of the cliff you are scaling. Building a business is one of the hardest and most rewarding thing you can do professionally and thinking about the view at the top while you climb can help you choose the best path. Your strategic decisions will be different if you believe you will enjoy green fields at the top of a mesa or be faced with a steep and dangerous decent forcing a traverse along a knife edge ridge (aka – Pivot).

When you speak with a potential investment partner, competition should be well researched and conclusions about the strategy they will pursue should be supported with historical evidence or facts about their dependencies. When an investor is asking about competition and other surprises that may exist in the business they are looking for both specifics about your business as well as your general knowledge and approach to the industry.

WHAT IS YOUR VISION?
- What is your big vision?
- What problem are you solving and for whom?
- Where do you want to be in the future?

WHO IS YOUR COMPETITION?
- Who is your existing & likely competition?
- Who is adjacent to you (in the market) that could enter your market (and compete) or could be a co-opted partner?
- What are their strengths/weaknesses?
- Why are you different?

WHAT PARTNERSHIPS DO YOU HAVE?
- Who are your key distribution and technology partners (current & future)?
- How dependent are you on these partners?

OTHER
- What assumptions are key to the success of the business?
- What “gotchas” could change the business overnight? New technologies, new market entrants, change in standards or regulations?
- What are your company’s weak links?

As an entrepreneur it is your job to see what others do not and to innovate around your vision. A business strategy is a best guess, and honesty about this, knowing what you do not know, is good. If you can also articulate a plan for learning what is currently unknown while keeping your options open, this is even better.

**My friend Jon Steinberg has written about this in the past and I agree with his push for execution and product focus, but would include potential consumer shifts such as the healthy trend that hurt Coke as one of the red arrows in my diagram above.**

For the last post in this series I will talk about the two areas investors care about that apply to the whole curve, team and fit with the portfolio.

Blazing a trail to the top

This is the fourth in a series of posts written to expose the analysis behind investor questions and to propose a simple framework to help entrepreneurs guide pitch meetings more effectively. I invite you to read the first, second and third posts as well.

The size of the opportunity and your ability to capture it are the drivers of investment and are the primary focus of my conversations with entrepreneurs. When we have both done our homework, this is the most enjoyable part of my day because I get to learn about a new technology or service that may change the world from the person who is passionate about making it happen. When I was out raising money, this was my favorite part of the pitch because I got to talk about my passions and the cool thing I was building.

Investors will typically lead with these questions because the opportunity size is a primary screen. If the market is not big enough, there is no need to evaluate the risks of a given investment or come to any conclusion about the ability of the team to capture it.When you pitch, you know that accurately sizing the market and understanding the key drivers of customer adoption help frame the opportunity for an investor. Because of this, clarity about what you are building, how you will sell/distribute it and comfort with both top-down and bottom-up estimates of the market are extremely valuable. Starting off a meeting by showing that you are attacking a big ass market with a kick ass team (Rob Hayes’s “two asses” theory) is the best way to frame the conversation. Your excitement for what you are doing and the reasons you have been compelled to build a company around your idea needs to carry you through the parts of the meeting focused on evaluating the investment risks. This is your time to shine as a founder.

DESCRIBE YOUR PRODUCT/SERVICE
- What is your product/service?
- How does it solve your customer’s problem?
- What is unique about your product/service?

WHAT IS YOUR VALUE PROPOSITION?
- What is your value proposition to the customer?
- What kind of ROI can your customer expect by using buying your product/service?
- What pain are you eliminating?
- Are you selling vitamins, aspirin or antibiotics? (I.e. a luxury, a nice-to-have, or a need-to-have)

WHAT IS YOUR MARKET OPPORTUNITY AND HOW BIG IS IT?
- How big is the market opportunity you are pursuing and how fast is it growing?
- How established (or nascent) is the market?
- Do you have a credible claim on being one of the top two or three players in the market?

One you have chosen a path and climbed the mountain, staying on top, defending the business from competition and copy-cats through continued innovation and customer loyalty will become the primary focus. The next post in this series will look at some questions investors ask to understand your approach to maintaining the value you have created.

How are we going to take this hill? How will you know when it is time to go to plan B?

Investors will usually ask what you believe it will take for the business to achieve the transitions from revenue generating to cash flow positive to monthly, quarterly and annual profitability and the key development milestones along the way. The actual outcome has a significant impact on the type of investment the fund is making, but your sense of the road ahead is the most valuable piece of information. It is impossible to predict with much accuracy so understanding the team’s approach to discovering the optimal path for the business (i.e. is it lean start-up?) is the goal of these questions in an early stage meeting.

When learning about a new business, questions about the business model and the market should really illuminate the entrepreneur’s approach to learning about the market and the customer and adjusting to create product/market fit.  The projected period between funding and revenue and the associated product milestones can reveal the emphasis being placed on market feedback and iteration as well as the ability to identify appropriate pivot points. As most start-up successes come from the pivot, not the blueprint that was funded, clarity around the process for discovering market fit and potential revenue models is key to evaluating the risk in an investment.

As you answer the questions below, imagine crossing a river with your investment partner by jumping rock to rock. With each question, he is trying to judge the distance to the next rock and decide if the team can make it without falling in the water. He is also trying to see how you choose your path and how you learn from your previous choices.

WHAT STAGE OF DEVELOPMENT ARE YOU AT?
- What is your stage of development? Technology/product? Team? Financial metrics/revenue?
- What has been the progress to date (make reality and future clear)?
- What are your future milestones?

WHO IS YOUR CUSTOMER?
- Who are your existing customers?
- Who is your target customer?
- What defines an “ideal” customer prospect?
- Who actually writes you the check?
- Use specific customer examples where possible

HOW ARE YOU SELLING?
- What does the sales process look like and how long is the sales cycle?
- How will you reach the target customer? What does it cost to “acquire” a customer?
- What is your sales, marketing and distribution strategy?
- What is the current sales pipeline?

In part 4, I plan to talk about identifying the opportunity size. This is where the investment conversation typically starts.

How deep is the hole?

one quetsion before I jump...How far down is it?

Early stage investing is about the excitement generated by a big idea in a big market being built by a great team. But it is also about understanding how much capital the company will require over its life and what this means for the value of the current investment in terms of dilution (or required follow-on to avoid dilution). These questions also helps set reasonable expectations for the entrepreneur’s ability to de-risk the business with the current financing. For example, a business currently raising 10% of its total projected capital needs may not be able to significantly de-risk the business prior to raising additional capital and may want to think about getting a little more runway to be able to make more progress before raising more money.

The outside capital needs of a business help investors assess the level of “fit” that the business has with the investment model. In my time with First Round, I have seen lots of great ideas that we were not able to fund because of the long-term capital needs of the business or industry.

When an investor asks some of the following questions from Brad’s post, they are really peering down a hole and looking for the bottom.

WHAT ARE YOUR PLANS FOR FUND RAISING?
- What funds have already been raised?
- How much money are you raising and at what valuation?
- How will the money be spent?
- How long will it last and where will the company “be” on its milestones progress at that time?
- How much additional funding do you anticipate raising & when?

HOW DO YOU ACQUIRE CUSTOMERS?
- What is your cost to acquire a customer?
- How will this acquisition cost change over time and why?
- What is the lifetime value of a customer?

WHAT IS YOUR REVENUE MODEL?
- How do you make money?
- What is your revenue model?

As an entrepreneur, targeting potential investors who are comfortable with the capital requirements of your business and have knowledge of the industry you are entering will make this part of your meeting much more successful. You will find the fit with someone who understands why you are raising the level of your current round, agrees with how you plan to utilize the money and the time you are allowing your team to iterate and learn in order to show meaningful progress prior to the next round of fund-raising begins.

The next step is figuring out how long we will be working to climb to success and if the core methodology of the team will allow for the learning required to discover product/market fit. Eric Ries has written about this here and here.  I hope to add to this conversation when I put together my thoughts on the climb toward sustainability tomorrow.

If you force the fit you may lose the feel

Over the past few months I have looked at hundreds of potential investments and I have had to say no to all of them. I knew this would be the case when I made the transition from entrepreneur to investor (see Josh Kopelman’s thoughts on this here). In a meeting with an entrepreneur last week, he told me that another VC had described their job as saying no. I disagree. The job is to say yes, but finding the right fit is difficult. Over the years many people who are much smarter and who have much more experience as investors have written about the questions that an entrepreneur should expect from a VC and I have linked to my favorite example from Brad Feld, here. I love what Brad wrote and have looked to it as a guide for my meetings with founders. But after I have answers to these 15 questions, in the work after the meeting, the analysis and decision making, I am really focused on five questions that determine how well a given investment opportunity fits with our model at First Round.

1. How deep is the hole we are climbing into?
2. How long will it take us to climb out (to sustainability)?
3. How far to the summit?
4. How is the view?
5. Is it a match?

The first four questions are loosely based on the return on invested capital curve developed by David Wessels in his book on valuation.

Return on Invested Capital = (Net Income – Dividends)/Total Capital and is reported as a percentage. The goal of investments is to generate ROIC that is higher than the weighted average cost of capital (hurdle rate or WACC). Andy Metrick’s research (chapter four in his book) suggests that the WACC in VC is about 15% and so I have labeled the graph that way, but this can be anything north of the risk free rate in reality.  The curve below illustrate the ROIC over the life of a company assuming outside equity investment and long-term success.

It's a hell of a ride

I will try to group Brad’s 15 conversational questions with by the five investment analysis questions over the rest of this week in separate posts. I hope the series of posts serves as a form of translation tool and helps provide incremental transparency into the VC decision making process for entrepreneurs. I also hope it helps founders think through how to sell investors on the value in their company, not just the product or service the company is selling.