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shaking the moneytree 4: Q2/2000

a billion dollars in mixed signals  

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Mr. Burke:  I think it's also important to realize that the VC understands what you're going through.  In two of our recent deals part of the money was to fund the search for a CEO or other high level executives.  We have also done staged investments where we'll put in $5 million to fund a search, build the Web site or whatever.  Once that metric is hit, once we've hired the CEO or hit some other milestone, then the next $15 or $20 million comes in.  If you work those things out ahead of time, it saves you a lot of heartache.

Mr. Muleta:  I haven't been in the VC business a long time, but I've been around long enough to know that you should assume that you will always run out of money.  You're never going to solve the money problem, so let's be realistic.  The only thing that changes is the order of magnitude of your problem, right?  When you start out, $3 million seems like a big bogey, then you have a crisis when you need $50 million.  When you have a business running and enough customers to get to the next stage, that can be the worst time.  Get to the point where you have traction, and we can help.

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on changing your business model

Mr. Thompson:  We see a lot of B2C or B2B companies saying that they have to change the business model because those systems are no longer in fashion, valuations are down and it's tough to sell them.  Do you think this can be done?  Would you invest in a company that started out as a B2B or B2C and is now changing to be service provider or something else?

Mr. May:  With the early stage money that I deal with, there are so many choices¾we're looking at 100 companies, meeting with 10 and choosing two¾so we’ll probably go with the clean idea that we think is directed toward the problem or the infrastructure or the talents of individuals instead of trying to resurrect, save or help somebody modify their plan.  I think most early stage money will go with the fresh, direct idea and not give too much attention to the restarts.

Mr. Burke: I could not concur more.  It’s so weak when somebody comes in with a B2C model and three months later they’re back and it’s B2B2C.  They’re saying, “It's changed!  It's better!”  No, it's very weak and it’s transparent.  The deeper issue is that if you have to change the model to get money, you have a real problem¾you're not passionate about what you're doing.  It's not really what you love; you're just chasing the dollar.  It's just financial engineering, and it's clear to the investors, let me tell you.  We've seen a lot of companies that have done that.

          We don't typically revisit plans.  A lot of people get turned down and they'll come back two or three months later and want to redo it.  We don't do that unless something significant has changed or a significant amount of time has passed.  When B2C fell out of favor, we had companies come back and say, “Okay, now we're B2B.”  Now, they’re coming back and saying they're something else.  It's very transparent.  Don't do it.  I was talking with a guy who ran a utility company in mid 1999.  That's what they did; it was a utility company.  Then they realized that the dot.coms were getting all the money, so they just added a “.com” at the end of their name.  It was exactly that.  You haven't changed the business, and the investors see right through it.

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Mr. Muleta:  I'll make this not quite a love-fest, and say that I sort of disagree.  As I said, you have to be honest and say, “Look, the model's not working and I need to change it, but I have a kernel of a good idea.”  I think it's transparent if you show up and say, “Okay, I'm not going to be a B2B company, let me just use your money and I'm going to start a whole new business plan.”  But, if you come in, get rid of the nomenclature, say, “I've done more research on the market, I've been out there.  It's not really a B2B, but I figured out that this product is actually more appealing to institutional rather than retail buyers.”  It’s okay if you're honest about it and you are not changing the real kernel of the idea, just your approach to marketing.  Maybe you have had a senior marketing executive teach you that you were directed at the wrong place, for example.

          A VC wants to hear the analysis and honesty behind your change of heart.  You know the anecdotal history of Silicon Valley, that if you haven't failed once or twice nobody will invest in you.  It's okay to say it didn't work.  There are personal effects that go with that which everybody has to deal with.  A lot of people who go out on their own are winners, and it's kind of tough to admit that you didn't win, so just deal with that and be honest.  Always be honest.  I think that gets you a lot further than anything else.

on corporate venture funds

Mr. Thompson:  During 1999 and 2000, a lot of technology companies started corporate venture funds.  Are these corporate venture funds really changing the venture landscape that much, especially in relation to the dynamics of their interaction with private venture funds?  We'll start with John Muleta because he runs a corporate venture fund.

Mr. Muleta:  (Laughing) We're really nice guys, okay?  You don't hear about corporate “vulture” funds.  We're nice guys.

          Seriously, we are strategic investors.  I can't speak for other companies, but our vision is to enable the Internet and we want to support companies that either further enable the Internet or make use of all that infrastructure being put up.  For all the people who are in the B2B and B2C market, just keep in mind what John May and John Burke said about a lot of money going to telecoms and Internet infrastructure companies. That tells me that it is only a matter of time before the B2Bs and B2Cs come back¾maybe not for all of the people who are here today, but there will be an another swing of the pendulum.  It's all cyclical, and it's going to come back.  You have to have a business plan or an idea that can last until the next wave comes in, but what do you think they are going to do with all of that infrastructure and all of those new tools they are coming up with?  Keep the hope and don't abandon your business idea simply because somebody told you it's not in favor with Wall Street.  If it's a good idea, it will get supported.  Keep at it.

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          As I mentioned earlier, PSINet Ventures is trying to help people who want to reduce their cash burn but still need to raise funds.  I won't go into more of a sales pitch, but talk to us and maybe we can help you.  We only have one basic requirement, show us that one of these guys like John Burke or John May believes in your idea.  The reason I say that is because it reduces my transaction costs since these guys are going to do a lot more due diligence than I can afford with my limited staff.  Doing due diligence on seed level companies is not my  main line of business, so spend your cycles with them, then come to us and say, “Hey, John, John, and John have already bought into my idea.  Do you want to have a share in it and can you reduce my cash burn?”  Say things like that and we'll say great and put in a load of cash and a lot of services to support you.

Mr. Burke:  We have invested with PSINet Ventures.  It obviously does reduce our companies’ cash burn, and they've been a great partner.  So much for the love-fest.  (Laughing)

Mr. May:  When you invest with a corporate venture group, you sometimes get access to their technology or access into the company.  For us, it's worked out very well, in addition to the cash burn reduction.

          One of the best things going on in our region is the proliferation of non-traditional funding sources, such as investors from outside the region, corporate sources, angels, accelerators, you name it.  You don't have to think “either/or.”  Almost all the groups syndicate, almost all are getting to know each other and figure out who the quality players are.  It's probably gone under-reported because there tend to be separate silos of information¾VC reports, corporate reports, etc.  One of the things to learn about is the new lay of the land for multiple funding sources and how to use them.  Just as you wouldn't necessarily want to be angel-financed all the way up to a $50 million round because the number of angels at that end are very few, so, too, most of us would advise you, and I think John Muleta would agree, that you don't start out being financed only by Intel or Dell or PSINet.  That’s because they have a certain culture, certain strings attached and they are not, as John says, fully staffed and fully able to provide value-add the way the life cycle venture capital funds are.  You really have to look at the pluses and minuses of each pocket of cash.  The best case scenario would be a solid angel or structured angel group round early, then early stage VCs leading to late stage VCs and corporate funds.  You cover all the bases as opposed to thinking that just because somebody has money, they are smart.

Mr. Muleta:  When dealing with a corporate venture fund there are two things you particularly need to do.  One is to listen to what their objectives are.  That's very important.  Don't deal with them like you deal with a VC, where you trot in, give your dog and pony show and say, “I want your money” or “I'll make you a lot of money.”  A corporate venture fund is a strategic investor, so listen first, then describe what you're looking for.  If it isn't the right fit, walk away because you'll waste their time and you'll waste your time.  Listen, first, and get ideas. Explore what they want out of it.  I'm being as honest and as direct and as clear as I can be.  Listen first.  Understand their strategic initiatives, then give your pitch the right way.  If it's not a fit, walk, because your time is the most valuable thing.  If John’s saying he wants to do early stage and I'm saying I want to do late stage and I want to do lots of services, and if there’s not a match, let's not waste each other's time.  Say thank you very much and walk on.

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          The second thing is that there are strings.  A lot of people come in and say things like, “If I sell this to you, you'll make $2 million for the next 12 months.”  If you're talking to Intel, do you think they care about $2 million?  They don't, sorry.  From your end, it's a great story to tell John May that you have $2 million in sales through PSINet or Intel, but they are looking to hear about $100, $200 million ramp ups.  Make sure that when you're ready to talk that type of deal you get it to the right scale.  If it's revolutionary, great, show how revolutionary it is, but think about the scale that the other side is operating on.  That's why I'm telling you to think about what the other guy is telling you.  I wouldn't go to Nortel Ventures and tell them about a B2B plan, for example.

Mr. Burke:  As a funding source, one thing we look for is that you do your own due diligence.  If you come to me for money, talk to people I've invested with before and see what the experience was like.  Do the exact same thing with a corporate venturing partner.  There are several large funds that make all kinds of wild promises in terms of getting into the development cycle with their products and how you'll have access to their engineers¾I’m not talking about PSINet, here.  Talk to companies they have invested in before.  Some of them are very large companies that do not move at the same speed as a venture capitalist and they won't make decisions using the same process.  Be very careful of the promises made at their end.

on evaluating investors

Mr. Thompson:  That's a nice lead in into the next topic, how do companies evaluate potential investors?  There are a lot of venture capital funds out there now, with many new funds having been started over the last 6-9 months.  How do companies decide what investors they ought to work with?

Mr. Burke:  First, look at the deals they have done.  Are they similar in stage, size and industry?  Talk to people at the companies in which they have invested and find out what happened.  Don't just talk to all the rosy stories; it's not all love-fests.  Lots of investments go belly up, so talk to the investments that did not work out and see how the VC reacted.  How long did they stick it out?  Did they stay until the end?  That's important.  Not everything is on the upside.

          Look at the partners.  What kind of background do they have?  Have they been venture capitalists their whole lives?  Have they ever actually created a product or done a job other than venture capital?

          Look at the portfolio.  We have 62 companies in our portfolio and there is probably somebody in there you can work with.  One of the true value-adds we can bring is making introductions into our companies.  A lot of businesses will come to us because of the investments we have made.  It’s that whole kiretsu thing that's so popular.

          What level of involvement do you want?  Do you want them to sit on your board?  Do you just want their money?  Do you just want their list of contacts?  Some VCs are very active.  We take board seats in 90% of our deals and we're going to work with you on a day-to-day basis.  Granted, you have to ask for the help and we're not going to meddle, but we will work with you.  What level of involvement will they have?  We've worked with some corporate venture groups that simply provide the money and don't participate; we vote their shares.

          The other thing to look at, particularly with early stage deals, is where do they help you go next?  There are tiers within the industry and if you get in the right tier, it's a lot easier.

Mr. May:  There are also a lot of intermediaries in town¾lawyers, accountants, the trade associations and such¾that can give you a lot of secondary information about who the dominant players are and the clients they are dealing with that are responsible, value-add investors.  I also couldn't emphasize more that there is a wellspring of accelerators, incubators, catalysts and angel groups.  You have to understand their value and do your due diligence on them, just like would you with VCs.  Ask for references, ask for their backgrounds, ask about their other portfolio companies.  This honesty thing we're all trying to get across goes both ways, and we're just trying to lessen the pain in the community of failed experiences and blind alleys.  If you do your homework, we'll all be better off.

Mr. Muleta:  Yes, just do your homework.


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