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Finding the Golden Needle
Netpreneurs Discuss Their First Funding Experiences

The Forum (part 2)

Q: I’m Jeanne O'Kelley with Blueprint Technologies. My question has to do with your management team. As you went out to meet with the venture community, did any of you get the response, "I don't like somebody on your management team," or, "I don't think you have the talent in a certain area and I want to supplement your team with somebody?"

Mr. Schmonsees: Yes. Fortunately, I wouldn't leave. As a matter of fact, we had very frank discussions about whether and when to bring in a "number two" in our organization. It seemed to make sense, so, it ended up as part of the deal.

Mr. Pittinsky: I look young, so when we talk with investors, I explain I have been in school all my life and have lots of experience in the education market which we serve. The first time that someone asked me whether I would be willing to step down as Chairman and CEO of Blackboard, it took me by surprise. It shouldn't have, because it's a legitimate question. There comes a time in every company's growth when those issues come up. So just be prepared for it. I haven't yet figured out if they ask you because they really want to know the answer or they're interested in how you respond. It's probably a bit of both.

Ms. DeFife: We heard more advice along the lines of, "You need a strong salesperson. We like what you have to offer, but let's fill that gap." My belief has always been that if there comes a time where the investors want to replace me, that's fine. I'll certainly step aside and find somebody who can carry it to the next step. Also, if I'm not doing my job, I fully expect to be blown out and should be.

Mr. Thomas: The answer I tend to give, and which I really believe, is "I wear two hats, a shareholder's hat and a company hat, but I'm a shareholder first and foremost. If you find someone who is going to make this company grow faster than I can or any of the people that we have, I'm more than open to talk about it."

Mr. Nelson: Bill Melton of CyberCash and Veri-Fone, who is a considerable success, said: "I fired myself too early once. I fired myself too late once. I have never done it at the right time." I have never been quizzed about anybody on my team, but I have been quizzed about myself by investors. Either you have the arrogance to say, "I'm running this thing until you yank me out of here." Or you say, "Look, I'm a shareholder, and my top concern is having a valuable company."

Q: My name is Monte Cole. I have a start-up doing custom environmental systems. Do investors really care if copyrights and patents, for instance of the source code, are held in the company's name or by an individual or individuals?

Mr. Schmonsees: I applied for a patent before I formed the company, but as soon as I formed the company I put it in the company. It is an asset of the company simply because I didn't want to have that discussion. If you believe that the company is going to succeed, why would you want to keep it in your own name? Give yourself some extra stock instead.

Ms. DeFife: The assets of the company are what the investors are investing in. The copyright, trademark, everything on our side is all held by the company.

Mr. Thomas: Besides the people, you have to have a product to invest in. It’s no good if the product is not part of the company.

Mr. Riechers: Unless there is some very unique story behind this, I would suggest it needs to get assigned unilaterally to the company.

Q: My name is Scott McLoughlin from The Adrenaline Group. What do you suggest for products like systems software or enabling technologies, where, without a significant sum of financing, there aren't going to be any customers? I’m thinking of something that takes a significant amount of investment to bring to market.

Mr. Riechers: Torrent Networking Technologies is a great example of a company locally that did a couple of rounds of financing prior to having any customers or a completed product. Hemant Kanakia, the founder of the company, is clearly a genius at designing switch equipment and software related to switching. The investors made a bet on Hemant when there was no product to analyze. You are still looking for milestones. Bob Nelson's point is right, that the milestones are different, and for the first few stages, there are no customers. It's a difficult story for which to raise money. You need one person or a couple of people around whom the money-raising revolves, because of their remarkable track record.

Mr. Schmonsees: If it's a new idea, figure out a way that you can mock up something that will show the revolutionary aspects of it. At least you get something that's a prototype. It shows how it would work if you really had enough money to build it. People need to see something tangible before they can take the first step. We walked around with our idea in mock-up to get our first investors.

Mr. Riechers: That's a very good point. Torrent had a synthetic version of the product. It showed the power of what they intended to build, but it wasn't the product itself.

Mr. Nelson: If you haven’t built a company before, you are probably not going to get a large amount of money to get to alpha. Bring somebody in who has been successful and can attract that kind of money on an idea or on sheer reputation.

Mr. Pittinsky: We developed the first version of our product under contract for several different people. We didn't need a product to get a customer, because we got our customer to pay us to build the product. We got the product done on someone else's dime and we proved there really was a market for it. You would be surprised—if you ask people to build your product, they will. It was interesting.

Q: My name is Sumant Hattikudur. In a competitive environment, how much proprietary information does the company share with the VCs?

Mr. Schmonsees: Everything.

Mr. Nelson: Ditto.

Mr. Schmonsees: Yes. Except you wouldn't go and tell them what the other VCs say you’re worth, because they will talk.

Mr. Hattikudur: Okay. So how do you remain competitive if that proprietary information gets out to 200 VCs, for example?

Mr. Thomas: When we first started, we were afraid to show anyone our technology. We asked for non-disclosures, but VCs were turning us down. Their reputations are based on this, too. Everyone has heard the horror story of technology being stolen by a VC, but most VCs that we talked to have good reputations. They are not trying to lose that just to share your idea. We were confident in ourselves, but we aren't so important that a VC is going to risk its whole reputation to steal our company’s product.

Mr. Schmonsees: I have never had the VC ask a question so deep in the technology that it worried me.

Q: Gary Honig with Creative Capital. What is the vehicle to find out who is investing in what and how they are doing?

Ms. DeFife: Most of these funds have Web sites which list their portfolio companies. You can take a look to see if there are companies like yours. We did a lot of research on the Web. If it’s not there, ask them who their portfolio companies are, and what they think about them. They're not going to give you numbers, but they will tell you honestly how they feel. If they say that they are not confident, so they can make another investment like yours, move on, because they are not going to invest in you.

Mr. Schmonsees: If you do get to the point where you are actually talking to VCs, call their portfolio companies and ask them some questions. "How are these people when it gets tough? What happens at a board meeting if there are some tough issues? Are these people rowing in the same direction?" You want to understand prior experience if you get lucky enough to get into the negotiation.

Ms. DeFife: We were two weeks from shutting down the first time and we were going to take any money that came in, to be quite honest with you, but I would still agree with Bob. Don't talk to the companies they invested in very recently, because that's still the honeymoon period. Talk to the company nine months or a year down the road, when they haven't met their projections. Find out what the investors are like to do business with at that point.

Q: I’m Paul Lyons. Bob, I was looking at your chart, and you give some estimates for time spent raising money. I currently have two firms running and I don't sleep.

Mr. Nelson: You can outsource that function.

Mr. Lyons: You'll sleep for me? Cool. How do you balance running the company and raising the money?

Mr. Schmonsees: I found a person who served as our arms and legs for a lot of the early-stage discussions with VCs. He ended up participating in the company when we were successfully funded. Even though I had a lot of contacts, I needed somebody who could be more objective. There are people who can do that. Some are pretty bad, but there are some good ones around.

Mr. Nelson: Some investment bankers in Washington will raise money for you for a percentage of the money raised. Raising the amount of money you need, from the kind of investors you need, for the kind of business you have, is time and money well spent.

Ms. DeFife: At some point you say, "I have to raise this money and I have to run a business, too. How many hours in a day do I have and how little can I sleep?" I've got two teenage kids who expect to see me at least occasionally. I walked away from everything else I was doing besides my business and family to make more hours. You just do it.

Mr. Pittinsky: It may be a platitude, but there is probably a problem if you are the only one in the company who can both raise money and run the company. I always try to make sure that I am completely replaceable in the company. I benefited from starting with a fantastic partner whose strengths complement mine very nicely. If there is someone in your management team or in your company who can develop into that role, it's an invaluable relationship.

Mr. Thomas: You've got to have other people in your company who can do it in your absence. When my partner and I first started, the company shut down when we went anywhere. No one would be doing anything. When we finally had someone we could leave and not have to worry about the business running, it was our best day. On the other side, I surrounded myself with really good mentors. From VCs, to legal advisors, to friends, everyone I surrounded myself with helped us on all phases. It’s incredibly difficult to do by yourself. You’ve got two companies. That's hard for me to picture.

Mr. Lyons: I’m getting lots of gray hair out of this one. Brandy, you said you have brought on and surrounded yourself with very good people. Has anybody on the panel looked at angels or bringing in people who will take a more active role?

Ms. DeFife: My business partner was a partner in a major law firm and worked for nothing for six months.

Mr. Pittinsky: Don't look for an angel investor to do that, because they are investing in the management team. Look for them to be mentors. One of our initial investors came to us right away with three other investors. Another one showed up with two Fortune 500 companies who wanted our products. You want those sorts of relationships.

Q: Hi, my name is Mark Dorf. I'm with Digital Cities and AOL Studios. Was there a formula or percentage to arrive at a line item for your salary?

Mr. Schmonsees: There wasn't really a formula. I get paid far too little, but other than that, no. VCs want to see skin in the game, at least until you are making the money. Most of them don't want to see you spending more time worrying about how you feed your kids than in building the business. They do want to be reasonable.

Q: Everybody leaves the impression that if you get your financing, things are fine and everybody is happy. Realistically, after you get your funding, are you under more pressure to perform? How much pressure have you been put under by the investors to meet your goals?

Mr. Schmonsees: We are meeting some goals, beating some and not meeting others. You are not going to make any headway if you can’t have open, honest discussions with your investors. We probably spent too much time on a couple of issues where we were jockeying around trying to be nice. After two or three meetings we had to jump in and figure things out. You are consistently learning in a new business. People who won’t work through the tough problems with you are not the right investors. 99% of the deals that VCs do have problems.

Mr. Riechers: To cite one successful venture investor, 51 out of 52 deals he invested in did not make their near-term numbers.

Ms. DeFife: I'm one of them. We did not make our numbers in the first year. Honesty is incredibly important. Investors can help you more than anyone. You may just be creating stress because you haven't sat down with your investor and really talked about your problem. It also depends on how long your investors are willing to wait before you are actually showing some good numbers.

Mr. Schmonsees: You and your investors are going to expend a lot of energy trying to figure out the whole story if you are not honest. You don't have time to deal with that. Facts are facts.

next: Wrap-Up >


 

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