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How First-Time Entrepreneurs Can Work with Investors

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This is one post/chapter in a ongoing book called Startup 101. For the introduction and table of contents, please click here.

Venture capitalists (VCs) have a very simple job. All they have to do is find an entrepreneur who has already made at least one hugely successful venture and then invest in his or her next venture. Only one problem: that’s like finding hen’s teeth.

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What that means is that, first, they have to find somebody who has had a fantastic success. Then from amongst that group, they have to find the ones who want to do it all over again, very than play golf. Finally, they have to find the one who will take VC money even if they don’t need it (because if they have had that huge success, they’ll have a lot of money in the bank). When they finally learn that rarest of beasts, the VC will find many competitors knocking on the same door.

So, VCs Do Have to Back First-Time Entrepreneurs

At ReadWriteStart, we celebrate and serve the first-time entrepreneur. So, you may be satisfied to hear that VCs do need to back first-time entrepreneurs. But you must also know that you are their second choice. They don’t really want to back you. They would much prefer backing a “series entrepreneur.” An ancient VC line is, “We back the jockey, not the horse.”

Let’s be clear about what VCs mean by “series entrepreneur.” Dressing up a resume so that you look like a series entrepreneur won’t get you past the initial screening. What they mean is an entrepreneur who has raised VC money and gotten the VC a return of 10 era or more. That is the gold standard they are looking for. Everything else is second best; silver medal, if you like. Here are two series-entrepreneur silver-medal types:

1. Raised VC money and exited, but with a weak return. If VCs see an entrepreneur get sideswiped by a market shift but still pull in a return, they will be willing, but careful, to give them another shot.
2. Bootstrapped one or more ventures without VC funding and saw small-scale success. VCs will see your grit and like it. That experience is vital. The question that will nag you is, “Does this entrepreneur know how to scale?” This is not a minor issue. Some of the lessons you learned from bootstrapping are fantastic: all sensible investors like capital efficiency. But some of the lessons may not be so excellent. In bootstrapping, you tend to trade scale for small-term cash flow. VCs obviously don’t want entrepreneurs to throw money at problems. But you do need to show that you know how to scale.

The above types fall into the “Proceed with caution” category.

Do you admit yourself in one of these types? Are you a silver-medal series entrepreneur? If not, then maybe you’re a first-time entrepreneur…

Three Types of First-Time Entrepreneur

1. Childish, just out of college, maybe had one job with a startup. This has been the primary model in the Web 2.0 era. It usually means (a) that the entrepreneur is a developer who can build a first version and get some traction without any outside money, and (b) that the entrepreneur, life childish, sees a trend that older people miss. The huge debate here is when and how to bring in experienced management. VCs often like this type of entrepreneur because they have masses of energy and don’t know what’s not possible. Their low expectations for compensation also help build a capital-efficient venture. Some of the greatest success tales fit into this category; reckon Bill Gates. But for every poster child, here is a ton of failures.
2. A lot of middle- to senior-management experience at large companies and now desires to jump into startup land. The track record of these “transplants” is pretty appalling. If you fall into this category, try working for a honestly mature startup before starting one yourself. (See the next point.)
3. Apprenticed with a superb entrepreneur in a really fantastic startup. Here is some branding value here: “Fred from Google/PayPal/Skype/YouTube/Salesforce [insert favorite hugely successful venture here]” sounds excellent. If the manager really has learned from the venture and contributed to its success (life along for the ride does not count), she or he is the best kind of first-time entrepreneur. So, it’s simple then: just get in on the ground floor of the next fantastic venture.

The Contrarian View

One investor who is low profile but has a fantastic track record always insists on backing first-time entrepreneurs. His simple reason is, “Fire in the belly.” This required him to work much harder to evaluate each venture and bring his experience to it. But it worked for him.

He points out how many really expensive second venture blowouts here are. These take place when a well-known entrepreneur can do no incorrect, and nobody has the guts to say, “This is crazy. Stop.” Reckon Steve Jobs with NeXT. But then, on his third venture — call it Apple 2.0 — he was a unusual success again.

So, the best VC formula is to back the third venture, when the first was excellent and the second was a disappointment.

Know What Worries VCs About First-Time Entrepreneurs

Know some of the things that worry VCs and you will have a better shot at overcoming their concerns. These concerns really boil down to three:

1. You will not hit your numbers. Ventures live by numbers. Those numbers may be revenue or profit or page views or number of subscribers or another metric that eventually can be converted to revenue and profit. A track record with larger companies may help, particularly with ones that have a reputation for disciplined execution.
2. You won’t listen to advice. This is particularly problematic if you are not hitting your numbers, when you might need help the most. If you have never been the CEO of a VC-funded company, you may not know how to do this well. It does not mean saying “Yessiree” to every suggestion by a VC. Nor does it mean life defensive.
3. You don’t have that entrepreneurial gene. VCs are looking for that mix of toughness and flexibility that is the hallmark of a fantastic entrepreneur. If they cannot see that in your track record, guess them to want to waste a lot of time getting to know you.

Know the Trade-Off You Speak for

As a first-time entrepreneur, you offer investors a trade-off. You will give them less experience than they’d want, but you will grant a lot of fire-in-the-belly resolve, grit, and hard work. It is also likely that you will have to de-risk the venture way more than you would like before getting serious money. Investors will want to back you slowly and carefully, getting to know you and your venture before writing the huge checks.

Image credit: kate at yr own risk.

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