What Investors Look For at the Seed Stage

Based on a SeedStart lecture by Charlie O’Donnell, Principal at

First Round Capital

THE APPROACH

• venture capitalists (VC) can only sit on so many boards, must spend out a fund in a certain amount of time, and have to wait (usually 5-7 years) for a company to exit - so a LOT of money is put into the companies they invest in

• First Round Capital (FRC) uses their money more wisely: “We can’t make the companies exit faster; we can’t multiply ourselves as investors, so how do we work this out?”

THE APPROACH

• your parents spend 18 years raising you; at the end, they write a big check for college, and though they can’t go with you, they hope they gave you enough tools to survive on your own

• FRC does a lot of upfront work, to make sure that your company has what it takes to get additional financing later (which FRC can lean into); this way, their work decreases and they are freed up to work with other startups

THE APPROACH

• FRC believes businesses need less capital to get product to market and to attract customers

• the money put to work should be small upfront

If you want to be part of the one percent that a fund like FRC will invest in, you will need to show your goods . . .

1. Deriskify your idea

Startup Compulsive Disorder

DERISKIFY YOUR IDEA

entrprnr says: you know you’re afflicted when you start taking all the risks, then removing their barriers one by one

DERISKIFY YOUR IDEA

as trained pattern makers, VCs will ask you: Have you figured out your No. 1 impediment and disproven it?

DERISKIFY YOUR IDEA

• in the local space, there is a really big gap between the local merchant and what’s actually possible in creating an experience, so there is a huge need to create easy-to-use tools for this marketplace

For example: tell VCs you are in the local space and they will ask you, how are you going to sell it?

DERISKIFY YOUR IDEA

• you could build the best, most turnkey tool out there – but how do you actually walk into a local pizzeria and walk out with a check?

• VCs recognize that there is a unique skill in building the kind of local sales team that can get your local business off the ground

• you need them to be trained enough, but not at the high cost of an enterprise sales team

• Groupon and Living Social’s ability to scale a local sales team is not something many people can do

DERISKIFY YOUR IDEA

If you want to prove to VCs that you have taken the risk out of your idea, sell ahead of the product• take orders ahead of time• you don’t need to build a product to remove the risk that way, you only pay for every customer you receive and you minimize any upfront risk

DERISKIFY YOUR IDEA

Example: Kickstarter• the IPOD Nano watch made Kickstarter history when Scott Wilson decided the iPod would be great on a wristwatch• Wilson put the idea on Kickstarter to see if people would want it• he knew that getting orders first would de-risk all upfront supply costs (“I’m not doing any of these unless I get paid upfront for 100 watches”) and told people they would get a watch if they donated $75 to the project• Scott got ~ $1M in orders

DERISKIFY YOUR IDEA

Example: BankSimple• BankSimple wanted to de-risk their customer acquisition process by telling people that if their banked sucked, they should come to BankSimple• they got tens of thousands of orders to sign up for beta• the interest was proven, and now it was time to build

DERISKIFY YOUR IDEA

Example: BankSimple• a lot of time went by between sign up and building, so the question became: are those first sign ups still viable customers?• BankSimple went back to those initial sign ups and said: “if you’re really serious about getting into our bank, fill out this form and put in your SS#”• 2/3 of the initial beta signups did it

DERISKIFY YOUR IDEA

D’OH!• VCs are less impressed by coverage in some tech blog (especially if your customers are more inclined to read People magazine) than saying you got 65K people to give you their SS# in your bank beta sign-up

DERISKIFY YOUR IDEA

Be the Chicken . . . • by selling your product first, you learn what the impediments of selling it are (remember that selling is the #1 impediment in local) • do you need a demo? • do you need a different pricing structure?• what’s enough to get the check?

. . . and the Egg

DERISKIFY YOUR IDEA

Beware of inventory• if you pre-sell make sure you keep an eye out for inventory• understanding cash flow cycle is important for inventory businesses• “Its worth spending 2x as much time on metrics/inventory than growth”• you will either be short on cash or inventory, so being able to predict inventory is key

DERISKIFY YOUR IDEA

Example: Warby ParkerWarby Parker, a startup for eyeglasses, ran out of inventory in two days (via Founded Project):

Two days after we launched, we ran out of inventory. That weekend, we had an emergency meeting in Neil’s kitchen to decide whether we should continue taking orders for our home try-on program. The debate was whether to fulfill some orders late and explain the situation to customers or just temporarily shut down home try-ons and ask people to be patient with us while we waited for new stock. During our 30-minute meeting, 100 orders were placed. It was clear we did not have the inventory to meet demand and we’d have to shut down the home try-on program temporarily.

DERISKIFY YOUR IDEA

• founded by high school sweethearts, Eric Koger and Susan Gregg Koger, ModCloth.com is an online clothing, accessories, and decor retailer with a focus on independent and vintage-inspired fashion• when product is out of stock, users can “notify me when this product returns”• this is a good tracking method for what is in demand – and allows ModCloth to buy inventory accordingly

DERISKIFY YOUR IDEA

• Gilt provides its members with access to coveted fashion and luxury lifestyle brands at sample sale prices• their early model of being closed off to the public is good for inventory businesses that want to control a high influx of purchases

2. Make love to a great market

MAKE LOVE TO A GREAT MARKET

• setting up the Special Purpose Vehicle of your rich aunt Norma (who incidentally thinks you have the cutest cheeks) will not pass as a legitimate pipeline that you’ve built to sustain and replicate itself• VC’s are looking for models with replicability and sustainability

won’t work

MAKE LOVE TO A GREAT MARKET

• there is a difference between being in a BIG space and an ATTRACTIVE one• the telecomm and recruiting industries are BIG; even LinkedIn’s stock went down since they went IPO• take a look at Hot Potato . . .

So what makes a Great market?

MAKE LOVE TO A GREAT MARKET

• Hot Potato connected fans and friends around live events• but they didn’t get the kind of traction they hoped for• however, they built a great team and were in a space that was strategically important to a lot of people• which was why Facebook acquired them

Example: Hot Potato

3. Create a great team

CREATE A GREAT TEAM

7 out of 10 of you are going to pivot

CREATE A GREAT TEAM

Some of you will pivot hardcore

MAKE LOVE TO A GREAT MARKET

• stickybits created barcode stickers companies could put on their products; when users scanned the codes, they could see reviews, tweets, videos and pics as well as add their own post and receive discounts on those products• the same team turned into Turntable.fm and is revolutionizing the social music space, allowing users to play and listen to music with their friends online

Example: stickybits to Turntable.fm

MAKE LOVE TO A GREAT MARKET

• “ at the end of the day, you’re building these little black boxes – doesn’t matter what’s in the middle – what matters is that money comes in and comes out the other end; those are the basics of business”

Ultimately what VCs are betting on is a team in a market

Final thoughts

FINAL THOUGHTS

• the pattern matchers are also pattern makers, so find an investor who is pre-conditioned to things you’re interested in

Matchmaking will improve your odds

FINAL THOUGHTS

• but REMEMBER: every investor you are pitching is very colored by what cycles they’ve experienced (especially from the late 90s)

You are in a really good fundraising environment now