An entrepreneur asked me at a recent networking event, “So, what makes a deal ‘”hot'” to a venture capitalist?” Of course I told her the stock answer that you would likely get from every VC when presented with that question, something like, “It is a great team with domain experience solving a tough problem in a big market.”
But I have to admit, that wasn’t all I was thinking. I clearly told her the characteristics of an investment that will likely get VC funding, but not how a deal becomes “hot” within the VC community. I didn’t tell her how experienced entrepreneurs often use emotion as a tool to create momentum, move deal terms, and get term sheets from VCs. From what I observe in many VC partnerships, a “hot” investment is as much about greed and competition quickly overcoming fear as it is about supporting due diligence.
Early stage investing has substantial risk—team, technology, market—this stuff is not for the faint of heart! Every VC has a track record (every company that individual invested in and the associated returns for each) that impacts him or her much more and much longer than, say, an entrepreneur’s failed enterprise from eight years ago. A VC’s track record is how that VC is measured by fund investors and partners—and you need to hold your own to keep both of those constituencies happy. Further, many VC investors are pension funds and endowments. Losing money for a pension fund that provides income for widows during retirement or for an endowment that provides higher education funding for under-privileged students certainly doesn’t make a VC feel very good.
It is a real emotional hurdle for a VC to write a multi-million-dollar check (okay, to authorize a wire). Fear is the emotion that favors making no decision or passing on an investment altogether.
So the challenge for an entrepreneur with a great investment opportunity is create enough momentum to push through investors’ fear of losing money. The challenge for an entrepreneur who wants a “hot” investment opportunity is to blow through that fear and get deep into VCs’ competitive spirit and greed!
VCs tend to be type “A” personalities, and many are (fading) athletes. When an investment happens by another partnership in a space that is close to me and I didn’t get to hear about the company, that is a problem for me. My partners expect me to see investments in my areas of core competence and I expect it of myself. I am letting them down if we don’t get an opportunity to hear the story and possibly invest. Every VC wants the option to invest in every “invest-able” opportunity, and certainly in the spaces that they cover. So, are VCs competitive with each other? You bet.
The greed part is obvious. VCs are in the business of making money for their investors. Meanwhile, if VCs are good at their jobs, they make a good amount of money for themselves in the process.
So, how does an experienced entrepreneur use this understanding of fear, competition, and greed to create the perception of a “hot” investment opportunity?
1. Experienced entrepreneurs target their fundraising efforts. They share their investment opportunities to the general partners who will “get it.” Those VCs either have relevant operating backgrounds, have made related (but not competitive) investments, or have shown an interest in the space (blogging, conferences, speeches). VCs who require an education process from the entrepreneur will more than likely fall victim to that fear of losing money sooner or later in the due diligence process.
2. Experienced entrepreneurs approach the target list of VCs they know or to whom they can get
