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How to Approach Start-Ups

July 4, 2009

By Naval Ravikant, startupboy.com

1. Valuation is temporary. Control is forever. The point is that entrepreneurs should make sure that, at the beginning, they always retain control of the company’s voting rights, regardless of how much money they raise. It does no good to have a high valuation where you take in lots of money, if you lose control. The way to do that is to create alternatives to one particular deal, using creative financing ideas.

2. The less you raise, the more it matters. Usually the early raises (first institutional rounds, known as the Series A) have a lot more impact than later raises (Series B+). Usually, this is because early rounds are the most dilutive (i.e., you have to give up a greater percentage control of your company) and establish the terms which are often picked up by the later investors. And the more you raise from investors, the more your control decreases.

3. If you want advice, ask for money. And vice versa.  If you go asking for money, VCs give you an earful on how to run your company. If you go asking smart people for advice, eventually you’ll do well enough that those advisors will refer you VCs. This is assuming that you get good advice and follow it.

4. Money has karma too. Too much money can actually kill a start-up because it raises expectations about what kind of return will be possible. Big amounts of money are like drugs. They’re addictive. But it means you can’t go after small markets, even if you can build a highly profitable company. Going after niche markets is a problem because early stage investors know you’re not finance-able by later stage investors, so they won’t fund you. It’s game theory, looking back from the end.

5. Appearances matter. Even angel investors won’t fund companies that are focused on niche markets. Actually, you need to go after a big enough market that VCs will fund it, but not raise so much money that you start acting like a big company. In other words, build a lean, capital-efficient startup going after a big opportunity.

6. Forget the business plan. The 50-page PowerPoint slide shows with lots of macroeconomic predictions are pointless. Instead, understand your company’s microeconomics and prepare an elevator pitch and 10 slides.

7. Negotiate from power. Reason follows. Investors will make all kinds of arguments as to why they need a multiple liquidation preference, one-sided no-shops, big option pools, board control and other clauses. But often these arguments will make no sense or ring hollow. A recent favorite comment came from an investor who wanted board control because he “wanted to be heard.” Usually these nonsense arguments go away if you have multiple term sheets and a “hot deal.”

8. It’s not smart money. It’s wise money. Wise investors see long-term potential. Entrepreneurs often choose VCs based on how well the VC knows the company’s industry or has a specific skill set (like good at business development or understands the technology.) The entrepreneurs think that this is what “smart money” means. But really, the job of a VC is not to figure out your industry better than you or to fill a gap in your team. Their job is corporate governance — financing issues, recruiting, firing a CEO (or possibly you!), or mergers and acquisitions. These issues require wisdom – understanding the long term consequences of your actions. As such, what you’re really looking for is wise money.

9. Vesting is good for founders. If you keep board control, you won’t have to worry about your investors firing you. However, you still need vesting in case one founder drops out or doesn’t scale and the others are left building the company. If 25 percent of the company belongs to a founder who had to be removed in year one, the company is effectively a zombie.

10. Hire founders. Get people who are as motivated as you are to join you.

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