Like magicians, successful entrepreneurs have a repertoire of a few basic tricks, shrouded in mystery and glamour. At no time is that more true than when raising finance, surely the most opaque process of all in the new economy.
Time after time, an entrepreneur who knows more about an industry or technology than a venture capitalist ever will, makes a basic mistake in securing initial funding. There is no Venture Capital 101 course at any British university.
If you are an entrepreneur, did anyone ever tell you to bring in angel investors through a convertible bridge loan? I wish someone had told me.
That simple mechanism, which I will explain below, is one of a few devices that can save both time and value.
So why is the world of venture capital so opaque? One explanation is that the new economy has its equivalent of the Magic Circle, a guild that drums out members who expose the few basic procedures that lie behind the magic. And the internet establishment sometimes feels like that to outsiders, a closed shop with strange rules.
I am more taken with another explanation - that true venture capital is new to Europe. Silicon Valley has developed an institutional memory of the startup process, residing in VC firms that have been around for more than 20 years - entrepreneurs on their third and fourth startups, held together by a highly efficient gossip network. In the UK, apart from US imports such as Christopher Spray of Atlas Venture and Eric Archambeau of Benchmark Capital, many venture capitalists are themselves learning the ropes. And some of the most established entrepreneurs are self-funded.
Third, there is an argument that the status quo suits established entrepreneurs and venture capitalists just fine. VCs, believers in the survival of the fittest, want to see entrepreneurs working the rules out the hard way.
What entrepreneur would put former naivete on public display to benefit future competitors?
If there is a big enough advance, maybe somebody will one day defy the Magic Circle and write the definitive 100-page guide to the tricks of the venture capital game. In the meantime - take this as a book proposal - here are my top tips.
Bring in angels with a convertible loan. Angel investors can provide initial financing, introductions and credibility. But they are often poorly placed to judge the price that venture capital firms will pay. So angel rounds can be priced too cheaply, so the firm feels it's overpaying, or too expensively, in which case the angels may need to be granted additional shares. One solution is a loan that converts into equity at a discount of 10%-20% to the price paid by the firms.
Always get an introduction, to prevent your unsolicited business plan going straight into the slush pile. The best references come from other companies in a VC's portfolio, or a well-connected angel investor. Or try pitching to people close to a VC or to a general partner.
The market: not too big, not too small. If the total size of a UK market is under dollars 1 billion, and the online part of that is typically under 1%, revenues are unlikely to interest venture capitalists. But claiming too big a market - a share of the dollars 3,000 billion global B2B market, for instance - will be met with guffaws. Optimal market size for business plans: dollars 10 billion to dollars 40 billion globally.
Fixed deadline. A startup is a fast-perishing good. If it hangs around, venture capitalists will suspect something is rotten. Set a fixed timetable for financing, and make the deadlines clear to potential investors. Beware of firms who say they need more time - they're probably not interested.
And if they ask for more information, they are probably looking for reasons to pass on the deal. So drop them.
Never agree exclusivity. Term sheets mean nothing. Less ethical venture capitalists will produce them just to take a deal off the market. Even well-meaning investors often change their mind during the due diligence process. So keep at least a couple of investor groups in the running until close.
Focus on the lead investor. Venture capital firms are like sheep; if one leads a deal, others pile in. And always choose quality investors.
A contingent of elite Silicon Valley venture capital firms, such as Benchmark Capital and Accel Partners, are now setting up London offices.
Asking for non-disclosure agreements clearly marks out the naive entrepreneur.
VCs cannot sign NDAs, because there are half a dozen plans like yours in the inbox. They don't even have time to rip off your idea. At most, ask whether they are funding anything similar.
Define the business as infrastructure. VC firms will not invest in B2C companies, particularly in a small market such as Britain. They are also sceptical about the B2B sector, which is taking on water in the US. Infrastructure is the new buzzword. That may change. Read the Industry Standard magazine to stay on top of shifting fashions.