Click here for printer friendly page
A VC approach to seed investing05/10/2005. Source: Israel Venture Capital Journal. Zvi Schechter, Giza Venture Capital 
Zvi Schechter, co-founder and managing director of Giza Venture Capital, looks at seed investing from the venture capitalist's perspective. Success has many fathers he says, but failure is an orphan. The history of Israeli high-tech is written by the successful entrepreneurs.
But, in fact, it is difficult to learn much from success stories. Success usually
reflects three factors: being at the right place … at the right time … with the
right idea.
Behind the success stories, one can discover many failures
as well. Despite the high failure-to-success ratio, entrepreneurs maintain dreams
of building their own company and duplicating the triumphs of their peers. Entrepreneurs
believe passionately in what they do and are ready to leave their jobs and spend
long days to achieve their goals.
High potential in seed Venture capital
funds raise money from institutional investors and promise to deliver superior
returns compared to other investment alternatives in private equity funds.
It is well known that in an upward market, superior returns are highly correlated
to investments in early stage deals. The key to achieving significant returns
is investing in seed opportunities.
Fundamentals of success
After being involved in the VC industry for many years, we have realized that
there is no scientific formula to make a successful investment. Being a successful
venture capitalist is the art of taking advantage of opportunities and managing
risks. The "magic recipe" is to have a winning mixture of people, markets, business
model and product/technology.
The entrepreneur's angle
An
entrepreneur seeking financing is faced with navigating the rapids of the venture
capital process in search of a partner. For an innovator, choosing the right VC
firms to target for potential financing is critical. Just as VCs perform rigorous
due diligence before investing, an entrepreneur ought to weigh the prospective
benefits that a particular venture firm can offer to the company.
Setting
expectations
An important part of every successful partnership is
the setting of expectations at the outset. In order to build a successful venture,
VC funds and entrepreneurs should view their relationships as a true cooperation
and partnership.
The following statements should be engraved in the minds
of entrepreneurs and VC funds to avoid later frustration.
- VCs are not
the enemy.
- VC success is dependent upon the entrepreneur.
- VCs are
not set up to run businesses.
VCs are responsible to oversee their portfolio
companies.
The entrepreneur has to make decisions on his own. If the VC is
playing too strong a role, at some point it may be handed the keys to the front
door.
VC involvement
Many VC funds talk about a "hands-on"
approach. In practice, the scope of activities is confined to the following:
- Assistance in recruiting senior management
While quality ideas
come from talented individuals, quality start-ups require talented teams. A successful
business is usually an outcome of teamwork, not an individual. VCs typically prefer
a team that has worked together in the past in some capacity. One of the most
frequent mistakes by "first-time" entrepreneurs is hiring the wrong person to
fill a key position.
The most frequent failure that Israeli start-ups
encounter is hiring an incompetent US CEO and/or VP Sales. Although there is no
guarantee that the assistance of an experienced VC will prevent frustrations and
the hiring of unsuitable people, the VC can at least reduce the probability of
repeat mistakes. Many start-ups are founded by a core team of two to three people
who know each other from the past.
The selection of co-founders should
be performed carefully. The reason that entrepreneurs seek to add co-founders
is to consult with trusted partners in uncertain situations. Entrepreneurs often
forget that it is like a marriage, and divorce is very painful and expensive.
Another frequent mistake made by inexperienced entrepreneurs is hiring
for convenience rather than skill. Experienced VCs know that hiring relatives
is not desirable. In many cases, they are the wrong people for the job. Moreover,
friends and relatives are difficult to fire should they prove not right for the
position. VCs know that people are to a business what location is to a restaurant.
It sounds almost a cliché to say I would rather have an A team with a B idea than
a B team with an A idea. The right team can fix a lot of problems. A great management
team will be able to adapt to a changing environment.
- Hand holding
and sounding board
VCs bring to the table the relevant experience of a
"man with grey hair". VCs serve as an objective eye to subjective entrepreneurs.
Experienced VCs can see the signals of failure in the raw stage. Based on the
accumulated experience of many ventures, VCs know that things are going to go
wrong. They are going to be harder, take longer and cost more money than the assumptions
in the original business plan. Companies have to have a strategy to survive.
- Long-term oxygen provider
A typical start-up raises funds over
the course of a few rounds. Development of a detailed set of financial forecasts
demonstrates to VCs that the entrepreneur has carefully thought out the financial
implications of the company's growth plans.
Preparation of sales forecasts
can be a difficult undertaking. Inexperienced entrepreneurs will underestimate
the amount of money and the timetable to achieve beta customers. VCs can help
in fine-tuning the raw estimates and convince the entrepreneur to raise enough
money to achieve a significant milestone required to trigger an up B round. Strong
and committed VCs with deep pockets can assure bridge financing in case a company
encounters delays in securing a new round.
- Business development
VCs should help introduce start-up companies to potential customers and
business partners. Sophisticated entrepreneurs understand that getting early traction
with marquee customers and partners can accelerate the penetration pace. The ability
of VCs to open doors to these accounts is highly valuable.
- Exit
strategy
The goal of a VC is to help the entrepreneur build a great company.
Success is measured by going public or trade sale to another company for a meaningful
price.
VCs and entrepreneurs should develop an exit strategy and think
about it in advance. The investment model of VCs calls for preparation of an exit
strategy from inception. If we can describe the investment act as a marriage between
the VC and the entrepreneur, the couple should agree on day one about the divorce
process. There should be long-term alignment of interests between the VC and the
entrepreneur.
Many entrepreneurs tell VCs what they think the VCs want
to hear. This is a mistake. VCs have realistic expectations about exit options.
Many companies are developing products to meet the needs of emerging markets.
In order to survive as a stand-alone company after raising a reasonable amount
of capital, the target market should evolve at a pace that will enable the pioneer
company to capture a significant market share.
Any delay in the maturation
of the market will enable the big guys to catch up and launch their own products.
In such a case, it is clear that the optimal exit strategy is to sell the company
to one of the potential competitors that is considering whether it should build
or buy.
Challenges in seed investing
VC funds face several
challenges when considering seed stage investments. Among them are:
1.
Early stage ventures have difficulty getting their business off the ground.
2. Seed stage returns are typically realized upon 5-7 year investment time
horizons.
3. Seed stage companies need less money than their later stage
counterparts, but require much more hands-on help.
4. Large fund dynamics
preclude managers from investing in seed stage companies. Alternative strategies
to seed investing
In order to cope with the challenges of seed investing,
VC funds should consider unique approaches. At my firm, Giza Venture Capital,
we've adopted unique business models that were structured from inception to the
special needs of seed and pre-seed situations.
We were among the founding
entrepreneurs/investors, along with Teva Pharmaceutical, Hadassit and others,
in BioLineRx, which offers an innovative approach to drug development. It seeks
to leverage the accumulated IP generated in Israeli academic institutions, incubators
and laboratories in order to create new blockbuster products. Giza and its partners
have ensured that BioLineRx will succeed by providing appropriate funding from
day one, and by building a strong management and drug development team, complemented
by a hands-on world-class advisory board.
Another model to seed investment
is through ATI - Accelerated Technologies, which accelerates the development and
market entry of companies focused on cardiovascular medical devices. ATI is led
by hands-on world-class opinion-leaders, a physician-founder team and experienced
management with the intimate and continuous involvement of investors.
The
entrepreneur-in-residence program, such as we have at Giza, is yet another approach
to seed investment. EIR candidates are seasoned technology executives and former
entrepreneurs that are invited to join a venture capital firm for a time on a
stipend in order to create a business from within and/or join a new venture that
needs leadership.
The VC role is to assist with market assessment, sizing
and competition; technological feasibility and value proposition; customer and
partner introductions; and team building. And a measure of good fortune
In
conclusion, we have tried to shed light on investing in seed opportunities. Special
models for investing can be very beneficial, but we should also remember that
a little good fortune never hurts. This article first appeared in the Israel
Venture Capital & Private Equity Journal. IVC Research Center publishes the
Israel Venture Capital & Private Equity Journal (IVCJ), a quarterly review of
trends and developments in the Israeli-related venture capital industry. IVCJ,
distributed worldwide, is dedicated to provide wide-range coverage of Israel's
venture capital industry. For more information please visit www.ivc-online.com
|
