How to Shop for Venture Money – Rule #1: Don’t raise money. Rule #2: Choose equity investors with a long-term view. Rule #3: Choose equity investors with a real life view. Rule #4: Choose equity investors who understand and are passionate for your

A couple weeks ago, Microsoft hired Jessica Simpson to entertain the geek hoards at its annual TechEd in San Diego. Sitting in the front row (don’t ask) watching Jessica serenade a privileged ubergeek in a chair on stage (admonishing him with "Don’t touch my butt!") I couldn’t help but hearken back to the good old days and wonder if it’s time to belly back up to the bar.

Martin Tobias, Ignition Partners

http://www.nwen.org/venturer/0904/article2.htm

Recent metrics and my own experience working with entrepreneurs shows a marked improvement in the environment for new tech companies. IT budgets are growing, VCs are writing checks again, Google is going public soon, and, most importantly, smart people are starting companies. Last time around, many otherwise level-headed entrepreneurs got caught up in the froth and engaged in a multitude of unnatural acts. Many investors counseled their companies to "get big fast" and spend lavishly to get ahead of the competition, if only in number of press hits. Last time around, money was basically free. This time around, it won’t be free. Hopefully the advice you get on growing your company will be better as well.

So, what can an aspiring entrepreneur do to avoid getting drunk on the Kool-Aid? The good times are fun, but how does one choose investment partner wisely? As a company founder myself now on the venture side, I have put together a handy-dandy little guide called "How to Shop for Venture Money."

Rule #1: Don’t raise money.

What? A VC saying don’t sell equity? Selling equity is the most expensive way to finance a company. Exhaust ALL other options first. When I left Microsoft in 1997 to start Loudeye, the first six months were total bootstrapping. We begged, borrowed, and squeezed whatever we could out of our reserve cash, friends, neighbors, and even strangers. The first money into an idea is always the most expensive, and it should be your own if you can afford it and your own sweat if you can’t. If you believe in your idea, run up your credit cards, take out a second mortgage, apply for research grants, go to the SBA, borrow money from your parents-whatever you do, putting some real skin in the game before sharing with any equity investors. Think about it; future investors will value the personal commitment: if your idea is great, why sell part on the cheap? Here is another trick: Put in the early money as a bridge loan, which converts at a later financing round. Let the market put a value on your idea later, after it is worth more! Necessity is truly the mother of invention. Less money = more necessity = more invention!

Rule #2: Choose equity investors with a long-term view.

When you go to a bank to borrow money for a car they ask what your income will be next month, check your credit, ask for a financial plan, and make a decision. If anything material in your financial plan changes, they will probably want their car back. Banks have a very low tolerance for ambiguity and bumps in the road. I am starting to see business plans again that are "built to flip"-companies with an 18-month view of the world going for a quick sale. Your equity investors should not act like this or condone these strategies.

Investors who have been through a couple of tech cycles will have the right tolerance for change and desire to build a business with legs-in good times and bad, in sickness and health (sound familiar?). Ideally there should be a similar level of commitment. Software products are especially iterative undertakings. Remember Microsoft Windows 1.0? 2.0? 3.0? You probably didn’t buy until 3.1 with everyone else. As an entrepreneur with a big vision, you need investors who share a similar time frame.

Rule #3: Choose equity investors with a real life view.

Good equity investors should be business partners, not just financial investors. Purely financial investors should be the public markets. Unfortunately, as the mood brightens, many of them will come back into the private equity markets. Look for people who have worked in related businesses to yours. An entrepreneur-turned-investor who has raised money and run a P&L statement is a good bet. Ask for references from other companies they have invested in. Call the CEOs. Ask how the board meetings go, what kinds of questions are asked, how the investor manages, their level of engagement, and so on. Google your potential investors. How active are they? Do they contribute to trade publications? If they have a blog, read it. Through this research, if you get the feeling that potential investors are more interested in their golf handicap or mastering an Excel spreadsheet, move on. Life is too short.

Rule #4: Choose equity investors who understand and are passionate for your business.

Great startups solve hard technology problems. I am a technology geek. My first computer was a Tandy TRS-80. I owned a Timex Sinclair, a Kapro, a Commodore 64, Compaq’s first "luggable," and many other firsts that I am embarrassed to admit. I get bored if I don’t have a hard problem to solve. I find it incredibly stimulating to be around other people with a passion for technology and a desire to solve hard problems.

Investors whose interest in your business is primarily financial and have only a passing interest in the hard problem you are trying to solve can actually do more harm than good. A good way to test this is to pay attention during the diligence process. Do they ask informed questions about your business? Or is it the standard "What keeps you up at night?" Do they get up to the white board during the presentation? Are they candid and helpful with feedback? If you don’t come out of a meeting with an investor feeling smarter, more challenged, and more engaged with your business, move on to another investor.

These rules work best if practiced from the very start of your idea. But it is possible to apply the learning later. Look around the table at your next board meeting. Did you get the most out of the first money into the idea? Or did you raise too much money too early? Do the investors share your long-term view? Has their behavior to date reflected that (don’t expect them to change)? Are you getting real-life advice from your business partners? Or has their advice tended to randomize the company and take it off on wild tangents? Do the investors really share your passion for the hard problems you face? It is never too late to get the right business partners around the table.

With money getting easier to raise, entrepreneurs will have more choices. Learn from the past. Build your next venture with business partners who have been through it and share your passion.

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Martin Tobias is a venture partner with Ignition. This article first appeared in the Always-On Network (http://www.alwayson-network.com)