If you are trying to raise early stage venture capital and are actively engaged with a VC or two, you may have noticed a funny variance in the VCs level of interest, excitement and mood. This is completely normal! As a startup’s dialog with a VC matures the VC will go through a totally natural “Deal Hype Cycle.” I’ve diagrammed the important stages in this venture capital deal hype cycle below and included some tips on how you can recognize these stages in your potential funding partner - and what you can do to help keep the process moving along. As a startup CEO, you don’t have to be a passive participant on this roller coaster… you can positively influence the VC and keep your fund raise on track! Note also that this is the cycle for an investment that actually closes.* (You may also be interested in my previous post on the VC deal process.)
Stage 1: The Pitch
Hype Level: Pretty Good
If the VC took the meeting with you they must be at least decently interested. Most business plans introduced to venture capital firms never make it to this stage (i.e. are never met with), so your startup probably has something going for it.
What you can do: Deliver a good pitch. Answer the VCs questions as them come directly, but stay on message and get through the important parts of your business. Manage the time carefully! (At some point I’ll do a post or two with simple tips for delivering a good VC pitch.)
Stage 2: Happy Thoughts
Hype Level: Elevated
If the pitch went well the venture capitalist is hopefully thinking through the ideas that you presented. He/she may talk to another member of the venture capital firm or make a phone call to a portfolio company CEO to answer some basic questions, such as “Hey, would you buy something like this? Are you having this pain point? Have you heard of this founder guy? Is this technically possible?” This stage is very important for the VC deciding to commit time and effort to digging into your startup. You need the VC to internalize your basic premise.
What you can do: If the VC asks you if he/she can discuss your idea with one of the venture capital fund’s portfolio companies or with a friend of the firm, say yes. (VCs are usually pretty careful with portfolio company’s time and often are careful using “favors” with experts in their networks. Taking the time to do these things is a good sign that the VC is trying to work up enough mojo to spend time on your company.) Follow up on open questions left from your initial meeting, usually with things like financial models or industry research reports. Make sure the investor knows you are willing to introduce him/her to other members of your team or key contacts such as initial customers.
Stage 3: Real Work (Diligence)
Hype Level: Varies from Good to Poor to Good
There is naturally a depressed/low point to the deal cycle. This is the point where reality sets in and the venture capitalist realizes that the startup’s life is going to be more difficult than originally anticipated. It is totally normal, and it is the time where most VCs will do a serious bit of reflection and decide if they wish to continue trying to justify an investment in the company. Issues that contribute to this low point may include the VC deciding that the team needs additional management talent, that the overall market is too small, that the competition is too strong, the technology is going to be too hard to create, etc.
What you can do: You need to understand what the VCs real issues are and work to address them. Listen carefully to what the VC is saying, and try to match it up with their diligence requests/actions. There should be a method to their madness. For example, if they have conducted several meetings with their outside “experts” and your CTO, and continue to ask questions about the technology then they likely have serious fears that your technology isn’t feasible. Figure out the roots of this issue and address it head on. VCs can be dense, so this may require several attempts. You need to get the VC off of the low point and thinking positively again about your company.
Stage 4: Confirmatory Work
Hype Level: Should be High and getting Higher!
The VC has answered the hard questions and is now tidying up their diligence process, making sure all of the easy questions have been answered. They also may be aggressively introducing you to potential customers, in the hopes that their investment thesis will be “agreed to.”
What you can do: Responsiveness is key at this stage. The VC wants to know that you have an executive team that can “be worked with.” This means that you’ve adjusted your plans based on what you as a company have learned from the diligence process (or maybe what the venture capitalist has “taught” you - be careful who you decide to work with!) If the VC has introduced you to potential members of the executive team you’ve gotten them to join your company or come on after the funding closes. Finally, keep abreast of changes in the market or competitive landscape.
Stage 5: The Close
Hype Level: Off the Charts
When the deal closes everyone should be wildly optimistic. This is pretty much just human nature and you should enjoy it. The optimism around the company can be offset by difficulty in negotiating the final stock purchase agreements and other legal minutiae.
What you can do: Keep on top of your lawyer and make sure they are responding quickly with changes to the legal documents. Believe it or not, I’ve seen good deals die here - always due to an inexperienced attorney representing the company. Make sure you’ve got a very experienced lawyer!
Wow, this got to be a long post. I hope you found it interesting and welcome your comments!
*Keep in mind that very few potential venture capital investments become real venture capital investments. The hit rate for firms trying to raise venture is quite low. At any point along this cycle the process can grind to a halt and the venture capital firm can pass on investing in your startup.
