Thursday Feb 28, 2013 by Stephen Kraus - Partner, Bessemer Venture Partners
February is always a special month for me. Yes, in the Hallmark sense, it is the time of the year to celebrate love but, for me, February is one big celebration of the best thing in my life – my wife, Sarah. The second month of every year of course includes Valentine’s Day but also Sarah’s birthday and, most importantly, marks the time ten years ago when I met this wonderful woman.
Well, truth be told, our first date wasn’t so great. Not because I wasn’t smitten with Sarah but rather because I apparently flubbed the first encounter in a royally big way. Ten years later, I still have vivid recollection of the details of that night. I remember where we went to dinner (DeLux in the South End), what I ate/drank (grilled cheese and a bourbon), what she wore (a cute blue dress with a leopard print hand-bag and green eye shadow) . . . but most of all I remember the specific question I asked that night that sunk any chance of a second date.
“What are your life goals?”, I asked Sarah mid-way through our dinner.
Ever the funny one, Sarah has later joked many times when we have re-told this story to friends that her initial reaction was to answer, “to get through the four US Weekly’s sitting on my bedside table!”
Now, truth be told, Sarah did and does have very ambitious and aspirational life goals, many of which she has gone on to fulfill. But, at the time as a twenty-two year old just out of college, that question seemed a little too serious for the setting. And so we parted ways that night as did any chance of a Sarah-Steve combination presumably.
If you have gotten this far, you may by now be asking yourself why I am sharing this story in a blog devoted to venture capital? . . . The answer lies in the rest of the story.
You see, four years later, Sarah and I re-met at business school. We were friends at first but, by our second year, that friendship turned into a relationship. And that relationship has ultimately blossomed into an amazing marriage.
Yes, Sarah has had a lot of fun at my expense re-telling my bumbling of our first date but she also always ends the story by saying, “From that very first day, I always knew what kind of guy Steve was and what he was looking for in life.”
I share this story not to pat myself on the back for at least being persistent but because I think it is highly relevant to what I do for a living and how I try to do it.
If Investing = Marriage, does Diligence = Dating?
There is an old adage that choosing a venture investor is like choosing a partner to marry. In many ways, this analogy is spot on. Once the “knot is tied” (i.e., the documents are signed and the money is wired), there is no going back . . . well, actually there is, but as with marriages, the ending is often painful for both sides. And any partner of an entrepreneur or VC can tell you that their spouse sure spends a lot of time with said other entrepreneur/VC for not being legally wed to them!
But, in truth, a venture capitalist only invests in 2-3 companies a year and an entrepreneur only raises money every other year or so. So what is it that they do with the rest of their time when they are hearing or giving “pitches”?
The answer: DATING.
Yes, the secret is out, much of what I do on a day to day basis is platonically date entrepreneurs. While it may seem like a far-fetched analogy at first, many of the same rituals are shared and questions asked like:
If the analogy holds, then last year alone, I “saw” over 300 entrepreneurs, I probably went on a first date with ~150 of those, I went on a second date with fifty, I seriously dated ten and I got married to three (Liazon, Procured Health, and HealthEssentials).
If you are a healthcare entrepreneur reading this, you may be
thinking to yourself how do I improve my odds of getting from one of the
300 to one of the three? And thus the reason for the long pre-amble at
the beginning of this blog . . . As with my first date with Sarah, I
want to be crystal clear as to the type of investors we are and the key
things we look for in a healthcare investment opportunity at BVP.
The Insider’s Guide to Dating HCVCs:
Venture capitalists often use a bunch of different frameworks to analyze a company/investment opportunity. Our view is that whenever you are “pitching” a VC or VC firm, you should specifically ask what are the key criteria they will use to analyze your company. If you walk away from the first meeting not knowing the answer to this question, then shame on you.
To save you time and better prepare you for our first meeting (hopefully we get the chance to meet some time soon!), here are five key things we at BVP will be asking ourselves about your business.
1) Do the dogs eat the dog food? – More concretely, do end users/customers demonstrate that they “value” the product/service you are providing? For commercial stage companies, this is demonstrated by increasing year-over-year revenue, gross margin and EBITDA trend as well as decreasing (or better yet net negative!) churn. For companies who have launched a product/service but have yet to monetize it, this is shown by increased user engagement, by increased (and ideally viral) adoption throughout an organization/network, and by persistent stickiness. For all companies regardless of stage, this means the entrepreneurs/executives have spent time calculating, testing, and proving that there is a clear financial return-on-investment for a customer who buys your product or service . . . no pop quizzes here, rest assured we will ask you about and want you to walk us in painstaking detail through your ROI calculation.
2) Is your product/service pretty and powerful? –Specifically some questions we will ask along this dimension are: Is it well designed with a solid, differentiated, and hopefully defensible back-end and a friendly, intuitive, easy to use front end? Does it scale well and profitably? Specifically, what level of gross margin does it yield? How do you ensure a quality user experience? How have you integrated customer feedback? What does your product improvement roadmap look like?
3) How do you think about your business? – Of all the questions and items on our diligence list that we will send you, probably the most important to me is the KPIs (“Key Performance Indicators”) you use to manage your business. I want to know how you think about your business as, after all, I am betting on you to make it a success. And we are data geeks at BVP so the more numbers, the merrier!
4) Do you get the venture game? – This could be perceived as being code speak for are you capital efficient and, in many cases, this is exactly what I am asking about any entrepreneur I meet. After all, the less money you raise to get to an outcome means the better we all are. But some business models require more money to get to the promised land than others and, in these cases, we focus on whether the entrepreneur has laid out a clear, believable, and achievable path to milestones/value accretion such that the next round of financing will be raised at a significant up-round.
5) What’s love (or at least chemistry) got to do with it? – And if all of the answers to the above questions are positive, it ultimately comes down to that vague notion of chemistry. It is often hard to define chemistry; it can be guteral or something you know “when you see or feel it”. But, for me, some of the key things I look for in an entrepreneur and a potential relationship with him or her are: a strong sense of ethics/values that guide them, respect for their colleagues and investors, a seriousness of purpose coupled with a sense of humor, a transparent style of communicating which may even border on bluntness (much rather have this than passive or, worse, passive aggressive), a willingness to engage and be engaged (this includes in the initial meeting which should be a full give and take, not just a one way reiteration of your pitch-deck with me asking questions and you answering in rote fashion). All of this hard to measure stuff is often what defines whether our relationship will be a fun, productive, and mutually beneficial one.
Dating is a Two-Way Street
So that is what I am looking for. Hope it is clear and I also hope you are asking yourself, “what should I be looking for in him?” Ultimately, it is up to you to create a set of criteria that works for you when it comes to assessing the first meeting and an ongoing relationship with a VC. But in an effort to aid you in this process, here is a list that I have created and that I would be asking myself if I were an entrepreneur (hopefully, it is a little informed by how the process works on the other side):
1) Why is the investor taking the meeting? Do they have a thesis about the sector in which my company operates? – Investors find deals two ways: 1) pro-actively (i.e., they have a thesis in a space and they are looking to invest in leading companies in that space) - at Bessemer, we call this our “roadmapping process” – www.bvp.com/strategy or 2) re-actively (i.e., a deal comes over the transom from any number of sources but the investor has no real prior interest or knowledge in the area). If I were an entrepreneur, I would much rather deal with an investor behind door #1 for a whole host of reasons (they require less education and thus diligence will be quicker, they can provide me with market insight, they know the strategic players in the space, etc.) – all of which relate to my second point which is . . .
2) How can the investor add value? – There have been any number of blogs written on this topic so I won’t re-hash but, if I were an entrepreneur, I certainly would want to have a good sense of this after meeting #1 and would want to test throughout the diligence process and by talking to the investor’s references.
3) What are your key concerns about my business? – DO NOT leave any first meeting with a VC without specifically asking this question. Investors think about risks when assessing any opportunity (we are in the risk taking business after all!). You should be crystal clear what those perceived risks/concerns are when it comes to your business. Without knowing this, you have no chance to explain how you/the company plans to mitigate these risks/concerns and, without addressing this, you are less likely to advance to the next phase of courtship.
4) How are you going to get to yes . . . or no? Don’t be afraid to ask this question and push for specifics. You may feel a little pushy doing so but it is important to understand a given investor’s or firm’s process and timeline so that you can assess for yourself over time how the diligence and decision-making process is moving compared to how they said it would. If it is moving fast or on time, it means you are in good shape. But if it is moving slower than they said it would, you should address with them how to get it back on track and/or whether it even makes sense to continue spending each other’s time on it. If you don’t ask, you will never have a benchmark to assess against.
5) Chemistry . . . chemistry . . . chemistry – I told you my criteria; I will leave it to you to come up with yours. But if I were you, I would be asking yourself: “do I want this guy to be an important part of my life for the next 5-7 years in good times and in bad?” Like mine, your litmus test will be some amalgamation of a sense of admiration/respect/trustworthiness. The good news is that you can ask others who have been in your shoes. Ask for the investor’s references – both in deals that have gone well and in deals that have gone poorly or even ones they have lost to another fund.
Hopefully this list prepares you for a first meeting with us or any other VC, for that matter, and you won’t be caught off guard if any of these questions are asked. Transparency is always the best policy for me. While it may be perceived at times to be blunt or off-putting, it is the only way to do business (and life) to my mind. It not only saves time if there isn’t a fit but it is also key to building a respectful and meaningful relationship long-term. We may not decide to date or even get married after our first meeting but at least you will know where we are coming from and what is important to us if and when we meet again . . . it has happened to me before!
Stephen Kraus is a Partner with Bessemer Venture Partners in Cambridge. You can find this post, as well as additional content on his blog called HCVC's. You can also follow Stephen on Twitter (@stephenkraus) by clicking here.