Venture capital funds, business angels, or self-sufficiency?

Original author: Anand Rajaraman
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Greg Linden was one of the main developers behind the Amazon Advisor system, which recommends books, movies, and other products to its users based on their purchase history. He subsequently received an MBA from Stanford and in 2004 launched a startup called Findory, which offered personalized online newspapers. It’s hard to imagine someone more suitable to make this project a success, but Fayndory ceased to exist in November 2007. In a brilliant “grave speech”Linden pointed out that his biggest mistake was to finance the project on his own, while he was simultaneously trying to raise funds from venture finance companies — he simply could not convince them of the feasibility of the investment. Instead, he should apply for funds to business angels (a business angel is an investor ready to invest in the initial stage of an untwisted project).

upd This publication is now on the Venture Magazine blog.


Where to get start-up capital is an important decision for anyone who starts a project from scratch. In the early stages of a company’s existence, there are three possible sources of capital:

1. Venture capital funds;
2. Business angel. Usually these are wealthy individuals, but sometimes these are companies such asY Combinator ;
3. Friends and relatives. You yourself, if you can afford it.

In order to decide which option is best for your startup, you need to understand how investors value companies. Of course, there are a number of criteria, but the main three are: team, technology and market. Business angels and VC evaluate them differently.

How VC evaluate projects from scratch


Market. VCs want to invest in companies that give significant returns in terms of capital intensity (or the amount of their capital), which is usually valued at hundreds of millions of dollars. In order to interest VC companies, it is necessary to catch a fairly favorable market situation. If you cannot provide sufficient evidence that your idea will bring the company a return of at least 100 million USD in the horizon of 4-5 years, then VC is not suitable for you. Often it is enough to use consumers as the main point, replacing a favorable market situation; most VCs will accept an extensive and rapidly growing user base as sufficient evidence that market conditions and opportunities are favorable in relation to your project.

Command.VCs use simple binary classification. The founding team is deemed to be worthy of support (or in itself is considered “with strong rear”) if it contains one or more attracted key figures from successful or fashionable companies (such as Google) or entrepreneurs who already have assets, at least one firing project. Otherwise, the team is considered as a "team with weak rear areas."

Technology.VCs are not always well versed in technology assessment. For them, technology is either a risk (the team claims that their technology can do X; is that so?) Or it is an entry barrier (is the technology sophisticated enough to prevent mass entry of competitors into the market). If your project uses non-trivial technology, it will be very useful to have a person in the team who is a recognized expert in this field, either as a founder or as an invited specialist.

Here's the rule that VC needs to follow for you to vote: you must pass a test for favorable market opportunities and at least one of the other two tests: either you have a team with good rear areas, or you use a non-trivial technology that will stop competitors by its complexity from entering this market segment.

How business angels evaluate projects “from scratch”


There are many types of business angels, but I recommend choosing only one type: someone who was himself a successful entrepreneur and is deeply interested in the target market segment or technology that you are promoting. Here's how angels evaluate the three main investment criteria:

Market: you pass the test even if the market segment is just starting to develop, but both the angel and the team must believe that in a few months the company will reach a point where it can either convincingly show that the situation is on the market is favorable and provides many opportunities (and thus attracts VC) or to develop technology valuable enough to be acquired by a large company.

Command:there must be a person in the team whom the angel knows and respects from a past life.

Technology: technology should relate to an area in which the angel has experience and which he understands well.

Here's how the angel will vote: You must complete any two of the three tests (team / technology, technology / market or team / market). I financed all three of these combinations, and subsequently it led either to subsequent financing from VC (for example, Aster Data , ...), or to a quick takeover ( Transformic , Kaltix are both absorbed by Google).

Friends, Family or Self-Financing


This is the only option if you do not pass the criteria required by VC or business angels. However, beware of staying in the “self-financing” mode for too long. An external investor provides valuable authoritative opinions and prevents the situation when your company becomes an empty room where only your own ideas are echoed. Angel or VC can look at things in the long run. Sometimes an investor can impose something that later becomes a boon for the founder’s career: to close the company and do something else. This is a very difficult decision that is difficult to make without an external investor. My advice is to provide the project yourself only until you decide who you can attract - VC or a business angel.

But back to Greg Linden and his project Findery. According to my calculations, Findery passes tests for the team and technology from the point of view of an angel - if there is an angel who is interested in personalization technology. But the project does not pass a single test for VC. Given this, Greg should definitely have sought funding for the angels. It seems to me that this road would most likely lead to the subsequent sale of the company to one of many potential buyers: Google, Yahu or Microsoft, among many others. Of course, it is easy to argue retroactively. I deeply respect Greg’s mind and dedication, and wish him more successful endeavors in the future.

Anand Rajaraman is a co-founder of kosmix.com and a founding partner of Canbrian Ventures. As well as an investor in GigaOM.

Translation of the article on Translated.by.
Translation: © Renata33 , the_corrector .

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