Learn the Ropes of Entrepreneur- VC-Angel Tug of War

Karen Bantuveris entered the spring of 2009 hopeful that her company VolunteerSpot would receive the $450K in seed funding that would take it to the next level. But when the Texas-based startup actually did receive a bite from a local angel group, it decided to decline, and instead to create and go with a plan B.

“We were offered a Series A (the name typically given to a company's first significant round of venture funding) in the spring. Their terms were not acceptable to us. They wanted a lot of control for not enough money,” she said.

So VolunteerSpot walked away from the offer, with no regrets.

“We turned down the Series A at a time when we really needed the money, but in the long-term, it will be an advantage for us because we were able to prove customer acceptance, rapid growth and develop revenue features that will make us even more attractive to investors, at better terms, when startup investing is healthier,” said Bantuveris.

It’s a common tug of war that plays out between entrepreneurs and potential investors. But in the 2009 economic climate, as angels and venture capitalists tightened their grip on the rope, companies seeking funding found themselves playing by a new set of rules.

So what’s the state of the playing field and what can entrepreneurs expect from investors in the coming year? FoxBusiness.com spoke to angels and venture capitalists to get answers, advice and predictions.

David S. Rose – Angel Investor – Rose Tech Ventures

Jalak Jobanputra – Venture Capitalist – New York City Investment Fund

Owen Davis – Angel Investor – NYC Seed

Chris Fralic – Venture Capitalist – First Round Capital

Q: How has the economy changed your investment strategies?

Rose: For angels, there have been two significant effects of the downturn: First, virtually everyone has less available cash to invest than previously, and as such most angels are investing more carefully, concentrating their resources into fewer deals, including follow-on rounds (a subsequent investment made by an investor who has made a previous investment in the company) in companies already in their portfolios.

Second, because venture capital has tightened up, we no longer invest on the assumption that VC financing will be available to take over from us for the next round. Instead, our goal is to invest in companies where our initial capital can at least take them to cash flow break-even.

Jobanputra: The basic premise of investing in strong entrepreneurs in promising growth segments has not changed.  However, given the amount of economic uncertainty, we want to make sure that companies are raising enough money to give them 18 or more months of runway (the amount of time an entrepreneur can operate without additional funding) and working closely with the entrepreneurs and other investors to make sure that the companies are hitting their milestones.

Fralic:  We haven’t changed our strategy during the downturn, and in fact were as active in the last year as we’ve ever been. One thing that has been affected is the exit environment – exits (the sale or exchange of a significant amount of company ownership for cash, debt, or equity of another company) were harder to come by and valuations were down over the last 18 months.

Q: What are the biggest challenges and opportunities for entrepreneurs trying to obtain capital next year?

Rose: The market is only just now beginning to right itself, and competition for dollars is intense. It is important for entrepreneurs to realize that of companies seeking equity financing, only one in 40 is likely to receive angel funding, and only one in 400 venture funding. As a result, the bar for achievement has been raised, and investors expect to see quite a bit of traction.

Jobanputra: A lot of investors are looking for some market traction, customers that are using the product and show some willingness to pay for it.  It also takes longer to raise money these days.

Davis: There are many opportunities for companies in the coming year.  The intersection of mobile, real-time and location is very compelling.  Real-time information and next-generation of messaging are also important trends that will attract a lot of attention. The challenge is the same challenge as always; finding a great team that can build great technology, positioned to exploit an interesting niche.

Fralic: I’d say the biggest opportunity is that the VC community is increasingly open and accessible – more and more firms have started to hold events similar to our Office Hours. Dozens of VC’s and their firms are now blogging and Twittering. Here’s my Twitter list of VC’s to follow: http://twitter.com/chrisfralic/vcs2follow.

Q: What are the key attributes you look at when valuing a potential investment?

Rose: Management with high integrity, startup experience, significant domain expertise, a growing market and a business model that can rapidly scale.

Jobanputra: First and foremost, I look at the management team.  If there is just one entrepreneur, does s/he have the passion, commitment and drive to attract others to the company?  Will this person be flexible and work in tandem with the board to grow the company?  Does s/he have self-awareness, an understanding of his or her weaknesses so s/he can bring in people to complement him/her? Then I look at the product and market.  What market voids is the company addressing?  How big are the market voids and how much capital will be required to build out the product?  Who are the customers and competitors? And who will potentially be interested in acquiring the company down the road?

Davis: This is hard to answer because there are so many facets that make a company succeed. Facets include the technology and/or service of the company, how large is the market, timing of the product, flexibility of the team, execution and discipline and a host of other characteristics of great companies.

Fralic: We look for big market opportunities and great entrepreneurs, and we like to invest in areas where we think we can add value beyond just our capital.

Q: What’s the one piece of advice you have for business owners trying to obtain capital?

Rose: Don't! Seriously, though, the best thing a startup company can do is bootstrap to the greatest extent possible. The farther an entrepreneur can go before trying to obtain capital, the easier it will be.

Jobanputra: Make sure you understand your market and where your offering fits in, because you will need to educate the investor and instill confidence that you have an understanding of where you fit in the marketplace.  It’s always surprising to me how many entrepreneurs do not have this basic piece covered.

Davis: It may sound obvious, but do your homework in terms of who to approach and how. There is more than enough information online to learn about how to put together a good pitch deck, who is interested in what you are working on and other aspects of the process.

Fralic: Think about how much money you need and ask for that or maybe a bit more.  Focus on the firm/partner you’re working with more than just focusing on valuation.  You’ll be working together in good times and in bad times, so you want someone you can work with.