These are tough times for cleantech startups in need of capital. In the 2010 cleantech venture tally recently put out by the Cleantech Group, despite their positive spin on it even they had to acknowledge that Q4 was a second straight down quarter -- only Q1 and Q2 made 2010 look good. Heading into 2011, while I do think there will be a bit of an upward trend, there's little reason to think VCs are going to start pouring significantly more capital into the sector anytime soon.
So what is a cleantech entrepreneur to do, just fold up shop? Some will be forced to do so. Others will turn to alternative sources of funding (grants, NRE from strategic partners, or non-VC funding like angels and family offices). But for those out there looking at raising venture capital in 2011, I thought I would offer some words of advice.
This is all just one investor's impression of what will work overall, based upon lots of calls and meetings per week with entrepreneurs seeking funding. This list might be inappropriate for the specific investor you're speaking with. It might just be flat out wrong. Take it for what it's worth, food for thought.
1. Be prepared to hold a lot more meetings and take more time than you usually would have to
I've never seen such healthy deal flow as I do in the market right now. To the point where I just can't keep up with it, which is pretty frustrating.
From the entrepreneur's perspective this simply means more meetings and more time to get the deal done. Expect it, and plan for it. Start the fundraising process early.
2. Pre-qualify your prospective investors before spending too much time with them
With so many cleantech investors themselves short of capital, many just simply aren't in the market for new deals. But they can't say as much. So I hear a lot of investors say they have room for "one or two more deals" in their current funds. Some mean it. Others are just saying it, so that they have the excuse to keep seeing deal flow -- they need to show LPs they're seeing interesting deals.
Ask them if they're out raising a new fund. Ask them not just if they have dry powder for new deals, but what and when was the last new deal they did out of their fund. When possible, create a sense of urgency, a sense that the deal is moving somewhat quickly -- not so quick that you drive investors away unnecessarily ("we're expecting term sheets in two weeks!") but enough where you shake out the investors who simply don't have the bandwidth or fund situation to move quickly ("we're looking to bring in term sheets in about a month"). Be proactive about scheduling the follow-on meetings with a good pace to the iterations. If there's an investor you like and they just can't deal with putting out a term sheet in that kind of time frame, or keep up with once a week meetings, be respectful and understanding about it, but you might need to consider them more as a syndicate partner for the eventual lead.
3. Lead with the team
Many investors are increasingly aware that the innovation cycle in cleantech is often much faster than the market adoption cycle. This is de-emphasizing the importance of one innovation versus another, because it creates a backlog of innovations. I often describe the current period for many -- but not all -- cleantech sectors as "VHS vs. Beta time". Furthermore, when times still look a bit rocky investors are needing to feel confidence in the teams they back. For these and other reasons, with a few exceptions many investors are making Team their single biggest decision-making criterion.
I've certainly talked with some investors who still feel that the innovation is the most important thing. And that the investor's role is to build the team around the innovation. That's fine, and may work well for them. But for me, in an era where I see a backlog of more than 200 venture-backed solar startups (for example), what are the odds that one solar technology truly is so much better than any other solar technology that it can succeed regardless of the caliber of the team? It seems much more likely that the successful investment might not be the single best technology, but instead will be a pretty good technology but a world class team.
So I and other investors increasingly need to get to know the team as a first order of business. Therefore put it up front, in your pitch and in your message. Tell the investors about the team, and specifically why this team has an extremely high chance of succeeding in this particular challenge. Don't just do the classic 1 page, 3 one-line bullets per team member, very resume-oriented slide, squeezing in a brief mention of advisors.
We're all familiar with the chronologically-structured format of a resume. There's an alternative format to resumes where you organize your accomplishments by key functional areas of relevance to the specific job you're seeking. Do that, but for your senior team. One page where the key functional challenges the team faces are juxtaposed with the past accomplishments embodied in the senior management team that address those challenges. Then another page to give the more basic biographical information.
It's not just about past successes. Focus on demonstrated skill sets, not some lucky exit one team member had in another sector some time back.
And don't try to hide gaps in your team. Show self-awareness. A gap in an otherwise strong team isn't a problem for many investors, it's an opportunity to display "value-add"... as long as the rest of the core team is solid, and is 100% in favor of filling those gaps, even when they're at very senior levels (perhaps even CEO) in the management team.
Your goal is to make an investor feel confident that this is a team that will succeed one way or another. Not hopeful the team can make it work, with help from investors. Not just impressed with the potential of the team. But confident that this team already knows what they're doing for this specific business and market, and pragmatically understands their strengths and gaps.
4. Paint a vision of what a big win could look like
Don't be afraid to describe a very big vision of how your effort could reinvent a multi-billion dollar industry. With many investors hoarding their remaining capital, they're not going to be looking for investments that can only provide moderate returns even if they succeed. These investors want to feel like there's a really big potential story to be told. Remember, you have to tell a story that's plausible enough that the investor would be able to describe it to prospective LPs with a straight face. Don't manufacture a big vision just to do so -- but if you believe in one, don't hold back.
5. Don't be afraid of niche early markets
Even while presenting an exciting story of market reinvention (or whatever your "big win" story looks like), be ruthlessly pragmatic about early market entry. You can't reinvent any cleantech market in year 2. But you need revenue in year 2. Often what appears to work (at least to me) is to find an early-adopter niche market for your tech/service/product. A niche where the economic value proposition is clear, the playing field is less crowded, there's an openness to trying new things, and direct sales is an accepted model. And hopefully where your team already has made some inroads, in enlisting early trial customers if not actual contracted revenues.
I know some investors who feel these are just distractions, and that want their startups to go after the big market with single-minded purpose from day 1. I disagree, at least within most cleantech sectors, because these markets can be so hard to penetrate, much less dominate.
The niche market becomes your beachhead. It reduces the risk of the effort, brings in early cash, accelerates your learning, and in fact helps you gain the legitimacy you'll need when you start going after bigger fish.
After all, even black swans need to learn to swim before they can learn how to fly.
6. Be flexible about the amount of money you'll take
Increasingly, I see a mismatch between the funding needs of a company, and the size check that investors want to put to work. And it may surprise you to hear that the problem's often not companies asking for too much money, but the opposite.
A lot of surviving cleantech startups have made it this far in the economic downturn by really running lean. Especially with such a recent emphasis on "capital efficient" business models. So they may need only a few million dollars in new outside capital (especially if existing investors are exercising their pro rata rights in a follow-on round).
The problem is again that many investors are looking at doing fewer investments, so they want them to be big ones. Which means when they find one they think could be a big one, they want to put more dollars at work and own more of a percentage of the company.
There's a valuation component to the decision, of course. But also, startups need to be open to taking in more capital than they need.
On the other hand, I see many early-stage startups that are at an angel stage but are looking for venture capital dollars. These entrepreneurs need to think about how to break up their fundraising needs and either raise a smaller angel round to bridge to an eventual venture round, or structure a tranched venture round where the VCs don't have to put too much capital at risk until they see significant progress.
Finally, don't be too dilution-sensitive. Easy for me to say, I know. But be realistic, and focus on the bird in the hand more than the birds chirping away in the bushes.
7. Remember your prospective investors are viewing you through an LP lens
Even those VCs who aren't out of capital are keenly aware it's a tough fundraising market for them for their next fund. And so every investment they make is one they're going to have to justify not only on IRR grounds, but also as an indicator of what kinds of investments they'll make in their next fund. Especially since so many of their IRRs remain unrealized to date, they need really compelling stories to tell.
So help them tell your story. LPs need to understand how an investment fits into key themes the VC is pitching them on. So figure out what those themes are. Go ahead and bucket yourself, it's going to happen anyway so you might as well figure out the tagline and category you want to be associated with. Once you get a pitch meeting you can demonstrate more of the depth of your thinking. To get the pitch, boil it down to a one-liner that sings.
If you're in an out-of-favor sector, punch that shark in the nose. Tell investors you agree with the reasons why your sector is out of favor. But then tell them why your business is the exception, and why. It may be a more interesting application of a technology that never got market traction in other applications. It may be a significantly better way of making a product where others failed on cost and performance grounds. But make it absolutely clear that a) you understand exactly why the investor will be skeptical and for good reason; and b) you can arm them with what they need to be able to tell the story to their LPs, so that they sound smart and contrarian, not clueless.
8. Be polarizing
No, I didn't say be political. What I mean is that you need to be very distinctive, as a business.
Labrador Retrievers and Golden Retrievers have been the most popular dogs in the U.S. since 1991. Did you know that no Lab or Golden has ever won the Westminster Kennel Dog Show? The winner always seems to be some funny-looking dog, often a variety of dog you've never heard of even if the general category is familiar, and probably a dog that some people roll their eyes at and some people love. That's what you want your pitch to be.
If you design your pitch to be all things to all people, you'll probably be a solid B-grade investment opportunity in the eyes of most VCs. And only A-grade investments are getting funded right now.
If you go ahead and be bold in your vision, and take a very different tack on things, and are a bit contrarian, you'll turn off some investors. But to others, you may really stand out.
No need to be a jerk about it or anything, and remember it's dangerously easy to cross the line from "different" to "not credible". Don't manufacture some strange point of view just to stand out. But figure out what makes your business truly different. And really emphasize that, pretty much no matter what it is. And when investors push back on that ("no, that's not how you should try to sell this product'), go ahead and respectfully disagree. The dialog will be healthy. And although you'll turn off some investors who are just convinced you're wrong, you might really turn on some investor who sees something that stands out.
It would probably be best to try this out on some peers, or even better investors who are willing to help but won't be a fit, before you go to investors you care about. Really easy to hit the wrong tone here. But it's basically like dating... Be yourself, and emphasize what makes you special, don't just be one of the crowd.
9. Be prepared and thorough
Show that you have a really good depth of understanding of the specific markets you're going into. And a deep knowledge of your competitor set. And a healthy respect for the challenges other companies in your sector have encountered before you. Show that you know this is hard and you're doing your homework and taking a sober approach to your otherwise contrarian and breakthrough vision, in other words.
I meet with too many entrepreneurs who try to tell me it won't be as hard as I know it will be. And who haven't heard of the competitors I mention. And who kind of wave their hands when describing the potential customers they'll sell to, with an air of "well, we'll figure that out when we start talking to them for real." Uh huh.
Also, make sure you know what's going on in your sector not only in your local region, but across North America if not globally. These are global markets, and it's very easy for entrepreneurs to get parochial and think they're something special just because they haven't talked to anyone in other innovation regions -- which can be deadly when they find out too late that others elsewhere have been doing the same basic thing.
It will be tough to raise funds from new investors in 2011. But not impossible. Even in a down market, there are investors actively out there in the market, looking for great things. I hope these suggestions, while explicitly to be treated just as food for thought and NOT as direct instructions, help you show investors how great your company really is.