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More in the 50 Questions SeriesHow does the structure of the VC industry impact investment strategy? | 50 Questions: To what extent should I encourage competition between VCs? | 50 questions: Should I hire an adviser? |
50 questions: Should I hire an adviser?
Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful.
This is question #25.
I need to declare a bias here. I used to raise money for companies. It’s not what I do any more, but I like to think that I added value. So this post is written from my perspective, but I have also canvassed opinion from other people to provide alternative points of view.
What does an adviser do?
Different advisers are good and different things.
Some are best at investor readiness. They help you understand how to explain your business in a way that will be attractive to investors. This includes, among other things, ensuring that you pitch a company, not just a product; explaining how your business will grow (for example, by showing why customer acquisition costs will be lower than the lifetime value of each customer); and helping you hone your presentation into a short, punchy pitch.
Others are expert networkers. I’ve already written about how there is no such thing as a typical investor. Worse than that, investment priorities can change over time. I’ve taken a company in to see one venture capitalist who opened the meeting by saying:
“I know that we used to be early stage investors, but we’ve just changed our fund focus to look at companies with at least $2 million of revenue.”
That was an enormous change, I meant they were totally the wrong investor for this company.
A good adviser will know all of the major funds in their region. They will attend conferences, have coffee with them, know their foibles, and be able to help you to identify and prioritise the best investors for your company.
The third important skill is getting the deal over the line. Although entrepreneurs fret about how to meet venture capitalist in the first place, the truth is that venture capitalists have a professional interest in meeting companies who may be interesting. Even if they don’t want to invest right now, they want to know what’s happening in the market, who the hottest start-ups are, and what areas are attracting entrepreneurs.
Much more difficult is moving them from initial meeting to term sheet and from term sheet to investment. At this point, an adviser who is skilled in keeping competitive tension, making sure there is more than one party in the game and who can provide a useful “back channel” for negotiation between the founders and the investors can make all the difference.
What are the negatives?
Some of the negatives which I hear come from venture capitalists, which means they may be good for entrepreneurs.
For example, some venture capitalists fear the competition that advisers bring. I think this is a pretty poor reason. A good company will be able to get the right valuation with or without an adviser.
More worryingly, some advisers charge high retainers that take scarce cash from entrepreneurs whose businesses are not really fundable. (See Is your business right for VC?). Don’t get me wrong, advisers should be paid. However, when an entrepreneur is sufficiently desperate, and an adviser is sufficiently hungry, they can end up working to try to raise money for a company that isn’t really fundable.
Finally, for hot companies, there is a worry that advisers can set unrealistically high price expectations. This might seem like a one sided concern from investors, but there is a deeper problem. High valuation expectations can slow down the deal, turn off high quality investors, and in extremis can cause long-term problems for the company. (See Mark Suster on why you should price at the top end of normal for a deeper explanation of this issue.)
And the conclusion?
My advice is that advisers can add a lot of value. However, it is important to do some due diligence on them before you commit. What deals have they closed? Can you ask any venture capitalists if they have an opinion of them? Do you know or can you contact any of the entrepreneurs who’ve worked with them to get a view? (In my experience entrepreneurs are very helpful to other entrepreneurs about this sort of topic.)
But be realistic. I would be wary of picking an adviser simply because they proposed the highest valuation. I would make sure that you like trust respect the adviser, because they are likely to tell you something you don’t want to hear at some point during the process. You need to know that you will take their advice seriously, even if you eventually disregard it.
Advisers are not a prerequisite. Plenty of high-quality start-ups raise significant sums with no advisers involved at all.
On the plus side, they do the legwork of managing the process, can help you hone your pitch, and can get the deal over the line. On the downside, they sit between you and investors and can be very expensive.
In the end, it will probably depend on your assessment of your own expertise and networking are negotiating as to whether you need an adviser.
Hungry for more? Go to the 50 questions homepage for more insights into venture capital.