“The blockbusters are oftentimes the ‘ugly ducklings.’ Cisco is probably the best example in the VC world. Everyone passed except for Sequoia. In the book world, almost everyone passed on JK Rowling.

“It’s just hard to predict the future looking into the rear-view mirror, yet everyone wants to pile onto the brand names [VCs] and they in turn pile into the hot deals in droves pushing up valuations to unsustainable levels.

“It doesn’t help the poor entrepreneur who just wants a little capital to back his dream. He has no clue whether or not it will be another Google, yet in order to raise VC funding he has to make promises that only hucksters can make. The VCs in turn make those same promises to LPs and some LPs actually believe the nonsense. What a shame.”

Emphasis added. Read Ho’s full comment. Also see Simeon Simeonov’s How to raise money without lying to investors.

“Prediction is very difficult, especially if it’s about the future.”

Niels Bohr, Nobel Prize winner

By penalizing entrepreneurs who are humble and honest about how their companies will grow, many investors cause entrepreneurs to over-promise (and later under-deliver) when they’re raising money.

The histories of some of the best-known technology companies demonstrate the power of luck, timing, the mistakes of incumbents, and solid execution.

Execution is the main tool under a startup’s control but it’s often under-valued by investors.

So it’s not surprising that most entrepreneurs come to pitch meetings armed with very precise statements about a very uncertain future and a list of proven strategies guaranteed to make their company successful. While sitting through these pitches, I sometimes wonder which is worse: the entrepreneurs who know they’re spinning tall tales or the ones who “got high on their own supply.”

VCs and entrepreneurs collaborate to lie about the future

Instead of bringing entrepreneurs back down to earth, some investors push them further into orbit. Some VCs ask a seed-stage, pre-product startup for a detailed five-year financial plan. When I was a partner at Polaris Ventures, I saw many of these spreadsheets built “for fundraising purposes.” We didn’t ask for these spreadsheets — entrepreneurs had usually built them after meeting other, less early-stage, investors.

I find the process of planning — and understanding how a founder thinks about a business — educational and valuable. But pushing the exercise to the point of assumptions layered upon assumptions is not just wasteful, but dangerous, because it sets the wrong expectations.

After a few pitches, entrepreneurs realize that the distant future is safer territory than the immediate. It’s easier to boast about 30 must-have features your product will have in three years, than to show the three must-have features in the current prototype. It’s easier to talk about how you’ll recruit world-class CXOs when you’re big and successful, than to show a detailed plan for bringing in an amazing inbound marketing specialist, when everyone on the team is getting paid below-market rates to conserve cash. The examples go on and on.

I’ve co-founded four companies. The two that most quickly and easily raised money did it with nothing but slide decks. Both were funded by Polaris, which has a lot of experience with very early stage investing. We didn’t waste time over-planning the future in those two companies.

And for good reason. Both startups ended up quite different than the fundraising presentations promised — for solid, market-based reasons that were invisible during diligence. Plinky acquired a new product line and became Thing Labs. 8th Ring failed quickly and cheaply, only seven months after funding. The CEO and I decided the execution risk was too high. And, in retrospect, we were right: our only competitor had an unexciting exit a few years later.

Over-promising causes startups to throw away money

Over-promising is not a problem when it comes with over-delivery. But the overwhelming majority of startups fail to meet the promises they’ve made during fundraising. After years of observing this pattern, I’ve come to believe that over-promising can actually cause under-delivery. Entrepreneurs over-promise to raise money easily and set themselves up for pain down the road.

How? The reasons have to do with information signals, expectation setting, and the psychological contracts between entrepreneurs and investors. It’s very hard to pitch one story today and then change it the day the money hits the bank, especially if you’ve drunk the Kool-Aid.

An overly rosy pitch leads to expectations and fateful commitments that downplay the variability of the future. Decisions are made based on assumptions rather than tested hypotheses. The burn goes up earlier. The sales team is hired much too soon. In venture funds, over-promising also spreads from the investing partner to the rest of the partnership. It can also spread from the company to its customers and partners, further extending the reality distortion field.

If you’re Apple and you’ve got Steve, that’s awesome. For everyone else, it can get rough. I saw this play out with one of my companies that was expanding internationally (the reason why the company had raised money). The world was going to be our oyster and, before the reality that our go-to-market strategy wasn’t as effective as everyone had hoped set in, we had burned through a good chunk of capital.

Find investors you don’t have to lie to

How should you choose between being honest (and hearing “no” a lot) vs. amping up the pitch and risking the anti-patterns above? I give two answers to the CEOs I work with at my startup advisory firm FastIgnite.

First, I strongly advise startups to go to venture firms where the decision process is more collaborative and less “salesy.” One of the main reasons a VC will push an entrepreneur to over-promise is his need to sell a deal internally.

Second, pitch investors with a track record of valuing a team’s ability to execute, over any specific strategy or execution plan. While most firms pay lip service to this cliché, few do many investments this way. Here are some examples from my experience in the past few months:

• On the smaller side, Betaworks and First Round Capital get this. Their portfolios and their philosophy show it. I look forward to working with them some day.
• Among VCs, General Catalyst has repeatedly backed companies like Brightcove, m-Qube, and Visible Measures very early — with the understanding that many important questions will have answers only after months of execution. I’m actively partnering with them at FastIgnite.
• Surprisingly, at the very high end, a private equity firm like Warburg Pincus can be a great place for the right early-stage entrepreneur. Last year, a Warburg entrepreneur-in-residence incubated Better Advertising, a company where I’m a co-founder and acting CTO. Better Advertising’s market and business model required a backer with staying power that exceeds most other investors’.

The firms above practice a form of agile investing by (1) not forcing entrepreneurs to over-plan for an uncertain future and (2) following the principle of minimizing wasted effort. Ultimately, it’s the investors’ responsibility to reward honesty with trust and cash. And I think that’s a win-win. I’m looking forward to discussing this with you in the comments.

If you like this post, check out Sim’s blog and his tweets @simeons. And contact me if you’re interested in supporting Venture Hacks. Thanks. – Nivi

There is a behavior I witness in some first-time CEOs that I meet, not necessarily the younger and more mavericky generation, that I do not think is necessary, nor helpful. It’s an insidious but frequent tendency to let the board decide, rather than advise or approve. It goes like this…

Because VCs have blocking rights on some important decisions (approving the budget, your compensation, raising money), they are often able to wield way more power than their 20% ownership would suggest they should have. As a result, entrepreneurs often talk of coming to the board with their slides in hand, asking “what does the board want me to do?”, which is code-speak for, “I am here to ask for permission from my investors to do what I need to do.”

Entrepreneurs will present the strategy they believe in, but essentially allow the board (read: the investors) to walk straight through the carefully thought-out action plan and redesign the entire strategy in one swell meeting. The investor probably walks away feeling like he provided value and the entrepreneur now goes back to his team to explain that his investors puked over the team’s strategy and that the priorities have changed.

It’s the CEO’s fault

That may be the product of investor behavior, but I would argue this is the CEO’s fault. Nature abhors a leadership vacuum, and VCs will fill that gap if you don’t.

If you really believe in what you are doing, you come to the board telling board members what you are planning to do, taking considered advice on whether this is the right strategy, considering that advice and executing on what is, in your best judgment, the right path for the business. That’s what you are there to do. Make decisions fast, don’t fall for analysis-paralysis, trust your gut, execute and iterate. As Tim Ferriss would say, ask for forgiveness, not permission.

Why VCs shouldn’t drive strategy

Guy Kawasaki does lists all the time and it seems to work for him so I thought I would try one too: Here are the top five lighthearted reasons why VCs should not drive your strategy:

1. We forget 50% of what we said at the last board meeting.
2. We don’t know the people inside the company and hence have no clue what the team can really execute.
3. We meet many smart people and hence we have way too many ideas than you can possibly implement.
4. We are focused on the 5 year vision, yet we are focused on the quarter too — we’re confused.
5. We don’t need to deliver on it, you do. We come and collect when the job is done.

You want to leverage your board and you don’t want to get fired for being a solo player either. Personally I really like what my partner Jeff refers to as a culture of “champion and challenge”. I guess you have to be born in the USA to say phrases like that, but it’s spot on. If I really disagree with a strategy decision, trust me, we will have a serious discussion about it. But come and champion what you believe in, take ownership, step into the role. Ultimately, I backed you because I believe in you, and you know better.

If you like this post, check out Fred’s blog and his tweets @fdestin. If you want an intro to Atlas, send me an email. I’ll put you in touch if there’s a fit. Finally, contact me if you’re interested in supporting Venture Hacks. Thanks. – Nivi

– Sequoia Capital

“A business plan that doesn’t require a wonderful economic environment in order to succeed… is a good idea all the time.”

– Marc Andreessen

Summary: In good times and bad, startups should be asking themselves the same questions: (1) What’s our runway? (2) What experiments are we running to extend our runway? (3) How long will we try the experiments before we switch to plan B? and (4) What’s plan B? Startups that survived the last downturn didn’t take life-threatening risks with their runway—survival mattered more than market domination.

If you haven’t seen Sequoia’s presentation on the downturn, R.I.P. Good Times, watch it now and read the meeting notes from GigaOM and Silicon Alley Insider.

(If you don’t see the presentation embedded above, watch it on SlideShare: R.I.P. Good Times)

Sequoia’s presentation offers a lot of good advice with typical insight, simplicity, and clarity. Here are a couple thoughts on their presentation.

1. The future ain’t what it used to be.

Don’t take Sequoia’s (or anyone’s) predictions about the future too seriously. If they’re smart enough to predict the future, they should have done it before the downturn.

2. Sequoia’s advice is good advice anytime.

In good times and bad, startups should be asking themselves the same questions:

1. What’s our runway?
2. What experiments are we running to extend our runway? (e.g. chasing revenue, raising capital, taking debt, writing grant proposals, cutting burn, grabbing market share in the hopes that it will help us raise capital later, et cetera)
3. How long will we try the experiments before we switch to plan B?
4. What’s plan B?

Good times

When it seems easy to extend your runway (good times), companies operate with shorter runways, they run experiments that are less likely to work, that have higher value outcomes when they do work, and they run them longer:

Let’s chase market share until we have 3 months of cash left so we can raise money at a high valuation and let’s hope capital will be available then.

Bad times

When it seems hard to extend your runway (bad times), companies operate with longer runways, they run experiments that are more likely to work, that have lower value outcomes when they do work, and they run them for shorter periods of time:

Let’s raise money right now even though our valuation won’t be optimal, and if that doesn’t close in 2 months, let’s cut our burn and chase customers.

Good times, Bad times

Here’s a table that summarizes the difference between good times and bad times:

What’s your runway plan?

For some, Sequoia’s advice is good advice anytime. These people like to run their business as if it’s always hard to extend their runway.

Others (contrarians) will ignore Sequoia’s advice. They will take big risks and run their business as if it’s easy to extend their runway.

There’s nothing inherently right or wrong with either approach. Choosing a runway strategy is part of the CEO’s job description.

But our observations match Sequoia’s advice: startups that survived the last downturn ended up doing OK. They didn’t take life-threatening risks with their runway—survival mattered more than market domination.

After searching through the Venture Hacks archives, I realized one of our posts already covers it: How much diligence should we do before signing a term sheet? I think that post mostly stands the test of time—problem solved.

I revised the post to include this question for prospective investors:

“Do you agree with our plan for the next two/three/four quarters?”

Discussing this before you sign a term sheet has a few benefits:

1. You learn what it’s like to work with the investor—before you marry him for the life of the company. If you don’t like working with him, he may not be the right husband-for-life.
2. You discover if your investor agrees with your plan. If he doesn’t agree with your plan or you don’t agree with his revisions, why do you want him to join the company? Are you really going to put someone on the board who doesn’t agree with what your plans?
3. Getting agreement on the plan before the financing is normative leverage. If your investor wants to change the plan in the future, you can ask him to justify the change: “We agreed on a plan, how have the circumstances changed since we agreed on a plan, and why does that require us to change the plan?”

Completely unrelated (or is it?):

(Video: YOU ARE NOT THE FATHER!!!!)