Venture Hacks

Raising money is like finding a black swan.

It seems like you will forever keep hearing “no”, “let’s keep talking”, or “find a lead.” Or worse, you sign a term sheet and it blows up before you can close it.

It seems like you’ll never raise money, until one day—boom—you meet the right investor, he says yes, you negotiate a deal, and suddenly there’s money in your bank account.

What’s a black swan?

A black swan is a highly improbable, high impact, and unpredictable event. Nassim Nicholas Taleb popularized the idea in his book, The Black Swan: The Impact of the Highly Improbable.

9/11 was a black swan. It was hard to predict, it was highly improbable, and it changed the world—black swans define the future.

Once you see enough white swans, you start assuming all swans are white—until you see a black one. Once you get enough nos, you start assuming every investor will say no—until you get a yes.

The nos don’t matter.

The chances of raising money are low. You don’t know when or if it will happen, who will invest, or how much you will raise.

(The exception to this rule are the chosen ones: “obviously” fundable companies that are founded by successful entrepreneurs, companies that are making money by the truck load, or have cured cancer, or whatever.)

There will be no precedent for a yes. If someone looks at your string of nos, they won’t suggest that you’ll get a yes tomorrow—they’ll predict more nos. But just because you’re getting a lot of nos today doesn’t mean you will get a no tomorrow. The past is an indicator of the future—up until the moment you find a black swan.

If you’re looking for a black swan, ignore the nos.

Searching for black swans can be a big waste of time.

I’ve seen an entrepreneur sleep on my couch for months while he tried to raise money. It seemed like he had no hope—until he suddenly raised money from Big Firm X.

Many entrepreneurs implicitly understand this. They know that raising money is rare, unpredictable, and important to their business. So they spend months and months searching for a black swan.

But perpetual fund-raising is a bad way to raise money. Investors like to invest in working businesses—which means you need to work on the business—not spend the next 6 months raising money.

The problem with black swan processes is that they don’t always yield black swans. Sometimes they just give you white swans until you or your company dies. Black swans aren’t guaranteed—they’re the opposite of guaranteed: low probability and unpredictable.

How to find black swans.

Here are a few ways to search for black swans:

1. The Chosen One Strategy: Wait until you’re obviously fundable before you raise money. Keep building value until investors come to you.
2. The Hobby Strategy: Keep working on the business while you raise money as a hobby. Spend less than 25% of your time fund-raising so you can focus on activities that have a greater chance of creating value.
3. The Efficient Strategy: Raise money full-time and test the market very efficiently through focus, timeboxes, and lessons learned.

The Chosen One strategy is the best if you don’t need the money right now. Instead of trying to solve the black swan problem, this strategy dissolves it. If you do need the money right now, stop and seriously think about how to build the business without the money—remember, fund-raising is low probability and unpredictable if you’re not one of the chosen ones.

The Hobby strategy is awful. Don’t even bother—just work on the business instead. Raising money is a full-time job for at least one of the founders. If possible, also get your co-founder on the job part-time, so you can pair, like detectives trying to solve a crime.

The Efficient strategy is the best way to find black swans if you can’t or won’t execute the Chosen One strategy. There are three pieces to this approach: focus, timeboxes, and lessons learned.

1. Focus

Raise money full-time.

Pick up the phone and get introductions to investors from middlemen. Call in every favor you have and explain why the middleman will look good by making an introduction. Get the middleman to focus on making a single great introduction. Three weak email introductions won’t do anything but one strong phone call might.

This is a lot of work just to get 10 or 15 introductions. And you haven’t even met any investors yet. That’s why we say fund-raising is a full-time job.

2. Timebox

Put time limits on each step of the fund-raising process.

If you aren’t getting good introductions in 1-2 weeks, quit fund-raising and start executing Plan B. If you aren’t getting good meetings in 3-4 weeks, quit fund-raising and start executing Plan B. If you aren’t doing partner’s meetings in 5-6 weeks, quit fund-raising and start executing Plan B. If you aren’t signing a term sheet in 7-8 weeks—you know what to do.

And don’t start raising money until you have a Plan B—a Plan B is the simplest way to create a deadline and scarcity by fiat.

3. Lessons Learned

As you raise money, get honest, high-quality feedback from investors, advisors, etc. Once you get enough feedback and nos, stop raising money, fix your team, product, market, and traction, and try again.

It’s hard to get high-quality feedback from anyone period. Most people, even effective ones, don’t give good advice. Honest feedback from investors is particularly hard because they don’t like calling your baby ugly.

Try saying something like this when you get a no:

“Thanks. Yeah, I completely understand. We want to make this business work. What would we have to accomplish to make this business interesting to you?”

Optimism

One more thing. Optimism: you can’t raise money without it. The most effective way to stay optimistic is to find the right wife for your startup (also known as a co-founder).

Fund-raising isn’t a part-time job. It’s a black swan that you should avoid entirely or chase efficiently with focus, timeboxes, and lessons learned.

What do you think?

Summary: Pitches usually fail because they answer the wrong questions. The right questions depend on the stage of your business—for example, some businesses are just getting started with an idea, while others are printing money. Focus your pitch on the key questions for your stage and if you keep getting non-key questions, something is wrong with your pitch. This post includes a hierarchy that you can use to classify your business and the key questions for each stage in the hierarchy.

[Ed: This is a guest post by Eric Ries, a founder of IMVU and an advisor to Kleiner Perkins. Eric also has a great blog called Startup Lessons Learned.]

Every company will need to pitch itself from time to time. Usually we think of pitches in the context of raising money, but that is only one of many pitch situations. We pitch to potential partners, vendors, publishers, conferences, employees, and even lawyers.

Pitching is different from selling a product, because it is not part of our regular business practice, it is not something that relates to our core competence, and it tends not to happen in a repeatable and scalable way. (I’ll exclude those non-lean startups who basically exist for the purpose of raising bigger and bigger sums of money. You’re not one of those are you?)

Pitches usually fail because they answer the wrong questions.

Most of the times I have seen pitches fail, it is not because they are poorly written, or that the entrepreneur lacks passion. It is because they don’t answer the right question.

My favorite example of all time comes from students in an entrepreneurship class. Their idea was to build a next-generation autonomous robot, that could be used by defense and security agencies around the world. The whole pitch was about how valuable robots could be in the future. They even included a slide with The Transformers on it.

Now there was nothing wrong with their analysis: anyone who invents a technology as sophisticated as The Transformers is definitely going to make a lot of money. But these students completely failed to address the one and only question on their audience’s mind: can you three guys really build the robots of the future? (Turns out, they were incredibly well-credentialed graduate students who had, in fact, developed some interesting new robotics technology. But you wouldn’t have known that from their pitch.)

The right questions depend on your business’ stage.

I have come to believe that there is a hierarchy of pitches, and that understanding where your pitch falls in this hierarchy can assist in making decisions about what information to highlight. Pitches that sit higher in the hierarchy tend to be more successful, and if you can fit your company into one of those categories, you can get better results or better terms.

Now, just because you can do a thing, doesn’t mean you should—there are plenty of other great resources, like Paul Graham’s essays, that can help you think through whether and when to raise money (or do other kinds of deals).

With that disclaimer out of the way, here’s the hierarchy of pitches:

1. Printing money.
   Key questions: Are those numbers real? How big is the market? Can your team execute the growth plan?
   Most important slide: Valuation.
2. Promising results.
   Key questions: Can you monetize that traffic (or drive traffic to that profitable destination?) Do you know why you’ve achieved those results?
   Most important slide: Hockey stick.
3. Micro-scale results.
   Key questions: Who is the customer, and how do you know? What is the potential market size? What are the business economics?
   Most important slide: Lessons learned.
4. Working product.
   Key questions: What does the product do? What’s the launch plan? Who’s on the marketing team?
   Most important slide: Live demo.
5. Prototype product.
   Key questions: What will it take to ship a working product? How do you know anyone would want it? Who’s on the engineering team?
   Most important slide: Demo (if the product solves an obvious problem), engineering resumes (if the product is nearly impossible to build), or “a day in the life of a customer” (if neither of the above).
6. Breakthrough technology.
   Key questions: Who owns the patents? Can we make a product out of this technology? Are there any good substitutes?
   Most important slide: Barriers to entry.
7. All-star team.
   Key questions: Has the team made money for their investors in the past? Are they domain experts? Are they committed to an idea in their domain of expertise?
   Most important slide: Problem we are trying to solve.
8. Good product idea.
   Key questions: What kinds of risk does this company need to mitigate (technology risk, market risk, team risk, funding risk)? Is it a revolutionary and novel idea? Is this team the one to back? Can the team bring the product to market? Who is the customer? Who is the competition? Will they fail fast?
   Most important slide: About the founders.

[Ed: Here’s another way to think about the key questions and most important slide. The key questions should describe how you will get to the next stage of the hierarchy. And the most important slide should prove that you’re at the stage you claim to be.]

Focus your pitch on the key questions.

In a pitch meeting, try to spend as much time as possible talking about the key questions for your pitch. If you find yourself getting asked non-key questions, try to use your answers to steer the conversation back to the key questions.

But here’s the most important part: if you keep getting non-key questions over and over again, something is wrong with your pitch. Either you misunderstand where your pitch fits into the hierarchy, or you are not using the early part of your pitch to establish it.

Don’t keep banging your head against the wall—if you can’t convince your potential partners that your startup is printing money, try to figure out why. Experiment with different narratives. If you still can’t do it, move one level down the hierarchy and see if you can make that story stick.