deal making

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A lot of startups think they are ready to receive venture capital, risk capital, or some sort of "real" financing. I recently had to count; how many rounds of financing have I "done?" (not solo, they are always teamwork) It took some plain old organic memory search, and if I have it right that would be a total of 9 rounds so far. (just as a remark: IRC-Galleria had zero rounds.)

Based on that experience; When are you ready? Here's my take on that:

1. You have the right attitude. You and your startup need to be very good at what you are doing. You need to have your act together. Know your stuff. Know your competition. Already have plenty of things done instead of "just planned". You need to be there to succeed and as part of that attitude you need to be humble enough, yet know that you are a "catch" for them to have; and that you are the client shopping for financing services for the price of equity.

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2. Your materials are in good condition. Yesterday a highly competent venture capitalist (managing partner, none the less) said to me: "the good VCs know that the excellent companies probably don't have time to prepare a 50+ page business plan and perfect materials". Agreed. I think you do not and should not need a very long business plan and a beautiful polished power point. Many of the 9 rounds I have done have been done without the one of the other, sometimes without either.

What do you need then? You will need a very good executive summary. You will need to be ready to talk about your stuff at a "championship level". Solid financials are needed. And a good representation of your overall plans and goals. Specific roadmaps and such should not be so important - because they will change anyways, and the good VCs know this extremely well.

Many VCs don't read plans. They only read summaries, 1 page or 2 pages. Even the legendary Sequoia Capital asks everyone to send a maximum of 15-20 slide summaries, as they say "all that's needed". What did Eran Davidson the CEO and Managing Partner of Hasso Plattner Ventures say on stage at SIME Helsinki? "I'm a VC and I don't read business plans". There you have it.

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3. DD preparation is done or underway. Check my earlier post about the DD. Make sure that's at least in progress and you can answer questions about IPR and such in a very competent level and detail.

4. You have an investor plan. You have mapped out multiple investors. Actually found out about their investment focus, criteria, space, latest deals, terms, etc. You have schedules for the whole thing to progress, your team has divided the responsibilities of preparing everything, and you have created the most important thing: a shortlist of investors most likely to realistically invest into your startup. Where to find VCs? Check my previous post for a few ideas.

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5. You have time to raise capital. It takes a while. In this economic climate it takes a while and then some. You need to have that time, no hurry. Sizeable startup rounds (a few Big MOs) can go through in as little as 2 months, but that is an extraordinary accomplishment that does not happen often - there needs to be a real match between the startup and the investor for a deal to move so fast. Angel rounds can be faster. Typically it takes at least 6 months, and now quite possibly more than that. This old comic from the Dot-Com era sums it up nicely.

6. You have already engaged customers and partners. One thing that will greatly speed up your VC deal will be real commercial traction. Especially if you are in a space like "Web 2.0" that's sort of the requirement before you get any VC money. It helps significantly if you are already on a path towards growth and expansion, but would grow a lot faster with additional capital. One way to get there is to talk to your customers, partners, consumers etc as soon as possible, as much as possible. Hammer out your thing, what ever it is, in such a way that it is desired in the marketplace and has clear evidence of showing commercial traction. Score the deals. Close and sign them in. Then talk to VCs. Try to go for LOIs, non-binding contracts, MoUs, or even try to get upfront payments from the customers. Every name on the paper is tangible proof and will help you out. Try to get permissions to reference them and their interest when they sign.

7. You require money for growth. VCs don't really want to fund things like; proof of concept, product development, prototypes, "stage 1 development", "hiring a team", etc. The earlier in the game you are, the harder time you will have raising any VC money. They like to fund companies that need the financing for growth, not to build something risky that might quite likely fail. If you happen to be very early, then go for Angels or "Friends, Family and Fools".

8. Have a fallback plan. One indication of your readiness is your ability to come up with a fallback plan. If everything drags out and your startup is not picking up any interest (or just not enough of interest) from the VCs, then you need to have the famous plan B. And in this case I don't mean buying 5 years worth of green beans and a big gun.. You need to plan for extended periods without outside money, getting the company risk level and burn rate right etc. If its not VCs maybe its angels? or maybe its your own pockets? maybe its one good pilot customer? What ever it is, have the plan in place and expect having to go for it.

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9. Have your own term sheet ready. It speeds things up and ends up in your benefit if you make your own term sheet before the VC gives you one. it helps you to have a clear sense of the kind of stuff that goes into it. You might not end up actually using it for anything else than comparing, but there might be situations where you can offer to propose the first set of terms to the VC. This is probably way more common with Angels, since most VCs have their "standard" terms sheet (with nothing really being standard or fixed in them). Preparing your own set of terms mainly helps you to think and that comes in rather handy when you actually have to negotiate the stuff - you'll understand it better and have thought through the meaning of different terms. Actually the smart VCs prefer this as well: they would rather have an entrepreneur signing with them who knows exactly what he signed, instead of a one that has no clue at all.

VC terms can vary a lot. There's also a bit of a Gap between what the VCs say is "standard" and what they actually sign in the end. For example: many VCs claim liquidation preferences to be a standard term. Yet out of the 9 rounds of financing I have seen only two have actually had that term included. So in my book it's rather rare to be seen. Same goes for another classic "strict term": anti-dilution clause for the VC. Out of the 9 deals only one has had that. There's actually enough substance regarding this matter that I might write a separate blog entry on this alone..

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10. Finally: know what you are doing, and research the investors. Partially this is a repeat of number 4 above there, but I want to separately underline this one. It is vitally important for your "VC readiness" to research the investors, really find out about them, use your contacts, talks to people etc. Talk to other VCs, talk to startups that have done deals with the VC, talk to angels, to Tekes, to who ever. Find out all the classic and generic details: "sweet spot" for investments, typical deal size, typical exit, typical terms, the likes and dislikes (and the backgrounds) of their partners, etc. Finding out this stuff will mostly help you to figure out are they the right investor for your. And if they are the info will help you in the talks.

What to do if despite all of this you don't raise attention from the VCs? Then calm down. Leave it be for about 6 months. Get back in touch (with a revenge) and update them on all the fantastic progress you should have been making by then. Meanwhile go for the angels, or the FFF, or what ever keeps you focused on the Big Plan. Don't dwell too far into project services and selling the skin off your back, that may be a living, but its not going to be a venture backed startup any time soon. (sorry, it just rarely happens that way).

This is part II of the "funding of Taika" war story, part I here:

http://tane.li/2008/war-story-funding-taika-technologies-part-i

Brief summary: months after the dot-com nuclear meltdown of 2000 my first startup Taika Technologies managed to secure a financing round for more than 19M EUR valuation, with no product and no revenue. How? What's the story?

Taika had just managed to get professor Reijo Luostarinen onboard as our new chairman. He was vital in approaching VCs and we had just written a business plan. Our vision was that "one day the Internet will be social, people will share, talk and network online in a massive global scale".

Even prior to Reijo joining our team we had managed to get many meetings with VCs, and he helped in opening up more doors. The first VC we had originally pitched Taika to was no other than Nokia Venture Partners, the VC behind PayPal. They passed on Taika very quickly like a pro, and as they probably should have considering that we didn't have a written business plan at that time. Besides Nokia we had already talked to Tekes, Finnvera, SFK Finance, MVI Partners, and Sonera Ventures. Some of those companies don't even exists any more, how quickly do the times change.

With a door-opener and credibility boost in the form of Reijo we set out to talk to multiple investors. We presented our holistic and nearly all-encompassing vision of the "social Internet", which extended to online gaming as much as peer-to-peer filesharing. Concepts that were barely visible in 1999 and early 2000. Reading from my old files, the kind of rhetoric we used had stuff like:

- "grand global scale" (social networking megatrend),
- "online community feel and atmosphere" (horizontals vs the verticals, the user experience as the most important thing),
- "virtual economy" (habbo-like virtual stuff, online games),
- "virtual collective" (Digg, votes and user generated content),
- "business scalability" (scales to hundreds of millions of people),
- "effects of virtual economy on revenue models" (how to sell virtual stuff and trinkets),
- "product branding, visibility and promotion" (social media advertising),
- "Taika's unique way of segmenting customers and their needs" (forgetting traditional segments and redoing them in a more relevant manner).

Actually reading it now, about 9 years later, it still seems pretty valid and actually quite impressive. Did we write that? I guess we did ;) Our plans and presentations talked about the kind of stuff www.irc.fi and www.facebook.com, www.habbo.com, www.digg.com and www.myspace.com do as their daily business today.

We did the vast majority of our investor pitches as two man team: Reijo and myself. In some meetings Atte was also present to give a technical rundown of what we are going to do. My memories of the meetings are about this same pattern repeating: me, as the over-eager young dude, going on endlessly about the vision and everything it encompasses. Pretty soon the investors must have felt like their heads were spinning and the Q&A sessions were all over the map on a range of topics. To me (and to us, the founders) it all seemed so clear: having been part of the digital online culture from the BBS days (I was a SysOP of my own BBS for many years) we thought we knew exactly how the whole Big Picture was going to evolve and progress. The investors didn't have that same insight and convincing them of our vision wasn't quite that easy after all. We ended up talking and pitching to maybe around 30 VCs and investors in Finland, not that many of them demonstrated any signs of grasping our "social Internet" vision. Which is another way of saying that we (and I as a 21 year old) were quite naïve at times.

After learning a lot of lessons the hard way we started to get some headway and had our first really truly interested investor. After a series of talks they seemed to understand the grand vision and proposed that they would invest, and even accept our high valuation for the company, if we would find another investor to co-invest with them. This was an absolutely critical moment in Taika's history, and it allowed us to build on the situation of having one supportive investor committed to the project with the condition of finding them company. Also the fact that they accepted our rather high valuation was excellent: the other investor would probably have to accept it as well.

We had a round of planning and decided that finding the co-investor would have to be in a manner that preferably creates an atmosphere of competition around "who gets to invest". So we proceeded collaterally with multiple investors. We were bold enough to call many of them into a meeting at the same time: I remember being there and watching 4 VCs in the same room glancing at each other and making tense remarks. None of them really admitted that they didn't get the vision, but they did complain about the valuation. The mood got really serious when one investor showed signs of not really considering the valuation to be so high. Remember: this was about 17M EUR post-money with an extensive stock option plan that would dilute the investor in effect making it a 19M EUR post-money proposal, for a company that had a grand vision and an eager team, but no product or revenue.

The competition between the investors started to heat up when we did a round of calls to them and tried to push them to move forward. One of them was brave enough to verbally close the deal right there on the phone: we had found our second investor! I printed out the investment papers and hopped in a taxi to meet the investor at the airport, we signed the papers in the airport arrivals lobby and suddenly the deal was done. I was 22 years old and now founder/owner of a company valued at 19M EUR by very well known and serious investors. The sky was the limit! (or so I thought).

Taika had been running up to this point on the seed money fumes the founders had put in. There was already a proper technical team working on the product and burn rate was up. The dot-com meltdown had happened some months earlier and the climate around us had started to take a turn towards the doom and gloom of nuclear winter, with zero positive news coming from anywhere.

This is a bit of a secret that I'm sure comes as a surprise to many of the Taika Team members: at the time of receiving the investment the company was in fact out of money. During 1999 and the spring of 2000 we had burned through our seed investment and there was just about nothing left. After signing the investment papers the whole gang, 17 people at the time, gathered to the Russian restaurant Saslik to celebrate and really start building up the company. After giving a very short speech-like remark I broke my wineglass to the table hurting my hand and getting a small scar as a memory of the evening. The money from the investors arrived to Taika's bank account one day before payday, and nobody (besides the founders) knew how close it was to tumbling down like a house of cards.

And that, in brief, is the war story of how Taika got funded. There are many more stories to be told on Taika: how the team got together, how we managed to get all of those big name board members to join us, and how the company eventually failed and had to shut down.

Some lessons to be learned from this:

1) On a very rare occasion there are investors who have the courage to believe in excellent visions, even when the world seems to be freezing into nuclear winter around them.

2) Execution really is everything: look at Taika's vision and how its come true today (and by what companies?). All the elements of success should have been there, but the execution didn't deliver. That's a very long war story right there.

3) Enthusiasm, energy and belief in your own vision is impressive and founders should not forget that. Let it show, you need to be more into your vision than anyone, and know why you are correct.

4) Get as much help as you can: Taika had many co-founders and an authority of a man as the chairman. That clearly helps.

5) Creating some competition between the potential investors is an excellent thing. Taika can be elaborated as an example success case of how that's possible and what results it can produce for your financing round.

6) Speed is vital. Look at Taika's vision: it seems that many companies had the same vision (or part of it) around the same time. www.irc.fi started in the year 2000, www.habbo.com started in 2000. And this is not unique: the best ideas often come from megatrends and involve realizations that are visible to an open mind. If you plan to ride such a megatrend then speed is essential: you need get yourself to be "a Facebook" faster than other companies riding the same trend will.

7) There is such a thing as being ahead of your time, by multiple years.

Taika was my kickstart to my entrepreneurial career. It was the ride of a lifetime and I still feel like doing these fast moving startups will accumulate your experience and insight so much faster than a corporate job ever would.

This is the first "old war story" on a series of stories I plan to write about past startups I have "done".

Taika Technologies was the first startup I co-founded in 1999 with couple of other people: Atte Lahtiranta (now at Nokia), Sami Sunila (private investor), Jouni Mannonen (Mahtava Development, Anyfun Games), and Niko Punin (Designer).

Other members of the Taika Team were (and still are) some of the most highly competent technical people I have ever seen. As a sort-of proof of the team's excellency the real interesting war story about Taika is this one thing:

Taika was a company with no product, no revenue. It closed a financing deal in late June 2000, months after the Dot-Com bubble had already burst (it went in the beginning of the year, March at the latest), and yet still the company managed to get financing with over 19 million EUR (fully diluted) post-money valuation.

How did we manage that?

Before answering to that, let's explore what Taika actually did. There's not a whole lot on the web that has survived about Taika. Only few odds and ends and random pieces of news. Since the company is buried a long time ago (August of 2002, and that's another war story), all of the IPR and software is now owned by the Taika Team who have a registered organization set up for that as Taika.org.

Taika worked on what would nowdays be know as social media, social software, instant messaging and micro blogging. All of them, plus a bunch of other things that complement the same "social Internet" vision. As a blast form the past here's an untouched old PDF of Taika's "communication suite" product from February of 2002. Reading the leaflet reveals that almost all of the products and ideas it talks about are being implemented out there by other companies. In essence Taika tried to create a Facebook, and a LinkedIN, and a Twitter, and a Second Life.. years before its time. I have tons of Taika's old designs and documents sitting in my hard drive, and its rather amazing to see that still the level of implementation and design on social networks has not reached the level we envisioned already in 2001/2002. Progress is always slower than one might expect?

Early funding of Taika was committed from the founder's pockets directly. Four of the founders together put in some 424 thousand EUR or so of financing to piece the team together, rent an office, and all that. At that time I was 21 years old and full of motivation, so I threw 106 thousand EUR of my own money into the company (partially debt-leveraged). That's about what it costs to get a top-notch MBA from one of the world's leading business schools. Considering the fact that the company was eventually shut down; do I feel bad about spending that in retrospect? Not one bit. The "education" I got out of that experience was better than any MBA and I would not be here today without it - besides you can always do your MBA later, like I did a few years after Taika was done with.

So, the company had seed funding but no product, no revenue and no proper written business plan either. Writing the plan was what came next. Taika had rented a gorgeous 100 year old Villa in a posh district of Helsinki (Kulosaari) to be our HQ (anecdotes about that: the building was a former Iranian embassy, which we noticed when one day political protesters showed up in our doorstep. The building also had a garage originally constructed for the purpose of hosting Adolf Hitler's car on his state visit to Finland). The office was 600 square meters and totally empty. I took up a room on the 3rd floor of the building and started working on the business plan by sleeping on the floor and writing for about a week. It was agreed among the founders that it would be faster just to let one of us write it quick and the rest would edit if needed. So I ended up soloing almost the entire plan, 51 pages plus another 50 pages of enclosures, analysis, excels and such. My memories of that week are bit hazy: I basically don't remember anything else except sleeping on the floor, eating unhealthy food and writing, writing, writing. But finally it was done. Jouni (from the other founders) contributed with a few enclosures about technology, and Professor Reijo Luostarinen (our new Chairman of the board) acted as the editor/consultant on structure and content. Sami worked on the excels.

I'm skipping ahead and sharing an interesting picture with you from the past. This is from the time when Taika had closed the big financing deal and had its first proper board+advisory board meeting. In the picture are: (from left to right, back row): Prof. Erkko Autio, Mikko Heikki Kosonen (Nokia's CIO at the time), Prof. Frank Biocca, Jouni Mannonen, Chris Donahue, Tuomo Airaksinen, (middle row): EU Commissioner Olli Rehn, Sami Sunila (CFO), (front row): Atte Lahtiranta (CTO), Taneli Tikka (CEO), Prof. Reijo Luostarinen (Chairman), Antero Norkio (VP Product Marketing). Me in that picture with a big fat black beard an all is a good example on how I have moved from "corporate stiffness" towards much more laid back style and touch.

Back to the story: so we had a plan and it was time to approach some investors. Actually we had done that already and had started talking with investors even without a proper plan, using some plain presentations and materials. After all Taika was something we had envisioned for many years in with our dealings with online games and communities, the Legendary BatMUD in particular.

An important factor in getting the investors to meet us was our new chairman of the broad: professor Luostarinen. We managed to get in touch with him through knowing his son, Antti, and we presented our vision to him: "one day the Internet will be social, people will share, talk, and network online in a massive global scale". Much to our amazement he grasped the idea pretty quick and actually agreed that it was a great vision. Amazing us even further he offered his multiple decades of growth company wisdom and agreed to join us as our chairman.

.. the story continues in Part II

Over the years people have often approached me with questions like "what we need to do in order to be ready for VC investment?" "what's there to prepare?" etc. Often it seems that companies and their founders know more about raising capital than closing the actual deal in the end.

I will be writing more on this topic, perhaps even a series of posts, so I'll start with some rather summarized tips. Feel free to jump into the conversation and agree/disagree with these.

1. It takes time to close. Sometimes up to 6 months. So you need to have time, and you need to have an attitude that you are in no hurry. Never ever plan your business based on any dates when "the money will be there", because often it won't. There are positive surprises, but they are exceptions to the rule.

2. Do your homework very well regarding the Due Diligence process the VC will have to do anyways. Proper DD includes pretty much everything, but focuses especially on: IPR, Legal and Technical. Have those areas covered as well as you can. Some good practical tips are:

A. Maintain an active IPR registry. This can be done in Google Docs or where ever. Can be quite simple and it should be something everybody has access to. A good registry has every IPR, idea, concept, design, component etc (you get the idea) written down in a headline level and a brief summary on how it works. Many of the companies in this space primarily only own IPR (and nothing else of substantial value) so doing this register is quite vital. You can also verify the register as prior art by having it time-stamped officially in the local magistrate. If you need (and can afford) the help in building a registry like this these people are some of the best in the business here locally in Finland. Why is this important? When a professional VC sees a beautiful all-inclusive IPR registry with summaries they will be very happy. Makes their DD job a lot easier and also plays positively in the psychological side: clearly this is a company that knows its stuff! As a benchmark the IPR lists of some of the companies I have run have been about 35 pages with only the headline and 1 row of summary for each IPR. Just saying that if you do this right you will end up listing a whole lot of stuff (which is good).

B. Legal DD is next: have your IPR list time-stamped by the magistrate every once and a while. That way you can prove that the idea/concept/etc existed at some point in history, and if it did enter public domain at that time it will be a lot harder for anybody who might patent the same thing later to stop you from using it, since you can prove you had it already. Have all of your legal documents (employment contracts, SHAs, board meeting minutes, NDAs, agreements, etc) in one place: one directory in digital format with only the final signed copies in there (no drafts), and one folder full of paper. In addition to this most bigger companies maintain a registry/list of all the contracts they have: this can be a similar brief list, listing contract names, dates, person who signed, and the other party's name etc. Having all this in neat order will help you alot when the legal DD hits. Usually VCs use a contracted lawyer or some other professional expert to asses your stuff. When they encounter a neat pile of paper with complete lists etc they will be impressed. Believe me, most startups don't do this part very well and they have to hunt for the papers in the DD, makes you look really unprofessional. Your local lawyers can help you get "DD ready", some law firms I have worked with: AKG, Borenius & Kemppinen, Fennica (or BIrd&Bird nowdays).

C. Tehcanical DD is pretty straightforward: you need to document and maintain your technical stuff in the IPR registry as well. One of the most important things; be sure to write understandable prioritized documentation and functional descriptions on how your stuff works. Use plenty of graphics. Remember: this is primarily a document your are preparing for an outsider to read - so feel free to highlight the really important stuff and to underline the uniqueness of your solutions. Allows them to "grasp it" faster. Think of yourself going through the tech in a random technie company: how would you want to read about it? source code directly? good documentation? What ever it is, prepare it well and have in a neat pile like the rest of the DD stuff. And make sure your top technical people have the competence to talk about the details in a manner that represents you positively.

D. The rest: during a DD process the VCs often i) look through everyones CVs, ii) interview everybody (or almost everybody) in the company. So have your CVs ready, prepare your gang for the interviews. Resolve any and all internal issues and conflicts before the talks: it can get nasty if VCs talk your people in the middle of some internal hickups.

Even great companies can get this stuff "wrong", as highlighted by TechCrunch in this posting about how Google walked away from Digg because of "technical due diligence was to blame" and "Digg's top team just wasn't a fit".

Scandinavia/Finland also must have cases that have failed during the DD phase - do you know of any? People never talk about those..

This is ending up to be a pretty long post, so I'll share one more tip and continue this later in another post then:

3. Pressure the VCs. Don't have just one alternative around, have several. Don't be "begging for financing" but rather "on the market shopping for financial services, as the customer/buyer". VCs are financial services vendors to the startups and the startups ARE the customers. The price you pay is equity, but they need to sell their services to you just as well as you need to prove you are a good "catch". It's not unlike humans pairing up ;-) shares many of the similar concepts on how you finally end up between the sheets together. The best position for a startup is to have several VCs competing on investing to you. At the very least you need to have (and to build) alternatives. I plan to blog about a couple of war stories were this was successfully done.

To be continued..