January 15, 2005
| Entrepreneurs must often feel as though they operate in parallel worlds. The process of raising money has many similarities to that of selling product. Venture capitalists and customers both struggle with the "vendor risk" issue, whether they are deciding to make an investment or buy a product.
The "black box" of decision making within a venture capital firm is almost impenetrable for an entrepreneur, and is usually a source of enormous frustration. How VCs undertake due diligence, what they find important, and who they need to speak to are often characterized as chaotic and random. A better understanding of that process may allow the entrepreneur greater success in raising capital.
In essence, investors are trying to assess how customers will assess the vendor risk issue. Is this a product that will uniquely satisfy a meaningfully large number of customers, and not require extraordinary customization or support? VCs are trying to put themselves in the customer's shoes. On top of that, VCs want to understand the hierarchy of needs within the customer organization and be sure there is a deep value proposition in the offering. While the pitch to investors and customers is similar, entrepreneurs should not make the pitches the same.
Rainer Fuchs, vice president of research at Biogen Idec, says, "It is still stunning how many entrepreneurs have good technology but cannot explain it in business terms. They should cut the PowerPoint slide deck in half." Fuchs goes on to say that "many entrepreneurs present as if the customer does not understand the market, and never get to the point." When meeting with VCs, that's fine, and, in fact, it is dangerous to presume investors have a deep understanding of your particular area of expertise. But the opposite is true for customers.
Andy Palmer, COO of Infinity Pharmaceuticals, makes a similar point: "We strongly prefer immediate benefits, and the product needs to be tied to clear, demonstrable value." Palmer is not interested in "horizontal solutions" and other platforms, and, in fact, seems to be focusing mostly on applications.
The issue of vendor risk is more complicated than it might first appear. In addition to understanding a company's current standing — what the competitors look like, their levels of funding, the strength of their management teams — VCs are trying to assess what its position will look like over time. One of the lessons from the bioinformatics field in the 1990s was that too many companies were funded by the venture community, which made it exceedingly challenging for any one company to generate meaningful revenue traction.
Fuchs also advises that vendors should not believe they have the perfect solution, but rather the ideal solution. "Vendors are never ready to discuss broader integration issues, and they need to be careful in believing they will change business processes overnight," he says. Investors have learned to be cynical when the success of enterprise solutions is predicated on some other modification in workflow. When this is the case, both customer and investor will conclude there is a high degree of vendor risk.
Anecdotal evidence suggests that things are improving for younger vendors. Fuchs says he particularly likes working with earlier-stage companies in this investment environment because they tend to be more flexible. At Infinity, "early-stage companies are part of our reality," Palmer says. "We like dealing with early-stage companies because we have more influence over the product, and we can get a great deal."
The assessment of vendor risk is a process both investors and customers must go through. How the entrepreneur manages their questions will determine if the company gets the proper funding it needs to properly sell product.
Michael A. Greeley is managing general partner of IDG Ventures, a global family of funds operating in North America, Europe, and Asia, with approximately $600 million under management. E-mail: firstname.lastname@example.org.
ILLUSTRATION BY STEVE ADAMS