Winning venture capital funding is increasingly difficult for entrepreneurs. As Professor David Brophy of the University of Michigan’s Ross School of Business told me in a recent Forbes interview, the number of venture capital funds has shrunk by half since the recession. With heightened competition, founders are increasingly required to demonstrate actual results before a VC will commit. “There’s a much higher burden, a winnowing process with companies,” says Jeffrey Bussgang of Flybridge Capital Partners, who is the author of Mastering the VC Game: A Venture Capital Insider Reveals How to Get From Start-up to IPO on Your Terms.
But there’s also an upside to that higher bar: “If you can come out of this clutter, there’s an incredible lift for those companies that do distinguish themselves,” he says. Citing recent industry success stories like Dropbox and Airbnb, Bussgang says it’s “a classic network effect dynamic…distinguishing yourself is so unique that when you do it, so much value aggregates to the winner.” Those companies are more likely to be rewarded with major funding that enables them to rapidly grow. “What we’re doing differently,” Bussgang says of his firm and the industry in general, “is putting out less money in initial checks, but you see bigger money in scaled companies. Once a company hits and starts scaling, they’re raising $30 million, $50 million, $100 million, and that never would have happened [in the past] in a pre-IPO setting. It’s a big new trend in the last five years.”
Less funding for early stage ventures isn’t simply risk aversion on the part of VCs, says Bussgang; on the contrary, he says, it’s a smarter way to do business, aided by today’s lower technology costs (startups can often get by without expensive infrastructure) and the Lean Startup ethos of launching fast, getting data, and pivoting quickly where necessary. “If a great entrepreneur is pursuing something that’s a bad idea, you don’t want to tie up $10 million and three years of their life,” says Bussgang. “Instead, try it out for a year, spend $2 million, and if it doesn’t work, free up the capital and free up the entrepreneur, and let them go do something better. I think it’s a very positive phenomenon.”
So what makes for a successful entrepreneur in today’s high-stakes environment?
Part of it is charisma: “We like people we think can be pied pipers, with the ability to lead, to draw people to them, and to be a magnet for talent and for investors,” says Bussgang. “If you don’t have the magnetic ability to fabricate followers out of thin air, it’s going to be very hard to be an entrepreneur.” Skills, of course, are also critical. “We look for people who have a comparative advantage; they’re uniquely good at doing that thing [their business is focused on], relative to anyone else.” Sometimes, he says, that means “deep domain expertise,” such as particular technical skills or knowledge of a key industry; other times it manifests in “less senior people who are so brilliant and gifted, they have an insight no one else has; they see something different than anyone else.” Finally, Bussgang says passion is critical. “Entrepreneurship can be very hard, and it’s actually not rational. If you did the analysis, you’d never be an entrepreneur, because the odds are too long, yet people’s passion irrationally pushes them through. It’s only with irrational force that you can shift immovable objects, and entrepreneurship is all about shifting industries, people, investors to take action.”
Risk aversion, on the other hand, is a major turn-off when it comes to Bussgang’s funding decisions. “Some entrepreneurs want to hedge,” he says. “They want you to take the risk, but they don’t want to take the risk. I love entrepreneurs who are in it 110%.” Other mistakes include exaggerating your background or accomplishments (“we’re professional BS detectors”), not properly researching or understanding your market and product details, and being a bad listener. “It’s not that they have to listen to us,” he says, “but they have to listen to their market, their teammates, and their customers.”
The real secret may be an ability to see – and at least make a good case for your vision of – the future. Recalling one of the best pitches he’s ever seen, by Mike Baker of DataXu (yes, they did get funded), Bussgang says, “Mike diagnosed the online advertising industry so thoughtfully and painted a vision for where it was heading that was grounded in his own experience and a lot of data. He was clearly targeting the future – not where it stood today, but where he thought it would stand 3-4 years from now. He was so articulate in describing, ‘If I’m right, this is going to be unbelievably valuable. I might be wrong, and that’s the risk, but if I’m right, I can execute on it, I know this technology, and I have the right partners lined up to take advantage of it. You don’t need to believe I’m right to make the investment; you just need to believe that if I’m right, it’ll be really valuable.’ And I thought that was a pretty good pitch.”
Overall, says Bussgang, it’s not a question of whether entrepreneurs or VCs have more power in the current business landscape. Yes, he says, “there’s less capital out there, and people aren’t leaning into making risky bets. But there’s enough so that high-quality opportunities can raise money…if you’re a great entrepreneur and you have a great idea, you’re going to get multiple term sheets.”
What do you think makes for a successful entrepreneur in today’s environment? Is the trend toward less funding upfront – and bigger investments for the emerging winners – a positive one?
This post originally appeared on the Forbes website on November 24, 2012.
Dorie Clark is CEO of Clark Strategic Communications and the author of Reinventing You: Define Your Brand, Imagine Your Future (Harvard Business Review Press, 2013). She is a strategy consultant who has worked with clients including Google, Yale University, and the Ford Foundation. Listen to her podcasts or follow her on Twitter.