Venture Capital: Doorway to Internet Dreams
Washington Post Staff Writer
Sunday, June 27, 1999; Page H1
So you want to be an Internet star -- put your FreeLunch.com on the Web, grab some of that Internet funny money and retire to the Virgin Islands. If you're like most Internet dreamers, you have no clue where to start and you're worried about being late to the cyber-bonanza.
I have two words for you: venture capital.
Venture capitalists collect spare change from millionaires and use it to buy into the dreams of hungry entrepreneurs. VCs do for Web entrepreneurs what Hollywood studios do for film stars and directors, putting big hits together behind the scenes and delivering them with a splash to the public financial markets. That's usually the first we hear about quirky Web sites such as Broadcast.com and Xoom.com, after they go public with stock market valuations in the billions.
Venture capitalists have good news for people who think they have the next Internet hit: It's not too late to start from scratch. Funding for "dot coms" today is like a fire hose, with an unprecedented $2 billion in venture money being pumped into online companies in the first quarter of this year, according to market research firm VentureOne. While the money supply for high tech will probably tighten once Internet stock mania subsides, few experts believe it will tighten enough to break the entrepreneurial fever.
"We are maybe in the second inning of the Internet revolution, and there is a lot left to happen," said Gene Reichers, managing director of technology venture capital for Friedman, Billings, Ramsey Group in Arlington. "It is absolutely not too late to get started. Every day I get surprised by a new business idea."
But venture capitalists have bad news for the Internet dreamers, too: They turn down all but a few dozen of the thousands of business plans they review each year. Only a choice few get the bucks.
What, then, are the mysterious sparks that light the fires of successful high-tech entrepreneurs? Before quitting their day jobs, do they sign up for entrepreneurial boot camp, read how-to books, go to trade conferences and write clever business plans?
Entrepreneurs may do all of the above, but that's not what experts say differentiates the Internet winners. They seem to be the ones who have their own internal Web sites wired to their brains, with names like CanDo.com and HighSpeed.com.
"Where to start is the real test for any entrepreneur," said Mario Morino, founder of the Morino Institute and the unofficial godfather to the Washington area's high-tech entrepreneurs. "The successful entrepreneur will find the time to start a business even if they have another job. The one who doesn't isn't an entrepreneur. The difference is the drive and the hunger: Entrepreneurs are obsessively compelled and irrationally driven."
Sam Parker, an Arlington man who spent the past decade selling services for various companies, seems to have that hunger. He registered the Internet domain name JustSell.com in November 1997, a few hours after he and a colleague dreamed up the notion of a Web site catering to the nation's 15 million salespeople.
Three months later, Parker, 33, quit his job and went to work full time in his basement, trying to prove his vision of a new-media company that would use the Web to provide services, products and information to sales and marketing people. His move was especially risky because Parker has two young children, a wife who is not earning a traditional paycheck and a concept that was not entirely clear to anyone other than himself.
Soon he persuaded his colleague and co-founder, Jim Gould, to quit his job, too. Gould now works from his garage in Sterling. More than a year later, the two are finally seeking their first round of outside financing from "angel" investors -- private individuals who provide the capital that helps garage-bound start-ups take their business to the next level. That's where they prove some of their ideas about generating revenue and make business contacts that make them appear more credible to venture capitalists.
"We presented our plan at the Harvard business angel conference in May, and we are talking to other angels now," said Parker, who believes his Web site is on track to generate at least $600,000 in revenue this year. "The venture capitalists need to see some buy-in from angels in the first level of financing, so they can feel confident there are people involved who support and believe in the organization."
Parker's bootstrapping story is typical. He financed his first stage with money from the three F's: friends, family and "fools." "Cash flow has been very difficult," he conceded. "I have gone deep into my savings as well as my retirement money. The credit card companies are having a field day on me."
That's precisely the kind of hook venture capitalists like to see, because it makes entrepreneurs hungrier when their entire net worth is on the line. Founders of start-ups usually need to start with enough money to spend at least six months proving their concept: researching their market, contacting potential suppliers and sales partners, and making credible five-year projections of how their business will grow.
"We do not see people who have a job and say, 'If you fund us we will quit,' " said Jack Biddle, a partner with Washington area venture capitalists Novak Biddle Venture Partners. "They need to be serious, which means quitting their job, cutting the ties, focusing on their idea, recruiting the right people and moving the ball forward."
The Washington area offers plenty of resources for high-tech start-ups to move forward, experts say, including an increasing number of angel investors, venture-capital funds and business "incubators." The first step in starting a high-tech business here can be to join the Netpreneur Program, a networking group that Mario Morino founded.
"All roads here lead to Mario," said Mark Walsh, a local entrepreneur who is chief executive of publicly traded Internet start-up VerticalNet. "In Washington, there are two degrees of separation from Mario: Ask anybody anything, and two people later Mario is involved."
Sharad Daswani joined the Netpreneur program four months ago, shortly after launching his event-planning Internet business at www.pleasersvp.com. In April the 26-year-old quit his job at Andersen Consulting and began tapping his Netpreneur contacts to help him transform his business plan into a working company. "When you go to their monthly meetings you meet people who have worked in public relations, intellectual property or software development," Daswani said. "Whatever piece of the puzzle you are looking for, someone there can help you."
Fran Witzel, vice president of Netpreneur, advises start-ups to create their own advisory group before approaching outside investors because they can offer a needed sounding board. Financing gurus agree that getting good advice early is crucial. "Surround yourself with a good law firm and technology firm from day one," Reichers said. "Convert executives in other companies into being your mentor. Maybe even give them stock options as an incentive to meet you for breakfast every two weeks and keep you on track."
Failure to seek legal advice early often leads founders to structure their companies in ways that make outside funding harder later, Reichers added. An even bigger mistake many make, he said, is assembling a complete management team before talking to potential investors. The fact is, venture capitalists want to help pick key players in any company they sink money into.
That is part of the tug of war between entrepreneurs and investors over the company's valuation, ownership and control. The rules of thumb governing equity investing are fairly simple. One is that the amount of equity, or the percentage of ownership interest, that venture capitalists get grows in proportion to how early and how much they invest. The earlier their investment the greater their stake, because a company is considered riskier in its early days so its shares are worth less. The trick for founders is to delay taking outside money for as long as possible, so they give up less equity.
In addition to giving stock to outside investors, founders typically must give ownership interests to the top managers in the form of stock options -- often amounting to 5 percent to 10 percent for a chief executive, and a 0.5 percent to 3 percent each to key vice presidents, with the amount declining the later someone is hired.
While deals vary widely, there are also guidelines for investment amounts. Angel investors typically kick in less than $1 million in the first round. The total value of a raw garage start-up with a good idea but no customers can be about $2 million, according to Biddle. "If we gave them $1 million we might take one third of their company," he said. But if that same entrepreneur can hang on for another year while driving the business to a more credible level, he or she might get 10 times as much capital for the same percentage equity stake.
Founders are often surprised at how little they own of their company after multiple rounds of financing and aggressive management recruiting. Experts say that by the time a start-up reaches the promised land of selling stock to the public, the founder typically holds only between 3 percent and 20 percent of the company.
Experts often debate whether the company's mission or management team is more important, but all agree they are the critical ingredients.
Marc Andreessen, AOL's chief technical officer and co-founder of Netscape Communications Corp., believes the No. 1 priority is a company's mission or "riding the right horse."
"If you are on the right horse, with the way these markets are developing and the growth rates that we see, you will probably figure out everything else," Andreessen told 1,000 people at last month's Netpreneur meeting. "If you are on the wrong horse, you are probably dead."
But professional investors often take a different view, saying they bet more on people than ideas because it is people who build businesses.
"Ideas are not worth a lot," Biddle said. "The ability to execute a good idea is priceless."
© 1999 The Washington Post Company