How VCs decide which startups to back — and which to avoid

By George Deeb

Having a great, defensible business idea in a scalable market is only half of the puzzle to attracting venture capital. The other half is having a backable management team. Today we are going to define exactly what that means, in the eyes of a venture capitalist.

The first thing a VC is looking for is domain expertise in the industry you are targeting. How many years of experience do you have in that industry? In what roles did you operate that were relevant to your new business? Or, for tactical positions like CMO or CTO, what other marketing or technology roles have you had in the past, and were they relevant for a startup in this industry (e.g., a Fortune 500 CMO will not understand how to market a startup on a shoestring budget)? While in these positions, what successes can you share, and what failures did you learn from? And, frankly, they care a lot more about your failures to see how resilient you were and how battle tested you are at getting your business through the bad times (which will always happen at some point).

The second thing they look for is credibility. Is your business plan well thought-out and are your revenue assumptions believable in relation to your industry size and marketing budgets? So, be sure to reread my earlier lesson on How to Write a Business Plan. And never come across as overly pushy or too salesy. The last thing a VC wants to back is a “used car salesman” trying to sell him the Brooklyn Bridge.

The third thing a VC looks for is passion and energy. Do you have the fire in the belly to wake up every morning and bust your ass to execute the business plan? I think it is safe to assume most good entrepreneurs are not lacking in this area, but you would be surprised how many startups come in with unenthusiastic or boring presentations that don’t get anybody excited, regardless of how great the idea may be. And, if you cannot get your VCs excited, it is unlikely you will get potential customers excited in driving revenue and hitting the VC’s ROI expectations.

The fourth thing VCs look for is your listening and communications skills. The biggest mistake an entrepreneur can make is to assume he is the only smart person in the room and nobody else knows what they are talking about. Hence, digging in and entrenched viewpoints. Let’s not forget a good VC sees around 200 business plans a year, 2,000 plans a decade. And, most likely, many very similar to your own, in one form or another. So, they bring a ton of market intelligence to the table and can help you avoid known pitfalls. It is critical they think you are flexible and will listen to input as needed. And be prepared, at some point, a VC may make a recommendation to put in a new CEO with more skills than you. So, listen with open ears, as protecting your 65 percent equity value is a lot more important than protecting your job title. But, hopefully, you will never give them that opportunity by knocking the cover off the ball the entire way up.

The days of the dot-com boom in the 1990s are long behind us. No longer can a 21-year-old with a high-level idea on a piece of paper (without even a revenue model) walk into Silicon Valley and collect a $10 million check. You are much better served with at least 5-10 years of real-life work experience, and the relevant lessons therefrom. And, frankly, a second-time CEO is a much better venture bet than a first-time CEO, since that entrepreneur has already learned how to avoid many startup pitfalls and can point to a track record.

That basically narrows the attractive pool of entrepreneurs down to a very small list. But, there are ways to offset your lack of executive history, by surrounding yourself with a smart team of people who are proven experts in their field. If you are launching a new search engine, and you have a Google engineer on your staff, that will get a VC’s attention. If your startup is dependent on Facebook for successful social marketing, and your CMO is an old Facebook executive, with a lot of relationships there, that will get a VC’s attention. Not to mention, the VCs will be impressed by your hiring skills (finding the best talent) and your sales skills (getting these proven winners to buy into your vision). This deep team around the management table is exactly what the VCs want, to make sure your business is more than a “one-man show.”

Entrepreneurs are an eccentric bunch, often flying by the seats of their pants, living on the edge between reality and pipe dream the entire way up. These trailblazers and visionaries are what make startups so exciting, and potentially, a lucrative investment opportunity for VCs. But, at the end of the day, a VC is looking for an experienced, credible, passionate, energetic and flexible team more than anything else. Management teams make or break businesses, and smart VCs know good teams when they see them.

As I have said before, and it’s worth reiterating: VCs would much rather invest in an A-plus team with a B-plus idea than an A-plus idea with a B-plus team. So, keep that in mind.

George Deeb is a managing partner at Red Rocket Ventures, a Chicago-based startup consulting and fundraising firm with expertise in advising Internet-related businesses. More of George’s startup lessons can be read at “101 Startup Lessons — An Entrepreneur’s Handbook.”

George’s posts appear on Crain’s blog for Chicago entrepreneurs on Fridays.

Follow George on Twitter at @georgedeeb.

Join Crain’s LinkedIn group for Chicago entrepreneurs. And stay on top of Chicago business with Crain’s free daily e-newsletters.

Another tech bubble on the verge of bursting?

By Gini Dietrich

Is anyone else concerned we’re very close to another tech bubble bursting?

We don’t have to look far to begin this conversation: A little more than a year ago Groupon Inc. was offered $6 billion from Google (an offer they turned down in order to go public, which they did less than a year later). At the time, I predicted they would falter and never see that kind of money again.

I didn’t make this prediction because I have some crystal ball that tells me what’s going to happen and gives me winning lottery numbers. I made it because I was reminded of what happened during the dot com bubble.

We just watched Facebook buy Instagram for $1 billion (a year’s worth of profits) and insane valuation numbers being thrown ($96 billion) around as Facebook prepares for their road show.

This is a lot of money for companies that don’t make money (excluding Facebook, which has figured out the profit game). I’m reminded of 1999, when venture capitalists were paying big money for great ideas and lots of eyeballs, but for companies without business plans or a way to make money.

During an event I attended last night, Carol Roth reminded the audience a company is worth what just one person will pay for it. Hence, Instagram was worth $1 billion to Facebook because it clearly had something the giant social network does not.

And Chris Dixon reminds us no good VC firms invest in companies with the idea they’re going to flip them. He says this is a bad strategy and they’re much better off investing in companies that have a good chance to build a very profitable business.

But is this enough? Did we learn our lesson from just 12 short years ago? Or are we quickly careening toward another mistake that could have been prevented by studying history, setting aside our egos and forgetting about greed?

Gini Dietrich is founder and chief executive officer of Arment Dietrich Inc., a Chicago-based firm that uses non-traditional marketing in a digital world. Her column appears on Crain’s blog for Chicago entrepreneurs every Friday.

Follow Gini on Twitter: @ginidietrich.

Join Crain’s LinkedIn group for Chicago entrepreneurs. And stay on top of Chicago business with Crain’s free daily e-newsletters.

Crain’s small-business editor Ann Dwyer is on Google+.

How to get a VC or angel investor’s attention — the right way

By George Deeb

I can’t tell you how many entrepreneurs first approach investors either at the wrong time, in the wrong way or in the wrong format.

Today, we will tackle these simple-to-fix pitfalls.

First, what do I mean by wrong time?

Have all the required elements in place before approaching investors. This includes completing all the necessary research supporting your business plan. (See Lesson No. 7 on how to write a business plan.) And, if possible, have some type of “proof of concept” behind you. This could include a working prototype, closed customer contracts, a brand-name pipeline, growing traffic to the site, a proven team in place, etc. Anything that gets the investor comfortable that the heavy-lifting research is behind you, that there is some initial traction for the product, and that a solid team is ready to begin execution of the plan. If you don’t have these pieces of the puzzle firmly in place, wait before approaching any professional investors.

Second, the proper way to approach an investor is typically through a referral.

The investor is much more likely to hear your pitch (among the 200 they listen to each year), if it is being sent to them via somebody they already know and trust, who can vouch for you. So use LinkedIn to look for mutual connections that can open that door for you, if possible. Or ask your lawyer or accountant for intros. If there are no mutual connections, you have no choice but to cold-call the investor — your lowest odds of probability to getting a deal done. But if that is your only option, it is important that you come across as professional, smart, enthusiastic and polished in both your information and your delivery.

As for the desired format, I typically find that investors are very busy and are more receptive to getting an introduction via email (which you can access via their website or calling their office). Email gives them a chance to research you and your idea before committing to a phone call or an in-person meeting. So make sure you keep a clean social networking trail on Facebook and Twitter, as they will most certainly be Googling you. And make sure your LinkedIn profile is as complete and compelling as is your online resume.

The contents of that email are the most critical. Remember the short attention span of investors: If they can’t understand your business in 30 seconds of reading, they are moving on to the next one. So you need a very short and sweetly written cover letter that summarizes your story in a few sentences (not paragraphs!). Something that gets them jazzed up.

For example, my startup iExplore’s email could have read: “iExplore is the No. 1 ranked website in the rapidly growing $10 billion adventure travel industry with over 1 million visitors per month and a strategic partnership with National Geographic. Our revenues are growing 50% per year, and we are raising venture capital, which should yield you a 10x return. See attached for more details in our executive summary. Let me know a good time for an introductory call or meeting to discuss further. How do you look on Friday morning?” That’s all you really need, including a clickable link to your website so they can easily learn about your product in more detail (so make sure you have a snazzy website, to back up your snazzy pitch).

Notice what that paragraph did:

• It described the business and its leading market position

• Detailed industry size and growth

• Highlighted a brand-name strategic partner

• Showed the business was driving revenues and how quickly they were scaling, and

• Wet their beak with the opportunity to make a big 10x return.

That was a lot to accomplish in two sentences. The paragraph also closes (as it always should) with a clear call to action, which will be very easy for the investor to hit reply and say, “Friday looks fine at 9 a.m.”

Now that the cover letter is solid, follow the above linked Lesson No. 7 to prepare a one- to two-page executive summary (with the best of the best from the bigger business plan, including management bios and a five-year forecast). That is it. Do not send them any more than this. They won’t read it at this time. They will certainly ask for much more information during the due diligence process, which you will already have prepared with your full plan sitting in reserve. And graphics and charts go a lot further than text to getting your message across.

You only have one chance to make a good first impression with a prospective investor. Don’t blow it!

George Deeb is a managing partner at Red Rocket Ventures, a Chicago-based startup consulting and fundraising firm with expertise in advising Internet-related businesses. More of George’s startup lessons can be read at “101 Startup Lessons – An Entrepreneur’s Handbook.”

George’s posts appear on Crain’s blog for Chicago entrepreneurs on Fridays.

Follow George on Twitter at @georgedeeb.

Join Crain’s LinkedIn group for Chicago entrepreneurs. And stay on top of Chicago business with Crain’s free daily e-newsletters.

Crain’s small-business editor Ann Dwyer is on Google+.

VC heavyweights put muscle behind data-driven weight-loss startup

By Steve Hendershot

Retrofit, a Skokie-based company that offers data-driven weight-loss programs with one-on-one coaching from fitness experts, will announce today it has raised $2 million from three Chicago venture-capital funds. The investment round was led by I2A Fund, New World Ventures and the FireStarter Fund.

This marks the second substantial investment in Retrofit in just a few months. The company raised $700,000 from angel investors last September, then used the money to fund a beta test. That beta test of 160 clients was a hit — they’ve lost an average of 1.1 pounds per week — and now Retrofit will use the additional capital to scale up its operations and add features.

Retrofit’s fitness program works by pairing clients with a team of master’s-degree-level fitness professionals ranging from dietitians to counselors. The company collects data from Wi-Fi-equipped scales and pedometers, then funnels the information to the client’s team of advisors. The Retrofit service costs $250 per month and includes unlimited access to the service providers, who use the video-conferencing service Skype to meet face-to-face — virtually — with clients.

“Weight loss is a very squishy type of industry, and people are susceptible to hope, fear, a lot of theories, and lots of bad ideas. We decided to use data as a champion, so that people are working from a very quantitative, unarguable set of information, not hoping and praying they got it right,” says CEO Jeff Hyman, 43, a former Dyson VP who started the company under the name Strong Suit in order to build his product, then rebranded as Retrofit last summer when it was ready to market after about 18 months of research.

Retrofit has 10 full-time employees in the Chicago area in addition to 40 fitness experts nationwide. Half of the fitness experts’ compensation is tied to their clients’ results.

In additional to the three institutional investors, angel investor Larry Levy, chairman of Levy Restaurants, also participated in the $2 million venture-capital round. Mr. Levy also participated in the angel-investment round last fall.

Steve Hendershot writes “Silicon City,” Crain’s weekly column on tech news and newsmakers. Follow him on Twitter: @stevehendershot.

VC heavyweights put muscle behind data-driven weight-loss startup

By Steve Hendershot

Retrofit, a Skokie-based company that offers data-driven weight-loss programs with one-on-one coaching from fitness experts, will announce today it has raised $2 million from three Chicago venture-capital funds. The investment round was led by I2A Fund, New World Ventures and the FireStarter Fund.

This marks the second substantial investment in Retrofit in just a few months. The company raised $700,000 from angel investors last September, then used the money to fund a beta test. That beta test of 160 clients was a hit — they’ve lost an average of 1.1 pounds per week — and now Retrofit will use the additional capital to scale up its operations and add features.

Retrofit’s fitness program works by pairing clients with a team of master’s-degree-level fitness professionals ranging from dietitians to counselors. The company collects data from Wi-Fi-equipped scales and pedometers, then funnels the information to the client’s team of advisors. The Retrofit service costs $250 per month and includes unlimited access to the service providers, who use the video-conferencing service Skype to meet face-to-face — virtually — with clients.

“Weight loss is a very squishy type of industry, and people are susceptible to hope, fear, a lot of theories, and lots of bad ideas. We decided to use data as a champion, so that people are working from a very quantitative, unarguable set of information, not hoping and praying they got it right,” says CEO Jeff Hyman, 43, a former Dyson VP who started the company under the name Strong Suit in order to build his product, then rebranded as Retrofit last summer when it was ready to market after about 18 months of research.

Retrofit has 10 full-time employees in the Chicago area in addition to 40 fitness experts nationwide. Half of the fitness experts’ compensation is tied to their clients’ results.

In additional to the three institutional investors, angel investor Larry Levy, chairman of Levy Restaurants, also participated in the $2 million venture-capital round. Mr. Levy also participated in the angel-investment round last fall.

Steve Hendershot writes “Silicon City,” Crain’s weekly column on tech news and newsmakers. Follow him on Twitter: @stevehendershot.

What makes Chicago’s newest VC fund different? An insider’s perspective

By Steve Hendershot

Mr. Hand, the FireStarter co-founder who developed the fund structure, tells Crain’s more about how it works:

Crain’s: Why does it make sense to bring these local entrepreneurs together as partners in a venture-capital fund?

Brian Hand: The concept was, just about everybody here has started and run a company in the web/social/mobile area, so we all have direct experience in building and running businesses. Many of us had said we’d like to invest in companies that other folks in the group were already investing in. So that spawned this idea for how we can make that happen without hindering anybody’s ability to invest as they currently are doing.Virtually every (member) is already an angel investor or early stage investor, so this is not a brand new thing for these people—it’s something we’ve been doing. This is just a way to organize this in a way that will help us and help the community. Up to this point, it’s been people individually getting out there and making investments, but not everybody has access to the same deals, and not everybody sees the same opportunities. Many times in the past, our members have had skills they could use to help a particular company, but they weren’t exposed to that company in a way where they could get involved as an investor.

Crain’s: How unique is this fund structure? Explain how it works and why you set it up this way.

BH: There’s nothing like this out there. We’ve made it so that with smaller investments we don’t need a lot of people involved. If you needed 42 people involved in every single deal, the process for getting everyone on board and up to speed through all the due diligence on would be quite cumbersome. Instead, I don’t need to vote on deals I have no interest in, or that are outside my bailiwick—even though I love the fact that the fund might invest anyway. Then, with the deals I really like, I’ll get involved and vote and maybe get active with that company if I so choose.

Smaller investments by the fund require a much smaller number of people to vote, and to vote yes. To make an investment of $25,000 to $75,000, all we need is a minimum of six yes votes. If there are six yes votes and no one else votes, we could do up to a $75,000 investment. It’s still majority rules, so those six votes can’t rule by themselves (for instance, if there were six yes votes but also seven no votes, there would be no investment). We did it intentionally this way so that we don’t have to round up everybody every time. It’s a much lower threshold for making smaller investment. Then, the bigger the investment, the more people have to get involved. For example, to make an investment from $75,000 to $250,000, you need a minimum of 16 yes votes.

Crain’s: What do you hope FireStarter will accomplish beyond making smart investments?

BH: It’s going to help the cohesion within this group of (investors). We will all get to know each other much better over the next few years, and that can only be good for Chicago and the Midwest from the standpoint of having a more cohesive group of investors and entrepreneurs. If you look at (Silicon Valley), for example, they have a much more cohesive group of early stage investors. Our hope is that FireStarter is the way to do that here, as well as to finance some great companies.

Crain’s: How about the nuts and bolts? How will you handle administration, and what will your investments look like?

BH: It’s going to be a self-managed fund, so nobody gets paid, there’s no carried interest, no fees, and everybody is free to continue doing whatever other investing they (already) do today. Unlike most funds, where you cannot invest side by side with the fund, this is not set up that way.

Our typical deal size will be much smaller than that of a traditional fund. We’re looking at a $150,000 to $350,000- type of total investment (including follow-on investments) in each company, and then 15 to 20 total (companies) over the life of the fund. It’s a 10-year fund, and we cannot make any new investments in companies after the first four years, though we can make follow-on investments after that.

Because the size of our investments will be smaller, we’re not going to crowd out any traditional venture funds. In fact, we’ve already spoken to other venture funds to let them know who we are and what we’re doing and that we’d love to work with any existing fund that thinks we can add value and help their portfolio companies grow.

Crain’s: Considering that this is a self-managed fund and that all 42 members seem pretty busy, how will you handle it if your website is deluged with pitches from companies hoping to join your portfolio?

BH: We are encouraging (entrepreneurs) to seek out one of the 42 (FireStarter investors) rather than just sending a plan in under the proposals sidebar at FireStarterFund.com. People can (make online submissions), but the likelihood of success will be much reduced versus finding somebody.

We want there to be a real hurdle. We don’t want people just throwing stuff over the transom. There are 42 people involved, and if you can’t get to one of those 42, there’s something wrong. We want people who are hungry enough and innovative enough to figure out ways to find (a FireStarter investor) and convince them they have a good idea. Then that member can bring the idea to the whole group.

Steve Hendershot writes “Silicon City,” Crain’s weekly column on tech news and newsmakers.

Follow Steve on Twitter: @stevehendershot.