I recently had the privilege of being a judge at the U.C. Berkeley Venture Capital Investment Competition (the “Competition”). This program was hosted by the Berkeley Entrepreneurs Association and the Berkeley-Haas Entrepreneurship Program (affiliated with the Haas MBA School at U.C. Berkeley).
The Competition was terrific, bringing together Berkeley-Haas and U.C. Berkeley graduate students to expose them to the venture capital industry and early stage startup companies. The event lasted a full day and was expertly administered by the Competition Executive Committee (particular kudos to Adeeba Khairzad, Esmond Ai, Rhonda Shrader, Neha Ruikar, Neha Dobhal, Ludwig Schoenack, Terence M. Kelly, and Dmitriy Berenzon for helping to put on a great event).
The Competition consisted of real, interesting startups that were currently seeking funding, pitching their business ideas to the student venture capital teams. The startups competing were Intento, Jobwell, Mooqita, World Hearing Organization, and ZoneTap. I particularly liked the potential of the World Hearing Organization to revolutionize the hearing aid industry.
After the initial pitches, the student venture teams dug deeper into each startup investment opportunity through due diligence reviews and interviews with the entrepreneurs. The student venture teams also engaged in a mock negotiation of a venture capital term sheet with the entrepreneurs.
The judges, who consisted of seasoned venture capitalists and entrepreneurs, sat in on all of the startup pitches, the due diligence review sessions, and the mock term sheet negotiations. The judges’ role was to pick a winning student venture team, taking into account all the relevant factors.
All of the student venture teams were terrific, particularly the winning “Alpha” team consisting of Andrew Briggs, Alibek Dostiyarov, Amy Fan, Matthew Bond, and Max Kubicki. They stood out because of their targeted due diligence questions, their technology savvy, and their strong presentation skills.
Here are some of the most important things I learned from being a part of the Competition:
1. Be Prepared to Come Before Very Savvy People When Pitching to Investors
The Haas-Berkeley student venture teams were much more sophisticated and technology savvy than I expected. They quickly understood the key elements of the startups’ underlying technology—including artificial intelligence, internet, apps, SaaS, and more. They were also particularly smart about sales and marketing issues the startups would face.
2. Most Startup Entrepreneurs Can Do a Better Job With Their Pitch Decks
Each entrepreneur had a 15-minute time slot to pitch their company using a PowerPoint pitch deck. All of these pitch decks could have been better, addressing some of the following key issues more completely:
- What is the mission and vision of the company?
- What is the big problem you are trying to solve?
- What is the addressable market opportunity for the company? (Investors want to see that the company has the potential to grow very big in a large market.)
- What key traction has the company obtained to date?
- What proprietary technology does the company have that will help it stave off competitors?
- What is the go-to-market strategy?
- What is the business/revenue model?
For tips on developing strong startup pitch decks, check out How to Create a Great Investor Pitch Deck for Startups Seeking Financing.
3. Selling Is a Two-way Street Between Startups and Venture Capitalists
Naturally, the startups were all in “selling” mode trying to impress the venture capital teams about their potential prospects. But the best venture teams were also in selling mode—explaining to the entrepreneur who the venture team was, their relevant experience, and how they could help the entrepreneur become successful. Some of the venture teams jumped into due diligence questions without much of an introduction. In the real world, it’s important for both sides to build mutual rapport and respect.
4. Startups Must Be Prepared to Answer Hard Questions About Competitors
The startups frequently received questions about the competitive landscape for their business. These questions included:
- Who do you see as your principal competitors?
- What differentiates your company from those competitors?
- If Google or Amazon decided to go into your space, wouldn’t they just crush you?
- How do your competitors match up on price and functionality?
Entrepreneurs have to thoroughly understand their competitors and be able to clearly explain why their startup has advantages over those competitors.
5. Startup Entrepreneurs Must Understand Complex Financial Issues
As a startup, you must keep on top of your expenses and learn how to thoroughly understand financial statements and budgeting. Many startups have failed because the entrepreneur wasn’t able to adjust spending to avoid running out of cash. Establishing a detailed, month-by-month budget is important, and this budget must be regularly reviewed.
Understanding your financial statements will also help you answer questions from prospective investors. Here are some financial statement questions you can expect to get from potential investors:
- What are the company’s five-year projections?
- What are the key assumptions underlying your projections?
- How much equity and debt has the company raised; what is the capitalization structure?
- What future equity or debt financing will be necessary?
- How much of a stock option pool is being set aside for employees?
- When will the company get to profitability?
- How much cash burn will occur until the company gets to profitability?
- What are your unit economics?
- What are the factors that limit faster growth?
- What are the key metrics that the management team focuses on?
- What are the anticipated gross margins?
6. Startups Should Focus on Getting Adequate Capital Rather Than Be Overly Concerned About Dilution
The entrepreneurs made the following mistakes about the capital-raising process during their pitches:
- They asked for too little capital that would not last them long enough to get to a meaningful milestone for the next round of financing.
- The entrepreneurs worried too much about dilution of their equity ownership.
- They had unrealistic expectations on the valuation of their company, especially the companies that were pre-revenue.
- They didn’t appreciate that their company would likely have to go through multiple rounds of equity financing in the future.
- They didn’t appreciate how difficult it is to raise capital and the lengthy time period typically required to close a financing round.
- They didn’t have a clear and concise explanation of how the capital raised would be spent and what progress would be made with that capital.
7. Startups Must Understand Venture Capital Term Sheets
Both the venture teams and the startups struggled with some of the provisions of the venture capital term sheets presented. This is understandable, as venture term sheets can be highly legalistic and complicated. There is no real “standard” term sheet for a venture capital equity investment and a number of points often get negotiated.
Here are some of the key points that were negotiated by the venture teams with the startups:
- What will the pre-money valuation of the company be?
- What size will the company’s stock option pool be, and will it be computed before or after the financing? (Venture capitalists argue that the pool should typically be 15%-20% of the company and be computed as part of the pre-money valuation of the company.)
- Will the form of investment be a convertible note or will it be a preferred stock instrument?
- If preferred stock is the investment vehicle, what is the liquidation preference? Is the preferred participating or non-participating?
- How will the Board of Directors be configured so as to not relegate total control to the management team?
- What veto rights will the venture capitalists receive? (VCs will typically insist on approval rights on future rounds of financings, a sale of the company, and other major events.)
- Once the term sheet is countersigned by the startup company, it will typically be subject to a “no shop” provision preventing the company from talking to other potential investors, unless approved by the venture capital fund. The time period for this no shop provision is negotiable, usually between 30-45 days.
- A hot button issue for the founders will be whether their existing stock in the company will be subject to a new vesting schedule to ensure their continued participation in the business. Founders will often request that they be given vesting credit for time already spent in the business.
- VCs will expect other standard terms, such as pre-emptive rights; drag along rights; information and registration rights; and rights of first refusal/co-sale on sales of stock by the founders.
8. A Startup’s Management Team Is a Critical Component
Many venture capitalists will proclaim that the strength of the management team is the most important factor in determining whether or not to invest in a startup.
The venture teams in the Competition did not generally do sufficient probing of the management teams to make sure they were passionate, dedicated, and had relevant experience.
Here is the type of due diligence often done on the management team:
- Who are the founders and key team members?
- What relevant domain experience does the team have?
- What motivates the founders?
- What key additions to the team are needed in the short term?
- Why is the team uniquely positioned to execute the company’s business plan?
- Does the team have any issues with prior employers? (See, for example, the issues arising out of the Waymo/Uber litigation.)
- What background checks (schools, prior employers, references, past misconduct issues, etc.) should be performed?
- Are there any public statements on social media made by any of the team members that are problematic? (Note that the New York Times recently hired and then fired someone within seven hours because of the discovery of inappropriate comments made on Twitter.)
9. Startups Should Have a Strong Marketing and Customer Acquisition Strategy
The startups and the venture teams did a very credible job on the issues of marketing and customer acquisition.
The types of good questions that were asked included:
- How does the company market or plan to market its products or services?
- What is the company’s PR strategy?
- What is the company’s social media strategy?
- What is the cost of a customer acquisition?
- What is the projected lifetime value of a customer?
- What is the typical sales cycle between initial customer contact and closing of a sale?
10. Startups Should Expect Questions About Their Intellectual Property
For many companies, their intellectual property will be a key to their success. The investors will pay particular attention to the answers to these questions:
- What key intellectual property does the company have (patents, patents pending, copyrights, trade secrets, trademarks, domain names)?
- What confidence do you have that the company’s intellectual property does not violate the rights of a third party?
- How was the company’s intellectual property developed?
- Would any prior employers of a team member have a potential claim to the company’s intellectual property?
Conclusion
All in all, the startups and the venture teams did a terrific job and showed a high level of sophistication and technology savvy. Congratulations to the U.C. Berkeley Haas School for putting on such a great competition!
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Copyright © by Richard D. Harroch. All Rights Reserved.
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on investing in Internet and digital media companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, Fox Business, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He was also a corporate partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, strategic alliances, and venture capital. Richard can be reached through LinkedIn.
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