What Do Venture Capitalists Want?

What Do Venture Capitalists Want?
The View From Inside the Moneybag

An interview with Tim Draper, Founder
Draper Fisher Associates

Tim Draper is the founder of Draper Fisher Associates, a leading venture capital firm specializing in high technology start-ups. Since 1985, the firm has invested more than $40 million in 70 different businesses, including Parametric Technology, Digidesign, Combinet, PLX Technology, and Upside Magazine.

Culpepper and Associates: What factors separate the start-up contenders from the Don Quixotes?

Tim Draper: We look very hard at two things: the individual entrepreneurs and the company’s markets. Entrepreneurs are by definition heroes. They must have an intense dedication to what they’re doing—one that will overcome all odds.

We also look for the “change the world” factor. We see 20 plans a day, so eventually we run into some serious innovations. We’re seeking companies offering significant improvements over existing technology that could, if there’s a large enough market, change the world.

We’re also investing in a team of people. Management must be committed to getting the best people possible for the jobs—people who can do those jobs better than the founder. And the founders must be willing to give those people enough of the company to make it work.

Some entrepreneurs want to hold on to 100 percent to make sure nothing happens to the company. Those are your Don Quixotes. They’re tilting at windmills. They don’t quite make it.

The contenders think in terms of giving equity to the team that has the expertise and the drive to make it happen.

Describe the successful software entrepreneur.
Software entrepreneurs must be completely driven, with no eye to anything else. They’ve got to be willing to allow other people into their vision—a hard thing for some to do.

Today’s successful software entrepreneurs really need a revolutionary idea. Revolutionary concepts let you enter the market in such a way that the Microsofts and Oracles will have to work with you.

Over the years, the sort of people founding businesses has changed. It used to be hardware people, tinkerers, guys like Wozniack at Apple Computer. Then, from 1987 until recently, it was the individualistic software engineers who started companies. Now we’re seeing marketing people taking concepts and starting firms.

Ten years ago, businesses were thinking about hardware and building a better black box. Then it became software and thinking about how to use that hardware. Now the hardware and software are in place and marketing people are looking at using the Internet.

The business model has definitely changed. Last year multimedia was the rage, and I would see about 20 multimedia business plans a week. Now I’m seeing 20 Internet plans a day.

What do you look for in a management team?
Experience. Experience and contacts.

When has your advice made a big difference?
I’ve spent a lot more time with companies having trouble. We have completely changed direction for some. One company actually changed its business from software to semiconductors.

One time my advice didn’t help, but my action did. When I met Parametric Technology, it was just Sam Geisburg and a very small office with a new kind of CAD software. They had difficulty getting financed, so I invested and put them in contact with a guy that had run a CAD software company in the past who was also a venture capitalist. He became the chairman and we recruited the president and VP of sales together. Now Parametric is a $3 billion company.

When we get excited about an entrepreneur’s idea, we become part of his headhunting firm, his investment banking firm, part of his corporate partnering. We put him in contact with the one or two big customers that can make the company. Eventually we can advise about going public.

What return on investment are you looking for?
We need extraordinary returns. We want our limited partners to achieve better than 40 percent initial return. In early-stage businesses we plan on losing a certain number, so for the entire portfolio to take flight, each company must have the outside chance of returning 40, 50, 100 times the investment.

What are the most common weaknesses you see in business plans?
I just saw a plan that called for landing people on the moon. Some are unrealistic. Many are too far ahead of their time. I like to be five to ten years ahead of the market. Further out than that just doesn’t make financial sense.

One whopping mistake we see is plans written by people other than the entrepreneur. Some other plans are incomplete. We need plans with full blown resumés attached, even references.

Plans need well thought-out business proposals. I would say the lack of business models that suit the technology is the biggest fault we see. The model can really determine success. The best example of that is Apple trying to do the whole box, while Microsoft just did the operating system. You have to focus on what really makes you special.

We can tell the difference between the pitch of a company that is a pipe dream and a company that is really happening. Saying “If you guys give me X dollars, then we’ll have a company,” just doesn’t excite us the way this does: “For the past nine months we’ve been developing this product. We’re ready. Do you want a piece of the action?”

When should a software company seek venture capital?
They seem to find us at all different times. Some companies are just desperate—on the ropes—and they come to us as a last hope. These can be good opportunities, but they’ve got to be flexible and willing to allow more organized management to come in. Often an entrepreneur just didn’t plan for the next stage.

Some companies come asking for X dollars for development. They may or may not be desperate, but at least they’ve thought it through.

I’m not comfortable heavily funding development, because three good guys are often more effective than 20. It becomes a management issue rather than a production problem. I prefer smaller, well-managed development teams.

Once in a while, a software company will say “Hey, our product is selling better than we thought. Give us some money so we can produce more.” Then it’s just a question of how much.

However, the best companies have entrepreneurs who have been looking for money for a while and had time to consider their direction. The great successes, Apple Computer or Parametric, have come out of start-ups that were looking for money for a long time. Sometimes, another year out there will make the difference and develop into a real opportunity.

Some software executives fear venture capitalists taking control of the company. Is this realistic?
Many entrepreneurs worry about the wrong things when seeking funding. We don’t have enough time to control anybody else’s business. As long as things are going well we have little to do. And if they’re not, all we can do is offer to help put the company back on its feet. We’re not going to call our loans: We’re shareholders, not a bank. Even if we control more than 50 percent of the shares, it’s really the entrepreneur who directs and drives the daily operations.

Generally, the companies that take most of our time return the least money.

The best experiences, the ones that make the most money, usually take the least time.Management comes to us only when it’s important. For instance, Parametric made us 200 times what we invested. After we put together the initial team, it ran the company and did a terrific job without our input.

How can a software executive ensure a good relationship with his VC?
Perform. A good relationship has nothing to do with sucking up and everything to do with performance.

Draper Fisher Associates, a Redwood City, CA venture capital firm, specializes in high-tech start-ups.

Article from Issue 144, February 1996.