Don't "Pull A Patzer" And Other Lessons Learned On Our Trip Down Sand Hill Road

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Editor’s note: Earlier this month, BrightRoll raised a $10 million Series B for its video ad network. In this guest post, CEO Tod Sacerdoti shares some of the lessons he learned trying to raise that money in the current environment.

As Peter Drucker once wrote, “The entrepreneur always searches for change, responds to it and exploits it as an opportunity.” Put more simply, change is good . . . of course, that’s unless you’re trying to raise capital in these trying times.

After my company BrightRoll recently closed its Series B round of financing, we took a step back to digest the lessons we learned from pitching and negotiating with a handful of VCs over our 6-week fundraising effort.

To say raising money in the current economic environment has been different than it was two years ago is a massive understatement. Saying it’s night and day would be more accurate. As a year that was touched off by Sequoia’s now famous “RIP Good Times” presentation, 2009 was highlighted by massive layoffs, significant cost cutting and many well publicized company failures. As a result, many VC firms, and their portfolios, are now fraught with uncertainty—walking a fine line between licking their wounds thanks to poor fund returns and looking for new opportunities to improve their fortunes as the market recovers.

Perhaps the most important lesson gleaned from our financing is that over the last two years, the fundraising environment has become more complex. A still dormant IPO and comparatively sluggish M&A markets offer little hope for the future in terms of exits, while a handful of well-publicized scandals have led to more bureaucratic layers in the due diligence process and a new series of metrics are being used to gauge long-term prospects.

It’s a market in flux, with a whole new set of best—or worst—practices, depending on how you look at them. What follow are some highlights from BrightRoll’s most recent trip down Sand Hill Road.

1. The Mint.com Acquisition Left Anything But a Minty Aftertaste in the Mouths of Many on Sand Hill Road

If you read TechCrunch, you undoubtedly know the story of Mint.com. The winner of the inaugural TechCrunch40, Mint.com’s personal finance application lets users track and monitor their financials. The company grew by leaps and bounds following its debut and just three years after its founding was acquired by Intuit for $170M.

By most accounts Mint.com’s rapid rise to prominence and ultimate acquisition is the quintessential Silicon Valley success story. Yet, the Mint.com acquisition brought to light an interesting phenomenon, one I’ve coined the “Patzer Problem.” Prior to submitting offers to invest, three separate VCs wanted to confirm that we had no intention of “Pulling a Patzer,” modern-day Sand Hill Road parlance for selling too early.

Here’s why: with large funds being raised on Sand Hill Road and returns from previous funds underperforming, investors are becoming increasingly desperate for that single homerun investment that returns $1B or greater. Even though Mint.com was a huge success for the founder and team, generating $60 million in equity value per year, many VCs believe they sold too early and left too much potential value on the table.

2. Fraud and Its Impact on the Due Diligence Process

In addition to the challenge of getting a term sheet signed, new barriers have emerged that make closing transactions harder than ever. Chief among them is completing due diligence, which has gone from a relatively efficient and painless series of “check-the-box” financial and legal processes, to a full-blown corporate and financial audit.

These changes can be primarily attributed to the alleged fraud and ultimate failure of Canopy Financial, a company that raised more than $85 million from FTP and Spectrum. Canopy is alleged to have falsified financial reports and auditing statements and its investors were left holding the bag, which means that other entrepreneurs seeking funding are now paying the price. To prepare for these changes, companies should make sure to negotiate a cap on legal expenses ($25,000 max) in all term sheets because there is no end to what can be attributed to due diligence under this new model.

3. Perception is Reality, So Prepare Your Third-Party Data

As Mark Twain once said, “Facts are stubborn, but statistics are more pliable.” While both companies and venture capitalists often argue that internal logs are both factual and the most accurate source of online traffic data, this data carries little weight when there are millions of dollars at stake. At BrightRoll, we were amazed how many investor decisions relied on metrics provided by comScore and Quantcast, even when the same investors would simultaneously mock the validity of those reports.

The lesson here? VCs act like public market investors and perceived leadership may be as valuable as actual leadership—don’t forget to put apples-to-apples measurement in place before making your pitch and understand how to explain any discrepancies that may exist between your logs and those of third-party providers.

4. New Metric: Revenue vs. Money Raised (RoR)

We all know that Rome wasn’t built in a day and that venture investing is by nature one of the most risky investment classes. History has shown that companies pursuing billion dollar exits that VCs covet are often required to spend significant amounts of time and capital in their formative years to build out their product and gain market share.

Yet, in what may be a harbinger of things to come, in multiple meetings I was asked to compare BrightRoll’s annual revenue to the amount of money it had raised in previous years. This is what I now call the Revenue on Raised (RoR) Ratio. If your RoR is greater than one, meaning you generate more revenue every year than your total capital raised, then you are in good health and outperforming most later-stage startups.

Just a few years ago, the “Patzer Problem” and the “RoR” ratio would have seemed paradoxical. After all, how can a company be expected to pursue a multi-billion dollar opportunity, bring a product to market and generate revenues in excess of the funds they’ve raised fast enough? As difficult as it is, that is what companies must do. Savvy investors now realize that fast time-to-market, and massive market opportunities and significant revenue generation are all possible in today’s online environment.

5. Revenue Growth or Profitability, Pick One

There is a perception that in 2009 companies were either reducing head count to get profitable or gaining market share to grow revenue. Yet, in most of our conversations the concept of doing both—doubling revenue and getting profitable in a down year—was regarded as the gold standard.

Is this thinking the fatal flaw in the venture model? Looking back to early 2009, it would have been a smart move to invest in companies at low valuations to enable them to deliver either revenue growth or profitability, not both. These results would have been achievable through a disciplined approach, focused on several factors, including:

  • Resisting raising too much money before the business was scaling so that achieving a desirable RoR was possible in the short term
  • Only hiring where desperately needed, to preserve capital to hire through the recession;

Together, these small steps can pay dividends when it comes to raising follow-on rounds, particularly during tough economic times.

I hope the above lessons help other companies looking to dive into today’s VC environment, as a little knowledge from the companies that have come before you can go a long way.

Photo credit: Flickr/ Steven Damron

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