Heavenly Strategies for High-Tech StartupsPublished: September 29, 1999 in Knowledge@Wharton
Each week, the web-based, early-stage venture financing firm Garage.com receives hundreds of proposals from prospective high-tech startup companies looking for mentoring and investors. Only a few make it to "Heaven"the section of the firm's web site dedicated to showcasing promising startups for its venture capital members and individual investor "angels." On September 27, Garage.com CEO and author of Rules for Revolutionaries Guy Kawasaki spoke at Wharton about Garage.com's operations and the criteria for successful fundraising in today's high-tech world. The talk was part of an on-going series of lectures at the school on the electronic commerce industry.
Kawasaki is no stranger to the process of starting a high-tech company. In addition to co-founding Garage.com, he is the former chief evangelist for Apple Computer, he has started two software companies of his own, and he has been an "angel" for three others.
"We find, fix and fund," Kawasaki says about the mission of Garage.com, which operates to fill the gap between what he calls "the three F's" in fundraising ("Friends, Family and Fools") and major venture capitalists who are willing to invest $5 million or more in seed capital for high-quality technology startups. "We help entrepreneurs raise about $2-$3 million to begin," he says, noting that this strategy places startup companies in a stronger position than they would otherwise be with higher levels of venture capital. "They would be too financially diluted," he says.
After carefully reviewing proposals submitted to the firm, Garage.com begins the process of "raising" startups by purchasing five percent of a company's common stock and then drawing the attention of investors by placing the company on its "Heaven" page. Through its own broker/dealer subsidiary, the firm raises money, charges a five percent investment banking fee, and then re-invests that fee in the company. "We are cash neutral," explains Kawasaki, "but we own five to six percent of each company." Since January 1, 1999, the firm has helped to raise over $60 million for 20 technology startup companies. Ultimately, Kawasaki says, Garage.com would like to invest in 40 to 60 companies per year.
The firm uses three major criteria for evaluating proposals: the quality of the team, the quality of the idea, and the quality of the market. "This is not a science, though," Kawasaki is quick to point out. "A lot of it involves gut feeling." He stresses the importance of having solid ideas about product building and selling. "Good ideas are easy," he says. "We see them everyday. But implementation is the key to a good company." And he offers two additional pieces of advice to would-be entrepreneurs: never tell potential investors you have no competitors (it's just too unrealistic) and always express a willingness to make changes in the management team.
Kawasaki mainly reviews proposals through e-mail, and he expects them to be short, executive summaries without attachments. When business plans are solicited, he says, they should include no more than 10 PowerPoint slides. With the candidness and humor that are typical of his writing (he is the author of seven books in all), he warns: "And don't send consultant testimonials or financials. No one believes them anyway!" In fact, Garage.com has its own preferred form for proposal submissions. This streamlined approach, according to Kawasaki, allows the firm to evaluate the high volume of proposals it receives much more efficiently.
According to Kawasaki, the most important value Garage.com offers entrepreneurs is seed money that is connected to industry in Silicon Valley. "All money is not created equal," he states. "Look for value, not valuation. Money with the right connections is worth much more in the long run, despite the actual amount." In fact, when money is well connected, Kawasaki views it as a marketing opportunity, because the investor will certainly publicize the startup within the right circles. "This is marketing by capital raising," he says. When the right investor shows interest, Kawasaki also advises entrepreneurs to accept more financial dilution than they might otherwise. "A small increase in the percentage of dilution doesn't matter over the long haul. In this business, either you end up more successful than you ever imagined, or you're already gone."
That said, Kawasaki also warns that it is still important to give any interested investor serious consideration, even if it doesn't seem like a perfect match. "Don't be too proud," he says. "The market changes too quickly to pass things up."
In what may seem a counter-intuitive turn, Kawasaki also coaches companies to ask investors for less than they actually want. "If you need $2 million, ask for $1 millionnot $4 million." It all has to do with perception and what Kawasaki refers to as "Silicon Valley logic." "If you ask for $4 million and an investor only gives you $2 million, then you aren't fully subscribed," he points out. This, according to Kawasaki, sends up a red flag to other investors. "If you ask for $1 million and get $2 million, then it won't be long before other investors want in. You need to create the illusion of scarcity," he adds.
On the subject of company longevity, Kawasaki advises entrepreneurs to "keep cash balances high and the burn rate low." Many companies, he explains, begin with one business model but then find the need to change that model as they grow. "If you have some cash, you have time to make mistakes and to grow," he says.