Question: What are the main problems facing the early‐stage entrepreneur in the venture funding process?

Mr. Morganstein's Reply: Many venture capital organizations pay more attention to early‐stage financing because of the higher potential returns concomitant with the higher risks that are associated with these investments. The problem for the early‐stage entrepreneur is the great imbalance between the entrepreneur's vital need to raise money, compared to the venture investor's need (or, more accurately, lack of need) to participate in any single investment. For the early‐stage company, getting funded is an absolute “do or die” situation, whereas for the venture investor, there are plenty of companies from which to choose. Perhaps a better way to state this is, if an investor passes on a particular investment, his loss is a loss out in the future, when and if the company is successful. On the other hand, if a company does not get financed, it is most likely disaster for the company. The investor and the company simply do not have the same level of need to close a deal.

Venture Capitalist's Response: Mr. Morganstein correctly perceives the imbalance between most entrepreneurs' critical need for cash, particularly in the early‐stage company, and the venture capitalist's need to make this particular investment. However, once a venture capitalist focuses a considerable portion of his most important resource (after money), his time, on an investment, he is reluctant to walk away from the investment opportunity unless a major red flag makes an unwelcome appearance. The best time for the entrepreneur to be raising money is always when he doesn't really need it—this goes for both debt and equity.

Question: How does this imbalance cause problems during the entrepreneur/venture capitalist relationship?

Mr. Morganstein's Reply: For one, the venture capital investor is extremely busy. He or she is researching several proposals, is probably on the boards of portfolio companies, and is called on from time to time to assist in some problem situation. When an entrepreneur sends a business plan to a potential investor, he wants a quick answer. Given that the venture investor is busy and does not share the company's urgency to make the investment, delays inevitably result. A proposal which is not going to go anywhere will probably get a courteous rejection very quickly, but a proposal that gets attention will take a good deal of time (I expect an average is six months). During this time, of course, the entrepreneur is in limbo.

This same imbalance leads to another problem. The entrepreneur must look under every stone to find his or her funding. On the other hand, because venture capitalists are so busy, they don't like to compete with each other. If a company is lucky enough to find two potential investors and is working seriously with one of them, one or both of the potential investors may lose interest. They are simply too busy to waste time on an investment which will not select them.

This imbalance could also lead to problems at the negotiating table. Here's where the importance of a good venture investor comes in. The good investor, one who is interested in building companies and making a good return, will not try to extract a pound of flesh. The experienced investor will realize that exercising too much power will damage the company if the investment goes forward.

Nonetheless, with the present high level of venture money and with a lack of sufficient numbers of experienced investors, many venture capital companies are hiring relatively inexperienced staff people who make it unnecessarily difficult for the company. We have met potential investors who are quite pleased with the imbalance I have described. They perceive that it always works for them. I am not making a comment on the fairness of the process—it doesn't have to be entirely fair—I am only pointing out that the imbalance of the needs of the entrepreneur and the investor is the biggest problem a company has in seeking venture financing.

Venture Capitalist's Response: While venture capitalists do not like to be rushed into making an investment decision, financings can be arranged in weeks or even days if the particular opportunity is both urgent and rich enough and if the entrepreneur is flexible as to the terms of the deal once the price is agreed upon. Most venture capital financings get strung out because, even once a price is agreed upon, the entrepreneur and venture capitalist are really continuing to negotiate the terms of the deal up to the final closing.

Mr. Morganstein is correct in his belief that the experienced venture capital investor is interested in a deal which is fair to all concerned. Unfair deals quickly come unraveled, the parties start squabbling, and little or no good is achieved.

Question: Looking back on the venture funding process, what is your overall opinion of it?

Mr. Morganstein's Reply: The process of raising venture capital is very difficult. It is fraught with risk and anxiety, as I will describe in some of the following answers. But, there is one particular positive point that I would like to make.

Others have pointed out that American business, in general, is short‐term oriented. Despite the fact that many businesses require a long‐term view, many corporations get nervous in situations which require more than a year or two to reach profitability. In such situations, a short‐term, bottom line–driven plan would probably be adopted by the corporation instead of a longer term, albeit more pragmatic, plan.

Venture capital is pretty different. Venture investors know that they are in a situation which will usually require from five to seven years to mature. In this respect, the venture capitalists are more “strategy” oriented, and are more like others, particularly the Japanese, who, on the whole, take a longer‐term view of business success.

While I think overall that the venture capital process is extremely difficult for the early‐stage company, it is certain that if there were no venture capital process, we at Dytel would not have started the company. While the process is difficult and unbalanced, as I have pointed out, it is certainly one that we entered into with our eyes open. Many times we wished that somehow it could work differently, or that we could put it behind us faster than we in fact did, but overall we learned what it was we had to do.

Anyone who is thinking about immersing himself or herself in this difficult process should be buoyed by the fact that once the investment is made, a long‐term partnership will ensue. It provides a real opportunity to create successes which require more time than would otherwise be available. The patience and long view of the venture investors are hard to match anyplace else. It gives the entrepreneurial businessman the time and wherewithal to do his thing.

Venture Capitalist's Response: There are a number of objections which entrepreneurs may raise to venture capital—it is too expensive; why use it if you don't require it—just bootstrap your operation; it takes too long and is too much hassle; too much money in the wrong hands can be worse than too little; and the venture capitalists never really take the time to understand the business and yet intervene in critical decisions.

Entrepreneurs still often want the money, though, because as Mr. Morganstein indicates, money which is well and carefully spent buys time, resources, and at times an insurmountable lead over the competition. This lead is critical to success in those industries and for those products which, while innovative, are not one‐of‐a‐kind.

Occasionally an entrepreneur comes along whom excess cash manages to kill. He can't stand prosperity. Venture capitalists prefer cash conservers.

Most professional venture capitalists will take the time to understand your business. The entrepreneur must understand that in ambiguous, risky situations, honest, even honorable men will differ from time to time.

Question: Why were you successful in raising major venture capital?

Mr. Morganstein's Reply: We were successful, I believe, because we satisfied most of the classic textbook criteria that the venture investor looks for. First of all, we had a good management team. Unlike many technology companies, we recognized early the need for strong marketing skills. We spent a good deal of time recruiting the best marketing executive we could find, and frankly, we were lucky to land him. Our engineering department had a proven track record of managing the development of similar products. Our production operations manager also had done this before.

In fact, the biggest weakness in the management team was almost always perceived to lie with me, since I had never had complete CEO responsibility, despite the fact that I had managed staffs and budgets larger than our entire company will be for several years. A good part of the reason we were successful probably had to do with my ability to overcome this objection. I am probably not alone in overcoming this objection. Many extremely successful ventures were started by people who have had the necessary skills but simply had not done it before. The literature abounds with examples.

We also had a strong, independent board consisting of outsiders. They had previously been involved with fledgling companies, and I believe they provided a good deal of confidence for the investors.

Furthermore, we had a new product which had already demonstrated success in the market. Our customer list was impressive, our product's reliability was excellent, and our market was paying good attention to us. In line with having a proven product, we had, to a certain extent, already begun to prove the company.

We had been in business for two years by the time the investment was closed, and we had proved that we could manage in times of adversity and that we were capable of accomplishing a great deal through a combination of skill and extraordinary effort. At the time we went to raise money, we were a very small company being managed professionally like a big company. Our success was most probably tied to our being able to convince investors of this fact.

Venture Capitalist's Response: The investors backed Mr. Morganstein and his management team despite a lack of CEO experience on Sandy's part because he surrounded himself with a chairman and directors with this vital experience, and because he had previous related leadership experience. In addition, he demonstrated the intuitive ability to make a decision after careful consideration. The team were proven survivors, and had the mark of winners.

Question: Was it more difficult to raise your seed capital or your later‐stage financing?

Mr. Morganstein's Reply: I really don't know that my answer to this will be meaningful to others. For us, it was unquestionably easier to raise the seed money, but I think this may have been by chance rather than a result of the nature of raising money. At the seed‐capital stage, the stakes were lower, both for the investor and for the company. We were lucky to have raised seed money from those who had strategic interest in participating with us. The early investors were clearly motivated by a desire to create a company in our business area. The profit motive was there as well, but the motivation of the early investors was qualitatively different from the motivation of the venture investors.

Venture Capitalist's Response: Some of the best seed‐capital investors are motivated as much by participation in the creative process of business‐building as they are by realizing lucrative rates of return on their capital. By and large, the earlier the deal stage, the more risky, so the returns in both capital and psychic income need generally to be higher for the initial investor. Earliest stage investors endure more uncertainty.

Question: How do venture capitalists differ? How are they the same?

Mr. Morganstein's Reply: I have a model of the venture capital community in my mind which, because of its generality, is probably fraught with error. Nevertheless, I look at four kinds of venture investors.

First, there is the inexperienced staffperson who is learning the business. These people can cause problems, and I don't want to say too much more about them.

Then, there are the experienced investors who are usually principals in a venture investing firm. They're interesting because, to a large extent, they themselves are entrepreneurs. These people tend to be very tough on valuation (that is, the percentage of the company they want) and, in my experience at least, have a bias that they know more about the business than the management team does. On the one hand, this can be good since they will be active participants in the business when it goes forward, but on the other hand, if this attitude is exaggerated, the strong‐willed entrepreneur will run into conflict with the strong‐willed investor.

Next is the experienced investor who works for an investment division of a larger institution. In our experience, these tend to be the most fair, since they don't have the natural tendency to view profits as only going into their pockets or into those of the entrepreneur. They are more likely to look at the prospect of investing in a company as being either wildly successful or savagely unsuccessful. Because of this, they worry less about who gets which percentage—a big part of zero is zero, while a little smaller piece of the moon is fine.

I originally thought that this type of institutional investor would be encumbered by his or her organization. There is a risk of not receiving the high‐level management approval needed to make a significant investment. Nonetheless, I suspect that if the lead analyst gives the entrepreneur a reasonable expectation that approvals will be forthcoming, then in all likelihood, the approval will be given even though the process is somewhat slower than that of an entrepreneurial investment firm.

Finally, there is the “seed investor.” I include the seed investor in this discussion, although some may feel that a seed investor is not a venture capitalist. A seed investor is usually a private person who invests his or her own funds, although a seed investor can be a strong individual within a large organization which typically does not do venture investing. Usually, of course, the seed investor cannot make the sizable investment really needed to take the company forward, but the seed investor probably does the most to help the company develop.

A seed investor is an early‐stage investor who will invest in things that others won't touch. They are as much motivated by the creative urge of sculpting companies as they are by making large returns. The seed investor will give the company an incredible amount of personal time and will guide the growing company in a nondirective, empathetic, constructive style. The amount of time a seed investor spends is significantly out of proportion to the funds he has invested because a good deal of his satisfaction comes from growing companies and executives. Seed investors are one of the best things that can happen to a company.

Venture Capitalist's Response: While initially an institutional investor may be more objective or detached than an investor from an entrepreneurial venture capital partnership, this detachment is difficult to maintain for any venture capital investor after the considerable investment of time, energy, and emotion, as well as money that the normal venture capital investment requires.

Question: Are venture capitalists really interested in company‐building or just out for a buck?

Mr. Morganstein's Reply: There are some venture capitalists whom I referred to earlier as seed investors. Their interests probably include people‐building, company‐building, and money‐making. But the tone of the question almost makes it sound like an apology is needed for those who want to make money but don't care about the growth of companies or people. While seed investors do indeed exist, an entrepreneur who expects only seed investors to invest is in for a rude awakening.

Not everybody who is associated with the entrepreneur's company has the same interests in or expectations of the company. This is true of both investors and employees. The entrepreneur who doesn't realize that a good part of his job is to take diverse interests and make something of value from that is probably not prepared to make the compromises needed in the day‐to‐day management of the company.

We had one venture investor tell us that he doesn't want to make the entrepreneur a friend; he wants to make him rich. Although no one is going to have animus toward another who makes him rich, the point that this investor was making is very well taken. The fuel or lubricant which makes this whole venture capital machine run is money. Seed investors are great, and often essential, but there is no reason to curse a daisy because it's not a rose.

Venture Capitalist's Response: Mr. Morganstein correctly identifies that a company has many constituencies and that the CEO must play to their varied needs and mold those needs so that they all contribute to the success of the company. Part of the CEO's job is to create both confidence and value in and through all the company's supporters.

Question: Are you concerned that venture capitalists will attempt to take over your company later on?

Mr. Morganstein's Reply: No, I'm not concerned about this, and for a variety of reasons. Early in our search for a venture investor, we ran across the companies that, if they didn't want to actually take us over, wanted to have a direct day‐to‐day impact on the company that bordered on being disconcerting. When we were being interviewed by these investors, we felt like we were being interviewed for a job. We felt like we were going to be hired to implement the investor's plan for building a related group of companies. I don't consider that approach as a “takeover,” but with such an investor, I would be extremely concerned about the degree of autonomy I would be able to exercise.

On the other hand, the hands‐off investor who lets the company do its thing with gentle guidance will undoubtedly play a bigger role if the business later flounders. In fact, I think many venture investments are structured such that the investor can, indeed, gain a majority control of the board of directors in the event any of several serious problems occurs. I'm not concerned about this eventuality. One reason is that my natural entrepreneurial optimism doesn't let me spend much time on it. Secondly, if things really do get that bad and the venture investors feel that all or part of management can't do anything about it, then management has failed and the company probably should be taken over.

Venture Capitalist's Response: Most venture capitalists would rather not run your company; that's why they invested in the entrepreneur. A number of successful venture capitalists have either run companies before and don't want to now, or have never run a company and don't want to try. The few that do want to run companies are probably not sure what business they want to be in, operating or investing.

Question: Why did you choose the venture capital route to financing your company rather than other alternatives?

Mr. Morganstein's Reply: I don't think we had much choice. We certainly weren't bankable. We may have been able to interest a large company to buy us and merge us into one of their divisions, but no one in our company wanted that. We couldn't have raised more money from our own savings; our seed investors, management, employees, relatives, and friends couldn't provide the kind of money we needed.

There may have been many other sources to look at, but notwithstanding the presence or absence of choice, venture capital was the objective we set for ourselves. We concluded early that venture capital would provide us with the kind of money we needed to position our company through early unprofitable periods. We felt that the venture investor has the necessary long‐term view to allow us to sacrifice immediate return for long‐term growth. Finally, we felt that the venture investor would leave management with enough equity to keep us motivated to the highest degree.

Venture Capitalist's Response: Some ideas are big ideas and they take big money to implement. Venture capitalists can provide that money, and they can do it early when it's really needed. Time and chance wait for no one.

Question: What traits do you look for in a lead investor?

Mr. Morganstein's Reply: The lead investor has several pretty important roles to play, and these roles may be difficult. Typically, venture investments are made by more than one investor because of the need to share the risk and to make it easier to raise more money should that become necessary. Once the lead investor decides to make an investment, he or she should play an active role in putting the rest of the investment group together.

Just locating potential investors is one part of this assistance, and only one reason why the lead investor role is important. The lead investor has a network of other investors with whom he has probably previously co‐invested and with whom he may be on a board of directors. The ease with which an investor can interest other investors says something about how he or she is perceived by his colleagues. If he can't get anyone to go along with him, he may have previously touted some bad investments, or he may have received poor marks in a director's role.

Once other investors become interested in the company, the lead investor's role continues to be important, at least until the time the financing is closed. The reason is that consensus on details of the investment has to be arrived at among the company and the venture investors. If there is more than one venture investor, you end up with the situation of trying to find consensus among a diverse and often terribly opinionated and even stubborn group of people. Reaching such consensus is difficult, and the lead investor should be both strong and influential enough to make sure it happens.

It may be just our experience, but it seems that many early‐stage financings get done when the company is in a precarious situation. If the lead investor has decided to make the investment, then it is important for him to ensure that the process of reaching consensus and making all of the finishing touches does not significantly damage the company.

The lead investor can do many things during this period. If the negotiation with the other members of the investment group runs into snags, the lead investor should exercise leadership. If the company needs to pay an important vendor/supplier, or pay a debt, then a bridge loan should be forthcoming (remember—the hypothesis is that the investor has already decided to make the investment). If the company needs an individual to complete or augment the management team, then the lead investor should be using his contacts to help make resumes available.

I think that our company has a particularly strong board of directors who will continue to provide advice and guidance as our company grows. It is important for the lead investor to be someone with solid business experience who will continue to be a major contributor once the venture investment closes. These traits of fairness, integrity, and good sense will eventually be more important than deal‐closing leadership.

Venture Capitalist's Response: Pick a lead investor who is not only able, and considered able by his peers, but also willing to work with, and consider the opinion of, other investors, particularly in times of trouble. The lone‐wolf investor as a lead can destroy both an investment syndicate and your company.

Question: Did you get a fair deal from the venture capitalists?

Mr. Morganstein's Reply: When the seesaw between investor and company is as unbalanced as I believe it is, it is hard to imagine how it can turn out totally fairly. Maybe it is a tribute to the venture investors with whom we dealt that our situation did turn out in a manner which we consider, on the whole, to be fair.

There are aspects of our situation, on the other hand, which we do consider to have been unfair. We try, though, to take our situation as a whole. We are quite pleased that we have been financed and that we can now get on with the business of running our business.

We feel we received a fair price for the percentage of the company which we sold, and feel it is particularly fair that the venture investors found a way to accept our valuation of our company provided we meet certain objective criteria.

As I stated at the outset, the process doesn't have to be totally fair, but if it is terribly unfair to the point of emasculating management and their incentive, then the investor risks a nonperforming investment. We've had investors tell us that they invest by the golden rule—“He who has the gold makes the rules.” So again, the agreements do not have to be totally fair. But, in answer to your question, yes, on the whole our deal was fair.

Question: Was the price of the deal important to you?

Mr. Morganstein's Reply: Yes, but for reasons which may be different from what you would expect. When you look at what the ultimate success of the company will mean to the founders, the price of the deal (meaning, do we give up “X percent” or “Y percent”) is pretty immaterial if “X” and “Y” are reasonably close. Even if they are not close, one tends to get lost comparing two very large numbers.

We worked very closely with two potential investors, and “X” and “Y” were in fact very close. What concerned us, on the other hand, was the fact that both “X” and “Y” were close to fifty percent. The fifty percent number meant that, according to the returns we predicted in our business plan, the venture investor would have had compounded returns of seventy percent per year.

This in itself is not a problem; we don't really care about someone else's return as long as ours is fair. But, what the fifty percent figure told us was that the investors viewed us as a very early‐stage company and that our achievements up until then—marketing, engineering, and production—were not being given proper consideration. Since the fifty percent figure did not correlate with our notions about desired returns for investors, we could not ascribe the offer to anything but a “venture capital kneejerk.” I guess the point of this is that some nonfinancial considerations get mixed into the entrepreneur's perception of a venture capital offer.

In our case, the dilemma was worked out in a creative way. If we performed according to profit target objectives for the first two years of the plan, we would give up “X percent” of the company, and if we did worse, we would give up “Y percent,” where “Y” depended on the degree to which we missed the plan. Also, “Y” couldn't be greater than a certain amount.

We were surprised that some investors later expressed opinions that this sliding scale approach to pricing based on profit performance over a period of time is a bad approach, and I never fully accepted their arguments. The nature of such a compromise isn't perfect, of course, since it could push the entrepreneur into making short‐term decisions which could affect long‐term profitability. There is no doubt that this risk exists, but the very nature of the entrepreneur as well as the venture investor is long‐term anyway, and so, in our opinion, the risk was outweighed by the extra motivation we had to perform according to our plan.

Venture Capitalist's Response: Performance formulas are controversial because they can cause the company's management to place their emphasis on objectives which maximize share pricing but minimize or dilute the company's long‐term business performance. They can be used if both investors and management are mature and appropriately focused on the long‐term success of the business rather than on immediate personal gain.

Question: What was the most difficult part of your experience in raising venture capital?

Mr. Morganstein's Reply: Since we were pretty far along with two different investment firms, the hardest part was to keep them both interested until we received a firm commitment from one of them. As I mentioned earlier, venture investors are among the busiest people around. Given the large volume of proposals they receive, and our assumption that they have a predilection to turning proposals down, we felt that if either of them decided not to compete with the other, then we would lose a potential investor. My earlier point was that it was of vital importance to us to get funded and of somewhat lesser importance for any given investor to invest in us.

We were, therefore, faced with spending a good deal of time with both investment firms. We helped both of them with their investigation and due diligence and doing whatever we could to keep them both interested despite their predisposition against competing with each other.

There were other problems, too. We, of course, had to continue to run our business while we spent a good deal of time with the investors. We had also planned to make some important hires, and we didn't know if we could afford to.

We did find, however, much to our surprise, that our customers were not overly concerned that investors would call them (as part of the investor's due diligence investigation). Customers did mind when they were called frequently by different investors, but this was more of an annoyance factor, and it didn't seem to raise concerns in the minds of our customers about the company's financial stability.

I think that the rest of the process of raising venture capital, while difficult, is not too different from that which is needed to run the business properly anyway. An investor needs a business plan—so does the company. A company needs a management team—investors need to see it. A company needs satisfied customers, and the investors need to see this as well.

Since investors check out customer references, the company must make sure that its customers are being properly treated. Again, a good company must do this whether or not it is raising venture capital.

Venture Capitalist's Response: Venture capital is a very time‐intensive business, and in recent years it has become even more so as there have been both more capital and a larger number of high potential deals than in the past. The active venture capitalist is trying to catch the best deals, while also helping revive one or more troubled deals, perhaps raise new capital for his fund (if a private partnership), hire and train new employees, and participate in an industry with its numerous meetings and associations. He has a very full plate.

The entrepreneur must both respect and obtain his fair share of this time if he is to successfully raise capital. Since the entrepreneur cannot be certain of financing until the terms are agreed on and the deal closed, it is best for a time to continue to work with several potential investors. Once a lead investor commits, however, it is time to stop courting others' favor.

Question: How could the venture capital community improve their approach in order to facilitate the money‐raising process?

Mr. Morganstein's Reply: I am heartened by this question. It goes back to my answer to the earlier question concerning the obstacles a going company faces in raising venture capital. The fact that the question is asked points out that the venture capitalists realize that all may not be rosy.

First of all, let me point out that the venture capitalists do provide an extremely professional approach. If they're not interested, they let you know very quickly, so that you can begin to knock on some other doors. Also, despite the fact that they are very busy, they are very good at focusing on the prospective investee company so that when you are working with them, they quickly grasp what your business is about. Further, they have been involved with many companies at similar stages of development, and so they can easily point out deficiencies in the company's planned cash flow, inventory, distribution, and so on. This experience factor is extremely important. Hopefully, venture capitalists will be careful how they use the “apprentices” who are learning the venture capital business.

The venture capitalists also do a good job of informing prospective companies about what the process is like. Several organizations exist which put on seminars about raising venture capital, and venture capitalists are almost always willing to participate. This book is another example of a service which hopefully will help the entrepreneur learn what he or she can expect when trying to raise venture capital. Of course, once an investment is made, the venture capitalist is in an extremely good position to facilitate the company‐building process. They usually will be members or observers of the company's board of directors. At this stage, they bring their experience and business skills to bear on the strategic decisions facing the young company. Furthermore, they are in a position to help the company with business contacts that the company might not otherwise have. Some refer to this as “know‐who,” versus know‐how.

Venture Capitalist's Response: A professional venture capitalist, like the entrepreneur he backs, mostly learns his business through the world of hard knocks. The industry does need to work on methods to help develop new members of the community other than through baptism by fire.

Question: What criteria did the various venture capitalists use to evaluate your deal?

Mr. Morganstein's Reply: All of the venture capitalists we talked to considered the strength of the management team to be extremely important. It's probably a cliché to point out that an investor would rather invest in a company with excellent management with an okay product than the other way around. Others, however, feel that if the product is extraordinary but management is only so‐so, they can strengthen the management team after the investment is closed. In any case, one of the important characteristics of the management team is its record of success in a situation closely related to the situation in the new company.

The investors certainly are interested as well in companies that are doing something new and different. They will be more favorably disposed toward a company whose product or service presents a strong economic incentive for the customer to purchase the product or service.

We would like to believe that one of the criteria used to evaluate the pricing of the deal is the rate of return the investment would provide. As I pointed out earlier, I don't think this was done in our case, and it's very difficult for this to be done in the case of any early‐stage company because of the extremely high degree of uncertainty inherent in the young company's own projections.

I think the venture capitalist also looks for a company which is in a business area of overall interest to the investor, such as computers, medical equipment, software, and so on. Some have mentioned that they look particularly for new market niches, and I'm sure that this criterion was used in our case.

Also, I think the venture capitalist uses geography as one criterion in making an investment decision. If the prospective company is close to the investor, the company has a better chance—other factors being equal—since the investor would welcome the opportunity to reduce his travel.

Question: Is venture capital money expensive money?

Mr. Morganstein's Reply: At first glance, venture capital money is very expensive. An investor is looking for forty to fifty percent compounded return on his investment. If a company borrowed $1.00 from a bank and paid fifteen percent interest per year, at the end of five years the company would pay back $2.01 in combined interest and principal repayment. At forty percent, this same dollar would cost $5.38.

So, it appears that venture money is expensive, but there's another way to look at it. Most companies that are venture‐funded are not candidates for bank financing, at least not for the same amount of money which could be made available by a venture investor.

Maybe this sounds like an apology for the high rate of return a venture investor gets, but I don't think my example is too farfetched. In many cases, a company could not borrow as much as ten percent of the amount a venture investor would invest. Overall, you may have to conclude that venture money is expensive, but you get a lot for the price.

Venture Capitalist's Reply: An experienced venture capitalist can rate the riskiness of your deal on a one‐to‐ten scale. Take some of the risk out of the deal for him, and he may give you a better price.

Question: What techniques did you use to sell your deal?

Mr. Morganstein's Reply: I believe that a good venture capitalist is motivated by the desire to build companies as well as the desire to make big returns. In our company, all of the key management were very enthusiastic about our business, our potential, and what we had already accomplished. We made sure we communicated our enthusiasm to each potential investor, and hoped it was infectious.

But, overall, I think that techniques used to sell the company to an investor are similar to those used to run the company. We tried very hard to get trade press coverage of our new product. The coverage was impressive and very positive, and we used reprints with potential investors and continue to use them for potential customers. We started early to present ourselves as a company with a strong commitment to customer service. Our customers and investors both liked this. The investors were favorably impressed with us because they spoke to customers who had had the benefit of our customer service. We were in business for two years before we raised venture capital, and were able to point out to potential investors that we could manage our business and plan and perform according to plan.

There were a couple of things we did which fall outside this premise which were specifically related to attracting venture capital. One of these tactics was chosen particularly to raise our proposal to a higher degree of attention than it would have otherwise received from the busy venture capitalists. I became personally involved in a nonprofit organization which supported other entrepreneurial companies. I got to meet several venture capitalists through this organization, and I believe that when the time came to present our business plan, it was somewhat easier for me.

Venture Capitalist's Response: Once the money is raised, the real work of company‐building begins. An entrepreneur who can sell a venture capitalist should have sufficient skills to sell his product. However, neither venture capitalist nor entrepreneur should ever forget that the product marketplace is often less forgiving than the venture capital deal marketplace. Some entrepreneurs are better at selling their vision than at closing product sales.

Question: Several venture capitalists turned you down. What did you learn from these rejections?

Mr. Morganstein's Reply: Grace.

Some of the reasons for the rejections we had in fact anticipated as problems and risks associated with our new business. When it came to rejections because of problems we knew about, we felt disappointment, but didn't learn very much from it. These rejections did, however, remind us that we should perhaps focus more on these problems and try even harder to address them. They could have just as easily turned us down out of concern that our market wouldn't develop.

Some of the rejections, however, made little sense to us. My favorite is the “fear of competition” rejection. We have a unique product and, if it is any good, there would certainly be competition. The opposite pole of this kind of rejection is the one which in fact fully recognizes the uniqueness of the product. This produces fear of there being no market for the product.

We felt that the people who turned us down because of “fear of competition” fall into the category of those who are looking for reasons not to invest. Maybe my view of this comes out of hubris, but overall I don't think we learned valuable lessons from these rejections. A venture capitalist who turns a particular investment down feels that the problem he or she sees can't be fixed. Otherwise, he would invest and then participate in fixing the problem. Maybe we would have felt differently if someone had told us that they would invest “if ________.”

Actually, we did get one such rejection from someone who didn't like our initial valuation of the company. He said that he would consider the proposal if the price were different. By the time we received the rejection, we had in fact already modified our initial valuation and were too far along with our ultimate investor to go back and start a price negotiation with the new one.

Question: Would you do it again?

Mr. Morganstein's Reply: Not soon.