Financing Your Radical Concept
Back in 2000, just before the bottom fell out of the IPO market and VCs began shut-ting their doors to just about everyone, entrepreneur Tim Westergren managed to raise $1.5 million in seed money for his fledgling company. Westergren, a former musician, came up with the idea to create a sophisticated database to help music lovers identify artists and songs they might like based on their listening tastes. At the time, it was a brand-new concept--but after the initial investment, no one would fund it.
The seed cash ran out after about a year, "and then things got really interesting," says the 40-year-old founder of Pandora Mediain Oakland, California. Over the next two years, the company managed to scrape up a few small investments. "But that was primarily to keep the lights on," says Westergren. "I literally had days when I went from a negotiating session with one of our big customers to the courthouse to fight eviction."
Part of the problem was timing, of course. VCs were gun-shy in the new millennium, focusing almost solely on existing portfolio companies. But it doesn't help when a startup's product or technology, as in Westergren's case, is so leading edge that VCs don't quite understand or appreciate it, much less envision it in the commercial market-place. "I think one thing that happens--and it's the nature of the beast-is a VC sees thousands of deals a year and [it has] a pretty short amount of time to spend on them, so you get categorized," says Westergren. "The VC tries to fit your idea into a box."
If it doesn't fit in the box, the entrepreneur has a tough time breaking through--even if he or she has indeed discovered the next big thing. There are ways to add credibility to a far-out idea, however. For one thing, while he was waiting for his VC ship to come in, Westergren spent time pitching big potential clients directly, and in 2002, he inked deals with both AOL and Best Buy.
"There are so many reasons why that's a great idea," says Ian Patrick Sobieski, founder and managing director of Band of Angels, a Silicon Valley firm that funds seed-stage startups. Getting clients signed on proves that your product is solving a real problem in the marketplace, he says, "and it also means you have a financing path."
That can help during the early period when your cash needs are still too small to attract serious VC attention or you are reluctant to give away too much control of the company prematurely. "Most entrepreneurs will only want to raise [amounts] in that $500,000 to $5 million window [from VCs] and keep it small because they want to prove the [company's] value and get a higher valuation," says Colin Blaydon, professor of management at the Tuck School of Business and director of the Center for Private Equity and Entrepreneurship at Dartmouth College in Hanover, New Hampshire. For that reason, he says, angel investors are often a better bet than VCs when trying to fund a cutting-edge idea.
Not surprisingly, another big variable is your company's management team. "VCs don't just invest in ideas," says Jon Gregory, president and CEO of Golden Capital Network, a Chico, California, networking and consulting firm for investors and entrepreneurs. "They invest in people with a prior track record of growing businesses with successful exits." If that's not you, hire someone who has that history, or at least bring them onto your advisory board, says Gregory.
And always be willing to make room for an experienced CEO--something that Westergren happily agreed to do when he finally got a serious bite from a VC in 2004. It was also a big plus that the lead investor was familiar with the company and with the online music industry. "As obvious as that is, it took me four years to figure it out," says Westergren. "Find someone who's interested in your space."
Pandora raised $8 million in that round, and in March 2005, it managed to shore up another $12 million in funding. For the first time, the company can afford to pay salaries without worrying about running out of cash, and it's planning much farther ahead than the next payroll. "We're going to grow quite a bit this next year," Westergren says, adding with a laugh: "It's a long way from facing eviction notices every other month."