The Graduates

Moving from individual investors to institutional VCs means learning to play by a new set of rules.
Magazine Contributor
8 min read

This story appears in the March 2001 issue of Entrepreneurs Start-Ups magazine. Subscribe »

By the time Jeff Tannenbaum and Brett Cohen reached the tender age of 25, they were already serial entrepreneurs. While still in college, the pair formed two successful businesses. Then, after what Tannenbaum calls an ill-advised, and ultimately unrequited, stint working as employees, the pair teamed up yet again in 1999 for a new enterprise called EnhanceNow.

Their Philadelphia-based company publishes a digital detective series that's aimed at the young adult market. "We've interwoven traditional books and the Web in a way that makes our books interactive," says Tannenbaum. The pair has developed two books that direct readers to a Web site to search for clues and essentially take on the role of the investigator. Then the reader moves back and forth between the Web and the book to solve the mystery.

The pair gives credit to friends and family, including their fraternity brothers at Sigma Alpha Mu and Tannenbaum's mother, for raising the initial $400,000 to fund their business. But the stakes are higher now. "We need to extend our brand, promote our concept and scale up our operations," says Tannenbaum. "We are beyond the stage where $5,000 here and there can help us." As a result, Tannenbaum and Cohen are now targeting institutional venture investors. Having met and talked with a few of them, Tannenbaum notes dramatic differences between professional and angel investors. And he realizes that to succeed, he and Cohen need to play by a different set of rules.

The Differences Between Angels And Institutional Investors

Before we delve into the differences between angels and institutional investors, understand that venture capital is just a certain kind of money that comes from different sources. Angels are one source. And institutional venture capitalists, or professionals who manage organized funds, are another. Now then, what are the differences between angel VCs and institutional VCs, and how do you overcome them? Just take a look.

The OPM factor: In case you've never heard the term "OPM," it stands for "other people's money." It's exactly what institutional venture capitalists are managing, and it has a profound and dramatic impact on their behavior. For Tannenbaum, the contrast has been stark. "Our friends and family believed in our dream," he says. "Individuals would grasp our story and run with it-even if they didn't initially, we could be persuasive and win them over." That's not the case with institutional venture capitalists: "These investors seem to have in mind a set of criteria that they want to stick very closely to."

Tannenbaum's intuition is on the money. The professionals are managing other people's money. Funds have investment criteria that the professionals have a fiduciary responsibility to meet. In addition, they operate with an investment committee, so if the partner you meet is unable to persuasively communicate your deal or how it matches their investment criteria to the committee, it's an insurmountable barrier.

In this respect, the best defense is a good offense. Resource guides and independent research can help you target institutional venture capitalists interested in your kind of company or industry. Just don't waste your time looking for them until you've done your homework, or you'll be in the reject pile right from the beginning.

Learn The Elevator Pitch
It can lift you to the investors you need.

The 20-minute pitch is standard operating procedure in the world of finance, but the elevator pitch is gaining currency in the fast-paced New Economy. It refers to a sales pitch that can be delivered in the time it takes to take an elevator ride. But you need two elevator pitches: one for institutional VCs and another for angels. The institutional pitch must tell the investor how much he or she can make and how quickly he or she can get out. The angel pitch provides the same information-but it leads with business issues. Going up?

Networking And Experience

It's who you know: Another challenge facing Tannenbaum and Cohen: The professionals are chasing more deals and are being chased more actively by entrepreneurs. That means they're more likely to say, "I saw one of those yesterday-no thanks." Another side effect of the high demand is getting and keeping the VC's attention. "You are not given the opportunity to present your deal for an hour and a half," says Tannenbaum. "You get the feeling that you have about five minutes, and, if you don't capture their imagination, it's over."

The solution to this dilemma is getting an introduction. The fact is, professional investors will be more courteous and more likely to offer quality time to referred opportunities than to cold ones-even if it's only to stay on the good side of their own contacts. Tannenbaum's initial experience bears this out. "Who you know is vital, which is why we spend time trying to expand our network. When we've gotten introductions, it has led to a much better initial meeting."

Experience levels: "Individual investors believe in you and invest in you as a person," observes Tannenbaum. But on the other side, the professionals make their living by evaluating deals and making offers. There's much less emotion and a lot more process involved, which can be a good thing because this is often good business practice. However, the hard part is that all this professional experience might cause investors to be rigid in their thinking about how a deal should be structured and closed.

There are a couple solutions to this dilemma, but you'll find them lukewarm at best. First, swallow hard and go with the flow. Second, try to find out beforehand how the firm structures its deals. Armed with this information, you're in a better position to take certain things off the table before they even become a part of the negotiation. A good way to find out how past deals have been structured is to contact the founders of companies that the VC has funded. (You can find this information on almost any VC's Web site.) You may be surprised at their willingness to talk. And when the VCs find out you've been researching their deal structures, it could be helpful.

Goals And Available Funds

Different goals: Both sets of investors are looking for a healthy return, but the angel's required rate may be somewhat more moderate. Why? The professionals are interested in managing the fund and reporting to their investors. Tannenbaum says that when professional investors ask about his previous ventures, "they're only interested in the bottom line. They don't care that the companies served a purpose or that they created jobs. They judge us by our previous monetary success."

By contrast, however, individual investors often fund companies for motives that may not be purely financial. Some reasons include a desire to put something back into the industries that made them successful, a longing to provide the resources that they wish they had starting out, a desire to be mentors, and the opportunity to relive their past successes.

The difference between these two types of investors can be tantamount to the difference between an alumni booster at a homecoming football game and a nuclear power plant inspector. There's little you can do to overcome this reality except to expect it and not be offended by it.

Bigger bucks: One happy difference to keep in mind is that professional venture investors have a pool of capital set aside to make initial as well as add-on investments. When they're in, they're in. But individuals have less to invest, and their situations are often far more complex. Remember, individual investors probably already have money invested somewhere else. They may have to liquidate; if so, there are tax implications they have to consider. That means angel and individual investors are considerably less liquid and have much less tolerance for putting in more capital down the road.

As a result, your strategy with angels and individuals should be to get as much financing as you can up-front. But with professional venture investors, you shouldn't raise too much more funding than you actually need. There's plenty of money left in their till-and if you succeed, you'll get it the second time around at a much better price.

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