Dances with VCs

I received notice today from a VC we recently signed a term sheet with that they have chosen not to invest in our company. I'd like to share with you some of the things I've learnt in the process, some of the traps I fell into and what I'd do differently next time.

The gist of the 'Dear John' letter we received:

"1. Maturity of company: [The VC]'s current Fund2 requires an established team and business. Skyrove would for the foreseeable future require a more hands on approach which deviates from this model.
2. Relative size of local market. It is uncertain whether revenue generated by Skyrove in the SA market would be sufficient to achieve [The VC]'s long-term revenue goals.
3. Barrier to entry: It is too uncertain how easy and attractive it will become for competitors to replicate Skyrove's technology and business model.
4. Other trends: It is uncertain what the impact of municipalities providing free data connective (such as San Francisco and Philadelphia) will be on Skyrove and its competitors' revenue."

Although reasons 2,3 and 4 are mostly hogwash they made up to lengthen a short letter, I completely understand their first reason. They launched a new and dramatically different fund halfway through our negotiations, about 4 months ago. The principal on the Skyrove deal resigned 2 weeks ago and things have generally been in turmoil.

A marriage at this stage may well have been to the detriment of both us and them.

Things I'll do differently next time:

1. I will not again accept an offer that gives majority board control to the VC when they're buying a minority share. When it comes to our product, we know our market better. We know free municipal Wi-Fi is much less of a threat to us than free water is to bottled water. We know our product can be replicated, but we're pretty innovative and will work hard to stay ahead of copycats.

2. I will not again accept an offer of more money than I need. We were offered twice as much as we asked for, for almost twice as many shares, in 4 conditional tranches over 2 years. They were effectively getting stock options, rather than outright buying stock.

3. I will not take VC funding before being cash-flow positive. This sounds counter-intuitive to some as you might argue that you need VC funding to get there! However, being cash-strapped has made us extremely focused on making Skyrove the best product for 90% of the market, even though we were only able to implement 10% of the features we first envisioned. When we started talks with the VC 6 months ago, we had zero revenue and zero clients. Now we have hundreds of customers signing up every month and revenues that are growing exponentially. Because of a lack of cash, we've become smarter and learnt more about all aspects of running a business. We've had to build partnerships to get our product out there. If we had cash, we probably would have struggled to manage newly founded 'divisions' headed up by overpaid 'vice presidents' appointed by the board, who could outvote the founders.

4. I will phone the founders of other companies in the VC's portfolio and I will listen to them BEFORE any serious negotiations with theVC.

5. I will more rigorously interview the VC at the first presentation. I will ask them how well their portfolio companies are performing and for more detail on how they intend to influence the running of our business.

6. I will not accept a vague term sheet that asks me to pay for Due Diligence costs in the event that I do not accept their offer. Trust me, the time you'll spend on negotiating a deal with a VC is much more expensive to your company than their costs of doing Due Diligence. In our case, the VC cut us loose, so we weren't liable for any costs. However, I was fearful that they could toss a red herring, forcing us to either accept new terms or to pay a large fine.

Yes, I've read this advice before from the likes of Brad Feld and Rick Segal, but it's a very different story when you're being wooed by VCs, have partners adding pressure and feel that it's up to you to make the deal work.

All in all, it's been a fantastic experience and we've come out of it a stronger company. We're still open to VC funding ($5 routers anyone?), but for now, I simply feel relieved that I can continue focusing on what's most important to me: building the best darn Wi-Fi service on the planet!