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Term Sheet Demystified

This article is co-authored by Ryan Janssen + Sanjay Gandhi.

Ah, the term sheet. That idol of venture capital that drives much of the engine of growth. There’s a huge information imbalance at play here – investors and advisors have seen thousands of them and know how to work the terms to their advantage, and first-time fundraisers have no experience in this area.

This is the first in a series of articles intended to balance that playing field. In this series, we’ll deep dive into the various sections of a term sheet to:

  1. Explain them in plain English,
  2. Show how VCs think about various terms, and
  3. Help entrepreneurs understand the opportunities and pitfalls that await them.

But first, let’s start from the ground up:

The Guiding Ethos for Negotiating Your Term Sheet

There are many templates out there (and we’ll get into specific terms later) but at its most basic level, a term sheet is just a device for negotiating terms in a non-binding way, before getting the lawyers involved for the long-winded stuff.

The entire purpose of a term sheet is to set the headline terms of the deal. Ideally, it will align the interests of the investor and the founder; this, however, is not always the case for two reasons:

  1. Market dynamics can shift terms erratically in favor of EITHER party. For example, in 2010 investors were getting unusually large preferred liquidation multiples. In 2015, entrepreneurs were commanding huge unicorn valuations driven by growth fever.
  2. Negotiating outcomes can go awry and one party can obtain a strategic advantage.

Generally, when interests aren’t aligned, there are unfavorable outcomes happen for both sides – including the party that’s getting the better terms. This happens for two reasons:

Firstly, because a venture deal is indeed like a marriage, short-term imbalances can lead to long-term contempt which does no good for a startup.

Secondly, misaligned interests in a term sheet will push it out of the “typical” market progression for venture funding. For example, a SaaS business with strong demand negotiated a valuation that was about 2 times market for their Series A last year. They felt like geniuses, until they went to raise their next round. Then, they were suddenly under intense pressure to keep up that momentum with an equally over-valued Series B. Ultimately, the misaligned interests between the company, the Series A investors, and potential Series B investors made it much harder to raise later capital. It’s not uncommon for situations like this to result in a significant down round with common shareholders (often founders and employees) paying the greatest price.

So the ultimate smell test for any ask in a term sheet negotiation should be “does this align founder and investors’ interests?” For example, this is why most convertible notes have a valuation cap; without one, there can be inherent misalignment of interest on following round valuation.

There are potential pitfalls everywhere in a term sheet. Some of common examples of terms that misalign interests are:

  • Participating preferred shares (radically changes founder/investor risk-return profiles)
  • Having several board seats that represent one investor (changes board dynamics from productive to protective)
  • Full-ratchet anti-dilution (misalignment of risk profiles)
  • Complicated voting mechanisms protective provisions (leads to perverse voting incentives)
  • Operational conditions from corporate VCs (restricts how the business can grow operationally)

The list goes on. We’ll get into more detail for each of these (and more) later, but hopefully this provides a general primer on how you should think about your term sheet negotiations.

Next time, we’ll take a detailed look into the sequence of events that brings you to a signed term sheet. Later, in future editions we’ll dive into financial, governance, and protective terms, respectively. Stay tuned!

For more information contact Sanjay Gandhi at sgandhi@oxfordvp.com. Look for more funding advice by visiting the knowledge section of the Oxford Valuation Partners website.

The 80/20 Rule In Venture

This article was originally published by Top Tier Capital Partners here on May 2, 2017.

The Pareto principle states that when thinking of cause and effect, 80% of the effect is driven by 20% of the cause. In our industry, this can be translated to 80% of the returns are driven by 20% of the funds or companies. As part of our portfolio construction efforts at Top Tier, we set out to test this and found it to be eerily accurate within our portfolio.

With the intention of determining what differentiates our top and bottom performing managers, we took those funds currently over 2.5x TVPI and those funds currently under 1.0x for all vintages 2012 and older. The data set comprises a total of only 26 managers (25% of our total primary funds older than 2012 vintage), but the results are clear. Regardless of performance, 18-22% of the companies within these venture funds return 80% of the value of that venture fund! The top performers had an average of 18%, while the bottom performers had an average of 22%. Due to the generally concentrated nature of our managers’ funds, this value is often held in three to five companies.

That’s where the similarities end between these two cohorts. Loss ratios were cut in half, the largest win (by value) in the portfolio was 50% larger and the multiple on the largest win (by value) was substantially higher for the top cohort, as compared with the bottom cohort. The table below shows these differences.

A key takeaway from this analysis is that loss ratios do appear to play a role in the performance of funds. Large losses require larger and rarer wins to offset. In all of the funds included in the Top Cohort above, the single investments with the largest single value return ranked in the top spots in terms of multiple.

For example, in all cases when we ranked the fund investments by value, that top company was also one of the top two multiples in the fund. This is a very important metric because a 2x return on a $50 million investment is different from a 6x return on a $10 million investment. Both are $50 million back to the fund, but the latter leaves more invested capital for other companies in the portfolio to create additional value. We found that these large value drivers were rarely the result of piling money into a company and receiving a 2-3x return, but rather are ranked so highly because they were good investments yielding an outsized multiple and return.

Finally, we see dragons (companies which return value to the fund that is greater than the fund size) as being important to the creation of high multiple funds. In fact, 60% of our top funds have at least one dragon and no two funds share the same dragon. The rest have at least one “half-dragon” or company that can return half of the fund. In some cases, a fund has multiple companies fitting these definitions.

We should note that no dragon on our list appeared twice perhaps indicating that ownership percents come in to play. All of the funds in the top cohort were in the top quartile for nIRR based on Cambridge Associates’ benchmarks*, but three fell into our second quartile when TTCP ranks against our opportunity set within a given TTCP fund.

In summary, the magic numbers appear to be 20% of the companies returning 80% of the value, keeping loss ratios to around 20%, leaving the other 60% of the fund to create the other 20% of the value. It sounds simple, right?

*Cambridge Associates’ U.S. Venture Capital index and benchmark statistics are based on data compiled from over 1,600 institutional-quality venture capital funds formed between 1986 and 2016. TTCP-managed funds do not mirror such index and the volatility may be materially different than the volatility of the index. Based on Q3’16 Cambridge benchmarks.


Readers of this blog are not to construe it as investment, legal or tax advice, and it is not intended to provide the basis for the evaluation of any investment. Readers should consult with their own legal, investment, tax, accounting, and other advisors to determine the potential benefits, burdens, and risks associated with any transaction involving any issuer referenced herein. This blog does not constitute an offer to sell or the solicitation of an offer to buy any security; it is neither a prospectus nor an advertisement, and no offering is being made to the public. Offers to sell any interest in a ttcp-managed investment fund shall be preceded by distribution of a private placement memorandum the contents of which shall supersede any information provided herein.

Square 1 Bank Announces Credit Facility to CIC Partners

Square 1 Bank, a division of Pacific Western Bank, today announced that it has provided a $20 million credit facility to existing client CIC Partners, an investment firm specializing in early stage, late stage and middle-market investments. Proceeds from the facility will support efforts to bridge the timing between the receipt of capital call proceeds and portfolio investments, payment of management fees and other fund related expenses.

Located in Dallas, CIC Partners is a unique middle-market private equity firm that invests in growth-oriented companies in the food, restaurant, healthcare and energy industries. The firm utilizes its capital and experience to help grow shareholder value through strategic and operational improvements.

Alan Buehler, CIC Partners’ chief financial officer, said, “Square 1 continues to provide CIC with excellent client service and is always quick to respond to our specific needs. When we needed to establish a credit facility for our latest fund in order to make an acquisition soon after fund closing, Square 1 really came through for us. We are pleased to continue our long-standing relationship with Square 1.”

“CIC Partners’ strong management team has a long history of helping companies scale and achieve outstanding results,” added Betty YuHasker, vice president of Square 1’s Equity Funds Group. “We are excited to support their capital needs as they grow the portfolio through future investments.”

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW). For more information, visit www.square1bank.com.

About CIC Partners

CIC Partners is a middle-market private equity firm that invests in growth-oriented companies primarily in the food, restaurant, and energy industries. CIC manages the personal capital of its investment team, operating partners and strategic investors and seeks to partner with owner-operators, founders and management teams. CIC looks for opportunities where it can leverage the collective experience of its investment team and its operating partners, who are successful CEOs and entrepreneurs, to guide, support and add value to portfolio companies. Based in Dallas, Texas, the firm has been generating wealth in private-equity investing for its investors and management teams for over 25 years. For additional information, please visit http://www.cicpartners.com.

Media Contact:
Square 1 Bank, a division of Pacific Western Bank
Dee McDougal
919.597.7479
dmcdougal@square1bank.com

5 Keys to Creating Your Early Product Pitch + Story

This article was originally posted on Bowery Capital’s website on April 6, 2017.

“Hooli is about people. Hooli is about innovative technology that makes a difference, transforming the world as we know it. Making the world a better place, through minimal message oriented transport layers. I firmly believe we can only achieve greatness if first we achieve goodness.”

– Gavin Belson, CEO of Hooli, Silicon Valley Episode 1

Wait, what? We’re weeks away from the start of Silicon Valley Season 4, and I have a confession to make: I still have no idea what Hooli does. While Gavin’s intentions here sound good (kind of), I’m not particularly inspired by “minimal message oriented layers,” and I don’t know what problem they’re trying to solve, and for whom. Gavin is likely a smart man though (ok, maybe), and similarly, there are many intelligent entrepreneurs who have an excellent idea, but struggle to unlock the full value of it through solid pitching and clear early messaging.

So how does one pin this down? Let’s take a look at 5 keys to creating your early product pitch.

Who is your product for?

Speak to your audience directly. Even if you’ve done a good job prospecting your potential client ahead of time, you need to make a connection with whoever is on the receiving end of your pitch. This starts with identifying who it is that your product is meant for and quite literally saying that. When you hop on the phone, construct your deck, or create your landing page, you need to say something like, “Our product does X for CTOs, Product Managers, and Lead Engineers, who are facing challenges with Y.” By addressing this early on, your prospect will listen more intently. It’s the equivalent of addressing someone by name in a crowd. We’ll get to the “X and Y” of that statement in a moment.

Social Proof: Who else uses your product that I know?

As the psychologist Robert Cialdini cites in his book Influence, using “Social Proof” makes the connection between you and your audience even stronger. That said, once you have the names of other similar companies using your product, you should insert that into your pitch, too. Why? Because similar to speaking to your prospect directly by title and name to boost reception, you’re now using their peers and competitors to signal that your product is for them, and they should listen up. Furthermore, the prospect tends to think, “Ah, another company I respect in the industry has already vetted this and also relies on it to propel their business that makes my decision easier.” Ultimately this will reduce the time this prospect will spend in vetting your product for their own company.

If you don’t have customers yet, that’s ok. “Social Proof Yourself” and build credibility by talking about your background, who you’ve interacted with in the past, and why you’re an expert in the space who has knowledge that’s worth hearing. Which leads us to our next point.

What’s the problem you’re solving and how?

You might be saying to yourself, “We’re solving a problem our prospect might not be aware of, or one that’s bigger than they realize,” and if that’s the case, then build a bridge to that problem so they understand it. Keep in mind, you’ve potentially spent years developing your thesis and the pain point you’re solving for, and now you only have moments to convey that to someone else. Psychologically, people grasp problems in a variety of ways, so here are few succinct ways you can outline your problem to help them understand it:

Quantitative: “Today’s companies pay $5,000 to onboard each employee and face 100% yearly turnover in their employees who focus on X. Our solution, on average, helps to cut that onboarding cost in half, while boosting employee satisfaction and therefore reducing turnover by an average of 20%.”

Qualitative: “According to the Employees of America Survey, hiring managers have cited high onboarding costs and maintaining employee satisfaction as the top two ranking concerns in the first year of a new employee’s tenure. We seek to alleviate those concerns by providing Y.”

Sense of Urgency: “With the rise of millennials in the workplace today, turnover rates are at an all-time high, and recruiters are excited to sweep them away from you. Our solution drastically improves retention rates immediately by providing Z, at a time when that’s keeping hiring managers up at night.”

Comparative: “Once thought of as innovative benefits to increase retention, 401k’s and gym memberships are now staples of an employee’s package and onboarding. Similarly, we believe our solution will be the next HR innovation that solves your retention challenges and boosts employee satisfaction.”

After outlining the problem, highlight at least three tangible examples of how the product works to solve these challenges. If you use a pitch deck, be sure to build it so that these use cases can be swapped out, depending on the industry or persona you’re pitching to.

Why you and why now?

It’s not enough to identify the problem and pain point, because there are lots of problems organizations are facing, and lots of smart groups trying to solve them. Now that you have someone’s ever-fleeting attention, focus on your differentiators, knowing that they’re likely comparing you to other solutions they’re familiar with. There are a few questions to ask yourself here.

  • Are you solving for a new problem on the rise? If so, then highlight that, and focus on the fact that you have years of domain expertise that make you unique in coming up with a timely answer here.
  • Are you solving for an existing problem with new technology? Great. You should focus on why your product trumps legacy solutions and any first-mover advantages you may have with your new solution.
  • Are you consolidating multiple products your prospects currently use, and therefore offering them a more efficient solution that’s going to save them money? This is good too, especially if there’s a high switching cost for prospects to ditch their current products in favor of yours. In this case, every day they spend with their current solutions is a day lost saving money and creating efficiency by using yours.

Ultimately, the goal here is to find your specific edge to highlight the question of why you versus someone else, and why the time to solve the problem is now.

Be a good storyteller. Bring vision into your pitch (especially if you’re a founder).

Storytelling is one of the oldest forms of human communication. It unifies people around a commonality, through good times and bad. Your story (to a potential customer at least) should not hint that there’s a big market opportunity or a lot of money to be made (by you). The customer does not care. Make your story personal and relatable. Perhaps you’re seeking to solve the problem because you came from the industry and it was a huge pain in your own life. Maybe you have an altruistic vision (assuming it’s real, don’t fake it) for coming up with a solution that will make people smarter and therefore happier in their day to day work. That’s something we can all get behind. People generally don’t like being sold to, but if they’re sold on you, your story, and the vision along with it, they’re more likely to ride with you. As one of my favorite product managers once told me, “It’s easier to cancel a product than a relationship,” and the beginning of establishing that ironclad relationship with your customers starts here. (Hint: this applies to rallying your internal employees, too).

In summary, the keys to creating your early product pitch are comprised of the following:

1) Who your product is for;

2) Social proof;

3) What problem you’re solving and how;

4) Why your company specifically is going to solve it now; and

5) A story or vision which ties all that together.

Finally, ask for, and listen to your early prospect’s feedback on the pitch, and iterate. If Gavin Belson had followed these steps, I doubt Pied Piper would be the thorn in his side that it is today.

Exploring the Finer Details of Regulation CF Crowdfunding

Early Growth Financial Services is fortunate to have many great clients with diverse business models and capitalization structures. We help many of these clients prepare for equity rounds of financing, so naturally we were excited when the JOBS act passed in 2012 and allowed for equity crowdfunding. While we are big proponents of accredited investing through traditional channels (Angels, Micro VC’s, VC’s), the May 2016 Regulation CF passing for non-accredited investors to invest in companies is a transformational fundraising milestone for new startups launching in the 21st century. The fact that everyday individuals can fund companies and democratize private equity is an exciting concept. That said, we’ve had more than a handful of companies go through this process and it was an eye opening experience that we’d like to share to inform others of what to expect.

Before we dive in, here’s a quick crowdfunding overview. Non-equity crowdfunding or “rewards based crowdfunding” is comprised of sites like Indiegogo or Kickstarter that allow companies to list a product for pre-sale for a promise of a reward without the exchange of equity. The 2012 JOBS Act allowed for equity crowdfunding in 2013 (Title II), but only from accredited investors. The Reg. CF (Title III) passing on May 16, 2016 then allowed for non-accredited investors (as a percentage of their income) to invest in companies who are raising up to a maximum of $1mm over a 12 month period. You can learn more about Reg. CF requirements here. Due to its immense popularity, we are going to focus on our experiences with Reg. CF campaigns.

As you can imagine, in the first half of 2016 we had many companies approach and engage with us to help them launch these Reg. CF campaigns. The work EGFS performed for most of these companies was extensive because of the need to be fully GAAP (Generally Accepted Accounting Principles) compliant per SEC regulations. However, in all of the campaigns, EGFS was just one of a few professional services firms involved. The typical process was as follows:

1) The company contracted with a securities law firm that is familiar with crowdfunding to prepare documentation.

2) The company contracted with EGFS to prepare accounting and financials.

3) The company underwent a formalized review (Audit firm) to review EGFS’ work in order to launch on the crowdfunding portal (different firm than EGFS due to conflict of interest).

4) The company launched on the crowdfunding platform, incurring either a minimum onboarding fee or success fee for the money raised, sometimes both.

5) Occasionally, a PR/Marketing firm was used to promote the campaign. These firms are highly specialized due to the rules of marketing this security.

Due to the cost burden outlined above, if you were to pursue this type of crowdfunding, it makes sense to raise larger amounts of money up to the $1mm/12 month maximum. Many companies choose to raise less than $500k with Reg. CF, but that means that the compliance costs represents a larger percentage of the money raised, leaving less money on the table for business expansion. We’ve yet to see a Reg. CF crowdfunding campaign launch for less than $25-50k by the time all parties are paid for their services. As you can imagine, this is a large amount of cash, especially if the campaign is unsuccessful.

Besides the costs of the campaign, there are some other important considerations that you’ll need to make as a Founder before launching a Reg. CF campaign. If you want to raise traditional VC money after this campaign, Reg. CF causes a crowded cap table and most venture capitalists are not fond of this. It causes their own compliance headache and doesn’t allow them enough room in the cap table to invest. Another important consideration is the strategic value a VC brings to the table beyond writing a check, which you don’t receive from Reg. CF individuals. The very best VCs and funds can attract customers, have deep networks to help with hiring and other needs as they arise, and – most importantly – help founders prepare for the next round of financing. Unfortunately, Reg. CF lacks this critical advisory element.

That said, there are particular use cases where Reg. CF makes excellent sense. First and foremost, most businesses are not ideal for venture capital investment. If you are launching a lifestyle business or a small business that is looking to compensate early adopters for belief in your product, then Reg. CF is a solid option. If you are looking for a relatively quick funding source, this is also an advantage, although it is not as fast as non-equity crowdfunding due to the aforementioned regulations process.

Overall, Reg. CF crowdfunding is one of the biggest developments in the startup financing landscape in recent years. This will be a viable funding option for many companies both now and in the future. It is important to dive deeper into learning how a crowdfunding campaign would fit into your overall fundraising strategy. We’ll make sure to send along an update once these early Reg. CF companies experience their first SEC review in the coming months.

Square 1 Bank Announces Credit Facility to mPulse Mobile

Square 1 Bank, a division of Pacific Western Bank, today announced that it has provided a $5 million credit facility to new client mPulse Mobile, a leader in mobile health engagement solutions. Proceeds from the facility will augment working capital and provide access to funds to accelerate the company’s growth initiatives, including merger and acquisition opportunities and ongoing product innovation, subject to the loan’s terms and conditions.

Headquartered in Encino, California, mPulse Mobile drives improved health outcomes and business results by engaging individuals through real-time, tailored interactive dialogue. By combining mobile technology, data science, analytics and industry expertise, the company assists healthcare organizations in activating consumers in their health and lifestyle choices. mPulse Mobile is backed by several leading investors including HLM Venture Partners, OCA Ventures, Echo Health Ventures and Rincon Venture Partners.

“Our sole focus is working with providers, Medicaid and commercial health plans, and pharmaceutical and wellness companies to engage and activate their consumers for improved health outcomes,” said Brian Chudleigh, chief financial officer of mPulse Mobile. “We’re pleased to have a great partnership with Square 1 to help us fulfill our mission.”

“Through innovative technology and partnerships with leading U.S.-based healthcare organizations, mPulse Mobile has positioned itself as a pioneer in the mobile health market,” added Rilus Graham, senior vice president in Square 1’s life sciences practice. “We are thrilled to support the company’s success as it continues to grow and adapt to emerging trends in healthcare.”

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW). For more information, visit www.square1bank.com.

About mPulse Mobile

mPulse Mobile, the leader in mobile health engagement, drives improved health outcomes and business efficiencies by engaging individuals with meaningful and interactive dialogue. mPulse Mobile combines technology, analytics and industry expertise that helps healthcare organizations activate their customers to adopt healthy behaviors. With over 8 years, a hundred million messages sent, and 50+ Health Plan, Provider, Pharma and Wellness customers, mPulse Mobile has the data, the experience and the technology to drive healthy behavior change.

Media Contact:
Square 1 Bank, a division of Pacific Western Bank
Dee McDougal
919.597.7479
dmcdougal@square1bank.com

mPulse Mobile
Paige Mantel
650.450.0425
paige@mpulsemobile.com

Square 1 Bank Announces Credit Facility to ItemMaster

Square 1 Bank, a division of Pacific Western Bank, today announced that it has provided a $4 million credit facility to new client ItemMaster®, a leading provider of product content services for the US CPG and CPG Retail market. Proceeds from the facility will support growth initiatives and provide working capital.

Based in Chicago, IL ItemMaster is a leader in creating, enhancing, managing and delivering comprehensive, certified content for major brands, online, in-store, mobile and everywhere a company or consumer may need product information. The company’s cloud-based platform allows manufacturers to verify, share and manage their product portfolio and custom branded content for distribution across all channels. ItemMaster is backed by leading venture capital firms including Edison Partners and Chicago Ventures.

“Moving to Square 1 provides us with access to additional investment funds to continue to rapidly scale our business to meet market demand,” said Michael Murray, chief executive officer and president of ItemMaster. “After conducting a review and considering a variety of banks, we determined Square 1 was the best partner to meet our needs and we look forward to our relationship growing as our business grows.”

“ItemMaster is a promising, high-growth Midwestern company that is revolutionizing product content to fuel today’s data driven retail marketplace,” added Jeff Lampe, managing director of Square 1’s technology banking practice in the Midwest. “We are thrilled to add ItemMaster to our portfolio and look forward to supporting the company’s mission to bring brands to life through consistent, high-quality product content in-store, online and via mobile.”

About Square 1 Bank

Square 1 Bank is a division of Pacific Western Bank, a Los Angeles-based commercial bank with over $21 billion in assets. A full service financial services partner to entrepreneurs and their investors, Square 1 provides clients flexible resources and attentive service to help their companies grow. Square 1 offers a broad range of venture debt, treasury and cash management solutions through offices in top innovation centers: Atlanta, Austin, the Bay Area, Boston, Chicago, Denver, Durham, Los Angeles, Minneapolis, New York, San Diego, Seattle and Washington, DC. Pacific Western Bank is a wholly-owned subsidiary of PacWest Bancorp (NASDAQ:PACW). For more information, visit www.square1bank.com.

About ItemMaster

ItemMaster® is the most comprehensive source of brand-verified product content to satisfy every outpost of market demand. Our cloud-based Brand Activation™ Platform enables manufacturers to share, verify and manage their product portfolio and custom branded content for distribution across all channels; turning shoppers into buyers.

More than 1,000 retailers, agencies and mobile app developers access ItemMaster as a one-stop source of certified brand content through our open exchange network. This allows ItemMaster to offer manufacturers real-time analytics and actionable brand data to drive business decisions. A privately-held company, ItemMaster already supports Complete and Verified™ content for over 5,000 brands and is on a mission to reinvent and deliver packaging for the 21st century.

Media Contact:
Square 1 Bank, a division of Pacific Western Bank
Dee McDougal
919.597.7479
dmcdougal@square1bank.com

 

Gaelen Bell
ItemMaster, Inc.
312.946.6089
gbell@agencymsi.com

Three Steps to Sustainable Competitive Advantage – Part 3

This article is co-authored with Ryan Janssen – tech investor & entrepreneur.

Review

Failure to articulate competitive advantage is probably the most common reason why pitches fail. Despite all of the talk of unfair advantages, we’ve seen this exact conversation in dozens of pitches.

More so, VCs care about unfair advantages for reason – getting this right is the most important ingredient for hypergrowth. Peter Thiel feels this concept is so important he spent three chapters of his book on it. It’s a fast-moving, competitive marketplace out there, yet many businesses fail to plan for this in advance.

The key concept here is Sustainable Competitive Advantage (aka SCA). It’s underrated, misunderstood, and especially elusive – and having a true SCA is ultimately the factor which separates the megaexits from the acquihires.

There are really three steps to building SCA into your business plan:

  1. Think long-term
  2. Find your unfair advantage
  3. Figure out how to get there

In the first and second installment, we discussed how to navigate thinking long-term when planning and pitching your business and how to identify your unfair advantage. Here in the third and final installment, we examine how to build your SCA.

Node 3: Figure out how to get there

The good news in this competitive gauntlet: every impenetrable incumbent today had no defensible advantage earlier in its history.

This is where the rest of the kickass stuff about your business comes in – great team, good products, solid customer traction, etc. In fact, most businesses zoom right to this node without showing enough consideration to your future defensibility.

So the key here is context. Every one of these things should be viewed as a path to your SCA.

We just decided a great product isn’t sustainable – in the long run, Google can out-build you. But a great product, timed properly, can help a company reach another SCA.  For example, before Instagram was an entrenched social network giant, it just one of the first apps to offer filters. People downloaded it because it took better photos, and that momentum led them a strong SCA.

In fact, almost every giant in tech today followed that same one-two punch:

Apple was a great product company who’s now an unstoppable brand. Facebook was an early mover/innovative GTM who’s now an impenetrable network. Google was an amazing team who built the strongest data advantage in history.

Maybe your business is the first to develop AI for a certain trading algorithm that it will ultimately parlay it into a Markit-style data advantage. Or perhaps your new social network for families is so well-designed it will grow rapidly until the network effects start kicking in. The most effective VC pitches use this one-two framework to articulate how your startup will achieve and sustain market leadership.

Conclusion

SCA is the key to nailing an amazing VC pitch, and it’s good business. Hypergrowth is only possible with an amazing business model, and amazing business models need to have a strong defense. To that end, every startup needs to:

  1. Think seriously about its advantages now.
  2. Be brutally honest over whether those can be copied (i.e., are they “unfair”).
  3. Plan how it can use what it has to get to that unfair advantage.

Even more importantly – this is an ongoing concept that you should revisit often as you grow your business. Your product strategy, your go-to-market, your revenue model, your capital plan – these should all be framed by that all-important unfair advantage – the one that will let your business take off like a rocket ship rather than getting stuck in the competitive swamp of decreasing margins.

For more information contact Sanjay Gandhi at sgandhi@oxfordvp.com. Look for more funding advice by visiting the knowledge section of the Oxford Valuation Partners website.

© 2005-2017 Square 1 Bank, a division of Pacific Western Bank. Member FDIC. All rights reserved.