VC Investors want Business Plan–and Funeral Plan

Venture capital investors love business plans that promise terrific upside, but they increasingly want a “funeral plan” in writing that explains what the entrepreneur can and will do if their start-up suffers from business problems or slow growth.

David Frankel, former entrepreneur and managing partner at the seed-stage Founder Collective, writes at TechCrunch that start-up entrepreneurs by their nature are optimists, and spend way too much time daydreaming about financial rewards from business success and adulation from the media.

But Frankel cautions that his early-stage investor group demands that the entrepreneurs they fund must also recognize their company’s mortality by understanding their sector’s business risks and have a “constructive, actionable plan” to deal with uncertainties.

For Founder Collective, “Funding isn’t a milestone to celebrate,” but a one-day event, according to Frankel.

That means the modern entrepreneur must analyze his or her own startup in the same way that an actuary would analyze risk for an insurance company. To “beware” of risks, the entrepreneur must “be aware” of the revenue numbers and financial ratios of the business’s closest competitors.

That means benchmarking the start-up by reading all public market reports, becoming familiar with trade journals, attending trade shows, and trying to assemble a list of the mergers and acquisition transactions that have happened in the last few years.

Frankel suggests reaching out immediately to companies that might eventually consider buying the start-up. The goal isn’t to sell before the entrepreneur can build up the business, but rather to develop back-up “warm relationships with the right decision makers if things don’t work out as planned.”

Life expectancy tends to be dramatically different between industries. Competing in an established market usually means there will be continuing opportunities, but the upside is limited.

Frankel suggests that entrepreneurs develop a group of trusted advisors who can help the company if “things go pear-shaped.” That must include an understanding of the legal playbook to manage taking the start-up through bankruptcy.

Even worse than failing outright is when a venture capital company becomes a “zombie.” With such high rate-of-return targets, venture capitalists believe companies that are growing at less than 2 percent per month are dead money. Twenty-four percent growth is great for a private business, but it is unlikely to generate a buy-out at 10 times the investment.

Frankel suggests that if the start-up is growing too slowly, there may still be potential, but the most important decision for the entrepreneur is to determine if there is enough commitment “to grind out the company at a subsistence level for another 5-10 years.” If that is the case, the entrepreneur can try to revive the business opportunity by taking dramatic action, such as laying off up to 60 percent of the workforce and becoming committed to survive on internal resources.

Frankel states that “Startups Dying is a Feature, Not A Bug, Of Venture Capital.” He expects that many startups will just die and companies that are “decent prospects approaching profitability” will be sold out from under the entrepreneur.

He warns, “It’s rocket fuel, not 87-octane regular gasoline. You need to ride hard or die.”