VC Investment: The Classic Case of the Chicken and the Egg

As an Associate on the Investment Team at OpenView, I have the opportunity to speak with a lot of really great entrepreneurs every day.  While very few conversations will end with an investment by OpenView, I try to make the best out of each call by learning as much as I can and trying to be as helpful as possible.

To set up some context, OpenView is an expansion-stage venture capital firm, investing in high-growth software and technology businesses.  With that backdrop, it is easy to see that we have a relatively narrow focus – we are not generalists with a multi-stage/strategy approach.  Given that narrow focus, it can be pretty easy for us to quickly determine whether or not an opportunity is for us given where it is today:

• Is it growing very quickly? (actual growth rate can vary based on scale of business)
• Is it in our revenue range? (>$500k in quarterly revenue)
• Is there real technology there? (i.e. do you have IP around software or tech?)

Obviously, just because your company checks those three boxes doesn’t mean it is going to be an investment, but it is probably worth spending some more time figuring things out (and there will be plenty more questions that need to be answered).  As a firm, I think we do a good job at being flexible to try and understand businesses and specific situations to see if we can be helpful, though more often than not, I just go back to those 3 simple questions above.  If I can’t easily answer those questions about the company, chances are we’d have to stretch too far to make the investment work.  As I mentioned in my last blog, I don’t enjoy turning down entrepreneurs, but I think the conversation can still be positive and productive.

So finally (now that I’ve officially buried the lead), it brings me to ‘the classic case of the chicken and the egg.’  This, like turning down CEOs, happens way too often in my conversations.  The chicken and the egg scenario can be applied to any of those 3 questions above (along with many others):

VC:  How quickly are you growing today?

CEO:  Well, we’ve been resource constrained, so we’ve been flat for the past 3 years.  But, with a $10M investment, we’ll grow 350% this year!

VC:  How big is the company today?

CEO:  Well, we did $50k this month, but with your $10M investment we’ll be well into your range by the end of the year.

VC:  Tell me about your product?

CEO:  Well, today we are entirely a services organization without any IP, but we plan to use the investment to productize and should begin seeing product revenue within the year.

Obviously, all of those responses may be true and we may miss out on some really interesting opportunities by not investing today, but in most cases, we simply aren’t the right guys for the company at its current stage.  While we spend a lot of time trying to understand the future of the business, we also care about what the company has been able to do with the resources it has had to date.  We look at the historical picture to understand where the company has been and how we can be helpful in getting it to that next level.  In the 3 scenarios above, we have no meaningful track record on which to base our investment – all we have is the CEO’s promise that with our investment they will soon be able to check all of our necessary boxes.  This is the classic chicken and egg situation – we VCs want to see growth before we can invest and you need the VC investment before you can show growth; how do we get out of this cycle?

Sometimes there is no avoiding the chicken and egg scenario – and I’m sure there are investors out there that would make those bets.  My suggestion would be to try and build as much of a track record as possible with as little resources as possible (totally easier said than done) – if growth is what you are going for, invest a small amount of capital (your own or an angel’s money) into the sales and marketing effort to fine-tune it so that you can show an investor a proven track record of return on capital (in this case, growth in revenue for investment in sales and marketing).  I think that will make conversations with VCs much easier as you look to raise a larger round to hit your goals.