These days, most entrepreneurs have gotten beyond the old adage that if they "build a better mousetrap," the world will beat a path to their door. They realize that to build a business, they have to have successful sales and marketing in addition to having a good product or service. But most entrepreneurs do not realize that to get outside financing, it's not just a matter of having a good product that "everyone needs;" rather, it is contingent on the successful selling of the business plan to potential investors.

The first step in sales is to understand your customer - how they think and what their needs are. In this myth, we'll try to understand your "customer" when raising financing Venture Capitalists (VC's) or other private investors. Venture Capitalists are referred to as "professional investors", because of the stringent criteria that they use for their investments. Although we will concentrate on VCs in this myth, the same principles apply to selling to individual investors.

The first company, PowerScout, was started in early 1996 with an interesting idea for the rapidly expanding web browser market. Their idea leveraged some research done at MIT and helped web browsers "see" the pages that were "down the road" from the current page. Based upon preferences, the product would "suggest" which links the user should follow from the current page.

PowerScout had a great product idea - one that most end users, when surveyed, would like to use. Because of the vast number of links that an end user has to click through to find useful information on the Web, this was a time saving idea for end users. Furthermore, the market-size was incredibly large: every single user of a Web browser was a potential customer, and the number of users gaining access to the Web was growing at a remarkable rate.

Raising financing became a critical part of their strategy, as they had to finish the product and then launch it, requiring a substantial sales and marketing campaign.

Interestingly enough, the founders realized that they didn't have the experience to run the company, so they recruited a CEO who had successfully raised Venture Capital financing before. A year later, the founders were forced to leave the company to get well-paying jobs because they had used up their savings. The financing never happened.

They had a good product, a large potential market, were in a hot market that Venture Capitalists were looking to invest in (the Internet). They even had an experienced CEO! What was the problem? The problem was the business model wasn't well defined, the market was a little vague and undefined, and their product hadn't been tested in the marketplace.

We'll explore both market size and business models in detail later in the chapter.

The second company, net.Genesis, shared some basic similarities with PowerScout- another Internet startup in Cambridge, also pioneered by MIT people.

However, their market wasn't quite as large, so rather than going after all of the web browsers, net Genesis decided to make tools to help the people who set up and run web sites. In fact, when they sought out financing, their first prototype product was completed, and they already had some customers in queue, including the Boston Globe.

The founders were very young, but they were able to raise several million dollars without an experienced CEO. They had a good product, and a large market, although not as large as PowerScout, since there are many more web browsers than web servers did.

What was the difference? Well, there were many differences. But the most important distinctions revolved around the demonstrable success of the company; it's products, and most importantly, the business model that they were using. With these factors, Venture Capitalists decided that net.Genesis was a viable bet in the hot "Internet tools" space.

Yet to effectively answer the question of how "attractive" a company is to investors, we have to understand how Venture Capitalists and Entrepreneurs think about the issue of investment...

First of all, Hollywood studios need to make a certain numbers of movies each year. They get hundreds of scripts, but they can only make a small number of movies; the rest get rejected. Of these movies, some of them will be blockbuster hits and some of them will be duds. The blockbusters will more than make up for the duds, resulting in a certain return on investment. The definition of a blockbuster is usually a movie that brings in more than $100 million in box office receipts.

Now, Venture Capitalists need to invest in a certain number of companies each year. They get hundreds of business plans, but can only make a small number of investments; the rest get rejected. Of these companies, some of them will be blockbusters and some of them will be duds. The blockbusters will more than make up for the duds, ending up with a certain return on investment. In the VC world, a blockbuster is referred to as a "home run", and it usually means that they make at least 10 times their money.

This leads to the first rule of Venture Capital investing: Big movie studios aren't interested in "independent films" that will make only a few million dollars in profit. Similarly, Venture Capitalists don't want companies that will be profitable companies with $10 million in revenues in five years. In order to cover their investments that aren't successful, their successes can't just be moderate successes. They have to be "home runs".

If your business plan doesn't show that kind of growth, then you probably want to go to individual, private investors instead of Venture Capitalists, because your business plan will be one of the hundreds that are thrown away.

Next, movie studios will naturally pick what is hot at the time: adventure movies, sci-fi, historical movies, westerns, etc. Venture Capitalists will also bet on what's hot: Internet companies, coffee shops, and large department stores, health care, etc. More importantly, though, Venture Capitalists want to place bets in small markets that will be hot over the next 3-5 years.

Next, there are two ways movies get made in Hollywood: A big name brings a script to the table, or every now and then, a good script is found and the studio buys it. In the second scenario, what happens? The first thing the studio does is try to hire a big name actor or director. After all, if they are going to invest millions in making a movie, then they want to be sure their investment is going to produce a big return!

Not surprisingly, the same is true of Venture Capitalists. If the "script" or business plan has good elements to it, their first reaction is to assign a "big name" (an experienced CEO, in this case).

Now, that doesn't mean that you can't get financed if you don't have a "hot market" or a "big name". It all depends on the quality of your investment story - your "script" if you will. To create the right story, you have to think like a VC - not like a first-time entrepreneur!

When queried about what makes a company attractive to investors, entrepreneurs tend to rank the importance of the various aspects of their company in the following way. VC's, however, think about almost each of these items in a different way then entrepreneurs. By understanding how the VC's think about each of these items, you can fine-tune your story to make your company much more attractive to potential investors.

1. The Product Idea

2. The Size of the Market Opportunity
3. Feature Parity with Competitors (market holes)
4. Sales & Marketing
5. Management Team

The first two items on this list are really a re-statement of our StartUp Myth; "Venture Capitalists invest based on the product and the size of the market".

At the top of the list (for the entrepreneur) is the product itself and how it fulfills a market need. Usually this is demonstrated anecdotally, "This is a great product!" cries out the first-time entrepreneur, and "when I was at this company, I wasn't able to do X,Y,Z effectively! But this product let's me do X, Y and Z!"

When presenting their companies to potential investors, many entrepreneurs forget that VC's don't want to be convinced that the product is good. Rather, they want to be convinced that customers will pay money to buy this product over other possible and competing products.

This brings up one of the most important factors affecting raising financing: demonstrable success with customers. The more names you have of potential customers who are willing to say that your product is worth buying, the more convinced the investors will be that you have a good business opportunity. The quality of the product is almost irrelevant...

It's also important for Venture Capitalists to assess the size of the problem that the product solves. A mistake that many would-be entrepreneurs make is that they try to solve a problem that everyone has (i.e. a very large market for your product or service).

When asked, "Who is this product for," the first-time entrepreneur replies: "every manager," or "every 12-year old," or "every engineer." After all, the biggest companies tend to be the ones that solve the biggest problems, right?

This is by far the most common mistake made during the early stages of a business plan. It indicates a lack of focus, and a basic misunderstanding of how small companies should reach their potential customers.

If every manager needs this product, then it's a good bet that an existing large company is already looking at this market. The key for small companies is to get into the market before it is extremely large; this way, they can use limited dollars to become a leader in this market. When the market explodes and big companies finally start to think about that market, the big company should then reach the conclusion that it's easier to buy a small company (like yours) than to start from scratch.

Most start-ups don't have millions of dollars of advertising money to advertise their revolutionary new product on national TV. Instead, they have to use targeted marketing (with limited dollars) to get a foothold into the target market. By the time the target market becomes large enough for big companies to be interested in it, the small companies will already have established themselves as market leaders in the minds of customers.

The Competition is usually the next item that entrepreneurs place on their hierarchy of values. There are two aspects of the competition that most entrepreneurs highlight. The first is that their product or service doesn't exist at the proposed price point, and the second is that competitors don't have all of the same features that their product or service offers.

In the technology arena, this is demonstrated by better technology. In the restaurant arena, it might be thought of as better or more "authentic" food. Or, following the same theme, the entrepreneur is likely to say that "there is no competition in this area!" or "There is no competition in this price range!" Unfortunately, most Venture Capitalists see competition from a different perspective.

Venture Capitalists, on the other hand, think of the competition in terms of how quickly they will gobble up the market once they start spending big bucks to do so. Big companies can always cut their prices and add features, and this will quickly plug the hole that you are looking to exploit. Now, if it will take the big companies two years to plug the whole you can fill right now, then there's a window of opportunity for you.

This principle hits at the essence of what most management gurus call, "sustainable competitive advantage". You have to show not only that you have an advantage today, but that by exploiting that advantage today, you will continue to have an edge in the minds of customers. This could be because it costs too much to switch once a customer signs on with you. Or it could be because you have something that will take competitors years to duplicate.

Finally, the entrepreneur is likely to recognize that both "sales and marketing" are important, but without understanding the elements that need to be in the plan for it to be attractive to equity investors.

What investors really want to see is a well-thought out strategy for reaching customers. This should be a strategy that is cost-effective, that will reach the target market in an efficient way, and will distinguish the company from its competitors.

A business model is an abstract description of how you are going to reach your customers, sell your product to them, and then get them to buy again and again. This includes marketing strategy, sales model, and distribution model.

Let's look at the two companies that we mentioned at the beginning of this myth. The business model for PowerScout wasn't well defined or demonstrated - they wanted to reach every single user of the World Wide Web out there - but they didn't show how it would be cost-effective to get to them. Net.Genesis, on the other hand, relied on telephone sales of its products to web administrators. It's relatively easy to call a company and find out who the webmaster is and then start talking with them about web sites. That is exactly what their business model called for them to do.

In short, a company with a well-defined, cost-effective business model who has demonstrated that the model can work, will be more successful than a company with a good product but a weak business model. You can demonstrate the model by making a few sales yourself, or by showing how other similar companies have effectively used the model.

Many books will tell you that Venture Capitalists will not look at entrepreneurs who do not have previous experience running companies. That's not quite true; in fact, most Venture Capital investments are done in companies that are run by first-time entrepreneurs.

What is true is that "people" are the most important factor for an investor to make an investment. Why?

Venture Capitalists understand that any good idea will have multiple people chasing it. So the difference is not just the model but how well you will execute against that model. And execution comes down to the management team.

Why is experience so important to them, and what can you do to counteract your lack of it?

First, understand that many entrepreneurs are fickle. They come up with a new application for a product, an untapped market, a new sales & marketing campaign, or any number of innovations and then enthusiastically pursue them. And being the creative thinkers that they are, they can sometimes get distracted from the business model at hand because they are constantly coming up with new great ideas. These might be great ideas, but they are usually implemented without having measured how well the old ideas worked.

An experienced manager, however, understands the importance of putting together a plan and sticking to it. An experienced manager sets up performance measurements along the way, assigns tasks to be sure that no part of the plan is left out, and then incessantly makes that plan come together, day in and day out, by providing daily course corrections. Yes, management is actually a pretty boring profession: much of it is simply holding everyone accountable for his or her pieces of the puzzle.

Secondly, an experienced manager will have seen multiple business models succeed and fail in the past. This breadth of experience should let them recognize when something isn't working and then change to a different model. When something doesn't measure up, experienced managers should (in theory) know why it isn't working and choose a model that will work.

Third, an experienced manager will know what the company should look like if it's successful, in terms of infrastructure, etc. For example, most entrepreneurs do not have a formal sales forecasting system in place. Anyone who has run a larger organization knows that a formal sales forecasting system is critical to getting any predictability in place.

Lastly, an experienced CEO will have many contacts in the industry. These contacts should be able to help the company get strategic partners, make additional sales, and recruit top-notch employees.

This leads us to the final and perhaps most important principle when presenting your company to private investors.

This means that you have to convince them of the following:

1. You have a viable business model. This can be done by showing your knowledge of what models other companies in your industry have used, successfully and unsuccessfully. You have to also show them that you considered alternate business models, but that this was the one that came out as the best for your target market.
2. You have demonstrated your ability to "stick with it" and "manage against a plan". This can be done by showing them your projections at the beginning of the year and how closely you've been able to stay with those projections. It is also done by showing them that you have set up "performance measurements" along the way so that you get early warnings if things are off-track.
3. You are bringing aboard more experienced people as advisors who have industry contacts and have seen more models than you have. This is typically done by establishing a board of advisors who have more credibility than you do. This also shows them that you are someone who listens.
4. You are putting in infrastructure for the company to scale and know what's required. This is a tough one, because you have to balance putting in infrastructure with how much that costs. It's also tough because you may not know what infrastructure is required. Try to visit companies that are two-three times larger than you, and find out what kinds of systems they have in place. Then, show the VC's your plans to put those same systems in place as your company scales.

There is, as always, a kernel of truth to this myth. Investors want to see companies that are going to be large someday. A good product and a large market are required, in theory, to create a large company. However, in practice, this barely scratches the surface of how investors evaluate companies. There are factors that are more important than the quality of the product or the size of the market. By understanding the following principles, you will increase the likelihood that your company can raise private financing: