Thursday, July 14, 2005

Commandment #8: Know What You Don’t Know – and Admit It

Commandment #8: Know What You Don’t Know – and Admit It

If all questions about your startup had well-known, easy answers, you’d be on your IPO roadshow, not meeting with early stage VC’s. Most good, early-stage VC’s don’t expect entrepreneurs to know everything, but they do expect entrepreneurs to know what they don’t know and to be upfront about it. This Commandment gives advice on how to handle this.

To set the stage: VC’s invest in people. You’ve all heard the old saw: “To a VC, what are the three most important things about a startup?” Answer: “(1) the team, (2) the team and, (3) most of all, the team.”

By and large, it’s true.

Now, if you followed Commandment #1, you’re meeting with VCs who know something about your area. I know it seems hard for entrepreneurs to believe (especially given some of the comments I’ve gotten), but VC’s are generally smart people (present company excluded). They can have lots of other unattractive attributes (just like entrepreneurs and other people), but they are, on average, reasonably smart. Thus, your jaw shouldn’t drop if you find yourself in a VC meeting and you get a question about your business to which you don’t know the answer. Believe it or not, this sometimes happens.

Here’s some really important advice.

When this does happen:

DO: admit (with confidence) that you don’t know the answer

DO: make a note of the question

DO: quickly find out the answer to the question

DO: promptly follow up offline with the VC who asked the question

DO NOT, REPEAT, DO NOT: fake your way through an evasive, oblique, or indirect attempt at an answer.

I know from comments to my blog that some readers reject my proposition that VC’s are, more or less, smart folks. That’s OK. Everyone’s entitled to their own view on this matter, and, who knows, they may even be right. But, even to those doubters (if they want to raise VC money), I implore you to believe that VC’s (smart or not) do have good bullshit detectors – even in areas where they’re not necessarily domain experts. Often, of course, it’s not even that hard. Human beings are generally pretty good at reading body language, and body language usually gives away evasive behavior.

To put this in a more positive light, from the VC’s perspective (no VC actually thinks about it this “formalistically”), I offer this little “algorithm”:

· There’s a “list” of the important questions about any new business idea, some of which are not currently “answerable” (e.g., will the market develop as predicted by the entrepreneur);

· The entrepreneur should have answers to most of the currently “answerable” questions on this “list” (e.g., why a large incumbent vendor with major brand recognition and a huge cash hoard can’t easily move into the market); and

· If the entrepreneur doesn’t, he should admit it, and quickly heed the aforementioned advice about follow-up.

Again, VC’s don’t expect entrepreneurs to have all the answers. As mentioned, if you did, you’d be on your IPO roadshow. VC’s do, however, expect entrepreneurs to know the “list” of important questions. Failure on this front is the real confidence deflator (though, to say the least, it also doesn’t inspire confidence if an entrepreneur doesn’t know the answers to questions that he should).

Failure to heed this advice can hurt an entrepreneur in a way that might come as something of a surprise. VC’s ultimately cannot know nearly as much about your particular business as you do (see numerous references in prior Commandments). After lots of due diligence meetings, reference checks, customer calls, etc., many funding decisions more or less rest on VC intuitions about the “character” of the entrepreneurs. This is why VC’s are so much more comfortable backing entrepreneurs they already know.

Keep in mind, many important questions about a startup are not answerable until the startup answers them (positively or negatively) by executing its business plan. VC’s, at least the good ones, know this. Thus, if the entrepreneur exhibits evasive behavior when answering a question, the “trustworthiness meter” starts running in reverse. Believe me, every startup will encounter situations in which the entrepreneur will have to report to the Board of Directors on a tense, critical situation, with highly imperfect information – and, after lots of analysis, the Board’s decision will often rest on beliefs about “character”.

So, for any entrepreneur who wants to raise VC funding, following Commandment #8 -- (1) know a lot, (2) know what you don’t know and (3) admit it when asked -- will get you a lot farther down the road.