Five Trick Questions Every Entrepreneur Should Answer Before Asking For Money

 This article originally appeared on Forbes HERE

From a venture capitalist’s point of view, there are no “trick” questions. However, certain questions can be tricky for an entrepreneur to answer.

Below are five common questions an entrepreneur will encounter when seeking venture funding. These questions, which manifest themselves in numerous forms, all share a common underlying objective: to divine your motivations, expectations and desires. Handled appropriately, these questions provide investors a window into an entrepreneurs’ soul, which minimizes the chances of a future misalignment.

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In most cases, professional investors are not looking for a particular answer. Thus, do not rehearse answers that you think will satisfy a particular investor. Instead, introspectively answer these questions before you sit in front of your first prospective investor.

Question 1: What will your exit look like?

Intent: Investor / entrepreneur conflicts often arise when a company contemplates an exit opportunity. Consider the situation in which the entrepreneur wants to accept a financially life-changing offer to sell her company which is vetoed by the investor because the price does not meet its minimal investment return criteria. Defining a shared vision of success, which encompasses a specific range of potential outcomes, reduces the odds of an exit-oriented conflict.

Response: Convey a range of acceptable outcomes which demonstrates your understanding of the investment returns expected by sophisticated venture investors. For instance, if you anticipate that your venture will require $10 million of investor capital over its life, an exit below $50 million is unlikely to be acceptable target to most VCs. Most venture firms target a 10x return on each investment, knowing that their average return across their portfolio will be far lower.

If your definition of an acceptable exit is incongruent with the reasonable expectations of a venture capitalist, consider seeking alternative forms of risk capital, such as government grants, venture debt or friends, family and fools.

Avoid stating a specific exit value. Rather, say something to the effect of: “The exit is simply another milestone on our long journey. Our goal is to build a self-sustaining company, which can succeed either as a stand-alone entity or as an integral component of a larger organization. We are not focused on our exit, but I can guarantee you that the time, place and price will be at our discretion.”

I often ask an entrepreneur how much money they personally want to walk away with, once their involvement in their venture is concluded. This is not an idle question, as I believe defining success, in concrete terms, is a fundamental building block of happiness. If you never answer the question, “How much money do I need to make at this startup to make me happy?” it is possible your exit will be emotionally unfulfilling. At my prior ventures, I was disappointed that some of my compatriots, with whom I shared multi-hundred million dollar exits, were haunted by the notion that, “I always thought my stock would be worth more.”

You can also leverage this question to show that you have a firm grip on your market’s ecosystem. In addition to the minimal acceptable size of your exit, you should be able to intelligently discuss the types of companies that are likely acquirers. Avoid too much specificity, as you may risk sounding like yet another startup that is, “Waiting For Google.” Like Godot, you will likely find that Google will never come knocking. As such, speak in terms of company types, such as, “I anticipate that our company will be attractive to companies like Google and Facebook, which have a history of paying a premium to enter emerging market segments.”

Question 2: What do you expect your role will be at the time of your exit?

Intent: Investors know that many of the personality traits that lead to initial entrepreneurial success can cause disruption within a larger organization. An entrepreneur who fails to modify their behavior as a company matures is a victim of Founderitis. This question helps an investor determine the degree to which an entrepreneur is prone to such debilitating tendencies.

One of the most insidious aspects of Founderitis is that the afflicted entrepreneur honestly believes their actions are in the company’s best interest, even when it is abjectly clear to an objective observer that this is not the case. For instance, in a company’s early stages, it might be prudent for a Founder to lead the company’s sales efforts. However, in the long run, if a professional sales leader is not hired, the company might lose precious time to market while the Founder attempts to learn on the job. By failing to acknowledge the need for a seasoned sales executive, this Founder is exhibiting Founderitis.

Response: Communicate a clear understanding of the operational areas in which you can add value now, in the intermediate term, and once the company is a mature, self-sustaining entity.  It is normal for an entrepreneur’s role to become more narrowly defined as a company matures. A self-aware description of how you anticipate your role will evolve over time will help alleviate concerns of potential Founderitis.

Do not respond with any variation of the following: “I want what is best for the company. As such, I will gladly step down as (insert appropriate title), once I meet the right person.” All too often, this is code for, “I doubt the right person will ever cross my path, as it’s hard for me to imagine anyone who can match my passion and desire to see this company succeed.” Rather than providing an amorphous response, describe the specific experiences and skills your replacement will embody, as wells as when you plan to initiate your transition to a more reasonably conscribed role.

Question 3: How much will you pay yourself and your senior staff?

Intent:  As noted in Entrepreneurs Shouldn’t Pitch Their Ideas, venture capitalists often base their portfolio executives’ salaries on their nominal living expenses. In this way, the majority of a startup’s funds can be applied directly to further the venture’s success.

During a startup’s early stages, its executives are seldom paid a market rate for their talents. Entrepreneurs who demand market-rate cash compensation risk alienating their early-stage investors and may be better suited for a job at a more mature company.

Response: Successful investors understand that an entrepreneur’s compensation should not be so meager that it is a distraction. Thus, state a reasonable base salary figure that will cover your essentials, supplemented by a performance-based bonus plan tied to measureable and meaningful milestones.

A benefit of moderating your pay base pay is that it effectively places a salary cap on subsequent new hires. I negotiated a number of compensation packages by stating, “If I agreed to your salary request, you would make more than me. Let’s talk about how we can exceed your proposed salary by devising a performance-based compensation plan tied to measurable objectives.”

Question 4: What is your Plan B?

Intent:  Entrepreneurs who have thoughtfully devised a Plan B scenario demonstrate a high level of sophistication and pragmatism. Conversely, entrepreneurs who refuse to contemplate alternative paths to their success at the outset of their venture may not be sufficiently creative or wily.

Response: Indicating a willingness to revise your plans to accommodate evolving market conditions will not cause a professional investor to question your commitment to your vision. Thus, unapologetically discuss your Plan B. However, be sure to clearly state that it is your fallback plan and not something you intend to execute concurrent with your primary mission. It is difficult to properly execute one business plan at a time, let alone multiple initiatives.

Your Plan B should be based on the same core competencies as your primary plan. If it is radically unrelated to your core plan, you risk appearing defocused and ill-prepared to address negative contingencies. Investors will not place a bet on your Plan B, but without one, they may be reticent to underwrite your Plan A.

Question 5: If you fail, what will cause your demise?

Intent: Similar to the Plan B question, this query seeks to measure an entrepreneur’s self-awareness. Entrepreneurs who can openly describe their team’s weaknesses, negative exogenous factors and potentially lethal competitive threats have a higher likelihood of success.

Response: Offer a straightforward recitation of the market and competitive risks. As you describe each issue, underscore the tactics you will deploy to mitigate each risk factor. You can also address this question by describing the conditions under which you would deploy your Plan B.

No matter how much confidence you have in yourself and your team, cite execution as a risk factor. A great plan, poorly executed, is doomed to fail.

The Best Policy, Redux

Irrespective of the question, the best answer is the truth, rather than what you surmise might be the “correct” response. An answer suitable to one investor might be considered ludicrous for another. For instance, if you are speaking with a venture capitalist who invests in billion dollar exits, telling her that you would consider a $250 million dollar exit a success would likely cause her to pass on your company. However, a smaller, capital-efficient venture firm might find such an answer entirely acceptable.

You may gain an investment in the short term with disingenuous responses. However, depending on the industry, venture investments can average five to ten years before an exit occurs. Even on the low end of this range, a half a decade is a long time to be in a stress-filled, conflict-ridden relationship. Thus, entrepreneurs should candidly speak the truth in their investor discussions in order to heighten the chances they will secure money from a like-minded partner.

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never Tweet about the weather, politics or that killer burrito I just ate.

Image courtesy of The Lolbrary

John Greathouse

John Greathouse is a Partner at Rincon Venture Partners, a venture capital firm investing in early stage, web-based businesses. Previously, John co-founded RevUpNet, a performance-based online marketing agency sold to Coull. During the prior twenty years, he held senior executive positions with several successful startups, spearheading transactions that generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.

Note: All of my advice in this blog is that of a layman. I am not a lawyer and I never played one on TV. You should always assess the veracity of any third-party advice that might have far-reaching implications (be it legal, accounting, personnel, tax or otherwise) with your trusted professional of choice.

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