Part I

So, we have Allen Morgan's post with a link to some conflicting advice from Mark Suster. There is also the recent

http://www.avc.com/a_vc/2011/07/continuous-financing.html

with conflicts with Allen Morgan's advice.

There can be another reason to contact VCs before looking for a check: When an entrepreneur accepts a check from a venture partner, commonly the partner will be a Member of the Board of Directors of the entrepreneur's company where the entrepreneur is the CEO. There the Member can give advice the CEO essentially has to take seriously, approve/veto some actions by the CEO, and fire the CEO. The Member has a 'fiduciary responsibility' to their limited partners and, thus, is not totally devoted to 'supporting' the CEO.

So, the Board has a lot of power over the CEO, and the CEO is very much 'working for' the Board.

So, about a venture partner, the CEO would like to know, "Do I want this person with a lot of power over me and my project? Do I want to work for this person? Can this person play a constructive role in challenging work on the 'bridge' of my ship crossing rough seas?".

Here, for entrepreneurs seeking success, is an inescapable, fundamental point: The successes the venture partners must strive for are, in our economy, necessarily rare. That is, only a tiny fraction of people in the population can be worth a lot of money, say, $1 billion.

Okay, such success is rare. Then, necessarily, other than luck, it is necessarily also rare that people can clearly see a path to such success. Darned rare.

Let's take an old example, the Wright brothers on their way to the first sustained, controlled, powered flight.

So, do the usual: Before the attempt, look at history and estimate the chances of success. Okay, so far, everyone had failed. Indeed, well funded and well respected Langley had recently fallen into the Potomac River trying.

Now, does this mean that the Wright brothers were fools for trying? The answer is, it depends on what additional information the Wright brothers had! It turns out, they had a lot of additional information:

First, the brothers knew that crucial points were lift of their wings, drag of their wings, thrust of their engine and propellers to overcome the drag of their wings, and good control on all three axes, roll, pitch, and yaw. Moreover, they were about the only people in the world with such knowledge!

Second, for lift and drag of their wings, they were not guessing. Instead, they had invented, built, and made good use of the world's first, good aerodynamic wind tunnel with a delicate 'balance' for measuring the small forces. Nice work. They didn't really understand Reynolds number (important for scaling to larger sizes) but otherwise did good work. Net, they had good, first-cut data on the lift and drag of their wings. Similarly for their propellers. Then they knew how much power their engine should have. They basically knew, just from their bicycle shop in Dayton, that they had enough lift, power, and thrust.

Third, they had worked out means for the needed three axis control.

With that additional information, their chances were quite good. They were right and for the right reasons and knew it quite well just there in the back of their bicycle shop.

Did they make money? Apparently: After their first flying successes, they were able to sell versions of their airplane for big bucks. They remained important in aviation at least through Curtis-Wright in WWII.

Okay, suppose the Wright brothers had had investors who were Members of their Board of Directors. Suppose the investors knew nothing about the wind tunnel, lift and drag calculations, power calculations, and three axis control. Such a Member might have read about Langley falling into the Potomac and used their 'fiduciary responsibility' to insist that the Wright brothers immediately stop, quit, cease, and desist and sell off all their supplies of wood for kindling.

Why? Again, it's fundamental: Only a tiny fraction of the population can see success clearly. That is, only a tiny fraction of the population, or investors, could have seen the difference between the Wright brothers and Langley.

That fundamental point remains: Only a tiny fraction of venture partners can look at a project just in development, say, like the Wright brothers still in the back of their bicycle shop, and evaluate the work at all accurately. Far too easily the venture partners will hear some bad news, say, about Langley, and tell the CEO to sell off the business for pennies on the dollar or to shut down the business and return the remaining cash. Why? Because the venture partners don't understand the work, from their limited knowledge can see only disaster, and need to exercise their fiduciary responsibility. Again, the ability to understand a big success early on is necessarily very rare; only a tiny fraction of venture partners will be able to, say, follow the Wright brothers into the back of their bicycle shop, look at the wind tunnel and the calculations, and understand what they are seeing.

So, what the venture partners really want to do is to wait until the Wright brothers have been successful at Kitty Hawk and made headlines in the newspapers. Of course then the brothers could glue together a second copy of their plane and sell it for enough to have cash enough to glue together several more and, for a while, execute 'organic' exponential growth, which is likely just what they did do.

So, between the entrepreneur, who does see the future clearly, as the Wright brothers did just from the back of their bicycle shop, and a venture partner and candidate Board Member, there can be a lot of 'tension': Early on, the venture partner will likely not understand the project well even if such understanding is readily available. Then on the Board, such a Member is dangerous, a loose cannon on the deck or bridge of the ship, someone, out of ignorance, about to jump into the lifeboats and leave the ship to sink, all for no good reason. Later on, once the project clearly works well, has paying customers lining up, etc., the entrepreneurs might not need the cash and, still, won't want someone really dangerously ignorant on their Board.

So, an entrepreneur, if they do want and need to take an equity check, needs to evaluate venture partners realizing that necessarily only a tiny fraction will be able to see the future with any accuracy.

Sure, this consideration holds for only a tiny fraction of entrepreneurs: Again, necessarily, only a tiny fraction of entrepreneurs will be like the Wright brothers and able to see the future clearly just from their development work. Mostly entrepreneurs will be like Langley, eager for a check so that they can dry off, fish their equipment out of the river, rebuild their plane, make some guesses about changes, and try again. Keep guessing, Langley: "Maybe glue some feathers on the wings? Where's your wind tunnel? You don't have one? Well, then, next try, wear a life preserver or, better yet, have an assistant be the pilot. Still better, f'get about building a plane, get a camera, be a newsie, go to Dayton, and follow around behind the Wright brothers.".

So, what in current information technology entrepreneurship central to Hacker News is at all analogous to what the Wright brothers did with their wind tunnel, lift, drag, and power calculations, and three axis control designs?

Sure: A traditional way to be successful in business is to pick a 'big' problem that so far is poorly solved and where a good solution will be valuable. Then invent some new, powerful, valuable technology for some 'secret sauce' difficult to duplicate or equal that will give a much better solution to the problem, one good enough for major business success, and with a Buffett "moat", that is, a technological barrier to entry. Right: This 'secret sauce' would not be just routine C/C++, Java, Python, Visual Basic .NET, C#, etc. software. And, right, again, such 'secret sauce' is necessarily rare.