While there certainly are some frothy valuations in certain parts of techdom, it's difficult to call it a bubble - at least not when compared to the Internet Bubble. The Bubble 1.0 tide rose all boats. It didn't matter what sector you were in, if you put “.com" at the end of your name, you immediately achieved valuations that you wouldn't have imagined in your wildest dreams. It didn't matter if you were selling low margin products like aspirin or pet-food; Dot-Com-it and you were a darling. Bubble 1.0 was also characterized by an obscenely large amount of venture capital. At the height of the DotCom mania in 1999, venture firms invested $100B. As a result of this flood of investment dollars, every good idea had 10 well-funded companies chasing it.
As has been often pointed out, a large portion of Bubble 1.0 companies didn't even have business models. They were valued on such esoteric metrics as eyeballs, clicks, or page-views. For the few who actually sold things and generated revenue, their values seemingly were higher the more money they lost, as long as they could spin a story about how losing even more money allowed them to grow faster. I remember well a conversation I had at the time with Pat Connolly, the CMO of Williams-Sonoma who was bemoaning the fact that Wall Street measured him on boring things like gross-margins and profits, but all of his startup competitors weren't held to the same standard.
Finally, during Bubble 1.0, public market valuations were bubblelicious even for large non-Dot-Com companies. Cisco, Microsoft, and Oracle had P/E ratios of 150+, 78 and 120 respectively (I can't say how high Cisco actually was because my reference source stops at 150!). Even GE, hardly a fast growing tech company, sported a PE north of 45. For large-cap companies, those are impressive valuations indeed.
Fast forward to the "Bubble" many commentators are claiming we're now in, Bubble 2.0. By virtually any measure, if you use Bubble 1.0 as your yardstick, we're not in anything close to a Bubble.
The primary argument that is being made for a new bubble are the fantastic valuations that the big 5 (Facebook, Twitter, Groupon, Zynga, and LinkedIn) are getting on the secondary market. In these markets, buyers and sellers don't have access to the same information. For most of the buyers, it is a momentum bet on the assumption of the existence of a greater fool. That said, unlike the last time, with the exception of Twitter, these darlings all have business models that are generating tremendous revenue growth and, if the buzz is to be believed, are incredibly profitable. We'll see when their numbers all become public whether these secondary market buyers were all "greater fools" or savvy trend pickers.
Go beyond those 5 and the signs of a bubble are pretty weak. Starting with the amount of money that venture firms are investing, today it is fully 1/5th of what it was the last time, a "mere" $20B. As a result, there aren't 10 well-funded companies chasing every great idea. What about all the "super-angels" you ask? They certainly make getting capital to start a company much easier, but once the company starts growing, in all but the rarest of cases, it still needs capital to grow. With less venture capital going in, there are fewer competitors with the capital to effectively scale their businesses.
Aren't VCs paying crazy valuations again? What about FourSquare's rumored $400m valuation, or Quora's rumored $85m valuation for their first round when they had just a few people and an idea. Heady valuations for sure, and not having been a part of the partner discussions when those decisions were made, I don't know what arguments used to justify them - but I can guess. Heady valuations for "Hot" and "Darling" companies are nothing new in Silicon Valley. And sometimes they even pay off. Google was a "hot" company with a seemingly outlandish valuation at the time and that seemed to work out just fine for everyone. There are always a few companies that, based on the charisma or track record of the founders or some particular set of stars aligning correctly get fantastic valuations. There are always the exceptional startups that generate the exceptional venture valuations. As I discussed previously, this sort of exceptional valuation is far from a guarantee of investment success.
Finally, look at public market comparables: they aren't even close to flashing red, I don't think they are even yellow. Back to the big three last time around and their average P/E, today the three highest profile public tech companies (who also happen to be the largest by market cap) are Apple, Google, and Microsoft, which together have an average PE ratio of 17.6. Far, far below the levels reached during Bubble 1.0.
Silicon Valley has been built on a series of major innovation waves. With each new wave comes some new mega-winners. We're in the opening stages of waves in social-media, hand-held computing, the consumerization of IT, Infrastructure 2.0, and the move of many IT functions and services to the Cloud. We haven't even scratched the surface of these opportunities so it seems a bit premature to be calling it a bubble. So for all those people paralyzed in fear of a Bubble, stop being a Chicken-Little and go out there and innovate!
I previously wrote about how having fewer resources was actually a benefit that startups have over their larger entrenched competitors because it forces them to do fewer things better - to focus. Another counter-intuitive benefit that startups have over large companies is their lack of existing customers. Not having an installed base frees a startup of the burdens of supporting old products and enables them to focus all of their resources on new innovation.
Sometime in the year before EqualLogic sold to Dell, Paula Long, the co-founder and VP of Product Development, presented to the Board a very sobering projection of where our precious product development resources were going. Two years before, when we only had hundreds of customers, we dedicated well over 90% of our product development resources to new features and only ~10% to supporting the base. At the time of the presentation, we had grown from 100's of customers to 1,000's of customers and our ratio of new features to support went from 90/10 to close to 50/50. But what was truly sobering was her forecast for the future. Just a couple of years out, nearly 90% of our product development resources would be focused on supporting the base. It's no wonder we were able to sneak-up on the big-boys of the storage world and create the market-leader in iSCSI. They were too busy supporting their base to effectively go after the opportunity.
It's not just with product development, legacy can have a detrimental impact on almost every part of a business from go-to-market to the core business model - name a successful enterprise SW business that is also a leader in SaaS. When I was in marketing at Apple early in my career, one of the constant debates about opening up new channels of distribution was about the problems of channel conflict with our then existing "legacy" channel partners.
This challenge is something every successful organization goes through - Paula Long referred to it as our "success-tax" at EqualLogic. If not actively managed, the very things that make a company successful can be the achilles heal that hobbles it's growth later. Most disruptive innovations are made possible because incumbents, like EMC and NetApp in the case of EqualLogic, spend all their time on servicing their legacy customers, updating their legacy products, and supporting their legacy partners. This leaves the door open for startups to put their foot in, but startups need to make sure they aren't making decisions that will hamstring them and burden them with premature legacy.
Rarely does the life of a startup travel along a straight path. With most of the opportunities a startup faces, come a set of tradeoffs, some obvious, and some not so much so. These tradeoffs need to be weighed carefully and not taken lightly. The no-brainer decision today - "They're paying us $X and it will only cost us half that to deliver." - could end up having tremendous legacy costs down the road. One of the ways I evaluate how good startups are at focusing their limited resources is by hearing how they weigh the tradeoffs they see in some of these decisions. If they truly understand the opportunity costs associated with a particular decision they have made, then that will be evident in their discussion of it and in how they worked to minimize those costs. If they don't understand the opportunity cost associated with a decision, then chances are they have made plenty of other decisions like it and all of those decisions are setting the boat-anchor of legacy that the company will be paying the price of for years to come.
Much has been written about building lean startups. It's certainly possible today for many startups to get to a minimum viable product and early customer validation with a lot less than was possible 10 or even 5 years ago. But ultimately if you want to build a significant company versus having a flash-in-the-pan that you sell quickly, it takes time, work, and more than a few people. All of these resources take money.
The world has changed for many an aspiring entrepreneur. No longer do they have the largest market in the world to themselves. With the secret out, Silicon Valley entrepreneurs now have to compete against extremely capital efficient startups from the many other "Silicon Valleys" around the world. They also have to contend with a significantly higher cost of capital driven in part by the shrinking amount of capital being committed to venture firms. Simply put, there are too many companies chasing too few venture dollars. It's no longer good enough to be just a lean-startup. To be globally competitive, and confident you can raise the capital you need to grow, Silicon Valley entrepreneurs need to focus on building lean companies.
Thankfully the rise of the social internet, globally ubiquitous broadband, and the always-connectedness provided in the new era of smartphones is enabling many Silicon Valley startups to start with the necessary foundation to grow into lean companies. Collectively these advances minimize the importance of geographic proximity in establishing, building and sustaining relationships that are at the center of any business. These virtual and remote interactions don't provide the same level of high-bandwidth communication that face-to-face interactions do. But the disruptive innovation they provide is giving an important edge to a new generation of leading-edge startups.
The Rise of the Social Internet: In Silicon Valley, businesses are started and built on relationships. Startups are famously a relationship business going all the way back to the Fairchild Eight. Like the Fairchild Eight, many a Silicon Valley company was started by a small group of engineers who worked together at a previous company. With the rise of the social internet, more and more people are comfortable building and sustaining these types of relationships virtually. When I talk to young entrepreneurs, the people they describe as their friends, co-workers, and partners can just as easily be someone they met and developed a relationship with online. We are already seeing teams assembled in this way. More than one company has come in whose initial product architect was someone the entrepreneur "met" through his or her contributions to an open-source project at the core of their offering. The fact that he or she happens to live and work in another country is largely irrelevant.
Globabally Ubiquitous Broadband: Much of the innovation in Silicon Valley has been created by small teams working on crazy ideas in very close quarters. This type of environment facilitates "high-bandwidth" communication between team members which is necessary to enable a startup to get a minimum viable product to market as quickly as possible. Ten years ago startups began dipping their toe in the water with outsourcing. For the most part, this was through contracting with or hiring entire teams that were located in a single remote location. Co-located teams were necessary because the only way to get the desired level of "high-bandwidth" interaction was to have the team members sit side-by-side. Over the last 5 years, services like oDesk have taken advantage of the myriad of communications technologies enabled by globally ubiquitous broadband to enable "high-bandwidth" communications to individual remote end-points. This has allowed startups to build and manage remote teams where each member of the team can be in a different location. Today it is quite common for me to meet with a startup team that has a couple of local people and 5-10 people on their remote team from around the country or around the world.
The Age of the Smartphone: Finally, in the age of smartphones we are all always connected. This means we can have "water-cooler" conversations with our co-workers at any time. We can exchange ideas, thoughts, questions, or opinions from anywhere. With smartphones and other similar mobile computing/communications tools our work is untethered to a physical desk and less impacted by timezones.
These disruptive innovations promise to change the way organizations are built. We are seeing that change already happening among the startups we meet with regularly. They realize that for many of them, the cost of capital is too high to fund a startup team of 20 - 30 people in Silicon Valley. This means fewer Silicon Valley located jobs in the short term. But in the long term, being more capital efficient and globally competitive will enable these "lean companies" to become the next generation of locally based global-market leaders - the HP's, Apple's, Oracle's, Cisco's, Google's and Intel's - that are at the heart of Silicon Valley.
Glory days well they'll pass you by
Glory days in the wink of a young girl's eye
Glory days, glory days
OK, I admit it, I'm a HUGE Glee fan. There. Now I've said it. I'm officially out of the closet. I've always been a bit of a geek, so the transition to being a Gleek has been a natural one for me. My wife, who unlike me actually can sing, is always having to shush me as I sing along.
The show's portrayal of the trials and tribulations of high school certainly resonates with the former high-school geek in me. The "in-crowd" of cheerleaders and jocks, while a bit over-the-top in their depiction, shares traits with every other in-crowd you weren't in that you can remember from high school.
How can this possibly remind me of Silicon Valley? Well in the 18 years I've been a part of the startup scene in Silicon Valley I've seen a lot of startup classes come through. And like the makeup of your high school class, there's the startup "in-crowd" and everyone else. Lots of entrepreneurs aspire to be recognized as a part of the "in-crowd". To be a Techcrunch darling; to be on stage with Walt Mossberg at D; to have venture capitalists calling you regularly to find out how they can get in to your next round. Who wouldn't. The failure comes when you confuse being popular with being successful.
Think back to the in-crowd when you were in high school. How many of them are successful now? A few, certainly not all. Now think of the rest of your class, how many of them were successful? Again, a few, but not all. The percentage of people who are now successful in each group is probably similar, but you never would have imagined that would be the case when you were in high school.
I've witnessed a similar dynamic in the different classes of startups I've seen in Silicon Valley. For every Google (a high flyer from the beginning), there's an eBay (not a high-flyer until they had the numbers). There are plenty of examples of companies that were fixtures of the in-crowd that vanished - remember Pointcast anyone? Friendster?
To be sure, being high-profile can have it's advantages and for some companies, it may even be a necessary prerequisite at some point along the way. It can certainly be helpful if you're marketing directly to consumers. But it's not the end-game and courting lots of attention, especially when you're not yet ready for it, can have dire consequences.
So if you're a part of the startup "in-crowd", enjoy. Make the most of the free PR. But don't lose sight of your true goal which is building a valuable and sustainable business. And if you're an outsider, don't sweat it. Relish your outsiderness and use the time flying below the radar to build a solid foundation for your business. If you focus on that and get it right, your glory days will be in front of you and you'll be the center of the in-crowd that everyone wants to join. Trust me, there's no better entry into the real cool kids club than a successful IPO.
Just sitting back trying to recapture
a little of the glory of, well time slips away
and leaves you with nothing mister but
boring stories of glory days
One of the classic venture pitch mistakes is overselling. Overselling your idea can take many forms, but one of the more humorous occurs when the entrepreneur shows you a set of projections that are wildly optimistic and then drops the G-Bomb as a way to claim that the projections are actually quite realistic bordering on being conservative. The entrepreneur will usually say something like: "Our business has many similarities to Google, so we took an X% discount to their growth rate and plugged it in to our model. We were conservative in taking the discount so we think our model is actually conservative." Really? And you're going to build your plan around that?
I've had the G-Bomb dropped in relation to startups doing ad-networks, the semantic web, and vertical search when that was all the rage. Today I'm seeing a switch to entrepreneurs using the F-Bomb for startups in the social networking or social shopping markets. Unless you're already at a point where you are seeing never-before-seen leading indicators, don't do it. And even if you are seeing something special, remember, a venture capitalist's job is to connect the dots and your job is to bring them close together. Putting wildly optimistic projections into your plan doesn't help me connect the dots to an enormous outcome, it causes me to question whether your feet are planted firmly on the ground or not.
Every few years Silicon Valley mints one of those iconic companies that defines a category and rides a growth trajectory that has never been seen before. It's part of what makes the valley so great. It's a great thing to believe that your startup has that potential. But there is a big difference between selling the dream and setting a realistic and achievable plan for your startup. If you build a culture around lofty unachievable expectations then you're going to have a very difficult time making it through the ugly adolescence that most good companies go through.
In a comment to my recent post on Focus, Ray Hood pointed out that VCs often overlook the importance of luck, chance, and serendipity in favor of a belief that everything is formulaic. I violently agree with Ray but I also violently disagree.
As I mentioned in my response to his comment, I am a huge fan of Nassim Nicholas Taleb's books - The Black Swan and Fooled by Randomness. In Fooled by Randomness, NNT expounds at great length on how often times people confuse the fact that they have been lucky with a belief that they are really just smarter than everyone else. As he says, randomness plays a much bigger role in how successful you can be at some professions than others. For example, the degree of success of a nurse or a doctor has much less to do with randomness than say that of a venture capitalist (his example). It's difficult to argue with luck playing a part in the magnitude of any win. Anyone who was a part of the startup scene during the bubble knows well that there were many >$1B exits that in any other market may not have been able to make any money at all.
But luck isn't an investment strategy and it isn't a viable strategy for building your business either. Despite the popular perception, venture capitalists by and large are not in the business of buying lottery tickets. What venture capitalists do, at least the good ones, is invest in great people who have a vision and a plan and then work with them to turn their vision (through it's many iterations) into a success. I've been on a mission to try and understand who are the great investors in the venture business and what traits or characteristics, if any, they share. Through that quest I was able to unearth a pretty interesting statistic. Out of a sample of more than 900 General Partners who had each been in the business for more than 10 years, for those who had generated more than a 3X return, fully 1/3rd of their investments managed to generate more than a 3X return. That's not luck. That's good investing and a great batting average.
I'm sure I can find a similar statistic on successful repeat entrepreneurs. The great ones follow a similar playbook and focus on execution. They don't build their plans based on being lucky, but they are smart enough and experienced enough to know when a lucky break comes their way and to take advantage of it. Surely luck can play a significant role in the magnitude of an outcome, but whether or not they have built the necessary foundation for success is based more on 3-yards in a cloud of dust than on throwing a Hail Mary. Forest Gump type successes happen from time to time, but again, that's buying a lottery ticket which I can do at any local service station.
So while I'd rather be lucky than smart any day, I prefer to rely on smarts and hard-work over luck. I know I can count on the former and I love it when I have the opportunity to take advantage of the latter.
Being focused isn't just the best way to maximize your chances for success, it also happens to be critical when you're pitching venture capitalists. It's difficult for a venture capitalist to connect the dots when they are scattered all over the place.
I've had some variant of the focus conversation, usually more than once, with every company I've been involved with, whether as an angel investor, an advisor, or a venture investor. It's not necessarily a bad thing to have to remind an entrepreneur to focus - in my experience, one of the hallmarks of a really good idea is that you always have more directions you can take it than you have time and resources to pursue. The key is figuring out what of your available options you are going to do, and more importantly what you are NOT going to do and then run like hell.
Focus permeates every function of a company, but it starts with product-market fit and determining the minimum viable product. Much has been written about these concepts, and while they are related, they are not the same thing. Product/market fit implies something about the customer you are targeting. It's easy to understand that the needs of a Global 2000 customer, and therefore, the minimum viable product you'd have to deliver to service them, are going to be different from the needs of an SMB customer - although I have had companies argue they can do both. Where it gets tricky is when you have what seems like the same type of customer, Global 2000 for instance, asking for the same solution delivered in a different way. One wants it delivered as a service and another wants to license it and run it themselves. While your solution may have found a product-market fit, the minimum viable product for those customers is different - pick one. A seemingly innocuous decision to "take the money" and serve both today has a compounding impact on every aspect of your product development, delivery, and go to market. You'll pay dearly for it later in your inability to innovate as quickly as necessary to stay competitive.
But what if the option I choose isn't the optimal among my choices? I need to keep several options open just in case I chose wrong or one of the alternate paths "pops." Typical. Keeping multiple options open is self defeating. While you think you're hedging, you're actually not doing justice to either alternative thereby dooming both. If you do come to the very difficult conclusion that you need to pivot, you need to do so with conviction and run like hell down your newly chosen path. Straddling two camps is a surefire way to rip your company apart.
Focus, focus, focus. Repetition doesn't spoil the prayer.
It was good advice when you were in high school, and it's good advice when you're out raising a seed round for your startup. Here's the scenario:
You and a small team have been working on a great idea for a new business. You start talking to a few of your friends who have been successful before to get their feedback and advice. Your friends like the idea and offer to put in some angel money themselves and introduce you to a few other angels who might be interested. You know that ultimately you will need to raise a venture round, but an angel round now sounds like a great idea. It will allow you to put more meat on the bones and get a better valuation for your venture round. Before you know it one of the angels has introduced you to a venture capitalist or two from good firms and they want to participate in the angel round, but since it's a seed investment for them, they won't take a board seat. Your startup has just been deflowered.
All early stage venture firms do seed rounds of any size. The next time I hear an entrepreneur say something to the effect of "I didn't think you guys would be interested because I wasn't raising enough money" I'm going to scream. We do. We all do. And if a venture guy said the round was too small for him he's either a) not an early stage venture investor, or b) he's lying because what he's really telling you is that you just haven't brought the dots close enough together yet. But beware of the venture firm that is going to make that seed investment and not make a commitment by taking a board seat. Early stage investors take board seats in companies they are committed to regardless of amount invested. Time is the most scarce resource a venture capitalist has, so they commit to Boards very sparingly. Board commitments are a part of a venture capitalists permanent track-record. If they're not making that commitment then all they are doing is buying an option. It's a great deal for them and a terrible deal for the entrepreneur.
But why, you ask, is it such a bad thing? I've got celebrity-VC's money or top-tier-VCs name as an investor and I'm all teed up for my venture round. Their money is truly a double-edged sword for you. Heads, they win, and tails you lose.
Heads they win: the VC wants to put money in the venture round. What you've done by allowing them to participate in the angel round is to cap the price they have to pay to lead the venture round. Regardless of how much progress you've made, any new VCs will be reluctant to spend too much time looking at the deal or giving you a term sheet because they will believe, probably correctly, that the VC who participated in your angel round has the inside track. Anything they offer will simply be matched so why waste the time. Your VC-seed investor won't have to give you their best price. The partner is always more important than the price they pay within some range, but every partner is wiling to pay more if the market demands it.Tails you lose: the VC decides not to lead the round. If you've come to the conclusion that the dog doesn't hunt yourself, then no harm no foul. You close up shop and move on to the next thing. But if you're still committed and believe there is an opportunity, you've just made your job of raising new capital much more difficult than it otherwise would have been. Any new investor looking at the company is going to assume that your VC-seed investor knows something they don't. They may be able to get over it, but it's hair on the deal and any hair on a deal raises barriers to getting a deal done. Even if you are ultimately successful in getting a new investor to lead, you probably ended up getting a lower price than you otherwise would have and it certainly was more difficult for you than it would have been otherwise.
All early stage venture investors make seed investments, but if you take a seed investment from an early stage venture firm, make sure you get the commitment of them taking a board seat along with their investment. If you don't, then you've been deflowered, so at least make sure you got a good kiss out of it as well.
I don't have an MBA, but I have earned my SIlicon Valley MBA. Let me explain.
When I was a few years out of college, I considered going back to get an MBA. I liked working in the valley and knew that I wanted to spend my career in tech and ultimately around startups - at that point I had only worked for Apple. So I asked around to a lot of people I knew well and respected. People who I thought had been successful in their careers and whose path I wanted to learn from. Many of them had MBAs and some did not. I wanted to hear their perspectives on the value of a traditional MBA.
I distilled all the feedback I received into three primary benefits I, or anyone, would gain from pursuing a top-flight MBA : 1) building an extended network of contacts that I would know throughout my career, 2) if I wanted to make a switch to a different industry, finance, consulting, etc., then an MBA would give me the opportunity for a fresh-start, and 3) for a number of different professions, an MBA is a requirement and with it comes a step-up increase in both current compensation and the compensation trajectory that the person is on.
I knew that I wanted to stay in technology, so #2 wasn't relevant and I was already in the job that a graduating MBA would be trying to get so #3 wasn't important in my situation either. What I struggled with was the value of the network I could build. I got accepted to the MBA program I was interested in, but ultimately decided to start my first startup versus spending 2 years in grad-school. Seven years and three startups later when I was selling my third company, I realized that although I had not earned a traditional MBA, during my 4 years at Apple, I had earned my Silicon Valley MBA.
Being an entrepreneur is in my blood. My father is an entrepreneur and growing up I always knew that I wanted to start companies too. But my ultimate success as an entrepreneur would have been much more difficult, if not impossible, if not for the amazing people I worked with in my time at Apple. There are people I first met back at Apple that I still work with regularly to this day. One of the best things about the valley is that there are always at least a handful of companies that the best and brightest from around the world strive to work for. Apple was one of those companies then and is again now, but over that time there have been many, many more among them - Cisco, Netscape, eBay, Yahoo, Google, Facebook, Twitter, etc., etc.
For anyone who loves tech and wants to make a career of working in the valley, I encourage them to first earn their Silicon Valley MBA. Go work for a company that is either already an institution, but hasn't lost the Magic (Yahoo and eBay fit into the latter category), or one that is on a clear trajectory to become one (Facebook and Twitter). Whether you have a traditional MBA or not, a Silicon Valley MBA will pay dividends throughout your career. Not only will you build your network, learn a ton, and most likely have a blast while doing it, you also have more opportunity for upside than you may realize.
I've been giving people this advice for years, but I used to couple it with: "the real upside is probably gone, but at least you'll be building personal equity for the future." I told that to a former HBS-MBA grad friend who in 2003 was trying to decide between an offer at an early stage startup and an offer at Google. I told her to take the Google offer because it was the best way for her to earn her Silicon Valley MBA, but, I cautioned her not to do it for the upside in Google stock because that game had probably mostly been played out. Happily for her I was only half-right.
After my post on Metrics Based Management, I got a number of specific questions about how to best present marketing in the context of your venture pitch. One of those asking was Tom Demers, Director of Marketing for one of our portfolio companies - Wordstream. Tom had three specific questions:
Good questions all, variations of which I have heard many times before. Let me try to address them one at a time.
First, in terms of the actual makeup of the marketing department, there is no one-size-fits-all makeup. We invest in companies that do everything from selling an online service to consumers to selling large industrial solutions to governments or regulated utilities. The marketing needs across that spectrum are very different and, as a result, the makeup of the teams can be very different from company to company. The one thing that seems to be common to all of these companies is the importance of their online presence as the primary point of interface with their customers. And while I can't translate that into a specific set of marketing professionals in any given organization, what I can say is that you'd better be able to explain how you are going to effectively use the web to talk-to and listen-to your customers, prospects, and targets. How you get that across in your venture pitch gets to the heart of the second question that Tom asked.
Second, it is critical that you make your online marketing activities "VC friendly." Why? I address this a little in my post on connecting-the-dots. Investors in general look for patterns, and while an early stage venture capitalist should understand your business better than investors who will come later, they still like to connect a set of dots that are heading up and to the right. Unlike the old world of marketing where you were measured on more "soft" results, this means you need to aggressively measure your online marketing activities from the beginning with hard data. Don't think it's OK to simply add the measurement later. The longer you wait, the longer it will take you to build up the critical time-series data that shows a discernible pattern. Make sure you are tracking as many different elements as possible so you can, prior to pitching to potential investors, start to understand what are the true leading indicators to customer acquisition. And then present your progress on those leading indicators. Generally speaking, the more up and to the right those leading indicators point, the more interesting the opportunity to venture capitalists.
And finally, you bet venture capitalists are skeptical of SEM heavy marketing programs. I personally hate the idea of investing in a company that Google is going to make more money from than I can. That said, SEM has a very important role to play for any serious online marketer. While every situation is different, I like to see the knowledge gained from effective SEM being poured in to SEO investments that the company owns and that don't stop paying dividends when you stop writing the check. I've heard SEO described as free-beer and SEM as crack-cocaine - you want to get as much free beer as you can.