I have a need to organize the world. Four years in as an angel investor and one as a VC, I realize the world of startups and venture investing is pretty noisy and ambiguous… very hard to organize! But there has to be an order, a pattern. How else can one make a successful career of venture investing (money) or entrepreneurship (time and heart) in startups? Without some structure, it is gambling.
Below is my framework for thinking about digital startup BUSINESS MODELS. This is based on the 500+ startups I’ve seen over the last few years. The framework is still evolving, because my data set is evolving too, and I am young and learning.
I think about businesses model as a vertical line connecting the customer to profit.
The BUSINESS STRATEGY is where and how the entrepreneur chooses to play on each of these dimensions. The spectrums of how and where to play are captured in the full framework below. There are many different ways to create and MONETIZE a valuable service for customers, depending on type of customer.
Implicit in this figure is that a vertical line represents a set of strategic choices on each key dimension that constitutes a potentially (you’ll see why I say “potentially”) winning business model.
Let’s get tactical. Below are highlighted two particular cases, SAP and Dropbox. SAP sells to enterprises – one of the few cases where cost benefits are an appealing value proposition. An SAP sale is a long, tedious and expensive enterprise sale into a market comprised of the top 10,000 businesses in the world, but the relatively small number of addressable customers and long sales cycle are justified by a very high ticket price.
Dropbox is on the other end of the framework. Does Dropbox save consumers and small businesses cost or drive revenue? Yes, maybe, but mostly Dropbox just makes life less annoying… eg, it has lots of “utility”. Dropbox was distributed “virally” (remember when it spread in ’08 and ’09?). Number of endpoints in the addressable market is HUGE, offset by a monetization level through SaaS subscription that is very low. Both of these companies are incredibly successful because their strategic choices have created a strong business model.
So now you see how the framework works.
MAKE SURE YOUR STARTUP FITS THE FRAMEWORK
I meet many startups whose approaches are off - sideways Ms, sideways Vs, forward slashes, back slashes, etc. For example, a backslash (\) doesn’t work because ticket price is too low to support a long sales cycle and small number of addressable endpoints. It doesn’t mean the business can’t be successful, just that tweaks are needed. When I meet with a startup, I check it against this framework in my head. If the line is not vertical, or close to vertical, my feedback centers on the deviations.
WHAT ELSE WE CAN LEARN FROM THE FRAMEWORK
Cost is a tough value proposition: Take a look at the value proposition dimension. You will notice that cost (eg, cost savings) doesn’t extend to the right beyond medium sized businesses. So all you startups selling into the cost side of SMB, professional and consumers’ P&L, good luck. It is a tough road. Not impossible, but tough. It is very difficult to get SMB or professionals’ attention by saying, “hey, you know that line item that is 10% of your cost structure? I can save you 10% on it.” Snore. That is 10% of 10%, or 1% to the bottom line. They would much rather spend the same time learning and investing in a way to raise revenue 5%!
A business can move right to left, but not the other way: Dropbox is a great example. They entered the professional and consumer markets and are slowly working their way left, with increasing monetization. Brilliant. I see this “dropbox” strategy a lot, and I like it. The older generation of VCs calls it the Webex strategy. But how many companies have you seen move left to right? What enterprise software companies have started delivering and monetizing great consumer apps??? Side note: one such folly is Autodesk’s free consumer app to turn digital pictures into 3D models. Don’t get me wrong, I REALLY want to 3D print my head, but not sure what that does for Autodesk’s core business.
You will notice this framework doesn’t fit two-sided networks: I suppose you could stick a mirror at the bottom and reflect it to achieve a two sided framework. The point is that two-sided networks are HARD. I have seen a ton of “first we’re going to be wildly successful in B2C, collect a bunch of consumer data via an app and then sell it to businesses B2B.” Scary. Just being wildly successful in B2C is hard enough without having to pin monetization on being wildly successful in B2B. Quick callout to Justin Massa at HPVP portco Food Genius. You realized within a few months that B2C2B2B was a bad idea. Please spread the word.
By the way, don’t confuse Dropbox or Facebook for two sided networks. They are networks, but primarily one-sided. Members of the same side create value for each other. Those fit this framework.
NECESSITY AND SUFFICIENCY
Making strategic choices to fall close to vertical within this framework is necessary for success, but it is not sufficient. A successful startup also needs a killer value proposition and incredible management. And don’t forget the competition.
Guy is Managing Director at Hyde Park Venture Partners. Follow guy at @guyhturner
The last thing I ever want to do is create work for my portfolio companies. That being said, I think that there's a certain amount of management communication that serves a purpose well beyond just letting the investors know what's going on in the company.
Ideally, investor communication serves the following purposes:
- Focuses the attention of the CEO on goals over a fixed about of time: "What are we going to accomplish between now and the next update?"
- It can create a sense of urgency by putting those goals to paper.
- Requires the team to reflect upon how well they acheived prior goals and whether anything can be learned to improve performance.
- Helps experienced investors identify fact patterns that the management team might not notice--because sometimes another pair of eyes can look at things just differently enough to spot a key opportunity or a potential future problem.
- Focuses the efforts of well meaning investors who want to help onto the most pressing issues and opportunities to contribute.
Here's a template you can use--inspired by Rob May of Backupify:
-- INTRO --
Cash in the bank: $x.x
Cash out date: March 2099
[Key performance metric]: What's the one headline number the whole company is focused on right now?
The biggest news in the company is this... and here's one sentence about it.
-- BAD NEWS --
- Here's a problem that we're facing. This is how concerned I am about it. This is the reason for the problem. This is what we're doing to address it.
- Here's another problem that we're facing. This is how concerned I am about it. This is the reason for the problem. This is what we're doing to address it.
-- GOOD NEWS --
- Here's something that's generally good about something really important to the company. Here's a reason we're optimistic that it will continue, based on this key assumption.
- We're launching some stuff and here's when it's going to happen, and why it's important to the company.
If we're a more mature company, we might even go this far to update you...
-- BUDGET UPDATE --
Here's our cash situation and that's based on several key assumptions. Are we moving fast enough, or too fast? Here's what I think the answer to that is, and why. Here's what we're driving to in terms of breakeven/goals for fundraising/revenue growth.
-- SALES and MARKETING UPDATE --
Now I'm going to talk about the top of our marketing funnel. Here's what's going on with new leads, and what's driving them. Here's what we're doing to get these up.
Here's how conversions are going. It is at/above/below plan and here's what we're doing about that.
-- HOW YOU CAN HELP --
There are two things I can use from you right now...
1. This is something specific you can help with... not something like "More devs!!" but something actionable like, "Can you introduce me to a recruiter, or to someone who excels at hiring?"
2. Here's another specific ask that I need from you.
3. Here's a list of our top five biz dev partners and a priority description of the kinds of companies we can work with. Here's a blurb you can send to them when you do an intro about what we do.
Thanks,
The Team
One of the least favourite things about raising money from VCs is having to deal with board meetings once you’re funded. Most board meetings suck. I’ve sat through my fair share on the company side. To date, as an investor, I’ve tried to avoid them favouring regular informal interactions.
But since board meetings are inevitable companies and investors need to work better to get the most out of them. Done right, they can be of huge value.
I’ve included some readings on how to do boards right below. In addition, I have prepared a model board package. This draws VERY heavily on the amazing board packages that portfolio company Localmind puts together. The structure is simple yet comprehensive:
- Get all agenda items and objectives established up front so we know what to cover
- Get approvals and governance out of the way
- Give clear, quick updates on all aspects of the business
- Share dashboard, KPIs, roadmaps and get the board thinking as an extension of management
If it was up to me, I’d limit formal meetings to governance and a brief CEO update, then terminate the meeting, but keep everyone around for an informal advisory session to dig into the dashboard and roadmaps.
As you will see, the model board package has not been formatted. Just the outline. Feel free to try it out at your board meetings and make sure they’re not “bored” meetings!
Readings:
http://www.freddestin.com/blog/2010/06/saving-time-in-preparing-for-board-meetings.html/
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This post originally ran on TechCrunch. Lately I have seen a number of deals announced on TechCrunch in which 5 or more different VCs were participating in the deal.
This always makes me chuckle because in my first company we had 5 investors in our first round and we picked up 5 more before we finally sold the company.
In my second company I had only 1 investor.
When this first ran on TechCrunch I got the greatest comment in the world that I had to repeat here, “VC’s are like martinis: the first is good, the second one great, and the third is a headache.” LOL. I love that. And it’s kind of true.
While there is no right or wrong answer, having seen the extremes I’d like to offer you a framework for considering the right answer for yourselves.
The Perils of Many
I understand the appeal of having many VC firms on your cap table. You may feel as I did in 1999 that the more smart people around the table the more intros you’ll have, the more sage advice you’ll receive and the more impressive you’ll seem to outsiders. Plus, if you need more money it’s far less for each to dip into their respective pockets to fund you.While all of this is true, it’s also true that nothing so perfect ever comes without a cost. Here’s the problem:
Let’s say you have 5 VCs (plus angels but let’s ignore that for now) and each one owns 5% so you took 25% dilution to get the round done. By definition each of those VCs (unless they are a micro VC – and one who doesn’t mind 5% ownership) will view you as a sort of “option” where they might get to fund the next round if you do well. Either that or there is something other than a financial motivator involved – NO VC is looking to build a business off of 5% ownership in startups. You simply can’t drive good returns that way.
So why else would they invest if not as an option to re-up in the next round? Maybe they wanted the branding associated with a hot company, maybe they wanted to work with the other investors around the table or maybe they thought it was a cheap way to get educated on your market – it’s always easier to learn an industry when you’re on the inside.
These are all dumb reason to invest – of course. But it happens.
So let’s consider a bad (but likely) scenario where either you don’t hit your targets, the market sours or competition is kicking your butt making it hard to fund raise. Most companies hit a bump in the road at some point. None of those 5 investors is sufficiently motivated to help you in tough times.
Firstly, they haven’t really signaled that it’s “their deal” in the way that leading a deal does. They can plausibly tell others, “yeah, we were a really small shareholder there – we had nothing really to do with the problems.”
Secondly, in tough times they’re also thinking about all of their other investments. Let’s say each of those 5 partners has at least 7 other investments each. In tough times I promise you their time & energy will be allocated more heavily toward deals where they have more money invested and/or where they have a larger ownership position to protect.
Sure, if you become Zynga everyone of those 5 investors will be helping you. In fact, it will probably show up on their Twitter bio & on their website. But how many of you are likely to become the next Zynga (and without hitting a few bumps in the road first).
Now let’s consider the upside situation where you happen to be in a super hot space. Now you have 5 investors of which at least a few will be vying to take a larger stake in your next round. By definition you can’t have 3 investors each wanting to increase from 5% to 20% ownership or you’re fawked anyways. So it will be an internal fight over allocations. This is not to mention the fight you’ll see if you want to bring in a new investor to lead the next round to set an objective price.
“Many” has benefits but it also has drawbacks. If you plan to do it I highly recommend that most of the VCs be smaller funds and ones who are generally not looking to invest much more after your first round of capital. There are firms with this stated objective – seek them out if you want to load the VC roster on your deal.
Note that I am talking specifically about 5 VCs splitting one round. It might be that over a period of 5 years you’ve done three rounds of investment and ended up with 4 VCs. That’s a different story. Each VC came on with different information, at a different price and with a different risk appetite. Hopefully each lead or co-lead their round so there is more harmony in the configuration.
The Pitfall of One
It is very common for funding rounds to have just one VC doing the investment. This is largely true because most VCs have a 20% minimum threshold in order to invest so bringing in multiple VCs can be very expensive in terms of dilution. So obviously before agreeing to work with this VC you better make sure you know them really well. And I always encourage entrepreneurs to do reference checking. Here’s my guide to how to do that.There is an obvious pitfall to working with just one VC – if you fall out of love you’re screwed. There are reasons why VCs sometimes don’t support deals once they’ve invested.
- The most common case is that the partner who did the deal left the firm. You are then a “stranded” portfolio company. You know the drill – the new guy says he’ll support you, but it was never really his deal. If you have any hair on you he can always distance himself and deny any involvement.
- You might have a VC who is at the end of their fund and doesn’t have deep enough pockets to fund you if you hit bumps in the road
- The VC might have lost confidence in you. You might just have differences of opinion on the direction / strategy of the company or how to handle situations in difficult times.
- I have personally seen some VCs who decide not to support certain industries they once had backed. I know that a lot of VCs had roadkill in the Internet Video 1.0 world and many pared back investments.
Whatever the reason, when you’re stranded and you have one investor the only way out is to find new outside investors. And this is doubly hard when your existing investor isn’t supportive. The standard line the new investor wants to hear from your previous VC is, “we’re behind this company 100%. We’re willing to do our full pro-rata & might even like to do a bit extra.” If your VC had stranded you, you won’t hear this – believe me.
Still, most deals involve one VC – just to be clear.
The Squeeze of the “Two Handed Deal”
The most tempting thing to do in a financing is to find two investors to split a deal. In my mind that’s the perfect scenario. You get all the benefits of the “many” deal without the drawbacks. If you can pull it off, I love the “two-handed” deal. If you’re doing well but need a little more gas to prove yourself, it’s so much easier for VCs to split an inside round. It’s both a smaller check and it’s external validation that somebody else was willing to fund.The biggest problem in two is the “squeeze.” All VCs want to own between 25-33% of your company. That’s the number they feel comfortable owning in exchange for their time & resources over what will likely be a 7-10 year endeavor (if you’re successful). They internally almost all have their secret minimum threshold, which is 20%. There – the secret is out.
So in order to get a two-handed deal you need to dilute by 40% which is an awful lot at the start of your company. When you consider that they’ll also want a 15-20% option pool in the company you’re talking about founders owning as little as 40% after just one round. That wouldn’t be bad if you had just one founder, but if you have 4 you’re already at 10% each and you have 7-10 years more work left (not to mention 3 more funding rounds!).
There are a bunch of VCs out there who don’t cling to the old “20% or the highway” mentality on every single deal and I suggest you seek them out. They are the ones who will often partner better with other VCs. There are ones I’ve worked with like True Ventures, First Round Capital, Greycroft, Rincon Ventures …. just to name a few. And of course most of the micro VCs (fka super angels) also don’t hold to this minimum bar.
The easiest configurations to push for are either
- One lead VC who takes 20-25% and one smaller VC who takes 7.5-15%
- Two leads who take 15-17% each.
Rules of the Road
1. Always Have a Lead
No matter which option you choose always have a lead. If you want the “many” deal then give half the round to one VC and let the other 4 split the second 50%. No lead = no one on the hook in tough times = no one to corral other investors to take action = nobody with enough skin in the game to give a damn. Always, always have a lead. Not just to get through tough times, but for conflict resolution in general.2. Make Sure You’re Stage Appropriate
If you select a lead VC make sure they’re stage appropriate. If you’re raising $2 million on an A round and it’s a $1 billion fund make sure they have a track record of backing and being active with early stage deals. If you’re raising a $10 million B round and a $100 million fund ponies up $8 million you better have a firm grasp of how much of their fund is allocated, how much they have reserved for you and how they plan to support you in tough times.3. Make Sure They Have Enough Gas in the Tank
In any scenario it’s a good idea to understand where the VC is at in their fund. You can’t ask this kind of stuff on the first date, but ultimately you politely want to get out of them: when their fund was raised, how much capital did they raise, how much is allocated, when they’re raising their next fund and what their “reserve” strategy is. Best if you get much of this from due diligence of calling other portfolio companies and then use this information to confirm with the VC.4. Make Sure They Play Nicely in the Sandbox
I often see VCs getting sharp elbows out at the time of a fund raising. They start muscling for ownership percentages and start angling to kick out certain investors or angels. I find this behavior strange but now a bit predictable.I usually counsel entrepreneurs with the following advice, “if your VC can’t play nicely on the way in when they love you the most and are on their best behavior, imagine how they’re going to be in difficult times or when the final pie is getting split!”
Seriously, man. Assholes in good times are insufferable in bad times. If you experience this behavior run. Didn’t you get enough of this crap in high school to want to revisit it again?
5. Always Pitch Outsiders for Follow Ons
I have staked my strategy as a VC as being both stage agnostic and willing to follow great deals by leading another round and increasing my percentage ownership. So it seems strange advice for me to recommend that you pitch outside investors first for follow on investments.Here’s why – even for a VC you really like and who you might like to lead your next round. You know the old saying, “great fences make great neighbors?” My corollary for VC is “pitch outsiders and you’ll have great insiders.” It just keeps us a bit honest. I think if your inside VC wants to lead a round and is giving you a “fair” price it’s reasonable to not “over shop” the deal and try to drive the highest price possible. Get a fair price from outsiders or at least market test the interest level.
6. Always Make Room for Value-Added Angels
Finally, I believe in making round for value-added angels on every round and in every deal. Yes, I include many micro VCs in this category. If there are 4-5 investors who each want to kick in $50-75k – why would I want to turn away smart people from working with the company? These aren’t people who are going to compete for increasing prorata in the future. They aren’t people who are going to demand minimum ownership %’s.They’re all dopeness, no wackness (presuming they are great angels and not PITAs).
If your new prospective VC is opposed to a great angel or a small investment from Founder Collective, Felicis Ventures, SV Angel or similar – please re-read number 4 above.
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Going to Raise VC? Here’s a Primer on Process, People & Powerpoint Deckby Mark Suster on January 11, 2011
If you want a very quick primer on all the stuff nobody ever tells you about raising venture capital check out this video where Mark Jeffrey & I break it down on This Week in VC. A summary of what we discussed is below:
Not 100% in order of the video, but close. All of this is covered in more detail on the TWiVC video above (and much of it is covered in text on this blog on the “Raising VC” tab)
1. Will a VC sign an NDA (non-disclosure agreement)? No. If they did they would be in constant violation because VCs often see 3-4+ companies in every market that they operation. NDAs would make it impossible to do business. Asking for one to be signed shows naïveté.
2. What is the VC process?
- Meet with one person from the firm – partner or associate. If you can meet a partner up front it’s always best but sometimes it’s not possible. The first meeting will often by with an analyst, associate or principal. Often principals are allowed to do their own deals whereas associates are not. Associates are good an important people – I discuss this in the video. Still, “call high” if you can.
- Potentially several other qualifying meetings before you get to meet the other partners if the person you have met is not yet convince / wants to do more work.
- If you make it past this stage you will go to a “full partners meeting” which is exactly what it sounds like. In the video I describe how to best play this meeting and why, without a champion going into the meeting, you’re unlikely to get an investment.
- After the partners’ meeting you should usually get a pretty good steer on where you’re at in the process. If you don’t, make sure you follow up and ask for feedback
- If they say yes you get a term sheet and once this is signed it is usually 3-6 weeks until your legal docs get signed and you’re funded.
3. Who should attend the meeting?
- 1 or more can attend first meeting depending on strength of your team. It can be a good strategy to bring just the CEO because 1-on-1 rapport is easier to build but if you have equally strong co-founders bring them.
- Critically at the partners meeting you should have 2-3 people. Most investors are looking for a team rather than backing a single individual. Whether or not they are co-founders or not – they want to know you can build a team.
- One big mistake is to bring a team and then not have them speak. At worst they look like stooges. Equally likely you show your inability to listen to your team and your over dominance of conversations. This is a common problem I see – the CEO who talks over his / her people. Give everybody pages of the deck they’re to cover or parts of the demo for which they are to talk. When you get questions act like a quarterback farming some of them out to your team. This isn’t weakness – it’s leadership.
4. What is a VC looking for? Above all – the quality & potential of the team. They are also looking for a well-defined market opportunity, evidence of your success to date and ultimately most are looking for a large addressable market as this is the only way a VC drives returns.
5. Do you really still need a Powerpoint deck in 2011? Can’t you just demo & talk? You might be able to do this with some investors but not most so at a minimum you need a deck ready to walk through in case you’re asked. Remember that most people are visual thinkers and Powerpoint slides simply help frame the conversations. The best ones are visual, high-level, have a narrative, move swiftly, are designed to prompt questions as much as “pitch” your company and importantly have a narrative.
6. What should be in the deck? Some variation of the following (this is a suggested order)
- Bio of top 3 people in the company. Short sentences, bullet points, easy to read.
- Problem definition (with the market … it’s why you exist)
- How you solve that problem conceptually at the highest level
- Details on the solution
- [Demo could go here]
- Why you believe there is economic value in what you do / how you think you can monetize one day
- Competition
- Progress to date of your company (when started, key milestones, what shape is the product in, any pilot / beta customers, financing)
- Market sizing
- Potential future exit possibilities
- How much are you raising, how long will it last, key milestones you plan to hit before the next round
You can vary from this but these are the key themes are the ones you need to cover. And you should have a narrative, which ties your whole story together. You should have 10-12 slides and anything else that is detailed should be in your appendix. I think it’s good to have a 10-20 page appendix that shows the details of the market, your product / roadmap & progress-to-date.
The “exit” slide is controversial but as I discuss in the video – necessary no matter what anybody else tells you. Here’s the deal: ultimately you’re likely to sell your company, not IPO. Don’t talk about wanting to sell any time soon. But you need to talk about who might “some day” be interesting in what you’re building and why. Ultimately VCs are in the busy of making returns and whether they acknowledge it or not for most investors it will form some part of their decision on whether to invest or not. And if you don’t plant the seeds they will fill it with their own ideas. Better that you expand their thinking. Trust me.
The video covered a lot more including viewer questions on whether a business plan is still necessary, whether VC decisions are “gut level” or rational strictly based on numbers, when should you accept a “no as a no” from the VC vs. showing persistence, etc. If you need to raise VC money in the next 12 months it’s probably worth the hour to watch it. Hope you enjoy.
Every new startup I know dreams of being funded by an angel investor. Yet according to the latest data from Gust (formerly AngelSoft), only about 3 out of 100 companies who initiate the formal request process actually get funded.
The Gust Deal Funnel from the last 12 months indicates is that 70% of the interested companies never make it past the initial screening process. Over half of the survivors remaining are eliminated during live presentations, and another 6.5% are eliminated during due diligence.
What is this daunting process, and what can you do to optimize your chances of surviving it? Over the past 10 years, I have had the opportunity to see how the process works, several times from the startup side, and more recently from the angel perspective (as a member of an angel group selection committee).
So what should you do to prepare for this stage in your venture, and optimize your chances of making it through the process? Here is my list of top ten action items to best prepare you for success in achieving a funding event with angels:
Incorporate the business now. If you expect to require external funding, you should first incorporate as an S-Corp, C-Corp, or LLC, rather than the more expeditious sole proprietorship or partnership. The corporate entity lends itself best to the concept of “sharing” equity required by investors, and unincorporated entities don’t get funding.
Line up an experienced team. Remember the old adage that “investors fund people, not ideas.” That’s why this item is so important, and is probably the biggest stumbling block I see in getting through the initial angel screening. If the founders are not experienced, find a couple of advisors from the business sector to fill the gap.
Get your Internet domain name and website. In today’s world, if you don’t have a web site up and running, you will not be perceived as a real company. Investors routinely go to candidate web sites to get a feel for the tone and scope of the company, as well as its maturity and offerings. Reserve the company name on social networks to protect it.
Define some intellectual property. File a patent and trademarks to show real intellectual property. Having a defensible competitive advantage or “barrier to entry” is another critical step to funding, and another common stumbling block during all phases of the funding process. Start early on this one, or you will lose the opportunity.
Build a prototype product. A conundrum for many frustrated entrepreneurs is that they need money from investors to design and build a prototype product, yet most angel investors expect to see at least a prototype before they invest. Use your own money or friends and family to demonstrate progress early.
Build an investor presentation and summary. Investors expect a one or two-page executive summary sheet for the initial screening, backed up by a ten-slide Powerpoint investor presentation. Remember to aim the content of both of these at investors, not customers. They must amplify your “elevator pitch” to investors, as well as key points from the business plan and the financial model.
Prepare an investment-grade business plan. Every entrepreneur needs a professional business plan for their own use, whether they intend to seek investor funding or not. As a founder, you may think that everyone understands your vision and plan from your passion and words, but it doesn’t work that way. It should answer every question an investor or associate might ask, including current valuation, funding needed, and exit strategy.
Finalize your financial model. Like the business plan, a financial model is required as much for your own use as to impress angel investors. In most cases, a Microsoft Excel spreadsheet is adequate, with projection formulas for revenue, costs, and cash flow over the next five years. Variables for “what if” questions add credibility.
Close at least one initial customer. This must be someone who is willing to pay real money for your product or service. Free trials don’t count. All the conviction and market research in the world are no substitute for real customers paying real money. This is called “validating the business model.”
Network to the maximum with investor connections. The last and possibly most important action item is to build relationships with investors and friends of investors BEFORE you need their help in building your company. A good start is taking an active role in relevant technology groups, trade associations, university activities, and local business groups.
In summary, being touched by an angel can lead you to your dreams of a new and successful business, but it doesn’t happen without planning, hard work, and careful preparation. Most angel investors are seeking psychic as well as financial benefit from their investment. Do your homework first to get their attention, but don’t expect anyone to swoop down and wave a magic wand.
Marty Zwilling
26 questions you have to answer correctly to get funding for your startupIt’s been a crazy week. On Monday we announced that our project received funding. Member of the Croatian Angel Network – CRANE, Mihovil Barančić believes that we have what it takes to create something big and worth mentioning. But I am way ahead of myself. We’ve started to explore the possibility of getting an investment roughly a year ago. So here are some questions that we got during that time.
- Why do you need an investment?
- Why don’t you sell your house/company/whatever if you believe that much in your product?
- Do you believe in your service?
- What does your service do?
- Why is that better than company x?
It’s good that your share all this info, because otherwise you’re a bozo (tm Guy Kawasaki-Steve Jobs)
- What if some big company decides to copy your service?
- What if your competitor or newcomer decides to copy your service and offer it half the price?
- Is there any competition?
- Can you see your company becoming a 10 million dollar company?
- Why don’t you start localy first?
Why don’t you go global from the start? Since we were going global right from the start, we weren’t asked that question (but some probably will).
Interrogation
- Can you bootstrap?
- What experience do you have?
- How did you get your idea?
- Do you have a working prototype or a proof of concept?
- Why should I invest in you instead of hiring 1/2/3 people and outsource the whole project?
- Would you be willing to relocate to: capital city/London/Sillicon Valley?
If you make any kind of statement, be prepared for questions about backing up that statement with facts.
- Do you have an executive summary?
- Do you have a business plan?
- How are you going to get your customers?
- Who needs your service?
- Who is you target audience?
- What is your business model?
- Do you have an exit strategy?
- Are you prepared to give up 10%/20%/30% of equity?
- How much money do you need?
- Why that ammount?
I am 100% positive there were more questions, but these were the ones that first came to my mind. Good luck in finding the answers. Please, please, please help share this questions and help other startups that want to receive funding!
Goran Duškić co-founded a game development team Generation Stars when he was a teenager, and he co-founded hosting and web develpoment company GEM Studio (which was sold in 2011). He co-founded tech startup WhoAPI and has 10+ experience in business development, online marketing strategy and PR.
Tags: funding questions, How to get funding, startup questions, whoapi
This entry was posted on Wednesday, December 21st, 2011 at 11:43 am and is filed under News & Updates. You can follow any comments to this entry through the RSS 2.0 feed. You can leave a comment, or trackback.
On the surface, value propositions seem incredibly straightforward. I’d argue that this is why, in practice, they’re often given such short shrift.
In reality, getting a value proposition right requires some focused thinking and structured analysis, some of which I’ll preview here. Given my particular background, much of what I recommend will have a bias to B2B startups — though, in many instances, I think that you’ll find applicability to virtually any endeavor.
I recently lectured to a group of students and aspiring entrepreneurs as part of my series of talks at the Harvard Innovation Lab (feel free to presentation slides). For this particular session, we examined the DNA of a value proposition by stripping it down to its foundational elements and reassembling it, workshop-style, around a variety of new business ideas.
But before we dig in, let’s define a value proposition.
In its simplest terms, a value proposition is a positioning statement that describes for whom you do what uniquely well. It describes your target buyer, the problem you solve, and why you’re distinctly better than the alternatives.
One of the classic mistakes of building a value proposition is diving headlong into the solution definition phase before really understanding the problem you’re looking to solve. To understand whether it’s a problem worth solving, I recommend exercising four U’s:
- Is the problem unworkable? Does your solution fix a broken business process where there are real, measureable consequences to inaction?
- Is fixing the problem unavoidable? Is it driven by a mandate with implications associated with governance or regulatory control? For example, is it driven by a fundamental requirement for accounting or compliance?
- Is the problem urgent? Is it one of the top three priorities? In selling to enterprises, you’ll find it hard to command the attention and resources to get a deal done if you fall below this line.
- Is the problem underserved? Is there a conspicuous absence of valid solutions to the problem you’re looking to solve? Focus where there’s whitespace, not scorched earth.
Problems worth solving yield a decisive “yes” to the majority of these questions.
Next, ask yourself whether the problem is blatant and critical. Problems that are blatant and critical are far more acute that those that are latent and aspirational. Blatant and critical problems stand in the way of business. They put careers and reputations at risk and whiten knuckles. Latent problems are unacknowledged, which means they often require costly missionary selling. Aspirational problems are optional, which is the hardest of places for a B2B startup to sell. Though in B2C, they can be drivers as people look for things like status or fashion.
Now that you’ve determined what problem you’re solving and validated its criticality, it’s time to define your solution. The most urgent question to ask is: What is your compelling breakthrough?
Think of 3D. What unique combination of discontinuous innovation, defensible technology, and disruptive business model are you bringing to bear and what makes it truly compelling — not just to you and your colleagues, but to your most skeptical customer?
Discontinuous innovations are the opposite of marginal improvements; they offer transformative benefits over the status quo by looking at a problem differently. Defensible technology offers intellectual property that can be protected to create a barrier to entry and an unfair competitive advantage. Disruptive business models, which are discussed in depth here, yield value and cost rewards that help catalyze the growth of a business.
Groupon is a good example of a disruptive business model that has changed the face of price-based promotions by using crowdsourcing principles to aggregate demand around deals.
As an investor, I look for non-disruptive disruptions — that is, technologies that offer game-changing benefits without requiring any modification to existing processes or environments.
When VMware popularized the hypervisor, it did so with a non-disruptive disruption—all benefit without much in the way of adoption hurdles. The same is true for Akiban, one of my more recent investments that’s innovating in database technology to yield 10-100x improvements in the speed of relational data access without any changes to applications or risk to data. That’s a non-disruptive disruption.
Non-disruption is critical because the gain you deliver will be discounted by the pain of adopting your solution, plus the inertia of vendor risk that every startup levies by virtue of being small. This means that you must deliver an order of magnitude improvement over the status quo to make the cut.
If you can’t deliver a 10x promise, customers will typically default to “do nothing” rather than bearing the risk of working with a startup. That’s the harsh truth.
Now that you’ve defined the problem you’re solving, evaluated the gain/pain ratio and discovered a problem truly worth solving, you’re in a good position to build your value proposition.
At the center of that value proposition is you. What problems do you understand uniquely well? What can you deliver uniquely well? What sort of disruptive business model can you bring to bear? Be true to yourself and play from a position of strength. A little self-awareness can go a long way in crafting a value proposition with power.
Credit is due to my colleague Adam Berrey for his thinking on the importance of segregating needs.
Top image courtesy of Yuri Arcurs, Shutterstock
Michael Skok is a general partner at North Bridge Venture Partners. His investments include Apperian, Akiban Technologies, Acquia, Unidesk, and Demandware (NYSE: DWRE).
I have had a lot of entrepreneurs ask me for introductions to various investors. In some cases the entrepreneurs use their reply to the intro email as a mechanism to gain social proof, emphasize urgency, and to reduce the friction to meeting the investor and closing their round (see e.g. VentureHacks for great tips).Unfortunately, a lot of otherwise savvy entrepreneurs don't follow up with investors well. You have to remember that every thing you do can signal to an investor a lack of urgency/interest in your company, the fact that you are taking your startup casually, desperation, or a lack of ability to follow through. Also, if you don't create urgency or a sense that the investor may miss out on something interesting, then the angel may drag their feet in meeting with you, extending the time of your fundraise.
This post is focused on the small tactics that go a long way upon receiving an introduction.
Example Of a Bad Reply To An Investor Intro
"Thanks Ivan Introducer for the intro!Hiya Angela Angel,
It is great to meet you! Love to connect! Let me know what works!
Regards,Elizabeth Entrepreneur"
Example of a Good Reply (tailored to an angel round with a lead)"[moving the person who made the intro to BCC][1]
Hi Angela Angel,It is great to meet you. As introducer said, we are in the midst of a round led by well-known investor and other well known angel is also investing[2]. We have seen really solid traction with user growth of X up Y%. [3] See below for team bios/key stats [7]Our round is coming together quickly so the sooner we can talk the better[4]. Are you free to chat at one of the following times?[5]Monday 2pm-3pm; 5pm
Tuesday 1:30pm-3pm, 6:30pmWe can also try to move things around to accommodate you - we have heard great things about you as a social media investor (in particular your investments in Tumblr and Pinterest)[6] so would love to connect before we close the round.Thanks,
Elizabeth Entrepreneur
----------
Team bios [7]Elizabeth Entrepreneur
-2008-2010 Tech lead at Facebook for newsfeed
-CS, MS degrees from Berkeley
-Side project stupidhipster.com getting 100,000 visits a monthCarl Co-founder
-etc.
"
What Is The Difference?
I added numbers to footnote the important parts of the email.
1. Move the introducer to BCC. They don't want to be on the 15 emails it takes to schedule the meeting.
2. Put social proof up front. All these great investors are part of the round! Angela angel will want to be part of the club and invest too. It also means you are more legit than the other random companies trying to talk with the same investor.
3. If you have good traction or a key stat, explain it in 1-2 lines. This is additional proof that they need to rush to talk to you.
4. Put polite pressure to chat very soon. You need to emphasize things are on a fast track for you. If things are moving slowly it suggests no one is interested in your round, which means this investor won't be interested either.
5. Add specific times. This reduces the friction to scheduling as if you leave it open ended it (a) does not convey urgency and sets up the timeframe within which you will meet and (b) makes the investor work harder to figure things out. Don't put the burden on them to suggest a time
6. Explain why the investor is relevant. This helps them understand why they are a good fit for the company. It also extends the the timeframe you can wait to meet with them if needed without looking desperate (e.g. if the can only meet in two weeks, their experience justifies you waiting for them as they are uniquely awesome for your company, rather then because you dont have other options).
7. Add team bios (2-3 lines, bulleted per team) + any key stats (if no good stats, just included bios). People will want to know who you are and why to meet with you. In some cases, even if the idea is bad they will still want to meet with you if you have a strong background. This will give you a chance in person to convince them to invest.Hopefully, the person who introduced you already covered items 2 through 5 or 6 in either their intro, or in the email asking if the investor will talk to you. If the intro explicitly included 2-3, you can skip mentioning it yourself, but you should keep the other elements in.
You can follow me on Twitter here.
Other fundraising posts:
Posted: April 6th, 2012 | Author: Dan | Filed under: Startups | 18 Comments »Vesting in general (and founder vesting in particular) is an oft-misunderstood tool that has a tendency to really screw up young companies. There are some deep misconceptions at work here that often cause founders all sorts of grief. Most of it comes from the simple fact that stock grants are, at their heart, a crude hack to avoid taxes. Vesting is a hack to the hack – and one almost every founder needs.
Let me explain with a hypothetical.
Imagine AcmeCorp, a new startup. Jack and Jill are the founders. They incorporate and give themselves each a million shares – in other words, splitting the company fifty-fifty.
The next day, Jack has a change of heart. Startups are a lot of work! He quits AcmeCorp and takes a cushy executive gig at a fortune-500 tech firm. Jill’s left solo.
Years pass. Jill first works without salary, then pays herself a pittance. She bootstraps the company, starting with consulting and moving on the develop a highly successful web service. As she brings on staff, she issues stock to new employees, ultimately handing out a half-million shares of the company. Eventually she’s the CEO of a 50-person firm, pulling down a respectable $200k per year as the CEO; nearly as much as Jack’s pulling down at his gig (not including his benefits and bonuses).
When the company is finally sold, it’s a great success – $100mm exit. And here’s what happens.
For her million shares, Jill gets $40mm.
The employees’ half-million shares net them $20mm.
And Jack? He gets a call one afternoon that, for sitting on his duff for the past five years, he’s worth a cool $40mm, same as Jill.Obviously something’s wrong with this picture. The crux of it is that, with stock grants, value is awarded in a big block at the beginning, even though the contribution is (or isn’t) provided over a long period of time. It would be like if you paid someone four years worth of salary in a lump sum on their hire date. The obvious solution, of course, is to not issue all the stock at once. Instead, treat stock like salary – give it out in small chunks over time.
Unfortunately this is a terrible idea. As time goes on, the stock gets progressively more valuable, and the tax impact to the founders gets worse and worse, plus the strike price (if they’re options) gets higher and higher.
As I’m sure you’ve gathered by now, the solution is – vesting! The founders get their stock at the beginning in a big whack, but the company has the right to take it back for a negligible amount of money (the “repurchase agreement”). As time goes on, that right erodes. So the net is the same – the founders’ stake grows over time – while still letting the founder keep ownership of the stock from a legal standpoint as it appreciates, allowing long-term capital gains treatment, favorable initial tax treatment, voting rights, and all that jazz.
“But wait!” the novice founder cries out. “If I build lots of value and sell the company, I get the shaft! My stock may not be vested, and I’ll lose out!” Yes you will, young padawan, unless you include acceleration in your vesting schedule. Acceleration is the final hack to the hack, which brings the force back in to balance.
Acceleration comes in two flavors. Acceleration on change of control (aka single-trigger acceleration) means that if the company is sold, some or all your stock vests. Yay! Double-trigger acceleration means that if the company is sold AND you’re fired, then some or all of your stock vests. Sort of yay!
The former is obviously better for the acceleratee, but keep in mind that a deal may be hard to get done if the acquirer knows that all the stock incentives to stick around disappear when the deal closes. Double-trigger, or a mix of single- and double-, is often a nice compromise to keep the company marketable (a few years down the road) while rewarding people for their hard work. This is often more of an issue for employees (who join later, and will still be vesting when a transaction happens, and who can’t leave en-masse if the transaction is to go through). For reasons of company lifecycle timing, founders are usually fully vested already by the time a deal happens.
Regardless, the important thing is this: founder vesting is founder friendly, the exact opposite of what most people think. You want it. Don’t fight it. In fact, don’t wait for an investor to tell you that you need it – get it done when you incorporate. Just remember to pair it with acceleration on change of control!
And now, some suggestions for vesting schedules.
- Use a four-year vesting cycle for founders, the same as you eventually will for employees.
- Put founder vesting in place before you start to raise money. Investors will be impressed that you know what you’re doing. If your vesting terms are reasonable, they’ll be accepted without argument. And when you’re negotiating terms, it’s better to have fewer things that matter to you on the table.
- If there’s a “trial period”, for example people working part-time for a few months, then consider a cliff that expires after the trial. That means the first vesting doesn’t occur until the trial period is over (and then you vest a lump of however much you would have received anyway). Stock is best used for people who are totally committed, so the stock accumulation shouldn’t kick in until the commitment does. The obvious exceptions to this are strategic advisers who will only ever be partially committed, but where that level of commitment is all the company wants and needs.
- If there’s a meaningful commitment of resources in advance of the vesting agreement, it’s reasonable to “fast forward” the agreement by an appropriate amount. For example, if you’ve been working full time for a year before vesting is in place, it’s not unreasonable to start with 1/4 of your stock vested already and put the rest on a 3-year schedule.
- Stock that’s in payment for resources doesn’t need to vest. For example, if the company is split 50/50, but then one founder puts in $100k in exchange for 10%, then the 10% that they get should not vest. Since the value is delivered up front, the stock should be too. (Obvious corollary: investor stock has no vesting terms)
- For founders, accelerate 50% of the remaining unvested stock on change of control (single-trigger), and 100% of the rest double-trigger. This is totally reasonable and fair, and makes it very unlikely that you’ll leave much value on the table.
- It is generous, but not unreasonable, to consider double-trigger acceleration for some or all of your employees. However, you may cause yourself problems during M&A down the road – check with your lawyer first.
- Try to avoid single-trigger acceleration for non-founders whenever possible. Not only is it sure to cause issues during M&A (the acquirer will be worried that everyone vests & leaves after the transaction), but an acquirer may make changing these terms a condition of a deal, which just leads to ugly.
- Get the legal paperwork for your stock agreements sooner rather than later, to start the capital gains clock ticking. This can easily be a seven digit difference if you happen to have an early exit (ask me how I know).
- Edit: File your 83(b) elections the day your incorporation goes through. You have 30 days to do it, and then you’re screwed forever. If you’re not sure if this applies to you, ask your lawyer. If they’re not sure, fire them and hire someone else. This is one of the most common, avoidable, and expensive mistakes founders make (thanks for the reminders about this in the comments!).
- One last thing: the founder vesting arguments assume multiple founders. If you’re a solo founder, you might skip founder vesting, and hope no one notices…
Founder vesting may sound terrible , but when paired with reasonable acceleration, it’s a good thing for everyone.
(You might want to subscribe or follow me on Twitter so you don’t miss new articles)
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[4.7.12 Addendum: Many of the management company details are now available on a SEC web site. More details here.]
Here’s how VC firms are paid.
When VCs raise funds, they are paid in two ways. First, they get a commission on gains they produce for the fund, which is usually 20 percent and is called “carried interest.” Second, VCs receive a set fee, to run the business, while they and their investors await a future good payday from investment gains. Usually, a VC firm collects annual fees that amount to 2% to 2.5% of every dollar it manages (after 10 years, those funds end and the fees stop).
What many don’t know (including many VCs) is that these fees are transferred to a separate legal entity, called a management company. This is the entity that pays out expenses (salaries, rent, travel, legal, etc.), hires and fires employees, and owns “the franchise.” It is where the power is.
What is left over after expenses is the management company’s profit. The “franchise owners” of the firm divide this up among themselves. Usually, a small group of partners are the franchise owners, and often, it is just one or two individuals (usually, the founders). Very important to know is that usually one person has voting control of the management company; that person is truly the “Chief Partner”. This person usually owns the firm’s trademark.
The management company financials are a closely guarded secret. Very few partners get to see it. Most are kept in the dark. It sounds odd, but there is a top-secret “firm within the firm.”
The existence of the management company has a few implications. First, the Chief Partner cannot be fired without his/her consent. Every other partner at a VC firm can be, including the ones who have worked hard to earn pieces of the management company. So, a partner at a venture firm is usually an employee-at-will. They can be fired at any time.
So, why does this all matter to entrepreneurs? Well, we’re living in a time when it is very hard to raise new funds, unless a VC is in Facebook or another very exciting and already-large company. And, that fact affects start-ups in two ways.
First, if a firm cannot raise more money, then that firm obviously will not be able to make new investments. So, entrepreneurs should try to understand where VCs are in their current fund. Ask the VC how much of their current fund has been invested and reserved for existing investments.
Second, the lack of a fresh fund can complicate life for start-ups already backed by a VC firm. An entrepreneur’s Board member may leave his/her VC firm, or get fired. Here’s why. Without a new fund, fees to the management company decline as old funds’ fees expire. So, a Chief Partner may want to trim expenses. The most expensive cost? Partners. So, a firm may lay off partners. In other situations, the next-gen partners may leave and start a new firm, knowing that it is nearly impossible to restructure the management company since the Chief Partner doesn’t have to comply.
So, an entrepreneur can suddenly find that his/her sponsor at a VC firm is no longer there.
Entrepreneurs can overcome this reality in two main ways. They can out-perform, so that even if their champion is no longer on their Board, they can point to clear metrics. Another way is to build good relationships with other partners at that VC firm, particularly the Chief Partner.
Now, a VC firm’s culture varies from one to another. The Chief Partner may delegate authority so that all partners have a voice in an investment decision–or, he may allow input from others, but in reality, is the one making the decisions. Entrepreneurs need to know that when they pitch a firm. Who is the Chief Partner and do the other partners have power? The best way to find about both is to speak with other entrepreneurs who have pitched that firm. In my opinion, 80% of venture firms have a collegial decision-making process.
I want to point out that this type of ownership structure is usually the norm in other asset classes. LBO firms, hedge funds and funds-of-funds (firms that raise a fund to invest in other funds) nearly always are structured like this, too. So, founders at VC firms haven’t come up with a new structure. This is the standard which their lawyers tell them to adopt.
Last, I want to share why we at Kepha have tried to simplify our system. This is admittedly self-serving, but I think it’s important for entrepreneurs to know about it. Eric and I are equal partners on the carried interest, the management company profit, and the management company votes. We’ve assigned zero economic value to the management company, and so, when Eric joined the management company, he received his shares for free. So, we are equal partners and equal owners.
Why did we decide on equality? First, we believe the entrepreneur is our customer. It is one of our Operating Principles. We think the best way to serve entrepreneurs is with the best people possible. The best people, in turn, demand and deserve great economics. So, we want to offer a great compensation package to field the best team we can for our entrepreneurs and investors.
Second, we believe early stage investing is best practiced as a team sport. By having shared economics, we together have a strong incentive to have all of our companies succeed. So, an entrepreneur doesn’t get just one person’s set of contacts and energy–he/she gets the entire partnership.
Note that our CFO is a Partner–he receives a piece of the carried interest and management company profit. Among VC firms, a small number of CFOs get the former and only a select handful get the latter. So, he too very much wants our companies and Kepha to succeed.
We certainly don’t have a perfect system, and only time will tell if ours works. But, we like how our compensation helps us focus as a team on the entrepreneur. It also makes for a very collegial firm culture.
Last, if you’re an entrepreneur or a VC who would like to engage further on this off-line, just give me a shout. Always happy to try and help.
I have had a lot of entrepreneurs ask me for introductions to various investors. In some cases the entrepreneurs use their reply to the intro email as a mechanism to gain social proof, emphasize urgency, and to reduce the friction to meeting the investor and closing their round (see e.g. VentureHacks for great tips).Unfortunately, a lot of otherwise savvy entrepreneurs don't follow up with investors well. You have to remember that every thing you do can signal to an investor a lack of urgency/interest in your company, the fact that you are taking your startup casually, desperation, or a lack of ability to follow through. Also, if you don't create urgency or a sense that the investor may miss out on something interesting, then the angel may drag their feet in meeting with you, extending the time of your fundraise.
This post is focused on the small tactics that go a long way upon receiving an introduction.
Example Of a Bad Reply To An Investor Intro
"Thanks Ivan Introducer for the intro!Hiya Angela Angel,
It is great to meet you! Love to connect! Let me know what works!
Regards,Elizabeth Entrepreneur"
Example of a Good Reply (tailored to an angel round with a lead)"[moving the person who made the intro to BCC][1]
Hi Angela Angel,It is great to meet you. As introducer said, we are in the midst of a round led by well-known investor and other well known angel is also investing[2]. We have seen really solid traction with user growth of X up Y%. [3] See below for team bios/key stats [7]Our round is coming together quickly so the sooner we can talk the better[4]. Are you free to chat at one of the following times?[5]Monday 2pm-3pm; 5pm
Tuesday 1:30pm-3pm, 6:30pmWe can also try to move things around to accommodate you - we have heard great things about you as a social media investor (in particular your investments in Tumblr and Pinterest)[6] so would love to connect before we close the round.Thanks,
Elizabeth Entrepreneur
----------
Team bios [7]Elizabeth Entrepreneur
-2008-2010 Tech lead at Facebook for newsfeed
-CS, MS degrees from Berkeley
-Side project stupidhipster.com getting 100,000 visits a monthCarl Co-founder
-etc.
"
What Is The Difference?
I added numbers to footnote the important parts of the email.
1. Move the introducer to BCC. They don't want to be on the 15 emails it takes to schedule the meeting.
2. Put social proof up front. All these great investors are part of the round! Angela angel will want to be part of the club and invest too. It also means you are more legit than the other random companies trying to talk with the same investor.
3. If you have good traction or a key stat, explain it in 1-2 lines. This is additional proof that they need to rush to talk to you.
4. Put polite pressure to chat very soon. You need to emphasize things are on a fast track for you. If things are moving slowly it suggests no one is interested in your round, which means this investor won't be interested either.
5. Add specific times. This reduces the friction to scheduling as if you leave it open ended it (a) does not convey urgency and sets up the timeframe within which you will meet and (b) makes the investor work harder to figure things out. Don't put the burden on them to suggest a time
6. Explain why the investor is relevant. This helps them understand why they are a good fit for the company. It also extends the the timeframe you can wait to meet with them if needed without looking desperate (e.g. if the can only meet in two weeks, their experience justifies you waiting for them as they are uniquely awesome for your company, rather then because you dont have other options).
7. Add team bios (2-3 lines, bulleted per team) + any key stats (if no good stats, just included bios). People will want to know who you are and why to meet with you. In some cases, even if the idea is bad they will still want to meet with you if you have a strong background. This will give you a chance in person to convince them to invest.Hopefully, the person who introduced you already covered items 2 through 5 or 6 in either their intro, or in the email asking if the investor will talk to you. If the intro explicitly included 2-3, you can skip mentioning it yourself, but you should keep the other elements in.
You can follow me on Twitter here.
Other fundraising posts:
The term "lead investor" is often misunderstood. I have seen VCs negotiate to be called a co-lead or a lead in the term sheet. But you don't get given that designation. You earn it.
Glenn Kelman (a long time AVC regular) has a great blog post on this featuring former Sequoia partner, now Khosla partner, Pierre Lamond in the lead investor role:
Then Pierre Lamond, the Sequoia partner on the deal, began working out of our office, acting as the virtual CEO. Pierre made a point of being there the day one of his other companies went public. We looked at a news photo of all the smiling people, who seemed to be living in a gated community, on a planet I would never visit. Then Pierre said “that company was once even more screwed up than you are.”
Glenn describes a strong parental figure providing support, encouragement, and criticism in equal doses. And he goes on to explain why:
That anyone gave us money was a miracle. But once we get the money, we prospered, eventually becoming one of only two technology companies to go public in 2002. I wondered why Sequoia went to such great lengths to get Plumtree funded when it would have been easier to write off the few hundred thousand dollars invested in our company. And the simple answer was that Sequoia cared about its reputation and stood by its companies.
That last bit is the key point. It is what every VC firm I respect and admire does. It is what VCs should do. It is the bargain we make with entrepreneurs when we invest.
I am old fashioned. I was trained by a couple VCs who are Pierre's age. This is how they taught me to do the VC business. It is how I do the VC business. It is how USV does the VC business. And I think it is ultimately the only way you can do the VC business.
There are roughly 265,000 active individual angel investors. If you want to go the route of tapping an angel network -- a group made up of up to 150 individual investors who pool their finances and share the due diligence work -- there are more than 300 of those. In short, there are lots to choose from and they're ready to invest. The challenge is finding the right angel investor for you and your business.
What a lot of founders don't realize is that not all angels invest for the same reasons. Backing a startup is a bit like shopping for a car: Do you want a sports car that does zero to 60 in four seconds? A dependable sedan? A Prius that appeals to your environmentally friendly side? Keep in mind that monetary gain may be a secondary reason for some investors.
Here are three of the most common types of angels and what motivates them:
Start by researching the backgrounds of individual investors to identify their motives. Once you know what they're looking for, here are five more things you should take into account before you approach them:
- Hedonistic angel investors are attracted to what they perceive as exciting ventures, seeking the thrill that comes with risk and innovation.
- Angel investors looking for a significant ROI seek companies that have the likelihood to be bought out by a large corporation or the ultimate prize of going public.
- Altruistic angel investors are motivated by a desire to support new companies and entrepreneurs, community development, and job growth.
1. The investor's experience. Most angel investors are not only looking to provide their money, but their insight and guidance as well. You can bank on the fact that they will probably want to be involved with your company should they decide to fund it, and thus selecting an investor with market-specific experience makes it easier to speak the same language.
2. Geographic location. Investors in close proximity to your business are more likely to invest because it makes counsel easier. It is not a coincidence that in venture capital, most VCs are in New York, Texas, and California because they're close to the action. Investors like to grow where they're planted.
3. Rate of return. Does your projected rate of return meet their objectives? Does your company have the potential to pass their investment criteria? Each investor has different requirements.
4. The needs of the market. Investors always evaluate the market's needs and consider whether your product or service will carve a niche for itself. Can you demonstrate vast growth potential, uniqueness, and an unfair competitive advantage? An investor is looking to see if you've done the research to show that you can make it happen.
5. Their investment portfolio. Investors have a comfort zone. Investors' past actions guide their future decisions, so the most likely fit will be with someone who has previously invested in opportunities similar to yours. Even within the technology sector, some investors prefer to see innovative applications of existing technologies as opposed to brand-new technologies.
Have you received angel funding recently? What tips can you add?
Flickr photo courtesy of rightee, CC 2.0
What Milestones Are Needed to Raise a Series A?
August 12, 2011
For entrepreneurs seeking to build big companies on a rapid trajectory, raising larger scale venture capital rounds is likely a necessity at some point after the initial seed funding. At NextView, we spend a substantial portion of our time trying to help our portfolio companies prepare for growth as “venture scale” businesses. Also a lot of other entrepreneurs frequently ask us questions like “What milestones do I need to hit to raise a Series A round from a larger VC fund?”
The challenge is that while there’s a simple answer, it’s not one that can be easily distilled into a set of metrics that can be followed as a cookie cutter plan. The simple answer is “be able to convince a partnership of smart investors that your startup has a good probability of being a $100M+ revenue company within 5ish years.” If this isn’t a reasonable probability, your startup might be a great business but probably is not well suited to VC funding.
For many entrepreneurs, even very savvy and experienced ones, this is a dissatisfying or even frustrating answer and I can appreciate that. Life as an entrepreneur is hard enough and it would be vastly easier if you had a specific, quantifiable set of things you had to achieve in order to raise a Series A round. But unfortunately there’s no magic formula… not getting X million users if you’re a consumer facing startup, or Y customers if you’re B2B SaaS startup, or Z revenue, or whatever.
So if there’s no absolute truth or concrete milestones to this question of Series A, what can entrepreneurs do to further their goals? I was in a board meeting for a seed stage company recently and a successful GP at a larger fund said “you know it when you see it” which is true. And there are some common precepts seed stage companies can follow.
1) Core team ready to scale - At the first round of larger scale venture funding, investors fully expect there will be more additions to the team to help it grow. But if the current team doesn’t provide a foundation to build upon, many will be unwilling to take the risk. This isn’t code for an “experienced CEO” or whatever. But having a single senior leader is certainly inferior to having 2-3. Having little or no domain experience among the team means a steeper learning curve in disrupting an industry.
2) Demonstrable market size – Sometimes it’s obvious to potential investors your startup is pursuing a large market oppty (TAM measured in billions). But even if it isn’t, you can prove smaller pieces of the puzzle to reduce the leap of faith an investor must make. If a tiny startup can get a few dozen paying customers in one small segment of a larger market, then there probably is a larger market. If Google just announced an initiative in your market segment, that’s probably good validation. This aspect is often the hardest to “prove” to a VC, but the more complete you can make the composite picture the better obviously.
3) Repeatable, cost effective customer acquisition – Nothing whets a Series A investor’s appetite like a startup that’s shown $1 of incremental marketing spend will yield $2-3 of gross margin. But even if you haven’t fully established the “cash register” of customer acquisition, showing that you have a clearly repeatable approach on trend towards profitable growth may be sufficient.
4) Metric momentum – Everybody likes those up and to the right graphs. Whether it’s customers, revenue, user acquisition, investors are more likely to be convinced when your startup has a good near past (last 3-4mo) trajectory. Also being able to show a solid dashboard and good grasp of your own metrics instills a sense of confidence in new investors.
5) Plausible monetization – If you’re an e-commerce or B2B SaaS company, it’s harder to raise a Series A as a pre-revenue company. But for other types of startups, particularly consumer-facing ones, a pre-revenue Series A may be entirely appropriate and feasible. In these cases you have to be able to layout a credible plan for monetization though, which will likely involve several approaches. I don’t mean just putting the words “freemium”, “virtual goods”, and “advertising” on a slide. I mean a thoughtful and specific plan of the 3-4 approaches you plan for revenue (a little data on small scale tests rarely hurts). We were post-product but pre-revenue when we raised LinkedIn’s Series A, but we laid out a specific plan around jobs/hiring and premium subscriptions which form the basis of nearly 70% of LinkedIn’s revenue today.
There’s no magic formula for a successful Series A unfortunately. But these five tenets can help internet / software entrepreneurs increase their prospects.
The CEO of one of our portfolio companies is working on a fundraising deck and asked me for some tips. I gave him my favorite, "keep it to six slides." He ended up with thirteen which I see as a moral victory.
The founder and CEO of another of our portfolio companies is wrapping up a large round and he showed me his pitch deck. Guess what? Six slides. I had nothing to do with his deck. But it was a work of art.
Like many things in life, less is more in fundraising slides. You can explain your business in mind numbing detail or you can inspire an investor and let them imagine. Guess what works better?
If you succeed in inspiring an investor, there will always be an opportunity to do a deep dive in a follow up meeting. If you must, you can put your other fifty slides in the appendix.
I learned this lesson when Brad and I starting raising USV 2004 in the fall of 2003. We retained an advisor to help us raise the fund and they told us to keep our deck to "six slides." I was aghast. How could Brad and I possibly take all that we had done and learned in almost 20 years in the venture business and put it into six slides?
But the advisor won that argument. Two things happened. We learned to simplify our story and we learned how to create six killer slides. And killer slides are not slides with a dozen bullets each. They are six powerful points that combine to tell the meat of the story.
So when you sit down and build your pitch deck, think of six slides that will inspire and leave something for the imagination. The best part of six slides is that you will get through them in time to have a real substantive conversation face to face about your business. Imagine that.
Editor’s note: This is a guest post by Jesse Rodgers who is currently the Director of Student Innovation at the University of Waterloo responsible for the VeloCity Residence & he is also the cofounder of TribeHR. Jesse specializes in product design, web application development and emerging web technologies in higher education. He has been a key member of the Waterloo startup community hosting StartupCampWaterloo and other events to bring together and engage local entrepreneurs. Follow him on Twitter @jrodgers or WhoYouCallingAJesse.com.
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Incubators are not a new addition to the financing and support for startups and entrepreneurs. On the surface, incubators and accelerators seem like a low cost way for VCs and government support organizations to cluster entrepreneurs and determine the top-notch talent out the accepted cohort. The opportunity to investing in real estate and services that enable companies where the winners are chosen by the merits of the businesses being built. It feels like a straight-forward, relatively safe bet to ensure a crop of companies that are set to require additional growth capital where part of the products and personalities have been derisked through process.
However, its not as simple as putting small amounts of investment into a high potential company. An incubator is a business and it’s sole purpose should be to make money.
What are the basics of an incubator?
The basic variables in setting up an incubator business are:
- Cost of the expertise, facilities, services and other overhead
- Amount of $ to be invested/deployed
- Number of startups
- Equity being given in exchange for cash
- Return on the total investment
There are cost of operations: real estate, connectivity, marketing, programs and services for the entrepreneurs, and the salaries of the individuals to find the startups, provide the services and build successes. These costs are often covered by governments, in exchange for the impact in job creation and taxation base. We’ve seen a rise in incubators that are funded on an investment thesis, where an individual or a set of “limited partners” provide the initial investment in exchange for an investment in the companies being incubated.
How much do incubators cost?
The goal is to efficiently deploy capital to produce successful investments. I’m going to explore how incubators make money by making a few assumptions based on the incubator/accelerator models we’ve seen in Toronto, Montreal, Palo Alto and New York.
Basic assumptions:
- Capital Investments: 10 startups x 20k = 200k invested with an assumed ‘post-money valuation’ of $2.2MM
- This means you now own 9.1% in 10 startups each with a post-money valuation of $220k
- Support Costs: 10 startups x $10k = $100k
- This is the cost of real estate, furniture, telecommunications, internet connectivity, etc.
Alright, we’re planning to deploy $200k and it need to provide approximately $100k in services just to provide the basics for the startups. We’ve spent $300k for the first cohort and and that is before you pay any salaries, host an event, etc.
Additional costs:
- People:
- $100k per year salary for one person to rule them all. Call them executive director or dean or something.
- Assuming you’re not doing this to deploy your own capital, the person or people in charge probably need to collect a salary to pay their mortgages, food, etc.
- Events - Following the model set forth by YCombinator or TechStars we have 2 main types of events. Mentoring events where the cohort is exposed to the mentors and other industry luminaries to help them make connections and learn from the experience of others. The other event is a Demo Day, designed to bring outside investors and press together to drive investment and attention in the current cohort, plus attract the next cohort of startups.
- Mentoring event: $1k for food costs with 25 founders
- Demo Day: approximately $5k
- Assumption: 10 mentoring events plus a demo day per cohort adds $40k.
The estimated costs are approximately $340,000/cohort. Assuming 2 cohorts/year plus the staffing salary costs, an incubator is looking at $780,000 that includes 40 investments and a total of $4.4MM post-money valuation. If we assume that I’m a little off on the total capital outlay, and we build in a 30% margin of error this brings the annual budget to appromimately $1MM/year to operate.
How do incubators make money?
Incubators make money when the startups they take an equity stake in get big and successful. The best exits for an incubator come when one of their startups is acquired. Why acquired? Because the path to getting acquired path is shorter than the path to going public which would also allow the incubator to divest of their investment.
Let’s do the math. If your running an incubator hoping to get respectable returns on the $1,000,000 you’ve laid out above, let’s say it’s not the mythical 10 bagger but a more conservative 3x, the incubator needs one of the companies to exit at near $30,000,000. It can be one at $30MM or any combination smaller than that totalling $30MM. This needs to happen before any dilution and follow-on funding for your cadre of companies. You have to assuming that they can make it to acquisition on the $10,000 and services you’ve provided. For more on incubator math, check out there’s an incubator bubble and it will pop.
The bad news is that it isn’t as simple as that. Startups are not just something that exist in a vacum. There are a lot of unknown variables that can make or break an incubator.
- percentage of startups that fail (or turn into zombies) in the first two years after investment
- time frame return is expected
- how many startups currently produce that kind of return annually
- total number of startups that receive investment in any given year
- total number of acquisitions in any given year
- avg. number of years a startup takes to get to acquisition (because they aren’t going public)
- avg. price a startup sells for (I bet those talent acquisitions drag the average way down)
- what do VC’s currently spend on their deal pipeline?
It is the unknowns that are where the gamble exists. You can tweak the numbers all you would like but assume startups have a no better fail rate then any small business. The common thinking on that is 25% of businesses fail in the first year, 70% in the first five years? If just more than half of those companies are alive in one year you are doing well. If one out of those 20 is acquired in 5 years and you get 3x return do you succeed? Do you have to run the incubator for the 5 years at $1MM/year to be able to play the odds?
Maybe this is why so many incubators focus on office space, it’s easy to show LPs what they are getting for their $5MM for 5 year investment, plus an impressive number of “new” startups that have been touched by the program (often without an exit, you know the way incubators make money).
What am I missing?
Editor’s note: This is a guest post by Jesse Rodgers who is currently the Director of Student Innovation at the University of Waterloo responsible for the VeloCity Residence & he is also the cofounder of TribeHR. Jesse specializes in product design, web application development and emerging web technologies in higher education. He has been a key member of the Waterloo startup community hosting StartupCampWaterloo and other events to bring together and engage local entrepreneurs. Follow him on Twitter @jrodgers or WhoYouCallingAJesse.com.
Related posts:
Since the Mini Seedcamp London is starting today and the good people of ReplyDone asked us about tips for Seedcamp here are some that came up. If you got more please comment below and I will add them to the post.
- First and most importantly have an answer for the question "Why do you need the money". Having no answer or not a sufficient answer ("We may do some marketing") may be a deal breaker. Think about how exactly the money helps your business and why you need the money from Seedcamp for it. Also be honest. If you don't need the money you won't fool anyone there. If you need the network, but not the money say so.
- Read through the list of mentors and get an overview who everyone is. Write that down (maybe crowd sourced google doc). Think about the questions you have for all the mentor groups (Marketing, Sales, Investors, Tech, ...) so you got something to ask anybody.
- Go through the list of Startups and try to see which ones you would like to talk to the most.
- Think about and get Feedback on all the weak points in your Idea. e.g. Why use your service, what if "big company xyc" does this. The Investors will ask you those questions and if you don't have a sufficient answer they will ask the question again and again and again.
- When answering a question take your time. Think about the question and the underlying meaning of the question. For example we were asked if a huge company could do the same thing we do with their current infrastructure. I answered as a techie and said no and listed some techie reasons. Let's say they were not impressed. The real question was what if they step into this market and the answer should have been then the market is already pretty big since they are multi million dollar companies. Thus I only care about the other startups in that space and how I can be the one big enough to either partner with the big company or get bought. So stop thinking as a techie. At least a bit.
- Business Cards FTW. Prepare some case where you put all the business cards you will get into. You don't want to lose those. Use a CRM to store your contacts. Highrise has a free plan that my be sufficient for now.
- See which other Startups from your area go there and book your accomodations together. Drive there together and drive home together. We had great feedback sessions with the Blossom guys at Ljubljana. Very valuable. Also someone to take you home :).
- Don't forget to put some numbers about your market into the pitch. No one is interrested how your technology works, as long as it works. Everyone wants to know how you make money (at least the people that count there)
- Don't hesitate to tell someone "Then you will maybe never be my customer". We talked to one guy who would probably never use our service out of very legitimate reasons. In a private conversation you can discuss that, in a more public setting don't hesitate to say "Then you will never be my customer". Don't get dragged into an open discussion with someone who will not use your service. There is nothing to gain out of having that discussion publicly in front of everyone.
- Introduce yourself over the mailing list. If you are the first one (damn you Thomas Schranz from Blossom for beating me to it) everyone will read it. But provide some interresting or helpful information with your email, for example a crowd sourced mentor google doc.
- Have Fun and go to the parties. Talk to everyone at the parties and dance dance dance.
- Last but not least get Mike Butcher to sing a song with the name of your Startup in it. Or any song for that matter. You may not get money or fame from that, but damn that was fun.
Best of luck to all the new Seedcampers and hopefully this helped you somehow.
Railsonfire provides you a simple hosted system to test every change you do in your application and if everything works deploy to your staging or production environment. We support GitHub as your git repository and Heroku as your Hosting environment.
We always want to improve our service and it would help us a lot if you could answer a few of our questions
[This blog post was originally published at Marc's blog on March 1, 2010.]
At our new venture fund, we’ve been spending time looking into new ways that will make the lives of entrepreneurs seeking funding easier. To that end, we’ve linked up with Ted Wang who has been working on an open source legal project called the Series Seed documents. We’re impressed with his work and are going to use these standard funding documents as part of our seed stage investments wherever appropriate.
We have to give a big shout out to Ted: he nailed this. It’s exactly in step with our intention of letting entrepreneurs focus on building businesses in today’s environment, without having to follow old VC rules.
In a nutshell, entrepreneurs and the businesses they are starting have evolved. Start ups today don’t need to build a manufacturing plant (as DEC, the very first high-tech VC investment, did in 1957) to start a business. They need less money to build a product and prove that it works before scaling the business. Yet, the paperwork involved in funding entrepreneurs hasn’t changed to meet these needs. Series Seed is the first to establish this new way of supporting funding suited for today’s entrepreneurs – and we’re big fans.
Let us know what you think: check out the Series Seed documents, and share your thoughts.
Here’s more background on our thinking behind how entrepreneurship has changed, creating the need for these simplified funding documents. I’m speaking here from the point of view as both an angel investor and a venture capitalist, two very different kinds of investors.
Angels vs. Venture Capitalists
Why do angel investors exist?
Before answering these questions, it’s useful to ask and answer a related question: why are there angels and why have they become more prominent in the last 10 years? After all, doesn’t the definition of venture capital include all of the activities that angels perform?
The answer lies in the history of technology companies and the differences between how they were built 30 years ago and how they are built now. In the early days of technology venture capital, great firms like Arthur Rock and Kleiner Perkins funded companies like Digital Equipment Corporation (DEC) and Tandem. In those days, building the initial product required a great deal more than a high quality software team. Companies like Tandem had to manufacture their own products. As a result, getting into market with the first idea, meant, among other things, building a factory. Beyond that, almost all technology products required a direct sales force, field engineers, and professional services. A startup might easily employ 50-100 people prior to signing their first customer.
Based on these challenges, startups developed specific requirements for venture capital partners:
- Access to large amounts of money to fund the many complex activities
- Access to very senior executives such as an experienced head of manufacturing
- Access to early adopter customers
Intense, hands-on expert help from the very beginning of the company to avoid serious mistakes
In order to both meet these requirements and build profitable businesses themselves, venture capitalists developed an operating model which is still broadly used today:
- Raise a large amount of capital from institutional investors
- Assemble a set of experienced partners who can provide hands-on expertise in building the product and then the company
- Evaluate each deal very carefully with extensive due diligence and broad partner consensus
- Employ strong governance to protect the large amount of capital deployed in each deal. This includes requisite board seats and complex deal terms including the ability to control subsequent financings
- Manage own resources effectively by calculating the amount of capital/number of partners/maximum number of board seats per partner to derive the minimum amount of capital that must be invested in each deal
It turns out that building a company has changed quite a bit since the early days of venture-backed technology companies. Building a company like Twitter or Facebook is quite different from building Tandem. Specifically, the risk and cost of building the initial product is dramatically lower. I emphasize product to distinguish it from building the company. Building modern companies is not low risk or low cost: Facebook, for example, faced plenty of competitive and market risks and has raised hundreds of millions of dollars to build their business. But building the initial Facebook product cost well under $1M and did not entail hiring a head of manufacturing or building a factory.
As a result, for a modern startup, funding the initial product can be incompatible with the traditional venture capital model in the following ways:
- Lengthy diligence process. Venture capitalists take too long to decide whether or not they want to invest because they are set up to take large risks and have complex processes to evaluate those risks.
- Too much capital. Venture capitalists need to put too much capital to work – often a VC will want to invest a minimum of $3M. If you only need 4 people to build the product and get it into market, this likely won’t make sense for your business.
- Board seat. Venture capitalists often require a board seat and, for that matter, a board of directors be formed. If 100% of the company is building the product and the team knows how to do that, then a board of directors may be overkill. In addition, it may be too early to decide who you want to be on the board.
As a result of the above, a venture capitalist usually requires a serious commitment from the entrepreneur to pursue an idea that is highly experimental. If the product doesn’t stick, it might make sense for the entrepreneur to pursue a totally different idea or drop the business altogether. This is much easier to do if you’ve raised $300,000 than if you’ve raised $3,000,000.
As entrepreneurs needed someone to bridge the gap between building the initial product and building the company, angel investors stepped up.
Angel investors are typically well-connected, wealthy individuals. They generally use their own money and come with none of the above VC constraints describe above: they don’t go on boards, they don’t need to put in lots of capital (in fact, they usually don’t want to), they prefer dead simple terms (as they often don’t have legal support), they understand the experimental nature of the idea, and they can sometimes decide in a single meeting whether or not to invest.
On the other hand, angels do not manage huge pools of capital, so entrepreneurs need to find someone else to fund the building of the company (as opposed to the product) and most angels do not plan to spend a great deal of time helping entrepreneurs build the company.
One more thing before answering the original question
Before getting back to the need for the Series Seed documents, it’s important to distinguish venture rounds and angel rounds from venture capitalists and angel investors. It’s possible for a venture capitalist to invest in an angel round and vice-versa. Sometimes this is a great idea and sometimes it’s tragic. We’ll first examine the rounds and then the investors.
When should you raise an angel round and when should you raise a VC round?
This question really comes down to the company’s development. If you are a small team building a product with the hope of “seeing if it takes” (with the implication being that you’ll try something else if it doesn’t), then you don’t need a board or a lot of money and an angel round is likely the best option. On the other hand, if you’ve developed a strong belief in your product or your product idea and you are in a race against time to take the market, then a venture round is more appropriate. You will benefit from both the extra capital and extra support that comes with a serious and large commitment from your investors.
So who is qualified to invest in each?
Obviously angels can invest in angel rounds, but what about VCs? Is it safe to have them participate? The answer turns out to be “if and only if they behave like angels.” What does it mean for a VC to behave like an angel? Well, they must:
- Be comfortable investing a small amount of money, e.g. $50,000.
- Be able to make an investment decision quickly, e.g. in one or two meetings
- Be able to invest without taking a board seat
- Not require control of subsequent funding rounds
- Not impose complex terms
- If the VC wants to be in the angel round, but refuses to behave like an angel, then entrepreneur beware. Having a VC who behaves like a VC in the angel round can jeopardize subsequent financings.
Angels can be great participants in venture rounds, but it’s generally better to have a VC lead those deals as they have more financial and other resources required to build the company.
What does this mean about Andreessen Horowitz and the types of investments we’ll do?
As I stated above, at Andreessen Horowitz, we invest in both venture rounds and angel rounds. When we invest in angel rounds, we behave like an angel. As angel investors, we can invest as little as $50,000, we do not take board seats, and we do not require control.
Rooted in this desire to help germinate quality ideas, our support for Seed Source legal docs will allow both us as investors and the entrepreneurs we fund to focus on building a winning product rather than scrutinizing legal docs.
Mark Suster recently wrote three blog posts about changes to the software industry in how those affect the VC industry. His first post articulated the “it costs less to start a web company today than ever before” point more succinctly and with more data than I’d seen it articulated before. The punchline is in the final paragraph: “Where open-source computing gave us a 90% reduction in our software, Amazon gave us a 90% reduction in our total operating costs.” That post – along with the other two in Mark’s three-part series – is well-worth reading.
In the second post, Mark explains that web and mobile companies have fewer capital costs upfront, so they need to raise less money to fund their first 12-24 months of operation. Mark argues this encouraged smart investors to create venture firms with smaller, more flexible funds – namely, that they can make smaller investments while still taking the time to understand a company’s business and contributing as helpful “active investors.”
Why is being an active investor who makes “small” investments hard for a larger fund? Let’s say we’ve got a $750mm fund that’s devoted to funding early-stage web and mobile companies. Let’s also imagine it expects to put $10mm into each company over a series of financings. ($10mm/company is a number that seems reasonable after watching a year of early-stage financings, but the math doesn’t really change if you double that number.) $750mm fund / $10mm/company = 75 companies you’ll be funding over a ten-year period. But wait! You’re an “active investor” and prefer to take board seats on those 75 companies. 75 boards? How big is your partnership? 8 people, sitting on ~10 boards each? 10 people sitting on 8 board each? And now how much more difficult is it to make decisions with 8-10 people around the table than 2-4 people? You’re getting really busy really quickly.
Union Square Ventures is one of those smaller, web-services-focused funds – when Brad and Fred started the firm in 2004, they correctly predicted it would take less money to start a web company, so they needed to raise a smaller fund. Fred wrote about the capital efficiency he and Brad saw in the USV portfolio in 2006:
So what this says is we are starting our investment positions in our portfolio companies with $1mm and under investments almost half of the time. And the $2.5mm to $3mm starting investment (traditionally the typical Series A round bite size) is only about one third of what we are doing these days.
That is a departure. Maybe a significant departure. But we are comfortable with it …
If internet companies are more capital efficient, have initial rounds gotten smaller?
It seems they should have – the arrival of the Amazon cloud and open-source software – and I’d imagine the size of companies’ first rounds would reflect that.Enter data from Pricewaterhouse Coopers and the National Venture Capital Association, two organizations that collaborate to release summaries of venture capital activity. Here’s numbers for “Internet company” fundraising from 1996 to the second quarter of 2011. The survey aggregates data from a handful of sources and is considered fairly comprehensive.
Surprisingly, it seems like first rounds today aren’t much smaller than they were.
The spiked blue line is the average of what Pwc/NVCA call “first sequence financing” for “internet-specific companies” between the first quarter of 1995 and the second quarter of 2011.
The flat red line gives the 16-year average, which isn’t significantly different from the 10-, 5-, or 3-year averages. Here are those stats, presented as: average (standard deviation.) The standard deviation doesn’t mean a tremendous amount here – the sample size is likely too small.
- 16-year: $4,094,271 ($1,483,344)
- 10-year: $4,050,407 ($1,046,173)
- 5-year: $3,736,960 ($889,660)
- 3- year: $3,476,997 ($965,790)
In other words: the average size of an internet company’s first institutional round is trending downward, but not overwhelming – or again, significantly – so. The PwC/NVCA numbers don’t reflect inflation, but if you add it in, things don’t change much.
Maybe you think quarters are too granular. If you bucket the years and then take the average, the differences aren’t drastic:
- 1997-98: $3,399,568
- 2004-05: $4,539,808
- 2009-10: $2,960,598
- 2010-11: $ 3,633,676
What’s going on?
Well, there’s always Benjamin Disraeli’s explanation (“Lies, damn lies, and statistics.”) A few other hypotheses:1. Data’s too obscure
The PwC/NVCA data isn’t very granular: it’s total dollars invested that quarter and total deals done that quarter without reporting standard stats like a min, max, or median value. It could be that rounds are generally smaller today than they were 7-12 years ago (bubble excluded) but there’s a handful of mega-rounds that skew the average upward. I’m trying to get a version of the underlying data and will follow up with another post if I can.2. Angel funding’s happening before institutional funding
PwC/NVCA only include angel funding if the angels come in to a round alongside institutional investors. It could be that startups are raising their “first rounds” from angels. The first institutional round will come later, after the company’s achieved more milestones, has more growth to show, and potentially higher expenses. If this is somewhat true, there’s a survivorship bias, too: unsuccessful angel-backed startups are unlikely to raise institutional capital, while angel-backed startups that show some sign of success may be likely to raise more capital than startups that hadn’t taken any money.3. “The money we had spent on servers? Yeah, we’re spending that on people”
Just because a company could get started on less money upfront doesn’t mean they have to. $4-5mm today goes longer than it did twelve years ago. On what could you spend that money today? People. Raising more money up front – because valuations are overheated or because of the “big fund” math outlined above – could allow entrepreneurs to take the cash they’d invested in servers and software and put it instead in the hands of new employees. There seems to be no lack of tech companies looking for new employees. This hypothesis provides an intuition explanation for the up-tick in first round sizes in the past 1-2 quarters.4. Longer periods of time between first and second raises
Perhaps startups are generally raising the same dollar amount now as they did 7-12 years ago (again, bubble excluded), but they’re able to go longer between financings the same amount of money.Other thoughts?
This hasn’t happened to me, but I keep hearing stories about situations like the following: 1) startup raises a seed financing round while working on a preliminary idea, 2) founders later “pivot” into a new idea that looks more promising and/or gains traction, 3) founders decide to raise a new round of financing, 4) founders argue that the new idea is so different from the original one that it should be part of a new company, and that the original seed investors shouldn’t own any part of it.
At Founder Collective, we think of ourselves as investing primarily in people, and only secondarily in ideas or products. I have to admit that until I heard about these situations happening, I hadn’t even conceived of the possibility of “pivots into new corporate structures”. In retrospect, I suppose it was inevitable given the founder-friendly market and the rapidly evolving venture environment.
As a legal matter, assuming the founders worked on the idea on the original company’s time and/or money, the seed investors probably have a strong claim. Founders and employees normally sign “invention assignment” agreements that would make the new ideas and products property of the original company (again, these aren’t situations I’m personally involved in so I am just speculating on the specifics). The reality is that most professional seed investors aren’t going to sue founders and will likely instead try to work out some compromise.
This is not to suggest, by the way, that founders are indentured servants to investors. It is perfectly fine, if an idea isn’t working out, to wind down the company, return the remaining capital, and go off and work on new ideas. If one of those new ideas shows promise, the founders are then (legally and morally) free to form a new corporate entity and raise new financing from whomever they choose. From news reports, it sounds like this is what the Odeo team did before they pivoted to Twitter. It’s the conventional and, in my view, correct way to handle these situations.
Here’s what really worries me. If it becomes a norm for founders to jettison seed investors when their company’s focus changes, seed investors who invest “primarily in people” will stop doing so. I think that would be a real shame: we’d lose an important source of capital and a lot of innovative startups wouldn’t get funded.
Pense primeiro em facturar, antes de se meter em despesas. Cada vez mais há que pensar assim, não só para aqueles que querem iniciar a actividade, como para quem quer fazê-la crescer.
I couldn't sleep last night so I figured I'd see if I could confirm a nagging suspicion about the early-stage VCs I know. About six months ago it seemed like they were slowing down their pace of investing while the corporates and newer super-angels were doing a lot more deals. If this were true it would be an interesting warning sign.
So I downloaded d3.js, pulled out the list of VCs I put together for VCdelta and built a visualizer for Crunchbase data. It's fun to play with*.
Here's a graph of the deals the 150+ VCs have done since 2005, according to Crunchbase. If you go to the site and click "All" at the bottom, you get this, except it's live to add and subtract either VC firms or round types from and you can hover over the bars and see the names of the companies invested in that month**. You can also, if you click the subsets below, see who I included and who I didn't. And then add or subtract to your heart's content.
What looks like a small downturn in 2008 and 2009 in deals done is mainly due to VCs continuing to do later rounds--B and later. I assume many of these were into companies that were already portfolio companies.Here are all the VCs, but just the rounds tagged Seed, Angel and A.
This makes it easier to see the dropoff in 2008 and 2009. But the low point in early stage investments came later than I thought, in 2009. It had seemed to me that early 2008 was dryer. Also, according to Crunchbase, more early stage deals are getting done now than in 2007.New York City is on a roll, right? Right. Below are the NYC funds (not NYC deals) and how many early stage (Seed, Angel, A) deals they did.
Compare this to Sand Hill Road:
Sand Hill Road has remained relatively conservative into 2010 and 2011.Some other VC subsets. I used the top 20 venture capitalists in Forbes' Midas List to create a 'smart money' subset of firms. Here are their early-stage deals. The pronounced uptick from the lows in 2008 and 2009 into 2010 and 2011 are heartening.
I also made a subset consisting of firms that have been around since before the 1980s, the 'old school.' I assumed that if they've made it this long, they must be doing something right. Their increase in early stage investments, while less pronounced, is also heartening.
Last, the Super Angels. No surprise here.
The one thing these graphs don't do is support my original thesis, VCs are not slowing down their funding of early-stage companies. Interestingly, I found that even the VCs who have flat-out told me they are slowing down their investing are not really doing so: while there's fear in the market, VCs are also clearly seeing opportunities they can't turn down.-----
* d3.js is awesome. The Yieldbot guys turned me on to it. I'm just learning it, so I know I'm manhandling it something awful, but it's a joy to work with.
** Let's do the usual caveats: Crunchbase data sucks for this kind of thing. It's incomplete, it's biased, it's not very clean or accurate, etc. This is all completely offset by the fact that it's free. If I had a better dataset, I'd use it, but I don't.
Don't worry, we won't post anything.
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