Great Angels Need Cheap Seed Rounds

Rinoa's limit, Angel Wing.Angelish Image via Wikipedia

One of the startups that I’m supporting just ran into a classic problem. It’s a great little company: big market, clear proposition, customers with cash, generating revenue, en route to CFBE, etc. They got the attention of a great angel — one who could really help with business expansion, but there’s no deal to be done. The founder pulled in non-web angel money just as he got started — at too high a valuation. The best angels won’t play above a $2M pre-money without extenuating circumstances.

By all means be a complete lunatic about keeping control (which this founder pleasantly did). However, think hard about whether or not you’ll want to do a flattish round a year from founding in order to upgrade your seed investors. It’s more likely than you think.

[NB: @toddsampson and I are going to start using the tag founder independence to start organizing our work on the topic, inclusive of Lifestyle Capital. I’ll tag older posts as I run across them.]

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reblogged from: bijan sabet

Exit Strategy

bijan:

When I meet an entrepreneur for the first time I like having a conversation about the idea or see the product (or prototype) in action or even a “chalk talk” for those of us that are more visually inclined.

I’m generally not a fan of slides, especially if it’s an early stage company.

But if the founder wants to use slides then I usually go along. Founders should use whatever tools they feel most comfortable.

The one thing I am allergic to is when a founder includes a slide that says “Exit Strategy” and then has a few bullets that says “IPO or sell company to company a, b or c.”

Oy.

An early stage company should be thinking about how to create something great and how they want to get there. How to build value. Not think about exits.

Now most VCs that I know feel the same way about that dreaded slide. But there is a topic where I’ve seen disagreement amongst successful VCs related to the concept of exits when considering an early stage investment. Some VCs will think about who might be the potential buyers of the company.

They do this analysis upfront because most companies never go public. So they want to know if there could be multiple buyers of a company someday. If there aren’t any potential buyers then they it might impact the VCs decision.

I don’t see the world that way.

If you build a great company then you don’t have to worry about exits because you will have many options (e.g. public, get profitable & stay private, secondary offering, sell the company).

I believe there have been many exits where the actual buyer wouldn’t have been on any list at the time the initial venture investment.

This is just speculation on my part but at the time of the initial investment in the following companies who would have guessed the ultimate buyer:

-Flip Video (Cisco)

-Danger Research (Microsoft)

-Daily Candy (Comcast)

-Sling (Echostar)

The list goes on.

Yes, you can imagine the strategic rationale for those deals. But not on day 1 of the venture investment. The world just moves too fast to try and predict this stuff. And it’s not the most important question anyway.

We would all agree, the real question is whether a particular team & product can make something special.

Rafer sez:
I want to hear about liquidity early, but the median deal size and half-life of the deals I’m involved in is much, much smaller/shorter than yours.

Your list of acquirers is a pleasant surprise for exactly that reason. Great startups of (from your model’s perspective) decent scale jump on large, nascent markets before incumbents can. The incumbents slowly adopt the market perspective of the best startups during the startups’ period of most aggressive growth. When those market perspectives are most convincing and the incumbents have to change their market participation significantly, the incumbents acquire those influential startups.

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"The angel network is asking chapters to waive their presentation fees for “true startups” — companies that have no revenue and less than $500,000 in capital and are trying to raise less than $500,000 from investors, said Randy Williams, Keiretsu’s founder and CEO. Williams said the change is not a response to the recent attacks on the fees launched by investor Jason Calacanis — who has promised to start his own angel network on Monday, November 16, unless Keiretsu and several other angel groups drop their fees — but have been in the works for several months. Keiretsu also has no plans to drop fees for other entrepreneurs."
—

Sleepy Bulldog at Mahalo HQJasonC’s Dog by cfinke via Flickr

peHUB » Keiretsu Forum To Drop Fees For Early-Stage Startups

Rafer sez:
Gimme a break. Don’t deny that JasonC influenced you about startup pitch fees. ‘We rarely let pre-revenue companies pitch, so we threw the droolin’ loony a bone,’ would have improved your reputation. This silly fable doesn’t achieve that.

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"So I’m stuck with the paper shuffler and the Blackberry man. I am not kidding you when I say that I was on the verge of literally saying, “let’s just call this meeting a day. It’s clear you have no respect for me and no interest in my company."
—

Marine parachuting at Parris Island, S.C. (LOC)Image by The Library of Congress via Flickr

Retro: My Favorite Blog Post on Raising VC

Rafer sez:
You shoulda pulled the rip cord. I have. Done politely, there’s no penalty. When it’s clear there is no chance that the firm will invest, all you do by staying is share competitive information that marginally hurts your startup.

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"It is shocking when you read someone as prominent as Dave McClure, writing a blog post like this. Whatever offense he believes Jason Fried committed, his piece makes Jason’s post seem mild and uncontroversial."
—

Why does everything suck?: Can’t We Disagree Without Being Disagreeable

Rafer comment on Hank’s blog:
Hank,
Dave is a little like that in person. It’s a persona he grooms and which works for him. He’s also a very worthwhile guy to buy a beer for.

I usually prefer the sort of civil discourse that you promote in this post, but I really support McClure’s lack of civility here (my reblog of his post — http://bit.ly/1lgMg ).

While titfortat is a bad idea unto itself, you neglect to mention that Fried’s post title is “[Aaron Patzer] bends over.” Fried’s rhetoric has moved well beyond the threshold of reason and into an apparent attempt to talk down everyone who has chosen a path different from his. I agree with Fried that institutional venture capital is rarely an appropriate way to enrich founders or make a difference, but that’s a long way from damning others for doing so.

Fried’s ignorant, bigoted homophobic imagery aside, accusing Aaron Patzer of being anything but brilliant and successful is deeply misplaced. Fuck him.

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Sharks in the Seed Water

closeup of the teeth of the tiger shark, showi...Image via Wikipedia

I figured that a “you’re being lied to” post about some startup funding topic would be a great Sharks post for Tumblr. The specifics were a little too easy to find. VentureBeat is distributing some bad, bad info to startups here. I’ve re-ordered the author’s bullet points to make things easier.

Good

* Avoid giving investors more than a 1x liquidation preference, and try to ensure that it is “non participating” (i.e., after the investors’ preference is taken, all remaining proceeds are allocated only to the holders of common stock).

* Don’t give investors Series-A-type control rights. A VC should expect to receive one board seat, but not to control the board, following a seed financing. Also, while it is customary to give investors voting “block” rights on financings and on a sale of the company, entrepreneurs should avoid granting voting rights that give VCs blocks on operational matters at this stage.

* Keep other “investor rights” to a minimum. For example, try to avoid granting demand registration rights, ROFRs on founder stock transfers or drag-along rights.

Bad, but an easy mistake for an attorney to make

* Beware of the negative market perception that results when the VC that seeded your company declines to participate in the Series A. This happens. Raise this issue with the seed VC early on to assess the risk of this happening, and always keep your communication channels open with other VCs interested in what you are doing.

If an decent-sized institutional VC participates in your seed funding, the situation is far more predictable than appears here. The next round had better be pretty big, and you’d better treat the VC like they are the presumptive lead investor. If both conditions aren’t met, the VC will be disruptive — because acting that way is their job. You should expect them to be diligent and conscientious in performing that job.

Just Bad, Bad, Bad, and he musta known it

* Don’t give away too much of the company too early. VCs shouldn’t expect more than around 20-40% of a raw start-up when investing seed-stage.

If you are selling more than 25% of your company in the seed round, you really need to decide whether to continue at all. If you sell more than a quarter of you company at this early stage, your likelihood of making real money is too tiny to both with. Please note that, my priority is entirely founder-wealth creation. The civic and other qualitative benefits of the startup aren’t something one can include in an objective framework.

* Many VCs will want a “super-pro rata” right in seed deals, giving the VC the right to increase its ownership percentage in the next round. This is not necessarily unreasonable, but take care to ensure that in agreeing to super pro-ratas the company is leaving room for a new VC to lead the next round.

Never, ever sell super pro-rata rights. Unless that investor owns a completely trivial fraction of the company, it puts them completely in control of all future funding and therefore the startup.

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"The entrepreneur is the customer and the LP is the shareholder. That’s the only way to think about the venture capital business that makes sense to me."
—

The VC’s Customer (continued)

Rafer sez:
I don’t agree with Fred on this, which isn’t comfortable but needs to be said. I think the VC is the customer.

Shareholders are simply a special kind of customer, who are buying a less well-defined good for fairly significant money (in terms of dollar scale, regardless of pricing) and therefore very reasonably getting a special say in how that good is defined.

I got into this conversation last night with the new CEO of Shozu Chris Wade, who agrees with me on the point above. We realized that much of the later angst about VC deals is that we are all analyzing the deals wrong. We’re looking at the deal terms solely at the moment in time that the deal is being done.

These customer-supplier relationships normally last years. We all need to figure out a Lifetime Value of the Customer analysis, which we do not yet have.

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Deprogramming VC & Reprogramming SWOT

SWOT analysis diagram in English language.Image via Wikipedia

Much is written about both whether or not the VC model is broken and how to evolve startup business plans in the face of market changes. Today, it hit me just how inextricably linked the two issues are and how my own tactical process needs to catch up to market realities.

I spent from 1992 to 2006 presuming VC-backed startups were the business I was in, and I worked towards understanding that system. After all that time, two things happened to radically change my outlook.

  1. I finally figured out that one should only raise VC if one is already rich,
  2. I also figured out that being boring and late has better risk|reward characteristics than being sexy and early, and
  3. Cloud computing arrived, making VC deal terms economic only as growth capital for Internet startups, leaving the early-stage field clear to angels (and bootstrapping).

Taking any number of lessons from Mashery’s good work, Lookery is a cloud-hosted SaaS vendor that uses an API to provide deep benefits to its customers and suppliers. Like Mashery in early 2007, we’re actively sorting our which customers and which decision makers love us and which look at us crosseyed (or don’t look our way at all). We have numerous data points in each category and the right kinds of patterns are emerging.

The problem is 15 years of old work vs. 3 years of new work. I haven’t finished retraining myself not to presume VC. I find myself mentally parcelling out multimillion dollar budgets that don’t exist. More importantly, calculating low-capital SWOT is not truly intuitive, particularly when analyzing VC-backed companies in Lookery’s market sector.

The VC-backed companies in our sector (principally Blue Kai and  Exelate) are doing a great job getting and giving data distribution via cookie exchange without the benefit or overhead of a centralized profile hosting system.  Cookie exchange works well for many user-targeting applications, but there are a few key tasks that aren’t covered including:

  • Efficient combination of data from multiple sources;
  • Forcing and enforcing the anonymization of targeting data without depending on good behavior by publishers and/or ad networks; and
  • …

Lookery exactly runs that exact scaled profile hosting system, and it changes the equation — but how in a SWOT context? We’re angel-funded and intend to remain that way until we’ve completely nailed the revenue model (see #3 above). Relative to the other sector participants, our near-term enterprise value calculations and related tactics are different. My erroneous, knee-jerk reaction is to compete directly with them but that makes no financial sense. They have an order of magnitude more resources (from their VCs) and a lot more pressure to scale revenues quickly without much regard for expense (also from their VCs). We certainly grow revenues every month but breakeven in Q4 is a much higher priority than absolute scale right now.

The punchline on SWOT for Lookery in 2009 is to build on the unique strengths of our system putting priority on relationship depth and interconnectedness. We want to be our customers’ profile hosting and delivery system — and the one they want their partners to use. That means of our customers require a little more care and feeding, plus we have to be careful to disclaim all rights to their profile data. It’s business that the heavily funded startups can’t quite slow down enough to satisfy, gives them a good reason to do business with us, but is healthy enough to drive us to scale next year.

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