- Are Eyeballs Good Enough?
- Intent, Term Sheets, and Off Limit Questions
- Where Are My IPOs?
- How Did We Get Our Idea For Our Startup?
- I've Got Angels Who Want To Invest But Not Lead - Now What?
- What's An Appropriate Equity Package For A Founding Board Member?
- More Thoughts on Structuring an Angel Investment
- Founders Termination Clause In Term Sheets?
- What Kind of Benefits Can I Expect Working at a Startup?
- Getting Into The VC Business
- Should You Expense or Capitalize Your Engineering Costs?
- Should I Be A Shareholder Representative?
- Term Sheet Glossary
- A VC's View on Why Startups Fail
- Should I Protect My IP Before I Try To Build My Product?
Are Eyeballs Good Enough? - Top
Q: In the era of "free" software, would a mobile software startup be committing short-sighted suicide by attempting to price their product at all? These days, it seems that "eyeballs" are considerably more valued than short-term monetization. Facebook being a prime example: they avg a mere $3.00 in gross revs per active user annually, but yet they hold a $15B valuation. Within the VC community, how much weight does the "build it now - figure out a way to monetize later" type model still hold? Are you seeing any trends of push-back against this model?
A: (Brad) There was a time not so long ago (1999) when it didn't matter how much revenue you had, or how much money you made (or more likely - lost) - all that mattered was how many eyeballs you had (and how fast that number was growing.) If I remember correctly, that cycle didn't end too well.
While there are plenty of different things going on this time around, ultimately all businesses have to generate a profit (and positive cash flow) to be valuable. But that's the not the question you asked.
These days, it seems that "eyeballs" are considerably more valued than short-term monetization. The key word in this statement is "short-term". In the short-term, it's important that you get enough critical mass behind your mobile app and this generally means users. However, with the emergence of the iPhone App Store and the crazy disruption it and the iPhone are having on the mobile phone and software market, I'd assert that all bets are off right now on what the best "short-term" strategy is.
For example, I'm aware of several very popular iPhone apps that are free; I'm also aware of several that generated significant revenue in the first week for their publishers.
Ultimately, if Apple is successful, it will help establish a new market price points for mobile apps that will range from "free" to "something". I don't think anyone knows what that range is yet, but it's not going to be "free" to "free". And - as a result, you shouldn't view pricing your app as "short-sighted suicide", unless of course you price your app too high (where - in many cases - the max price you can charge is nothing.)
I'd be a lot more worried about having an app that no one cares about.
Intent, Term Sheets, and Off Limit Questions - Top
Rick Segal has three great blog posts up this 4th of July weekend. He's Canadian so I expect he is still working - maybe we'll see a fourth from him.
Happy 4th Rick. Keep writing.
Where Are My IPOs? - Top
Today's great post of the day is from Fred Wilson titled The IPO Debate. There were no VC-backed IPOs in Q208 - the first time this has happened since 1978. The National Venture Capital Association (NVCA) is doing a big media push to get the word out about this and what it thinks is the underlying cause and ultimate impact on innovation in the United States. Fred has some great thoughts on the issue.
How Did We Get Our Idea For Our Startup? - Top
Q: We just started looking for venture funding and I have a question. Why do VC's ask us how our idea came about? Are they looking for an emotional and inspiring story or are they worried that we may have taken our idea from someone else or, what I believe is the case, do they want to see if we were driven by an opening in the market that we observed? Of course, if we are giving our answer in a way that addresses one or two of these issues then you are probably missing the third. Please help!
A: (Jason) Without sounding too glib the answer is "all of the above and maybe more, probably." Your guesses as to why are probably accurate and it, of course depends on to whom you are speaking with. I'll address each of your guesses individually.
1. "Emotionally and Inspiring Story" - Without getting all Sally Struthers-like, it is nice to see engaged and passionate entrepreneurs. Building a successful startup is really, really tough. If you aren't in love with the company going in, it will not turn out well for you or your investors. That being said, don't put on an act.
2. "Taken Our Idea from someone else" - This is a big one. If you come and pitch a next-generation social networking site and previously worked at Facebook, we are going to have an in-depth discussion. Maybe you didn't steal it, but maybe your former employer will have a claim on the intellectual property developed while you were employed.
3. "Driven by a new market" - This also might be part of the question. Whatever VC you speak to, you should know more about your market than they do. I, personally, ask many questions and rely on them as part of my education. Maybe you really have found an "unscratched itch."
One other potential reason is to see how you sell the vision and product. You are going to get this question often from potential customers and this is a way to see you sell and see how efficiently you can answer a potentially complicated question.
Or, perhaps it is just a trite icebreaker and the VCs are just asking you this so they'll have time to answer emails on their blackberry while you wax poetically.
I've Got Angels Who Want To Invest But Not Lead - Now What? - Top
Q: I have several angels that say the want to invest but non of them wants to lead. In your experience: 1) Is this a "call option" strategy rather than a serious investment intent? 2) any thoughts on how to turn "co investors" into lead? or should I try to get a lead of this "co investors" pack?
A: (Brad) While it's hard to tell whether this is a call option or serious investment intent, it is not that helpful in getting the round pulled together. When doing an angel round, you need two things: (1) a lead investor who is willing to negotiate terms and (2) supporting investors that won't lead but are committed to participating on whatever terms the lead negotiates with you.
While you can't contractually commit the supporting investors, you can usually separate the real ones from the tire kickers (or - more generously - the call option people). Committed supporting investors are going to let you use their names with potential lead investors, will engage in active networking, and will name a specific amount they are willing to invest.
These supporting investors are typically called "soft circles" - you've got a commitment from them, but it's not a legally binding one. A soft circle will always have a dollar amount attached to it.
So - don't try to convert these "followers" into "leads". Instead, try to get them into a supporting investor / soft circle mode.
What's An Appropriate Equity Package For A Founding Board Member? - Top
Q: I am trying to determine the appropriate equity position for my startup's board members. They are arguing that they are "founding" board members. They have put in a few hours a month of their time for around a year, have been very helpful with introductions, and have sat in on VC meetings. We are seed stage (pre-A). Can you suggest a range of equity for a "founding" board member? While you referenced the concept in your "Compensation for Board Members" article, you did not detail any specific ranges.
A: (Brad) I think their equity as "founding board members" - given your description of what they have been doing for you - should map to the post Compensation for Board Members or Board Member / Advisory Member Compensation. Specifically, you are in the 0.25-1.0% vesting over 2 to 4 years zone.
I don't really believe there is a "founding board member" construct. The opportunity for these early board members - in addition to the options you will give them - is to be able to invest at a very low valuation ($1m to $2m pre-money). You should give them this opportunity well in advance of approaching VCs.
More Thoughts on Structuring an Angel Investment - Top
I'm not a fan of convertible notes as the form of an angel investment. When I'm making an angel investment, I much prefer to price the round and do a "light Series A" (simple terms, but still a preferred instrument.) Basil Peters has a series of posts up on Angel blog that talks about the problems of Convertible Notes for Angel Investing, suggests Exchangeable Shares for Angel Investors, and even provides a One Page Term Sheet for Angel Investors.
Founders Termination Clause In Term Sheets? - Top
Q: Thank you very much for your term sheet series. Not being that familiar with "specific" term sheets, I have heard something about VC terms that effectively allow the VC to fire the founder(s) and in the process relieve them of their shares since they had then left the company before liquidity. I have read a previous Ask the VC post about the 'moral' and 'reputation' reasons that VC's will not do this.
However I am more interested in the legal binds and would like to know if these sort of terms are something that is standard/negotiable in various term sheets.
A: (Jason). There is certainly nothing in a standard term sheet that specifically addresses this. I've seen founder / CEO termination clauses in term sheets that effectively say "if X, Y and Z doesn't happen, you are fired." I've always found these to be egregious and worse yet, sets up the VC and founder / CEO to be enemies, not collaborators trying to help the company be successful.
As for different mechanics that a VC might use to remove a founder / CEO / founders, etc.:
1. Board control - if the VC has board control, or the ability to elect a majority of the board, terminating founders and / or executives is fairly simple;
2. Voting rights - be careful that there aren't any non-standard control provisions in the voting rights that allow the VCs to vote people "off the island."
As far as acquiring the terminated party's shares, I've never seen a VC with a contractual right to be able to do this. I've seen some documents which gives the shares back to the company, but never the VC.
And shares going back to the company is rare as well, so long as we are talking shares that have vested under a option plan or are not subject to some sort of repurchase. Those shares should be free and clear the property of the terminated party.
What Kind of Benefits Can I Expect Working at a Startup? - Top
Q: What kind of benefits do start-ups typically offer? I don't mean salary or equity: about which you already posted a lot of information. I am talking about health and life insurance, disability insurance - all of the typical benefits one receives when working for a large and established business.
Do you recommend a particular benefits package configuration to your companies? Are benefits ever a part of your conversations with your companies about the 'costs' of running the business?
How do you see startups dealing with a regulatory landscape designed for an entirely different type of organizations?
A: (Jason) In order to best answer your question, I asked Dan Cutler from TriNet to opine. Dan and TriNet have been great partners to our portfolio companies - so much in fact that we decided to switch our own benefit offerings over to TriNet. Here are some of Dan's thoughts, below of which I agree with completely.
A typical VC backed company will offer to pay 100% of a good benefits package for the employee and between 0-50% for dependent coverage. A good package will include medical options PPO and HMO and dental, long-term disability and a minimum of 10K life insurance with an option to buy more.
In order to hire and retain "A" players the savvy entrepreneur will use a PEO (Jason note: "professional employee organization" like TriNet) that can offer self-help HR, online enrollment, several benefit plans to choose from, a PeopleSoft HRIS, tiered pricing, and will pay a flat rate administrative fee.
Regarding compliance issues. All energy spent by the business owner to keep compliant is a waste of time when you can outsource HR and allow your outsource provider to shoulder the risk. The business owner's job is to move the business forward and select good partners that will provide assistance in areas that are not core.
Getting Into The VC Business - Top
Fred Wilson has today's great VC blog post up titled I Got Lucky. It's the story of how Fred got into the VC business - going back to 1986.
I met Fred in 1996 the same day I met Seth Godin at Yoyodyne (which ended up being the first investment out of Fred's new fund - Flatiron Partners.) Fred and I have been good friends since and I count him as one of my favorite people on the planet to work with. While it's fun to read the story, the punch line is powerful and important for anyone that wants to get into the venture capital business.
If you want to be a top tier venture investor, you must be recognized as one of the experts in the field you invest in. When I was at Euclid, I used to watch in admiration as guys like Bill Kaiser worked the enterprise software business or Paul Ferri worked the communications equipment business. They knew the business cold and if you wanted to start a company in their area of expertise you went to them first. That's what you have to get to if you want to make top tier returns in the venture capital business.
The way you do that is you work for at least ten years in the industry, getting operating experience, building a killer rolodex, and learning how the business works from the inside. Then in your mid to late 30s, you can make the move to the venture capital business, as a partner, not as a wet behind the ears associate who doesn't know anything other than how to push numbers around a spreadsheet.
I did it all wrong and got lucky. I don't recommend anyone reading this to try it the way I did it. If you choose to get an MBA, get a real job out of business school. Help to build a few businesses in an industry sector you really like. Become an expert in that industry. Then try your hand at venture capital. You'll be much better at it than I was my first ten years in the business.
And don't forget - eat your wheaties.
Should You Expense or Capitalize Your Engineering Costs? - Top
Q: At RealNetworks we always expensed (vs. capitalized) engineering expenses (as does MSFT). What is your philosophy on this engineering accounting practice.
A: (Brad) Subject to approval by the auditors, I always encourage companies I invest in to expense their engineering costs.
Regardless of the accounting treatment, I think it's a bullshit practice to capitalize engineering expenses. In an early stage company, this simply serves to obfuscate the reality of the P&L by transferring real expenses to an asset on the balance sheet which is subsequently depreciated over a multi-year period of time. The result - investors and managers have to work harder to understand the P&L and the real economic dynamics of the business. It gets even worse in a mature company, especially one that is public.
However, our good friends the auditors get in the way on this one and encourage some engineering (and R&D expenses) to be capitalized. Oh well - we need to follow the rules. But that doesn't mean we have to like them.
Should I Be A Shareholder Representative? - Top
Note: This was actually a question that I received from a colleague via email, but thought I'd post it here given the content.
Q: My company is close to signing a contract to sell the business. Although I’m prepared to do the role, one of the board members has suggested that we consider using a third party shareholder representation firm instead. Jason – I see that you’re involved with Shareholder Representative Services, the firm my board member suggested. I’m pretty committed to my company so what are the advantages and disadvantages of going with a third party rather than just doing it myself? BTW, I’m currently the CFO and plan on staying on for at least a while post closing.
A: (Jason) My short answer is that under most circumstances you want to avoid this job if at all possible. The shareholder rep issue is a problem that we and many other VCs have been struggling with for years on our M&A deals. Most buyers require that the stockholders appoint someone to have power to speak for all of the stockholders following closing to ease the administrative process. On most of our prior deals, somebody (usually one of the VCs) had to be the rep, and usually nobody wanted to do it. To be blunt, the job sucks. It takes a lot of time and is a big distraction if the person does the job properly, and not doing it properly can subject the person to risk of being sued under some legal theory like negligence, breach of fiduciary duties, unequal treatment, conflicts of interest or something similar.
In your particular situation, you have the added complexity of inherent conflicts of interest. If you are going to work for the buyer following closing, which is effectively what will happen if you continue to work for the company, you’ll have the problem of having to argue on your former stockholders’ behalf against your new employer if any claims come up. That significantly adds to the legal, ethical and emotional challenges you’ll be facing if you serve as the representative, especially if you personally have financial interests on one or both sides.
For all these reasons, I got involved with Shareholder Representative Services. I serve on their advisory board, but more importantly, our funds have used them on a few of our recent exits and have been very pleased. The selling company hires SRS to serve as the shareholder rep, and they professionally manage the entire process. We’ve found that we get better information and quicker responses from them than if one of the other investors serves as the rep, we get to avoid the risk and burdens of being the rep, and we still maintain significant involvement in the decision making process when material issues do arise.
Because of SRS, we’ve determined as a fund that it is highly unlikely that we’ll ever serve as the rep again – it would have to be a deal with unusual circumstances that I can’t think of right now. It’s not a good use of our time and is not in the best interests of our fund or our LPs. Besides, we hire professionals to manage every other aspect of the M&A deal process. Why wouldn’t we do the same with respect to the post-closing period?
Term Sheet Glossary - Top
Gigaom's FoundRead has today's great post up titled F|R Crib Sheet: The Term Sheet Glossary guest written by Jay Parkhill. While you can always entertain yourself for hours with the Term Sheet Series that Jason and I wrote several years ago, sometimes a crib sheet will suffice.
A VC's View on Why Startups Fail - Top
David Feinleib at Mohr Davidow Ventures has today's great post up titled Why Startups Fail. Given all the consumer web stuff that got funded between 2004 and 2006, we are heading for another wave of failure as companies run out of gas after their Series B / Series C rounds and their investors lose patience with them. In addition, you've got the natural cycle of "well - it never really worked" - such as evidenced by the rumor from VentureBeat that Akimbo has thrown in the towel after raising $47m.
Should I Protect My IP Before I Try To Build My Product? - Top
Q: I've got a software startup that has a novel approach to solving a market problem. However, the solution stems from the nature of the process, not from the code per se. In terms of trying to finance the venture, would this necessitate getting enough funding to be first to market and just try to grab validation/market share before the copycats (especially those with deeper pockets) come around, or is there actually IP that can be protected within the design of the process?
A: (Brad) As a deep cynic about software patents and IP protection around process technology in software, my short answer is that it's better to go build the product (and the business) rather than spend your limited time and resources on the IP protection. My position is not a uniform one - many people would encourage you to put real energy and time into trying to protect your IP before you build the product.
In almost all situations I've encountered, I encourage the entrepreneur to just go build the thing. I continue to be amazed that the number of entrepreneurs searching for money who want me to sign a non-disclosure agreement before they will tell me what they are working on, or who think they have a truly novel (and non-obvious) approach to something where the patent is the key to the long term value of the business. There are lots of ways to protect your software ideas - the best way to do it is to get on with building something that it truly valuable for your customers.