Author Archive

Don’t Have A Lazy Relationship With Your VC

Today’s great post is from Bilal Zuberi @ Lux Capital. In it he asserts that Friends Don’t Let Friends Have a Lazy VC/CEO Relationship. I see this play out so many times in so many ways that – while it seems obvious – it’s an important reminder to all entrepreneurs who hear their friends complaining about their relationship with a VC.

Oh – and make sure your VC has a sense of humor. For example:

Hornik: Get an Introduction

I love it when David Hornik – one of the very first (maybe the first) VC bloggers writes a post. Today’s is Want to get funded? Get an introduction! So simple, yet so often overlooked or ignored.

The punch line – it’s the transitive property that we learned about in elementary school math:

So how do you get funded?  Step one — get an introduction.  Find someone you know who can introduce you to the person you want to pitch.  The closer your relationship with the person making the introduction, the better.  And the closer that person’s relationship with the VC the better.  I’ve written about this before and described it as “borrowed credibility.”  If you are being introduced by someone who has credibility with the VC, and you have credibility with the person making the introduction, you will have credibility with the VC.

I learned about this in elementary school math class — it is called the transitive property:

if

A has credibility with B

and

B has credibility with C

then

A has credibility with C

And as a corollary to the traditional transitive property, (1) the stronger the credibility between A and B, and (2) the stronger the credibility between B and C, (3) the stronger the credibility between A and C.

If you don’t follow VentureBlog, you should. It’s the original.

Reid Hoffman – New VC Blogger (Essayist)

Reid Hoffman, founder / executive chairman of LinkedIn and partner at Greylock has started blogging. Well – he’s started writing long form essays on a blog that my understanding is will come out about once a month.

The first post is If, Why, and How Founders Should Hire a “Professional” CEOIt is outstanding and I expect Reid’s blog should be on your must read list. My only complaint is there are no comments open – I’d encourage Reid to engage with people reading this, rather than just lecture to us!

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What Is The Appropriate Time Horizon Of A Financial Model for VC’s?

Q: When building a financial projection model for a pitch to VC’s, should you include future rounds of funding in the model or simply show what measurable goal you are trying to achieve with the current round you are seeking?

A (Brad): It depends on the stage of the company. But first, it’s important to understand how a VC is going to look at your projections in the first place.

  • Early and pre-revenue: Investors are going to be most interested in your near term burn rate and how long their money is going to last. Focus on putting this information front and center – don’t hide it. Recognize that your revenue is totally speculative so the “base case” is going to be zero revenue.
  • First product in the market, < $100k / month of revenue: Revenue matters here and the projections out into the second and third year will give a good indication of how you are thinking about the ramp of your business. However, if your revenue is modest, a smart investor is going to look at your gross margin also. If you are a recurring revenue business, the month-over-month growth – both of revenue and gross margin, is going to be important.
  • Meaningful revenue, > $1m / quarter: You have entered the zone in which you have a real business and likely can have a credible growth plan out three or more years.

Now, in every case, a VC is going to be interested in how long the current round of financing is going to last. In early cases, they are going to focus on cash / monthly-burn-rate. In later cases, they will factor in some amount of revenue and gross margin projection, but likely discount both, viewing you as being overly optimistic on revenue as well as the gross margin percentage.

Then, building off of this, they will be interested in how much additional money you think you will need to get cash flow positive. They’ll calibrate this against whatever your current plan is. The earlier the life of your company, the more skeptical the VC will be of any projections of revenue, and any time horizon greater than one year.

Update: I just noticed a twitter comment that said “I would suggest that it should take you up to their expected exit as that is most definitely their primary concern.” While some investors may ask for this, it’s the exception as most rational investors will want to understand what it takes to be cash flow positive. It’s impossible to predict the exit as there are too many variables at play, including the notion that you can’t force an exit. However, you can run a business indefinitely without additional financing if you are cash flow positive. So I’d assert that showing the plan getting to cash flow positive is much more important than showing the plan getting to an exit.

Where Are The Best Executive Programs and Crash Courses for Venture Capital?

Q: As a rookie VC trial by fire is a great way to learn. Aside from crunching through some early deals, where are the best executive programs and crash courses for newbies to the VC world?

A: While self serving, we recommend you start with our book – Venture Deals: Be Smarter Than Your Lawyer And Venture Capitalist. In addition, there are a bunch of courses now using the book that are referenced on the web that include additional materials that are helpful.

Jason also did an excellent Crash Course on Venture Capital – the 90 minute video is below.

Venture Capital Crash Course with Jason Mendelson from Andrew on Vimeo.

Berkeley has an excellent Venture Capital Executive Program as do Harvard and Stanford. In fact, a quick Google search on Venture Capital Executive Program turns up a bunch of great resources.

There is also extensive information on the National Venture Capital Association website, the four day Venture Capital Institute is entering its 38th year, and the Kauffman Fellows Program is entering their 18th year.

If you know of other web based resources, please add them in the comments.

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Is There More Than One Type Of Convertible Debt?

Troy Henikoff and I had lunch a month or so ago in Chicago and the conversation turned to convertible debt. I’d recently made an offer to invest in a company Troy was an investor in and the entrepreneur and I got tangled up in the definition of pre and post money in the context of existing convertible debt. In this case there were multiple traunches of convertible debt at different valuation caps. My offer was above the highest cap, but I interpreted the way the convertible debt, and pro-rata rights associated with it, worked differently than the entrepreneur did. Given the magnitude of the convertible debt, the way the debt was handled had a significant impact on the post money valuation dynamics. Ultimately, the entrepreneur and I couldn’t narrow the gap and we didn’t end up working together.

There were no hard feelings on my side (I like the entrepreneurs a lot) but it made for an interesting and awkward discussion. Troy did a great job of processing it and wrote an important, and thoughtful blog post, titled Convertible Debt: really Bridge Loans and Equity Replacement DebtIf you are an entrepreneur who is raising, or has raised, convertible debt, I encourage you to read it carefully.

In our conversation, we talked about a nuance which Troy left out – namely that the magnitude of “equity replacement debt” matters a lot. If it’s a small amount (say – $300k or less) this issue isn’t that severe. But once it gets up to $1m or more, the problem often appears in a big way. My partner Seth covered this nicely in his post That convert you raised last year is a part of your cap table.

All of those convertible debt rounds that happened in 2010, 2011, and 2012 – including a bunch of uncapped ones – are now turning into either equity rounds or unhappy situations. The more everyone on both sides understands the dynamics, the more effective the future financings, including the future convertible debt rounds, will be.

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New VC Blogger – Greg Gottesman (Madrona)

My long time friend and favorite Seattle VC Greg Gottesman has started blogging. Greg’s a great writer and super thoughtful investor so I expect his blog will be one to read and comment on. It’s certainly going to be in my daily blogroll.

Greg and I are currently on the boards of Cheezburger and Startup Weekend together. We had several shared investments over the years including both good and bad ones. I’ve always had deep respect for how Greg thinks, works, and acts. Plus, I just love hanging out with him.

Greg was half of the motive force behind bringing TechStars to Seattle. He and Andy Sack, the TechStars Managing Director, literally made it happen. Greg’s been an awesome partner in the TechStars journey and completely embraces the mentorship model and the notion of “give before you get.”

Greg – welcome to the blogosphere. It’s never too late to join.

What Costs Are Considered Reimbursable To The Founders Of A Startup Company?

Q: What costs are considered reimbursable to the founder of a start-up company?  More specifically, if the founder has been boot-strapping his company since inception, and he agrees to a series a term sheet with a VC firm, are the operational costs incurred by the founder between this time and the closing of the round reimbursable to the founder? For example: The founder of a consumer product company and a VC firm agree to a term sheet in July.  The round doesn’t close until October or November due to raising additional capital for the round, attorney delays, etc.  In the interim, the founder continues to self-fund the day-to-day operations of the business – packaging design, inventory, PR firm, etc.  What expenses can the founder expect – if any – to get paid back out of the series a funding?

This varies widely and is fundamentally a negotiation between the new investors and the founders who have incurred the expenses. The four variables are:

  1. Amount of expenses
  2. Amount of funding being raised
  3. How the expenses have been accounted for
  4. Attitude / style of the investor

As the amount of expenses increases, the willingness of the investor to reimburse for any of them decreases. This is directly linked to the amount of funding being raised. For example, if $1m is being raised and the expenses are $50k, an investor will likely be ok with 5% of the funding getting paid back to reimburse the founders. However, if $1m is being raised and the expenses are $500k, it’s unlikely that an investor will be ok with 50% of the proceeds going to paying founders back for expenses that have already been incurred.

How the expenses have been accounted for also matters a little, if only for optics. If it has been treated as debt advanced to the company by the founders and is documented in an arms length transaction, it sometimes has more impact on the investors. The issues of amounts far outweighs the structural issues, but the structural issues sometimes signal that there was an intent to see the money get paid back at the close of the financing.

Finally, the attitude and style of the investor matters the most. Some investors are adamantly opposed to the idea of paying the founders back any expenses and view this simply as contributed capital to the business. Other investors will view this as part of the investment required by the founders to justify the pre-money valuation. Other investors will simply not want any of their new investment to pay for past expenses. In contrast, you’ll run across other investors who are more flexible, or who are happy to get a little more money into the company at what they believe is a relatively low valuation.

Ultimately, there is no rule – it’s just part of the negotiation.

McClure on Scaling Venture Capital

Dave McClure has a great post up today titled VC Evolution: Physician, Scale Thyself. It’s a long ramble, as is Dave’s style, on a bunch of issues around the evolution of how VC works and scales. I’m an investor in Dave’s fund and have believed in him from the beginning so it’s cool to see him continue to push the edge of things.

While Foundry Group has a very different strategy than 500 Startups, an awesome thing about Dave and 500 Startups is that they HAVE a strategy, which many VC firms don’t.

Do You Need To File A Form D With A Financing?

It used to be the case that whenever a private company did a financing, it filed a Form D with the SEC in order to comply with Regulation D. Suddenly, I’m hearing of lots of situations, especially in seed and Series A financings, where companies are no longer filing Form D. Apparently a number of law firms have decided that a Form D filing is no longer mandatory. After checking with some entrepreneurs who haven’t filed a Form D, their motivation is that they want to keep their financing “secret” so they can stay in a stealth mode for longer.

Jason Mendelson just wrote a post on his blog titled Why is Everyone Hatin’ on Form D? In it he explains the groundrules.

Regulation D requires a filing, but per Rule 507, if you don’t file it, doesn’t eliminate your ability to rely on RegD for the financing.   Therefore a company that wants to be stealth and elects against the advice not to file the Form D is violating an SEC rule, but it doesn’t jeopardize the offering exemption.  4(2) always exists, but that is factual, and in these very early rounds you may have small angels or others who are tricky.

Jason goes on to explain the implications and downsides of not filing. In the comments, Bart Dillashaw weighs in on the best reason to file Form D (it preempts all of the individual state securities laws and regulations.)

Both Jason and I feel strongly you should just suck it up and file Form D. I am completely confused by the advice some lawyers are giving about the reasons not to file. And I am concerned that some VCs are supporting what we think is bad legal advice and this will ultimately come back to haunt some entrepreneurs.