Archive for the ‘Fundraising’ Category

How Can I Invest In A Venture Capital Firm?

Q: Your site talks a lot about VCs investing into companies but I can’t find any information online (even on the VCs websites) about how VCs solicit investors to their funds.

I want to invest with a VC but I don’t know what is the minimum VCs accept. Who in the firm should I contact to invest? What kind of terms should I expect? What kind of returns does an investor normally expect? How soon would I get my money back with the profit? Would I be in a position to make demands and say "I want a fourth of my investments to go to XYZ company that is looking for VC funding"? etc.

A:  (Jason) Most venture firms do not take individuals as investors unless they have a pre-existing relationship with them.  Most VC investors are institutions, endowments, pension funds and other corporate entities that professionally and regularly invest in VC funds  As an individual, your best way of investing is either through high net worth family office organizations or through your financial broker, if they participate in these types of offerings.  Because of this, and because of securities laws that I won’t bore you with, you’ll never find information on VC websites on how to invest. 

As for your ability to control terms or designate investment particulars, this probably won’t happen.  The large institutions that invest in funds drive terms, not individuals, so if you do decide to invest, you’ll piggyback off the terms the VC fund and it’s largest investors negotiate. 

Am I In Trouble If I Don’t Raise Money From Kleiner?

Q: It seems that the venture community is dominated by a very few large names (Kleiner, Sequoia, etc.).  If I don’t get funded from one of those firms, is my company toast?

A: (Jason)  Nope!  While Kleiner and Sequoia deserve their great reputations, the list of successful venture backed companies that had syndicates that didn’t include either Kleiner or Sequoia is extremely long.   While having a great VC firm as an investor is often very helpful, the idea that you are “toast” if you don’t have an investment from one of them in nonsense. 

The real key is finding a partner at one of these firms who understands your business and whom you think you’ll have a great working relationship with.

Should I Pay My Venture Capitalist To Consult For My Company?

Q:  My company is backed by VC firm to whom we also pay a $2k/month "consulting fee." We have raised approximately $2MM from them in a Series A. Is that type of consulting payment typical in an early stage venture?

A:  (Jason)  I want to vomit again.  We received this question just a  few short days after posting that entrepreneurs should NOT pay their lawyers for introductions to VCs and how scummy of a practice that was.

Now today, we get this question.  This is even worse.  The answer is NO.  Companies should never pay their VCs consulting fees, board attendance fees, or any type of fees related to their involvement in their company.  I’ve never worked with a reputable VC firm that charges their companies to help them succeed.

As a venture capitalist, we are paid a management fee by our investors that is our "salary" and we receive a percentage of the profits (called "carry") on our fund.  We don’t get paid to sit on boards and certainly it is not appropriate for them to "round trip" your investment capital by paying themselves part of it. I would wager to guess if their investors knew they were doing this that the investors would revolt.

I’m sorry to report, but not only is this not typical, it’s unheard of in the venture world when dealing with reputable folks.

(Note, private equity is a totally different matter and fees are commonplace, but it’s a totally different model)

Should I Pay My Lawyer A Success Fee For Venture Capital Intros?

Q: My lawyer is asking for a "success fee" for a referral to a potential investor in my business. Since he’ll be doing the legal work, he’s offered to charge only 3% on the amount funded (solely from this one contact) as opposed to a 5% that a typical investment banker would charge (even though he’s not an investment banker himself).

As this is the first venture I’m actually raising capital for, I am simply unfamiliar with this practice in the legal world. Is this a common industry-wide practice? Should I be wary of this offer? Although I don’t feel like he is trying to take advantage of me in any way, it does feel a bit like he’s trying to double-dip.

A: (Jason)  Without sounding too unprofessional, I want to vomit.  This is egregious behavior by your lawyer and you should not accept paying ANYTHING to him for introducing you to potential investors.

First of all, it’s part of a lawyer’s job to introduce you to any investor contacts he may have.  If you get funded, he gets paid and gets to bill you throughout the lifetime of your company.  If you don’t think he is already making enough money, see my post on start-up lawyer compensation from my personal blog. 

Second, while investment banks may offer you a deal at 5% (and in my experience this can be negotiated down), individuals who find money for you (normally called "Finders") normally charge in the 1-2% range, so his quote is at least 50% too high.

Lastly, venture capitalists prefer to invest in deals without finders.  We don’t like funding a company that has to pay someone part of the deal proceeds.  We want our money to be used to operate and grow the company.  You will see many VC term sheets that have provisions that specifically call out the absence of finders fees. 

So yes, your lawyer is double dipping.  And that is stating it very nicely. 

How Did We Get Our Idea For Our Startup?

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. 

Do VCs Fund Entrepreneurs Who Have Failed At Previous Ventures

Q: Are you aware of any VC’s that have funded founders that have failed at their previous ventures?

A: (Brad) Absolutely.  Me!  Any many other VCs.  Failure is a normal part of entrepreneurship which I’ve written about extensively in the Failure section on Feld Thoughts.

My favorite entrepreneurs to fund are those that have had at least one success and one failure.  While it is a cliche, failure teaches the big lessons.  Most importantly, entrepreneurs that have some failure under their belt have humility and perspective that I think is deeply useful in the creation of the company.

There is a perspective – promoted by some people – that the best serial entrepreneurs have never been unsuccessful.  This is a myth – the vast majority of successful entrepreneurs who I know have a long string of failures in their past.

This applies to VCs and angel investors also.  If someone tells you they have never lost money on an investment or have never been involved in a venture that didn’t work, you should give them a very skeptical look.

Tranched Financings

Q: What type of structure have you seen where the VC agrees to fund over some time period 18-24 months and up to some level.

A: (Brad): These are commonly called "Tranched Financings."  The typical approach is that a VC commits to fund a specific amount in multiple "tranches" based on the company achieving some milestones.  For example, assume a $10m financing broken up into two tranches – an initial $5m investment on day 1 and another $5m investment after 12 months assuming the company "releases a product with performance characteristics acceptable to the investor."

There are numerous derivatives of this case.  The valuation on each tranche (or price per share) can be held constant or can vary (typically increase) for the second tranche.  The trigger (what causes the second tranche to get funded) can either be under the VC control (similar to a put option) or the company control (similar to a call option).  The amounts for each tranche can vary (they don’t have to be the same) and there may be even more tranches (I’ve seen situations where there are monthly tranches over a twelve month period.)  Finally, the characteristics of the trigger vary widely.

An alternative approach is to have a warrant attached to the financing round that is exercisable at the discretion of the investor within some time period.  This serves a similar purpose to a tranched financing, but gives the investor more control and potential option value in the case where the company is acquired early before the warrant expires.

Tranched financings tend to come into play more frequently in downside cases where a company and its investors are trying to extend the company’s life either to an exit event or another financing.  In these cases, the investors want to run a single process within their firms for getting approval for an investment, but then want to maintain control over how much money they invest at any given time in case the deal goes completely south (leaving the flexibility to decide to pull the plug in the hands of the investor.)

Occasionally tranches are used in the early stages of investments although more recently I seen the "warrant approach" instead of a tranched approach.

How Does A Small Angel Investment Impact a Future VC Round?

Q: Say I have an angel (SEC accredited) who’s ready to invest at an amount well below $100k. How would this impact on a future round with VCs? Is there some standard or average pre-money and post-money that happens in angel deals? Also, the angel in question is a family member of a friend, so would it be better to have them invest as a family/friend financier rather than an angel, and how exactly would that work?

A: (Brad) Let me address the last question first.  There is no real difference between a "family/friend" investor and an "angel" investor other than semantics.  Structurally and functionally they are doing the same thing.  Now – there might be an emotional difference when you have to see your "family" at Thanksgiving, but that’s it.

Regarding how a VC will view this, sophisticated VCs are used to having angel investors as early investors in your company.  Your life will be made easier if you treat the angel investment as a real investment and document it legally as such – I’ve written about this in What’s The Best Structure For A Pre-VC Investment

Insuring that your angel investors are accredited is important as this is likely one of the things that will matter to the VC.  If your angels can be specifically helpful to your company (because of their background / experience in companies similar to yours) you should make sure the VCs know about them.  In addition, you should try to enlist your angels in getting you connected to VCs that they know and have worked with.

Finally, there is no standard pre-money/post-money in angel deals.  We typically see pre-money ranges between $1m and $3m for angel deals, but they occasionally go higher and sometimes go lower.  Be careful not to price the angel round too high as the VCs are going to likely ignore the angel round pricing and – if they price their round lower – it can be a difficult conversation with the angels who supported you early on.

Why Isn’t There A Network or Hub Connecting Venture Capitalists With Startups?

One of the questions we get often is whether or not there is a central clearinghouse or hub (social network?) where VCs and entrepreneurs can connect.  The idea is that VCs would find good deals and entrepreneurs would find funding.  The answer is "no."  Lately, on top of the questions, I’ve gotten several business plans that seek to create such a network.  So why aren’t there any?  And if not, should there be?

I’ve always been pretty negative about the idea.  In general, I think there would be a natural adverse selection to those who would populate the network.  Here’s why:

1.  Great VCs already have more great deal flow than they can fund.  Therefore, they will not be interested in such a clearinghouse and will "opt out" from participating.  Also, keep in mind that there is always a higher hurdle to fund a deal that hasn’t been started by someone whom the VC doesn’t have some previous experience with.  If the best VCs opt out, then likely, so will the best entrepreneurs.

2.  Repeat entrepreneurs (who have had success in the past) already have a VC network.  They’ll likely opt out because they already know VCs from their prior successes.  In fact, most of these types of deals are done quietly without a lot of shopping around.  This assumes that the entrepreneur liked his/her VCs at his last company.  If not, it will still be very easy to find backers for a previously-successful team.  Successful founders are always hot properties. 

3.  First-time entrepreneurs who have executive-level experience are at most one degree separated from a VC network.  Even first-time folks who have been part of a successful startup probably got enough "air time" at board meetings to get to know the investor syndicate and thus have their own network.  If not, they can usually gain access through their former CEOs and other management executives. 

4.  It’s not really that hard to find VCs.  Unlike 10 years ago, there are many more VCs out there and many of us have our email address on our web site.  It’s not that hard to just email and ask!

So, who is left to be a part of a community like this?  It looks like first-time founders / unsuccessful repeat entrepreneurs who don’t know how to find email address on the web.  Yes, I’m being a bit glib, but the bottom line is that I’ve never thought that the "best of the best" would end up a part of such a community and is the reason why there isn’t one today and probably not one tomorrow.

Do Venture Capitalists Always Get Veto Rights On A Company Raising More Money?

Q:  Is it customary for an equity investor to have a veto right over future investments that are at parity or senior to that series?  Do you see it often?  Do you ever see it limited by the percentage ownership (e.g. if the series becomes a less than 10% shareholder, the veto right goes away)?

A: (Jason)  It is customary.  In fact, most times the previous investor gets a veto right on all equity financings, senior or junior and in some cases even debt issuances.  This is one of the “standard” terms that Brad and I blogged about in our term sheet series regarding the protective provisions section of financing documents.  As for a limitation, yes, it’s not unusual for the term to go away if X% of the preferred outstanding at the time the provision is adopted remains outstanding.   What is X?  I’ve seen anywhere from 25-75%.  50% seems to be non-controversial. 

Note also that beside the veto right, the prior investors will also have a right of first refusal to participate in whatever financing you are contemplated.  Here’s our prior post on the subject. So while they can say “no” to a financing, they can also say “yes” and either participate or not.

None of this is “as bad as it sounds.”  Remember, the VCs are going to want money to come into the company, if appropriate.  Without it, the company (and their investment) will not be worth much.  When it typically gets to be a problem is when a company raises several different rounds of capital and each series of stock has a separate veto right, instead of an aggregate veto right across all preferred.  There have been situations where a new / contemplated financing round is good for some of the prior investors and bad for others.  In this case, separate veto rights can, indeed, cause a problem.