Trading Deals, A Lost Art?
Bijan wrote a good post yesterday called We Gotta Do A Deal Together in which he outlined the common practice of VC's showing each other investment opportunities. That's how I got to know Bijan. He showed us Tumblr. And we reciprocated with Twitter where we serve on the board together. We have five investments in common with Bijan and his partners at Spark Capital, including Bug Labs where my partner Brad first started working with Bijan and his partners three and a half years ago.
So that's a success story in the world of VC deal sharing. But I think this practice is becoming a lost art. When I got started in the venture business in the mid 80s, this was a very big part of how the business worked. VCs would work in packs, called syndicates, and they'd trade deals back and forth all the time. When you had a deal to syndicate, you'd ask your partners "who do we owe one to right now?"
It still happens but there are bunch of reasons why it happens less. Let's start with the healthy reasons it isn't happening as much.
1) Entrepreneurs have all the cards now. They typically control who invests in their companies and they pick the VCs they want to work with. There is a lot more knowledge out there about VCs, which ones are good to work with and which ones are not. We cannot tell an entrepreneur to take money from Bijan and his partners at Spark. We can suggest it, and sometimes they choose to do that. But it is the entrepreneur's call these days, not ours. That's a good thing.
2) VCs are working harder than ever to figure out what are the most attractive investment opportunities. The best VCs go out into the market and figure it out. They don't sit back in their offices waiting for the calls from their friends in the business horse trading deals with each other. That is also a good thing.
But there are some not so good things at work here too.
1) There is too much money in the venture business. Many VC firms want to make large investments and obtain large ownerships. It is very hard to build syndicates these days. It used to be that the first round would be for 40% of the company, with two firms splitting it. We see most first round deals for 20-25% of the company these days. That is very good for the entrepreneur but not good for syndicates. It is more common to see a VC firm to do the entire first round by themselves or with angels, than to see two firms splitting a first round.
2) The markups between the first and second rounds in the best deals can be large. So if we turn to our friends in the VC business and say, "here's a good deal, but you have to pay three times what we paid less than a year ago", they are not always going to look at that as a favor. They might think we are taking advantage of our friendship not facilitating it.
We are thinking about several follow on financings in our portfolio right now. And as we walk through the options with the entrepreneurs, I am often tempted to do the round ourselves (or with our syndicate partners if we have them). If we can make a deal with the entrepreneur that both parties are comfortable with, we keep the team focused on the business and off the road. We keep the company from educating other VCs about how good the opportunity is and less likely to fund a competitor. And we can build a larger position in the company for ourselves and our investors.
We are not the only VCs who are thinking this way. This "do it ourselves" approach has been prevalent in the VC business for over a decade and is gaining even more adoption as VCs figure out how to make money in the new environment we all face.
I don't want to give the wrong impression with this post. Our firm, Union Square Ventures, has and will continue to syndicate deals with other venture firms. If you go through our portfolio, you'll see that we have VCs as co-investors in 22 our 29 announced investments. In the others, we have angels as co-investors. We like to invest with others and continue to try to do that as much as we can. But I feel like we are doing it less than before and I feel like we'll do it less going forward unless something changes in our business or the venture business as a whole.
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Comments (Archived):
great post. couldn’t agree more.i think much of this comes down to the often sacred 20% rule. If firms stick to that rule as religion then healthy syndicates become difficult. If firms are willing to “cut back and make room” then it has a better chance of working for everyone. and ideally, healthy syndicates add more value to the company for the same amount of dilution.
that is right because the more people involved the more connections we can make for our portfolio companies
That growing pool of interested supporters for a startup is hard to measure. It’d be sick to have a million investors all preaching and pushing your company forward (crowd sourced venture capital, lead by firms like covestor).
In my experience, the 15-25% range is typically because VCs want an ownership position that will be significant enough to legitimize their influence and the attention (time, travel…) spent on the company, in the eyes of both the entrepreneurs and VC-side stakeholders.Of course there are much better ways to legitimize power and influence than just that last column in the cap table, but maybe that’s where the leader + follower(s) type of syndicate comes in handy, in the context of a portfolio strategy.
Syndication is primarily a ‘rich get richer’ phenomena. If you look at vcs as a network, where a link between two vcs is formed if they co-invested, you’ll find that there is a huge concentration in this network. There are huge hubs, which mostly reside in sand hill road (with few reps from Boston). That means that these hubs still have a lot of power as the ‘distribution’ channel for other vcs who want in.
Great post Fred. I agree that many funds are less willing to co-invest and go it alone especially in the broader venture industry. That said, I think the NY early stage venture community is still relatively small (both in number of active funds and overall capital invested in a given deal) and that we don’t see that issue as much compared to West Coast funds. Given how difficult external financings are in this environment, it makes sense to have a healthy syndicate from the get-go that can not only provide capital over life of the company but can do heavy-lifting to guide growth. I think funds in NY are also beginning to be more collaborative and open on what they are seeing especially because many opportunities may not be a fit for one fund but could be a direct fit for another (one fund may like applied tech/B2B vs another that likes consumer internet). It is my hope that this continues so the local NY venture community can survive and thrive!
great point about the NY market Somak. i hope we can keep doing it. the key is that our fund sizes are all pretty small here in the early stage sector.
Fred I think this trend is altogether more positive for the Entrepreneur. Too many times investment decisions have been contingent upon a syndication, the “if they don’t invest, we won’t invest” syndrome permeated a lot of deal negotiations and either protracted the closing or scuppered it all together.The only drawback I see, is that the Entrepreneur is more reliant upon the single-partnership with the VC to fund the next round. He can hedge his position better with a syndicate.
excellent points david. you are spot on with both.
Great point on hedging bets with a syndicate for follow on support. Ideally business is booming so follow on investments are coveted, but why not increase your chances by having multiple investors.
“1) There is too much money in the venture business.”I’m going to disagree with this conventional view on the industry Fred. I don’t think there is too much money in the funds per se, rather there are too few viable companies for the level of funds. This means either too much money is being invested too early, or even worse…, money is invested in less-than-viable companies (speculation) for the sake of putting capital to work.As an ecosystem, we need to be looking more at ways of increasing the number of viable companies than we are producing currently. This is where EDUCATION is more important than funding in my view, albeit there is still a significant lack of seed funding for incubating start ups (something VCs do not fund).
IMHO there is too much money in VC funds, and not enough for earlier stages. need less conventional VC funds, more tech stars type stuff. i think the free market, if given enough leeway, can solve this problem on its own. unfortunately for those of us in the USA the proposed legislation that fred talked about that would raise the barrier of entry to be an investor hinders this problem. but, as VCs will increasingly invest across national boundaries, i think we may see jurisdictional conflict and multinational investment syndicates create an opportunity of sorts to solve these problems in an innovative way.
Hey Kid, I agree there is not enough SEED stage funding to get more companies into the viability state. But if I had the choice of: a) Less VC funds for existing viable companies OR b) Existing VC funds for MORE viable companiesI would definitely choose the latter.Our problem is not the level of VC funding, rather its the problem that we don’t have enough viable companies to match existing VC funds. We need to do more, to produce viable companies and this is where EDUCATION as well as genuine SEED stage capital are required.Disregard any VC that says; “we invest in SEED stage”. This is BS. VCs invest in early stage (or later) companies that are viable (w/market traction). We should not blame VCs for this because SEED stage funding is RISKY business.Unfortunately we have few alternatives beyond Angels and Universities (or state aid in Europe) which actually fund genuine SEED stage companies. So any legislation which curtails either of these is BAD for innovation including senator Dodd’s proposals.Y Combinator and Seedcamp are great for SEED funding but we don’t have enough of these incubator programmes and the current funding amounts are too small (only suitable for sustaining quick-to-market internet companies).I think the solution lies in identifying and addressing the reasons why embryonic companies do not progress onto viable companies (again EDUCATION + SEED CAPITAL).
Agreed. But another problem is that Y Combinator and co. are focused on geeks, and geeks will tend to focus on a better way to backup your files. To really change things you need people outside the IT domain, smart people from construction, production, accounting that will bring the disruptive ideas, and THAN get the geeks to build it (this is a generalization off course, but what is great with Mint or Yelp is that they are not an IT feature but a real disruptive demand fulfillment).
I agree full heartedly. We need to invest in manufacturing, healthcare, creative industries and more beyond killing ourselves to find the next great twitter app or facebook app.
Exactly. And when working on twitter/FB, target those areas as well.
By “EDUCATION” are you referring to general higher ed or something more specific?
When I say education I’m thinking on a few things here:open source communities (like this one to help put entrepreneurs in contact w/one another)mentorship programmes (voluntary, university associated or corporate)open source legal, VC and business luminaries (sharing the secrets of their trade, their failures, their recipe to success)incubation programmes Entrepreneurship to be taught and encouraged in the school system from the age of 14+ (difficult I know)Schools of Entrepreneurship (like Schools of the Arts) MBA’s do not suffice, nor turn out EntrepreneursThink of it like this; our entire education system is geared to producing job applicants and not job creators. We teach our children to espouse to become lawyers, professionals or accountants (all job applicants). An adolescent knows what a lawyer is, but hasn’t a clue what an Entrepreneur is. Our priorities on education are all wrong imho. So we need to be educating our students at a much younger age about the art and skills of Entrepreneurship and the benefits to society for having an enterprise culture.We have a lot of the list items I mentioned in place, but we need much more than this. I’m encouraged we have VCs like Fred Wilson, Fred Destin, Brad/Jason and Mark Suster lifting the veil and educating Entrepreneurs on the intricacies of the VC industry. We still need more. I’m disappointed that we don’t have more open source Lawyers and worst of all…., open source Entrepreneurs, men and women who have succeeded sharing their secrets with the rest of us. They’ll author nice books which glorify everything they did, but seldom do they really open up and say “OK, here’s what not to do, and here’s what you should do”.
Thanks for that explication. I see what you mean now, but I am unconvinced. Your idea of focusing more on entrepreneurship among teens is similar to sentiments expressed by Tom Friedman last month. Friedman argued wrote,In a world in which more and more average work can be done by a computer, robot or talented foreigner faster, cheaper “and just as well,” vanilla doesn’t cut it anymore. It’s all about what chocolate sauce, whipped cream and cherry you can put on top. So our schools have a doubly hard task now — not just improving reading, writing and arithmetic but entrepreneurship, innovation and creativity.As I noted in a comment here on Fred’s blog at the time,Not everyone has chocolate sauce, whipped cream, and cherries, as far as talent is concerned.With respect to adults, there’s plenty of low cost or free education and mentoring related to entrepreneurship available now. For example, you can get a certificate in entrepreneurship at my county’s community college, and our local SCORE branch offers free consultations with superannuated businessmen/advisers and low cost workshops. As I mentioned elsewhere a couple of months ago (“The Non-Starters”), Case Western Reserve professor Scott Shane has pointed out that most aspiring entrepreneurs don’t have the chops to start productive, successful businesses, and it’s folly to continue policies that encourage them to do so.
I think you’re right to an extent in regards to inherent talent. However there are FAR TOO MANY talented people out there trying to start businesses and either failing or overcoming failures but taking a long time to get there (ie, make their company viable). Education is required both at a younger age and as well as for current Entrepreneurs.YES, you’re right that there are tonnes of programmes and facilities out there to educate Entrepreneurs. The problem is, Entrepreneurs don’t know about them! I wasted a good 12 months in starting off in business because I read the wrong books, spoke to the wrong people and had to learn the hard way (by trial and error).We need to make learning much easier. And this includes making help more accessible. After all, you don’t know what you don’t know.
Have you collected your lessons learned in a post somewhere? If so, I’d be interested in reading them. I can’t say I learned anything new from my recent visit to SCORE, but it was worth going anyway, just to see if there was a viable marketing tack I hadn’t considered. It was also worth it to have a third party shoot down some well-meaning but unfeasible suggestions by a family member.
Funny you should ask! I’m working on getting my blog set up “Empowering Entrepreneurs” (Christmas homework for me!) where I am going to share my failures and my lessons learned, I’ll invite you when it’s up and would be honoured if you popped in. I’m also going to be doing this LIVE rather than retrospectively. So an idea for example, would be to do a video of me pitching Elexu. Hopefully by video #583 I will have cracked it!
Sounds great David. The more temporally relevant the better. Looking forward to your documentation.
we are in agreement…i view the techstars/ycombinator stuff as being in this genre….tehy leverage stuff like open source docs
great post boss. as much as i’ve got religion on the openness stuff, i actually think vc/investing is where it gets closed. or at least, i favor that route.the future i like most is one in which VC firms are basically economy creators. “network weavers” is probably a term that resonates more with a digital crowd. they invest in companies, and then they help those companies connect. this results in the ability of the companies to amortize all their shared costs. this results in a more efficient investment for the VC, making their dollars more scalable — i.e. it becomes easier to add companies that can easily be integrated into the portfolio. in this way, getting an investment is not just getting money; it is more like joining a family, or getting indoctrinated into a secret society. kookology ftw!
That’s a pretty funky perk, maybe get access to some awesome restricted APIs or libraries as well?
definitely. or conversely, now that twitter API’s is becoming set to turn into a standard, the stage may be set for twitter to create its own investment fund that invests in companies that leverage its API standard. in this way twitter can reduce their own technology development costs, and can easily integrate those companies, which sets the stage for acquisitions of the best companies that have been funded.
Not sure about other hopeful founders, but I’d love to get funded by a couple of investment firms, if and when Victus Media is ready for funding. That event timing will be triggered when we’ve bulls eyed a real consumer/business value proposition and require capital to best execute.I strongly believe getting a couple of well connected and sharp investors is a benefit to any growing business. Ideally I’d like to pitch to USV and the founder collective with a solid client base, and growing revenue numbers as ammunition.I know every deal is different, but how does the ownership transition as a startup proceeds through follow on rounds? Do founders start with 70-80% after the first round, and then exchange 10-20% per round for growth fueling capital?
Yes, or more, depending on how the business grows relative to its capital needs
Got it, thanks Fred. Off to see Avatar, a great indoor activity to compliment early shoveling.
the best way to ask the question isn’t what do founders start off with. its what do founders (and/or all common shareholders) end up with?most vc backed companies end up with preferred shareholders (vc’s) owning 60%-80% of the company. not all. most. which means in most cases founders + management + employees end up owning 20-40%.that’s assuming the company raises several rounds of capital from several investors over several years
Thanks Steven, that paints a pretty good model out.Now my concern, how does a founder run a company but own only 20-40% or likely less.Doesn’t seem very entrepreneurial, feels more like an executive (big manager)
It all depends on1) How big an exit or outcome you envision2) How much compensation or reward you need to feel reasonably rewarded (and what form – money? Prestige? Celebrity?)
I just want the breathing room to run my company. Owning only a very small fraction would appear in conflict with that navigation ability.How could I really provide the best value to users/customers if I was dreaming/concentrating on an exit? Building a business with lasting value is my goal. I see what you mean though, if/when an exit happens how much is enough? That’s easy, enough to pay the bills and maybe some seed cash to give it another go.
Remember how much the founders owned in gamesville when it sold to lycos steve?
indeed I do! but that was because we only raised VC many years after we started, and were already a healthy standalone entity, so we only raised one round before the sale of the companyin my original comment above, i qualified my remarks when I wrote – “that’s assuming the company raises several rounds of capital from several investors over several years”fred, you have tons of data. if you are amenable, give us the actual numbers — in your firms’ portfolio companies, what is distribution of percentage of the company is owned by preferred shareholders at exit?
I’ll have to pull that togetherDo I include the stock founders have sold along the way?
But the best companies often exit or get to sustainability with the founders owning vastly more
But the best companies often exit or get to sustainability with the founders owning vastly more
Remember how much the founders owned in gamesville when it sold to lycos steve?
What sort of distortions do you think this excess of money in venture capital is having on the economy?
This I’m interested in as well. Does it mean the investors (partners) can’t find other viable routes to invest in given the markets current condition (so longer term/growth options are more attractive)?
the biggest thing it will do is give more acquisition power to VC-backed startups, so that it strengthens capital as a competitive advantage against unfunded startups. that is the harsh reality, though many folks will naturally want to avoid it. this will also make the companies that have too much capital too likely to spend and thus be too inefficient, and to spend in the wrong areas. for instance, they may hire too many developers, which would create excessively high prices for developers, or something like that.
same as always, higher prices, reduced purchasing power of savings, transfer of wealth from lower classes to higher classes (i.e. inflation tax), excessive investment in unprofitable areas (i.e. malinvestments) — this delays/hinders real economic recovery.but VC fund size is symptomatic of the larger money supply issues, VC is just another domino that keeps the chain going. fortunately we are reaching a point of self-awareness and thus will soon improve the situation.
Not much.
Given the size of the overall economy relative to VC funding, you’re probably right. But I wonder if the surfeit of venture funding has exacerbated issues in media businesses, for example. By allowing currently unprofitable venture-funded Internet companies to offer their services at no charge, perhaps venture capital has helped condition consumers to expect things online to be free.Another possible example of distortion: I’m struck by the contrast between the amounts of money being raised by certain currently-unprofitable Internet companies compared to the negligible amount of initial capital raised by a tiny, publicly-traded manufacturing company with which I am familiar. That manufacturer is now growing its earnings rapidly, and so far has financed its growth organically. I’m used to thinking of manufacturing as being capital intensive relative to Internet businesses, but has the excess of venture capital money flowing into Internet businesses skewed that?The excess of venture capital raises a meta-question as well: why are you still investing in it? I realize you have to continue to tend to your current portfolio, but why not invest new money in a less crowded area, where you have potential for higher returns?
last question first: it’s all i know how to do.on the manufacturing company vs venture capital: those who invest in themanufacturing company will be rewarded if it is in fact a good investment vsventure capitalbottom line is i believe in the efficiency of markets over the long run andthe inefficiency of them in the short run
Couldn’t you transition to investing in early stage public companies, i.e., the (legitimate) ones that go public early on the OTC BB instead of bulking up with VC money first? I agree with your point about the long term efficiency and short term inefficiency of markets (Graham’s voting machine versus weighing machine). I just found it interesting that a manufacturing company serving heavy industry would be less capital intensive and require about a hundredth of the start-up capital as some prominent social media businesses. That seems like it might be an example of the distorting effect of excess venture capital.
Adding a few points I often hear from founders to a really good thread. I have found that many entrepreneurs become a bit ‘nervous’ when faced with a recommendation by a VC to partner with another firm where many deals have been shared. It would be good to gain insight into this communities perspective on them. The concerns voiced are:1. Gee, if you have shared so many deals together, if the going gets tough here, and legitimate disagreements are voiced, is the ultimate loyalty to the Company, or is to the relationship shared amongst many deals2. Is the recommendation given because the other VC is really the ‘best’ or is it because ‘you’ owe them one3. If you share so many deals, am I (the entrepreneur) getting real incremental value from bringing them on board.
All of those are legit and are healthy skepticism
Fred, thanks for the interesting post. I am curious to know how you usually see (or want to see) the board seat situation working out if it is a 20% round and there is a syndicate.
Usually one seat for VCs
As you worte Fred, Investing in herds per-se , is just plain conformism (reminds me the bubble times when you had to say B2B).However, syndicating deals is very important because it allow VCs to take higher risks.Now it seems that everybody is trying to lower the risks: build a tiny “one feature” startup, finance after beta, after enough traction is gained, and exit quickly with 20-30M$ Google acquisition. Rare founders dare to go all the way (maybe the Friendster post-trauma). They are sucked and more often than not die.This lower risk taking can turn the whole VC-startup industry into mere outsourced R&D of existing players.By working together, VCs can take higher risks, and continue to bring real game changers, companies that will go all the way. Maybe the compromise here should be to allow the founders to cache even in the middle of the road in order to safely reject small acquisition opportunities.
Will the emergence of smaller funds begin moving in the other direction?
Getting more value added partners on same dilution is always a plus.The real question is not the quantity of partners – but their quality.Most people forget that, whether you are an entrepreneur or a fund, if you share holings in a company you are, all, long-term business partners. And partners need to be chosen well.So the value of greater access to connections and resources (which can be substantial) needs to be supported by a team that can work very well together (in both style and substance/alignment).Otherwise, more shareholdings means more headache.In this, I believe too many entrepreneurs and VCs alike are blinded by rolodexes and brand names (of both funds and entrepreneurs). Businss is conducted by people and not resumes. So it is critical the people pulling their capital and time together are committed to the same values and goals.It’s a trivial comment on my part all-in-all. Surprisingly, it is not commonly practiced…
apparently the all-time deals syndication is marriage
As long as you marry well and for the right reasons that can be a good thing
yes
big, big thanks on this post (and the comments)!!i always thought the VC ‘syndicate’ preference was a bit of a paradox; if the best opportunities are so hard to find, why be so eager to share them? …..is it more a risk reduction strategy (i won’t get fired for buying IBM because everyone else does too) or a desire to network value creation (more vested people means more push for success)? this post really helped me understand the VC mindset on this…or at least yours :)my main thinking from the entrepreneur side is that investment capital is liquid and will find opportunity – it is the basis of capitalism. the job of the entrepreneur is to work your butt off to 1) create the most concrete and compelling investment opportunity possible, 2) ensure an efficient investment market for it. and if you can’t get it to work the way you think it should be, look in the mirror because you haven’t done 1) or 2) nearly as well as you think you have.
Hi Fred,Regarding “Entrepreneurs have all the cards”, could it be maybe that’s because you are mostly fishing in heavily fished waters? Maybe there are regions in the US where there are many striving entrepreneurs and essentially no investors willing to even consider web-related deals? (I can think of at least one. :)Just something to ponder…
yes, and NYC is not as heavily fished as Boston or Silicon Valleywe need more early stage VC in other locations around the country
At least the entrepreneurs can get-go and launch without any funding at all. 10 years ago we didn’t have Rails/Django, cheap VPS and mature open-sourced OS/DB/dev tools, so most entrepreneurs needed funding from day 1. And now, over the years, there are also much more internet start-up veterans.
Do entrepreneurs really have all the cards right now? if so, why are valuations so low?Perhaps its not the entrepreneurs that hold all the cards, its the VCs that all stick to the (exact) same playbook.”Playbook” companies are rare as as companies die trying to become “playbook compatible” of which the VC needs “20-40%” of. (Series A playbook company consists of 40%/30%/15%/15% for founders/angles/employees/ESOP. The CEO of a playbook series A company is an inexperienced founder. Playbook companies are all showing playbook traction ($300K-$1m revenues) in one of the playbook’s (V3 revised) markets).Which leads to limited number of qualifying companies, almost no diversity for VCs and a very high barrier for entry for non playbook companies to raise VC money.I do believe however that you need to break some rules to become a disruptive company. Why not start with the rules of the playbook?
i agree with the comment but not that valuations are so low$5mm to $10mm for a company with an idea, some code, and a few employeesseems like a lot of money to meand $500mm for Yelp, $1bn for Twitter seems like a lot of money to memaybe valuations are too high, not too low
yelp goes all the way. another Google is born?
HopefullySeeing more of this lately and its a good thing
I agree about yelp and twitter (didn’t you participate in the last twitter round?)However for seed companies, it’s below “reasonable financial venture” threshold.Only 5-10% of startups get funded.Out of those 33% fail, 33% break even for VCs (founders get nothing), 33% exit (averaging $120m).Translated into ROI, this is a high risk investment, with an average ROI of some 4%.
I’m curious of the downside for the entrepreneur in working with a syndicate.In a perfect world, it’s upside for everyone, but I have to imagine there are some VC syndicates driving down valuations, negotiating terms together, etc – in collusion against the entrepreneur.Perhaps a subject for another post…
I’m asking Bijan and Brad, too.Maybe you guys should syndicate for a blog. 😉
We do at times
Fred:When considering an investment, on what merits do you decide whether a deal is a syndicated with angels, with other VCs, or go-it-alone through USV?
Entrepreneur’s wishes, deal size, and valuation, in that order
I totally agree. We must invest in manufacturing, healthcare, creative industries, and then kill themselves to find the next great application Twitter or Facebook Apphttp://www.mobilephonebatte…
the problem is only that the ideal scenario is we invite our friends to invest at our initial price, not 3x our initial price
You don’t invite friends in at the new round’s price, perhaps with a discount? That would appear fair in my book.
Not to the entrepreneur who deserves the market price
Ahh I see to conflict. So entrepreneur’s do the negotiating. I suppose venture firms could be willing to spread their investment by offering some of their own ownership but that might be seen as a lack of faith in the business by other investors.What if entrepreneur’s and VCs both agreed on a strike price for new shares and the source of the ownership could come from either party? Is that how it’s done now?