Posts from August 2010

Some Thoughts On Convertible Debt

Seth Levine has a long and thoughtful post on convertible debt vs equity. If you are an entrepreneur or active in the angel/seed sector, you should read it. He wrote it in response to Paul Graham's tweet that said:

Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.

I am sure that Paul was talking about angel/seed rounds and was not suggesting that convertible debt has "won" as the preferred financing structure in the venture capital business. But since our firm does participate in select angel/seed rounds, this was interesting to me.

I have been doing venture capital for 25 years now and have also done many angel investments personally along with my wife. We have never done a convertible debt round. That run may soon come to an end if Paul is right. Maybe I will have to join the convertible debt parade.

But I don't like convertible debt for a host of reasons.

It used to be that convertible debt was a lot easier and cheaper to do legally. But with non-negotiated "light series A docs" from most top venture law firms out there, you can do a Series A Preferred for less than $5000. And these light Series A documents focus on economics not control and governance, just like converts do. So to me that is not a valid argument for doing convertible debt anymore.

It still is true that negotiating valuation can be very tricky in an angel round and it may be better to defer that negotiation until the next round. That is what convertible debt does. But I am a sophisticated investor. I do this for a living. I can negotiate a fair price with an entrepreneur in five minutes and have done that for a seed/angel round many times. So I don't think that argument applies to an investment I am making either.

Fans of convertible debt argue that debt with a valuation cap is no different than a priced equity round. That is true if the valuation cap is the same as the valuation that the investors would pay if it was equity. But if that is the case, then the entrepreneur is getting screwed. He or she is agreeing to either take the valuation that would have been offered, or something lower if the next round is lower. That is not a good deal for the entrepreneur.

In truth. there are many convertible debt deals getting done right now with very high valuation caps and some with no valuation caps. In that instance, we are simply seeing the impact of limited supply vs excess demand come into play in the angle/seed market and we need to call this what it is – a price increase.

And that is what I think Paul is actually seeing. He has done such a good job with Y Combinator and his leadership and vision has inspired a wave of seed and angel investment in web services that is unprecedented. That wave is creating price expansion. It is a seller's market and will be for some time to come. And then things will settle down. And when they do, I think we will see the angel/seed market return to a more normal place. A place where priced equity deals between entrepreneurs and sophisticated investors is the norm.

Of course, I could be wrong about all of this. It could be wishful thinking so that I don't have to eat my words and do a convert. That may well happen. Maybe very soon. Maybe my next deal. But I won't be happy about it.



What A CEO Does

I am posting this as a MBA Mondays post. But I did not learn this little lesson at business school. I learned it from a very experienced venture capitalist early in my post-MBA career.

I was working on a CEO search for one of our struggling portfolio comapnies. We had a bunch of them. I started in the venture capital business just as the PC hardware bubble of the early 80s was busting. Our portfolio was a mess. It was a great time to enter the business. I cleaned up messes for my first few years. I learned a lot.

Anyway back to the CEO search. One of the board members was a very experienced VC who had been in the business around 25 years by then. I asked him "what exactly does a CEO do?"

He answered without thinking:

A CEO does only three things. Sets the overall vision and strategy of the company and communicates it to all stakeholders. Recruits, hires, and retains the very best talent for the company. Makes sure there is always enough cash in the bank.

I asked, "Is that it?"

He replied that the CEO should delegate all other tasks to his or her team.

I've thought about that advice so often over the years. I evaluate CEOs on these three metrics all the time. I've learned that great CEOs can and often will do a lot more than these three things. And that is OK.

But I have also learned that if you cannot do these three things well, you will not be a great CEO.

It is almost 25 years since I got this advice. And now I am passing it on. It has served me very well over the years.

 



Women In Tech and Women Entrepreneurs Discussion

There was a piece in the WSJ on Friday about the dearth of women in tech and women entrepreneurs. We've been talking about this issue here on AVC and I was quoted in the WSJ piece:

“From successes come role models and from the role models come change,” said Union Square Ventures’ Mr. Wilson, who recently called for more diversity in the start-up world.

In the article, Rachel Sklar took a bit of a swipe at TechCrunch and Mike Arrington did not like that one bit.

He just posted a long rant on the issue on the TechCrunch blog. And guess what? He is using Disqus to host the comments to that post.

I would love to see this community join that conversation. I find the comment threads at TechCrunch to be a very different experience to what we have here at AVC. Maybe we can inflitrate and influence those discussions a bit. Maybe we can start with this issue.

I just did my part. I love commenting via Disqus. And I am so excited to see it on TechCrunch.



Taste Neighbors (continued)

A few summers ago, I penned a post called Taste Neighbors in which I described a web service that would do for food/restaurants what last.fm has done for music. From that post:

This problem has largely been solved in music. Because its relatively simple to watch what music I listen to and what music millions of others listen to, there are many services now that use musical neighbors to drive recommendations. My personal favorite of these services is last.fm and this is a list of my musical neighbors.

and

I am more optimistic about watching what they actually do. As my former partner Bliss used to say, "watch what they do, not what they say". With online finance services like Wesabe (one of our portfolio companies), you can easily build a database of every restaurant you eat at, every movie you go out and see, every book you buy from Amazon, etc.

Well Wesabe has come and gone but my interest in a taste neighbors service has not.

Last night my friend Vanessa said to a few of us, "couldn't you look at my foursquare checkins and figure out what other foursquare users like to go to the same places I like to go and then using their checkin history, recommend other places I might like to go?"

Bingo.

So is anyone doing this? Can it be done via the existing Foursquare API? I think this is a big idea and I'd like to see some people working on it.



Symbology

When you want to look up information on publicly traded companies, it helps to know the ticker symbol. Microsft's ticker is MSFT, Google's ticker is GOOG, Apple's ticker is AAPL. Every publicly traded company has a ticker.

But private companies don't have tickers. And as more and more private companies are attaining status and drawing the attention of mainstream media and the investment community, it is time for that to change.

Yesterday Stocktwits and Second Market proposed a set of tickers for popular privately held companies. The proposed list of tickers is here.

I'd like to see services like Tracked.com (a portfolio company of ours: $TRACK), Google Finance, Yahoo Finance, Crunchbase, Wikinvest, and their competitors adopt these tickers. If everyone supported the TWIT symbol for Twitter, the FBOOK symbol for Facebook, and the SKYPE symbol for Skype it would make it a lot easier to aggregate financial and other information on these companies.

I have been an investor and on the board of a company called Alacra for over ten years. We made the investment in the Flatiron partnership. One of Alacra's most successful services is called Concordance. They manage symbology for large enterprises with large datasets. It is a critical service for large banks, brokers, accountants, consultants, law firms, and other knowledge driven industries.

Unique identifiers are so helpful when you are trying to make sense of large amounts of data. It is particularly helpful in the case of company specific information and it is also expected in the investment community.

So I hope this effort by Stocktwits and Second Market gains traction with the other web services that aggregate information on private and public companies. I'll do my part by tweeting with these tickers (using the $ticker standard set by Stocktwits) when I talk about private companies on Twitter. I hope others will do the same.

And Stocktwits and Second Market can make my life easier by making sure that companies like Alacra and Wikinvest that don't have private company symbols get them asap. I wonder if they should open up this database in some way so that companies can issue themselves tickers. It seems like trying to manage this as a closed system won't scale very well and some kind of open system will work better. I'm curious what others think.



Angel Liquidity

Lots of talk these days about new forms of angel/seed capital. But less talk about the most vexing issue facing the venture ecosystem over the past decade – that being the shrinking amount of liquidity on the way out.

If you look at how much money has been raised by venture firms, including the seed and super seed categories, versus how much money has been returned in the past ten years, the ratio is not good. At some point the investors who fund the venture capital asset class will not be able to keep funding it.

The asset class needs to focus on liquidity. M&A continues to be the one bright spot and although I have not seen the data, I suspect M&A activity around venture backed companies in the past ten years has not shrunk and may have actually increased (if you take out the bubble years of 98-2000).

But IPOs of venture backed companies have almost been nonexistent over the past ten years. And that had been an important source of liquidity in the venture capital ecosystem. There is some hope that the IPOs of Skype and Demand Media will spark a renewed interest in tech IPOs. I am very excited about Skype. But friends on wall street tell me that the Skype IPO has issues, like a very weak stock market, the huge overhang of the eBay position, and a continued skepticism around tech IPOs. We will see. I am hoping my friends on wall street are wrong.

I have written about the emerging third way which is secondary sales of founder, angel, and VC stakes to late stage VC firms, growth equity firms, private equity firms, and even hedge funds. This has been a bright spot of late and the trend continues to be positive.

Yesterday our portfolio company Etsy announced that it had concluded a largely secondary transaction with Index Ventures. The interesting thing about this transaction is that it was not founder liquidity driven. The founders did not sell in the transaction. It was not VC liquidity driven. Some of the existing VC firms actually bought in the transaction. It was angel liquidity driven.

Etsy did two angel rounds early in its existence. Our firm participated in the second round. But both rounds were largely composed of individuals, including a bar owner and a restaurant owner who provided the first outside capital. In the video below, founder/CEO Rob Kalin tells the story of installing a new handmade wood bar for the bar owner and in return securing his first outside capital for Etsy. The entire video is very good. If you have a few minutes, check it out.

But the main point of this post is we are seeing that angels can get liquidity via these secondary transactions. They don't need to wait for the sale of the company or possibly the IPO. That is a very good thing, for the angel/seed sector, and for the overall venture capital market.

I hope these secondary purchases work out well for the funds that are making them. Because if they do, we will see even more of them. And that may be a way out of the liqudity issues plaguing the venture capital business these days.



Blogging and Venture Capital

I came across this interview I did at Wharton a few years ago. They asked me how blogging has impacted the way we do the venture capital business. I don’t think many people have seen this since the total views on YouTube are only 34 right now. I think it’s a pretty good explanation of how this blog is a critical part of how I work. It is only 3 minutes long.

The CEO Mentor and Coach

I’ve written about this topic before. I think many people with the ambition and the opportunity can become excellent CEOs. But it takes a lot of work and a commitment to self improvement. It is a very hard job. It is lonely. And it requires discipline and decisiveness. Most of these traits can be learned.

But who do you learn them from? Certainly not me. I have never been a CEO and never will be. I can help entrepreneurs with many things. But there are some aspects of running a company that I can’t help with.

So I encourage most of the CEOs I work with to get mentors or coaches (or both). I have seen this work so well for so many people. You might ask “what can a coach or a mentor really help me with?”

I’ll point to a blog post by Ben Horowitz on “office politics.” I tweeted this out yesterday so some of you may have read it already. If you are a CEO or plan to be one someday, you should read it.

Here’s an example of Ben’s advice on what to do when one exec comes to you complaining about the performance of another exec:

If they are telling you something that you already know, then the big news is that you have let the situation go too far. Whatever your reasons for attempting to rehabilitate the wayward executive, you have taken too long and now your organization has turned on the executive in question. You must resolve the situation quickly. Almost always, this means firing the executive. While I’ve seen executives improve their performance and skill sets, I’ve never seen one lose the support of the organization then regain it.

On the other hand, if the complaint is new news, then you must immediately stop the conversation and make clear to the complaining executive that you in no way agree with their assessment. You do not want to cripple the other executive before you re-evaluate their performance. You do not want the complaint to become a self-fulfilling prophecy. Once you’ve shut down the conversation, you must quickly re-assess the employee in question. If you find that they are doing an excellent job, then you must figure out the complaining executive’s motivations and resolve them. Do not let an accusation of this magnitude fester. If you find that the employee is doing a poor job, there will be time to go back and get the complaining employee’s input, but you should be on a track to remove the poor performer at that point.

Imagine having someone you can pick up the phone and call when this happens to you? How nice would that be?

You can get that several ways. You can take an investment from a VC like Ben or Mark Suster or Jeff Glass or many others who have serious operating experience. Or you can bring an experienced and successful CEO (or two) onto your baord. Or you can get a CEO Coach. 

I would not recommend you overdo it. Getting advice from too many places isn’t very good. Pick a mentor/coach and run with it. If you are struggling with the demands of being the boss, the first thing to realize is you are not alone. It is a super hard job. The second thing is to get some help. From someone who has done it before and knows what to do. Trust me, you will be much happier once you do that.

Getting Meetings

Getting meetings with VCs can be hard. I am sure that many people think it is hard to get a meeting with me.

But I thought I'd highlight an exchange that happened here at AVC yesterday.

A woman named Kelley Boyd left a comment on yesterday's post that I liked.

I replied and let her know that I liked it and asked what she was working on right now.

She replied and suggested we have coffee tomorrow (which is today).

That is not likely to happen, but I will absolutely meet her.

I don't know what will come of the meeting but I like meeting new people with fresh ideas.

I reblogged this quote from Clayton Christensen on my tumblog yesterday and also tweeted it:

if you have a humble eagerness to learn something from everybody, your learning opportunities will be unlimited

I don't think the word humble comes to mind when people think of me. I have to work on humility every day. It does not come naturally to me.

But the latter part of that quote about learning from everybody is something I totally buy into. I don't like to go to the "in conferences" and meet with the "in people." I don't learn much from them.

I like to have coffee with people like Kelley. I am sure I am going to learn something from her.

I know I am hard to reach, that I return less and less emails every day. But if you have something to share and say to me, please keep trying. I promise you that I am listening.

Commission Plans

Last week's MBA Mondays post about Bookings, Revenues, and Collections generated a number of comments and questions about sales commission plans. So I decided to ask my friend and AVC community member Jim Keenan to write a guest post on the topic. Jim's blog, A Sales Guy, is a great read for those who want to get into the mind of a sales leader. So with that intro, here are Jim's high level thoughts on setting up commission plans. I know the discussion on this post is going to be a good one. So make sure to click on the comments link and if you are so inclined, please let us know what you think on this topic.

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I get asked a lot how to build a good commission plan.  I give the same answer every time.  Keep it simple and align it with company goals.  

It amazes me how often companies screw this up.  

Sales people are coin operated.  Tell them they get a buck if they go get a rock, you'll get a rock, a whole lot of rocks.  Tell them they get two bucks for red rocks, you'll get a lot of red rocks, but fewer rocks in general. 

Sales people don't hear what you say; they hear what you pay!
 
Commission plans need to do two things; motivate sales people and sell product.  They should align what you say, with what you pay.

The killer commission plan starts with two critical questions;
1) What do you want to sell?
2) How do you want the sales team to behave?

Commission plans drive behavior, get it wrong or don't align commission incentives with the company’s goals you’ll get everything you don’t want and little of what you do want. 

What do you want to sell? Do you want to sell your existing products or your new products?  Do you want to sell your services or your software?   Do you want more revenue or higher margin?   Answering these questions up front matters.  Whatever you put in your commission plan you WILL get.  Build your plan for what you want to sell.

How do you want the team to behave? Do you want new accounts and new business or more business from existing accounts?   If you want new accounts pay for hunting, if you want them to work the accounts you already have, then pay for farming.   What ever you pay for you WILL get.  Build your plan for how you want the team to act.

The key is to sit down with finance, product and marketing with the budget in hand and ask the questions; what do we need to sell by the end of the year?  Where do we need the business to be?  How much revenue do we need?  How much margin do we want?  How many new customers do we need?  How much growth are we looking for?  How do we define success at the end of the year?   Once these questions are answered, incent the sales team to do exactly that.  What ever you pay for you will get. 

Once the incentives have been nailed and properly aligned, make the plan dead, stupid, simple.   Don’t overcomplicate it.  Don’t try to be sophisticated, creating fancy algorithms and fancy spreadsheets filled with if/thens.   Make the plan "simple stupid."

A plan is simple stupid if a sales person knows exactly what they will be paid on a deal without looking it up.  Simple plans motivate sales teams.  They know what their deals are worth and chase them accordingly. 

Complicated plans de-motivate.   When sales doesn’t know how much they will get paid on a deal, motivation is nipped.   Make sure it’s easy for sales to figure out what they get paid on a deal by deal basis.  

In addition to being dead, stupid, simple, all plans must have accelerators.  Don’t be greedy.  Don’t look to cap sales earnings.  If they are selling more, pay them more.   Accelerators are when more commission is paid for a deal after a certain threshold is met, usually quota.

Finally, AND most important, once the plan is done DON'T MESS WITH IT.  Nothing is more detrimental to a sales environment than changing the commission plan on the fly.  You have to live with what you have. 
 
Commission plans are the lifeblood of a sales team.  Get them right; start counting the money.  Get them wrong; it’ll be a long year.   

Remember; Sales people don’t hear what you say, they hear what you pay . . . so pay right.