Posts from November 2010

Donors Choose Update

Our November campaign to raise money for classrooms focused on science and math education for young women is one third of the way done. To date we've raised almost $3000 from 30 donors.

In prior years we've raised about $30,000 from about 100 donors so we are pretty far behind prior years. I just gave another $250 spread around a few projects. I am also going to email (via donors choose) all the donors from prior years. So if you get an email from me asking for your support, don't be surprised.

This is the one thing I do each year where I ask community members to dig into their pockets. If you are so inclined, I'd very much appreciate it and so will those young women. Here's the giving page.

#VC & Technology

Milton's "Three Things You Must Have"

Milton Pappas and his partner Bliss McCrum taught me the venture capital business. I was 25 years old and straight out of business school at the time. Ten years later, I left their firm and started Flatiron Partners. I owe a debt of gratitude to Milt and Bliss and part of the reason I blog every day is to pay it back by paying it forward.

Milt had three things he would never invest without. I have kept them and they are mine now. They are:

1) A liquidation preference

2) A right to participate pro-rata in future rounds

3) A board seat (or an observer seat and information rights)

That doesn't mean we don't expect and ask for a lot more in our standard term sheet. But what it does mean is that these three terms are non-negotiable for me. I won't invest without them.

A commenter on yesterday's post asked me why I would not invest without a liquidation preference and here is how I responded:

i invest $1mm in your company for 20%

the company is six months old and this is the first investment of outside capital

a week later you sell the company for $2.5mm

you get $2mm for six months work

i get a $500k loss

does that sound fair?

no it does not

that is why there is a liquidation preference

to protect investors from that happening to them

Some investors are willing to take this risk or structure governance and controls to protect them. I prefer the elegance of the liquidation preference. If you can't get me out at a better valuation than you want me to invest at, then just give me my money back. It's simple, it works, and it has stood the test of time, from Milton and Bliss to me and hopefully to all of you.


Barbara van Schewick at NYU Law School on Wednesday

Sorry for the late notice on this. One of our favorite academic minds on Internet Law is speaking at NYU Law School on Wednesday.

Barbara van Schewick is Associate Professor of Law at Stanford Law School and is Director of Stanford's Center for Internet and Society. Barbara's book Internet Architecture and Innovation is "essential reading for anyone interested in Internet policy-and probably for anyone interested in the law, economics, technology, or start-ups" according to Marvin Ammori, another of our favorite academic minds on this topic.

More information on Barbara's book, including an overview and excerpts, is available at .

When: Wednesday, November 10, 2:30pm-3:30pm.
Location: Vanderbilt Hall – Room 216 – NYU Law School – 40 Washington Square
South, NY, NY 10012
More Info: Email [email protected] or

I am hoping that some USV people and some readers of this blog will be there to hear Barbara speak on an important topic, maybe the most important topic of all when it comes to the Internet.


Employee Equity: Restricted Stock and RSUs

For the past six weeks, we've been talking about employee equity on MBA Mondays. We've covered the basics, some specifics, and we've discussed the main form of employee equity which are stock options. Today we are going to talk about two other ways companies grant stock to employees, restricted stock and restricted stock units (RSUs).

Restricted stock is fairly straight forward. The company issues common stock to the employee and puts some restrictions on the stock. The restrictions typically include a vesting schedule and some limits on how the stock can be sold once it is vested.

The vesting schedule for restricted stock is typically the same vesting schedule as the company would use for stock options. I am a fan of a four year vest with a first year cliff. The sale restrictions usually include a right of first refusal on sale for the company. That means if you get an offer to buy your vested restricted stock, you need to offer it to the company at that price before you can sell it. There are often other terms associated with restricted stock but these are the two big ones.

A big advantage of restricted stock is you own your stock outright and do not have to buy it with a cash outlay. It is also true that you will be eligible for long term capital gains if you hold your restricted stock for at least one year past the vesting period. There currently is a significant tax differential between long term capital gains and ordinary income so this is a big deal.

The one downside to restricted stock is you have to pay income taxes on the stock grant. The stock grant will be valued at fair market value (which is likely to be the 409a valuation we discussed last week) and you will be taxed on it. Most commonly you will be taxed upon vesting at the fair market value of the stock at that time. You can make an 83b election which will accelerate the tax to the time of grant and thus lock in a possibly lower valuation and lower taxes. But you take significant forfeiture risk if you make an 83b election and then don't vest in all of the stock.

If you are a founder and are receiving restricted stock with nominal value (penny a share or something like that), you should do an 83b election because the total tax bill will be nominal and you do not want to take a tax hit upon vesting later on as the company becomes more valuable.

This taxation issue is the reason most companies issue options instead of restricted stock. It is not attractive to most employees to get a big tax bill along with some illiquid stock they cannot sell. The two times restricted stock make sense are at formation (or shortly thereafter) when the value of the granted stock is nominal and when the recipient has sufficient means to pay the taxes and is willing to accept the tradeoff of paying taxes right up front in return for capital gains treatment upon sale.

Recently, some venture backed companies have begun to issue restricted stock units (RSUs) in an attempt to get the best of stock options and restricted stock in a single security. This is a relatively new trend and the jury is still out on RSUs. Currently I am not aware of a single company in our portfolio that issues RSUs but I do know of several that may start issuing them shortly.

A RSU is a promise to issue restricted stock upon the acheivement of a certain vesting schedule. It is a lot like a stock option but you do not have to exercise it. You simply get the stock like a restricted stock grant. And there is an added twist in some RSU plans that allow the recipient of an RSU to delay the receipt of the stock until the stock is liquid. Combined, these two features may remove all of the tax disadvantages of restricted stock because the employee would not have a taxable event until the vesting schedule is over and possibly until the stock becomes liquid. I say "may remove all of the tax disadvantages" because I believe that the IRS has never tested the tax treatment of RSUs.  Therefore RSUs are an "adventure in tax land" as one general counsel in our portfolio would say.

I do not believe there is an optimal way to issue employee equity at this time. Each of the three choices; options, restricted stock, and RSUs, has benefits and detriments. I believe that options are the best understood, most tested, and most benign of the choices and thus are the most popular in our portfolio and in startupland right now. But restricted stock and RSUs are gaining ground and we are seeing more of each. I cannot predict how this will all change in the coming years. It is largely up to the IRS and so the best we can hope for is that they don't mess up what is largely a good thing right now.

Employee equity is a critical factor in the success of the venture backed technology startup world. It has created significant wealth for some and has created meaningful additional compensation for many others. It aligns interests between the investors, founders, management, and employee base and it a very positive influence on this part of the economy. We strongly encourage all of our portfolio companies to be generous in their use of employee equity in their compensation plans and I believe that all of them are doing that.

#MBA Mondays

Competing To Win Deals

The venture capital business is highly competitive. There is more money out there chasing good deals than most people imagine. It is also true that there are good deals and good entrepreneurs that can't find anyone to invest in them. That is a failure of the system. But this post is not about that. It is about how a VC can compete and win a deal that many others want.

Here are my rules:

1) Do your very best to connect with the entrepreneur. If you don't have a great personal connection, you won't win the deal. Don't even bother to try to win a deal where you don't have good personal chemistry with the founder/CEO.

2) Bring your full partnership into the deal process early and consistently. Entrepreneurs are smart and they know they are doing a deal with a firm as well as an individual. Let them see the full picture early. Make it easy on the entrepreneur to meet the full partnership. Don't make the entrepreneur do all the work.

3) Encourage the entrepreneur to get feedback on you and your firm. Instead of references, I like to give a list of every entrepreneur I've ever worked with and an email address. I tell them "throw a dart at that list and talk to four or five of them randomly. you'll hear the same thing from everyone."

4) Don't pressure the entrepreneur to make a decision. Don't issue exploding term sheets. Don't put no shops into your term sheets. Those kinds of things are signs of insecurity. I prefer to tell people that we'll have an exclusive relationship when the deal closes and not before then. If someone wants to leave me at the altar, better it happens then than after we are married.

5) Make your offer in person and don't do it via a term sheet. Tell the entrepreneur you want to be their business partner. Tell them how much you will invest and how much ownership you want. Leave it at that. Tell them that if they are interested, you will send them a term sheet. Leading with a term sheet focuses the discussion on the wrong things. The process should be all about personal fit and very high level deal terms. Once the decision is made to try to work together, you can get into the specifics of the deal.

6) Add value during the process. Talk about the strategy issues facing the company. Talk about the hiring challenges the company faces. Try to help with these issues even before you are an investor. Show what you can do right away.

7) Use the product or service. Ideally you should be using it well before you start chasing the deal. But use the product/service actively and smartly. The entreprener will be watching. I assure you of that.

8) Don't feel the need to pay the highest price. Offering a crazy price to win the deal scares off most smart entrepreneurs. They will be wondering why you are so aggressive. Offering a fair price that is in the range is what you need to do. And communicate that if the entrepreneur chooses to work with you, you will be flexible on your offer. That way you put yourself in the position to win and you can work the specifics to close the deal when the opportunity presents itself.

9) Don't team up with another firm. We've made this mistake a few times recently. Entrepreneurs want to choose their syndicate partners. By pairing up with another firm, you signal to the entrepreneur that you want to choose the syndicate and that is a mistake in a highly competitive deal.

10) Be prepared to lose the deal and if you do, lose gracefully. There are plenty of good deals out there. You don't have to win them all. Lose gracefully and maintain your good relationship with the entrepreneur at all costs. They might come back to you on the next round.

Many of these rules are counter intuitive. But they work well for my partners and me. You might say they will only work for you if you are a top tier investor. That may well be true, but you have to act like a top tier investor to become one. So you might as well play the game that way from the start.

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#VC & Technology

Multi Party Video Calling

I spent some time yesterday afternoon trying to do a group video call. We ultimately couldn't make it work and ended up on an old school conference call.

That was a disappointment to me and I am hell bent to fix it.

I know that Skype just released a new client that supports multi party group video calling. But I've heard that Skype plans to eventually charge for that feature. I don't mind paying but I don't want a service that requires an entrepreneur to pay just to talk to me.

I'm looking for a free service. We tried jabber over gtalk in the iChat client. I've heard that works. But we could not get it to work for us. I think it may have been a firewall issue.

I can toubleshoot the firewall issue if it is on my end but I don't want to be dealing with firewall issues every time I try to video with someone new.

Possibly the best thing about Skype is that I've never encountered a firewall issue with Skype.

Anyway I would love some advice on this. We've got a great video setup on the Mac mini in our conference room and I want to look at the people I'm talking to if at all possible.

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Steve Blank in NYC Next Friday

Are you a fan of Steve Blank's Customer Development model for startups? I am. And next friday morning (Nov 12th) from 10am to noon, Steve will be speaking up at Columbia University in the Davis Auditorium in the Schapiro Center.

This event is hosted by our friend Professor Chris Wiggins and the Columbia Entrepreneurship Program and is free. Steve will be talking about his Four Steps To The Epiphany and the Customer Development Model.

I am trying to figure out how to attend. I'm already booked at that time next friday. But I am fairly certain there will be a number of people from our firm there. If you are an entrepreneur and want to get better at launching products and companies, you really should think about spending a couple hours listening to Steve.

If you want to attend, please save your place by emailing [email protected].

#VC & Technology

Your Worst Enemy Is Yourself

One mistake I see startups make a lot is getting too focused on what is going on around them. They spend too much time trying to figure out what their competitors are going to do. They watch the next hot startup with jealousy and it reminds them of when they were that "shiny new thing" and they want that back.

The reality of startups is that there is so much opportunity out there that if you just focus on what is in front of you, your company will do fine. But focusing on what is in front of you means not focusing on what is going on around you. You need to put blinders on and execute. Do not let what is going on around you whipsaw your strategy and your team.

I am not suggesting that you should put your head in the sand. It is critical to know what is going on in your market. But it is equally critical to have a strategy that makes sense in the context of what is going on and execute it with purpose and pace. If you spend too much time looking over your shoulder, you will not execute well. I've seen it again and again.

So don't let all the news of the day slow you down. Don't let your competitors press releases and launch parties get inside your head. Plan, build, ship, and scale. Assess. Repeat again and again. Win.


Do More Faster

I just finished reading Do More Faster. My friends Brad Feld and David Cohen, who founded Techstars, took all the lessons and mentorship that is provided to the teams in the Techstars program and put it together into a book.

Do More Faster is part entrepreneurship textbook and part startup torah/bible. If you start companies or want to do that in the future, Do More Faster is a book you need to read and own.

Here's the hardback version and here's the kindle version.

Speaking of Techstars, they are coming to NYC this winter. They will run the full Techstars program from early January to early April in a loft space right off Union Square. Here's a link to a description of the Techstars NYC program with a list of mentors, including yours truly. Applications are due for Techstars NYC on or before November 21st.

If you have a startup and are just getting going and could use some mentorship and a little bit of capital, you should seriously consider applying to Techstars NYC. And read Do More Faster too.

#VC & Technology

It's Election Day - Go To Your Polling Place And Vote

To all the non US readers, I apologize in advance. This post is not directed at you.

To all the US based readers, do me a favor. Go vote today. I don't care if you are liberal, conservative, or a member of the far center party. What matters is you exercise your right to vote today.

I am going to vote on my way to work. I am going to checkin on foursquare and contribute to this cool foursquare app called I Voted.You do that by including the tag #ivoted in your checkin.

I am going to tweet out my vote. And if I see any problems in our polling place I am going to alert the city via Twitter as Mike Bloomberg suggests:

Bloomberg tweet
It's cool that Mayor Mike uses TweetDeck.

I plan to vote for Harry Wilson for Comptroller (Rep). All the other contests I get to vote on today are not even races, sadly. But even if every single race was not a contest, I would still go out and vote today. It's our obligation as citizens to elect our representatives.

I saw a line the other day that said "if you don't like what is going on in washington, change the people you are sending to washington". Same thing can be said about Albany and City Hall. Today is the day to stop complaining about our government and do something about it. I'm going to and I hope you all do too.