Posts from July 2011

Transitions (continued)

Three years ago (almost to the day), I wrote a blog post titled Transitions that talked about transitions going on at our portfolio company Etsy. At the time, Etsy's founder Rob Kalin was handing over the CEO job to Maria Thomas, Chad Dickerson was coming in to run engineering, and founders Chris, Haim, and Jared were leaving the company to do other things.

And now, three years later, the actors in this transition story continue to evolve their roles. Chad—whose leadership in engineering has turned Etsy into the premier web technology company to work for in NYC—is taking the lead role as CEO from Rob, who is once again transitioning out of the day-to-day management. 

Being a founder of a highly successful company is thrilling but also a somewhat harrowing role. As the company scales, things change. Nothing happens as fast as it did when you first built the product. A minor feature rollout takes longer than it took to build the entire website. Nobody cares as much as you do about the sign on the door, the company employee directory, the brand, the copy on a marketing document, the place the checkbox is on the page, etc., etc. And yet, when there are hundreds of employees, you have to rely on all of them to do all of these things. It's a struggle for every founder I have ever worked with. And Rob is so very much that founder who cares intensely. He has given so much to the company over the years and he just completed a product roadmap that provides a guidepost for what Etsy will become in the coming years. As Rob transitions out once again, I want to personally thank him for all of this and more. Etsy is his creation and will always be.

Transitions are never easy on the people involved and the company that goes through them. But they are inevitable in any company's evolution. Some of them work out well and others not as much. But the role of the management and Board is to constantly try to have the right people in the right roles at the right time. And I think we've got that at Etsy now and I'm excited to see Chad step up to the top job and lead the company forward.

#Web/Tech

Syncing Up Your Credit Cards

Last week I posted about a service called BillGuard. BillGuard scans your credit card bills for questionable transactions so you don’t have to. It’s a great service. One of the things you do when you set up BillGuard is you connect your credit card(s) to the BillGuard web service. It’s straightforward and easy. Once you do that, the magic happens.

I did the same thing yesterday. I connected my Foursquare with my American Express card. Once you do that, when you check in at places that have Foursquare specials, you get automatic credit when you pay with American Express. Foursquare calls this “load to card“. You can do it here.

I really like the idea of syncing my credit cards with web services. I’m not so into the social value of sharing my transactions with everyone (where Blippy started), but I am very much into the personal value of leveraging my transaction history into various web services I use frequently. And I am also very into the idea of getting the benefit of offers and deals automatically credited to me via my credit card account.

I think we have just scratched the surface of what is possible when you sync up your transaction activity with other services in your life. There is great opportunity in this idea.

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#Web/Tech

Financing Options: Preferred Stock

Today on MBA Mondays Startup Financing Options series, we are going to talk about the financing option that I specialize in – preferred stock.

Almost all venture capital firms and many angel and seed investors will require the company they are investing in to issue them preferred stock. The vast majority of equity dollars invested in startups are securitized with preferred stock. So if you are an entrepreneur, it makes sense to understand preferred stock and what it means for you and your company.

Preferred stock is a class of stock that provides certain rights, privileges, and preferences to investors. Compared to common stock, which is normally held by the founders, it is a superior security.

Preferred stock takes its name from a critical feature of preferred stock called liquidation preference. Liquidation preference means that in a sale (or liquidation) of the company, the preferred stock holders will have the option of taking their cost out or sharing in the proceeds with the founders as common stock holders. What this means is that if the value of the sale of the company is below the valuation the preferred investors paid, then they will get their money back. If the sale is for more than the valuation the preferred investors paid, then they will get the percentage of the company they own. I'm not going to go into all the reasons for this as I've done a number of times on this blog already. Suffice it to say that this is an important term for investors, including me.

There are variations of the liquidation preference that give the feature a bad name. Investors will sometimes ask for a multiple of their investment as a preference. Or investors will ask for their preference plus the common interest (called a participating preferred). Our firm is not a fan of these "enhanced preferreds" but we do sometimes get them, particularly the participating preferred, when we join a syndicate where that security already exists. One thing to know about terms around liquidation preference is whatever you agree to with one set of investors, that will be what all the future investors will want because they will not want other investors in the cap table with a preferred position to them.

There are a number of important rights and privileges that investors secure via a preferred stock purchase, including a right to a board seat, information rights, a right to participate in future rounds to protect their ownership percentage (called a pro-rata right), a right to purchase any common stock that might come onto the market (called a right of first refusal), a right to participate alongside any common stock that might get sold (called a co-sale right), and an adjustment in the purchase price to reflect sales of stock at lower prices (called an anti-dilution right). I'm not going to explain all of these in detail because Brad Feld and Jason Mendelson did an excellent series of posts on all of these provisions which I recommend highly.

Like many things in life, there are many variations of preferred stock transactions, from the relatively benign to the ridiculously painful. I've come to the conclusion that VCs should specialize in the relatively benign because entrepreneurs have long memories and the VCs who specialize in the ridiculously painful will not get to work with the best entrepreneurs and the best deals over time.

There have been a number of attempts to specify what a "standard preferred stock deal" should look like. There is the NVCA standard set of terms and docs. Fenwick and Gunderson each have a set of standard terms and docs. I believe Cooley has a set as well. I just reviewed as set from Lowenstein that looks quite good. If the preferred stock your investors want to purchase resembles these "standard preferred stock" sets, then you are probably working with an investor who is trying to be reasonable and fair.

As the AVC wise man JLM likes to say, "in life you don't get what you deserve, you get what you negotiate." When you are preparing to sell preferred stock to investors, make it a point to familiarize yourself with all the important terms, what they mean (both to you and your company), and what an "entrepreneur friendly" deal looks like. And then go get one of them for you and your company. It helps to have some leverage and leverage in financings means multiple investors at the table. So when you are dealing with sophisticated investors, make sure you have options and make sure you understand the key issues and don't settle for a bad deal.

Preferred stock doesn't have to be a bad deal for entrepreneurs. It can be a win/win for both sides. But you have to work at this part of your business just like you do at the other parts.

#MBA Mondays

Be Smarter Than Your Lawyer and Venture Capitalist

Brad Feld and Jason Mendelson have written a book with this title. It is now available on Amazon.

I got a preview copy and gave it a read. It's a textbook on venture capital deals. If you plan to do one of them, as an investor, advisor, or most importantly, as an entrepreneur, you should get this book and read it.

A friend of ours recently got a new job. Part of her job will be doing venture investments for her new employer. She reached out to me and said "I need a  quick primer on venture capital investments, how they are structured, negotiated, and documented." I pointed her to this book. She looked at its description and said "that's perfect."

I suspect it will be equally perfect for many people. Venture Capital transactions have been a bit of a black art for a long time. It played to the advantage of the VCs because we do these things all day long all the time. But, like a marriage, it is not good for one side to take advantage of the other. It is not like selling a house. You have to live with the other side of the transaction after the deal closes. So over the past ten years, the VC industry has done much to increase transparency and trust with entrepreneurs. I'm proud to have played a part in that. Brad and Jason have done a huge amount of work in this area as well and their new book is going to be required reading for many. Well done.

#Books#VC & Technology

Explicit Groups vs Implicit Groups

Kevin Cheng (aka @k), product manager at Twitter and an all around smart guy wrote a great blog post called Can We Ever Digitally Organize Our Friends?. I've been thinking many of the same things that Kevin wrote about since I started to use Google+ a few weeks ago and Kevin's post is a good opportunity to riff on the same ideas. But first, a bit of humor courtesy of someecards:

Dante ecard

With that out of the way, here's my thinking on grouping things. I don't like to be that organized personally. I don't file stuff away very well. I never liked folders in outlook. I use a few labels in gmail (about 20) but I label less than one out of every 100 emails I get. I've created two twitter lists (one automatically). I follow two twitter lists. I belong to one or two google groups. I belong to less than ten Facebook groups. I am sure that there are many people out there who are different, who love to organize, file, group, and structure their lives and work. But I'm not one of them.

So when faced with the chore of taking all my friends and colleagues and dropping them in buckets (or circles as it were), I tired of that chore quickly. I stopped at about 20 people. And I am not eager to go back. It is not fun. It is work.

I did create two groups that I think are particularly valuable; my family and our firm. These groups are well defined, they are finite, and they don't change very much. I can see sharing things with these groups in Google+ and I'm happy to have that resource at my finger tips.

But past that it becomes muddy. How about a portfolio company group? Good idea. Except that our portfolio changes a fair bit. We add six to ten companies a year. And these companies add and occasionally drop team members frequently. Am I going to maintain a list of all the people in all of our portfolio companies? No, I am not going to do that.

How about the people I share music and music interests with? That's a passion of mine. But I'm finding new people all the time. I met Tyrone Rubin in a room on Turntable a few weeks ago. I started following him on Tumblr right away. I could have added him to a music circle on Google+ too. But I didn't. If he had an "add me to your music group on Google+" on his Tumblr, I might have clicked on that. But short of that, it becomes too much for me to do such a thing.

The point I am trying to make, which Kevin makes so well in his post, is that friends and interests are not so finite and fixed. They come and go. They are highly fluid and dynamic. And as such, there are very few groups that I want to build explcitly. Family yes. USV colleagues yet. Anything else, no thanks.

This is an oppportunity to use machines. And Google is doing this with Google+. The recommendations on who to add to what circles are amazing. So why make me do the drag and drop thing other than it is fun and cool to do that on a computer? If Google+ knows who my music friends are then just suggest "music friends" when I hit the share button and send it on. Do I care if it goes to a few people who aren't actually my music friends? No I do not. Do I care if a few of my music friends don't get it? Yes, but then I can add them explicitly. I trust Google to do a fine job of this for me. They've proven themselves worthy of the job so many times in my relationship with them over the years. I trust that they can build algorithms like this as well or better than any other company out there.

There's an iPhone app called Katango that apparently does this for Facebook friends. I don't have an iPhone so I have not tried it out. But I hear it is pretty amazing. That's an example of computers doing the work for you so you don't have to do it. That's what I think we should be doing in terms of creating more granularity in our social graphs. I don't want to put my friends into circles. I want a machine to do it for me.

#Web/Tech

BillGuard

I love it when entrepreneurs take a trick from one market and apply it to another. The founders of BillGuard have done that with credit card fraud. They took the lessons from the anti-virus and anti-spam markets and apply it to your credit cards.

I just signed up for BillGuard and put four credit cards on the service. They asked me for my credit card website logins, I provided them, and they took down all the transactions and showed me this screen:

Billguard screenshot

They list all the transactions that they think could be problematic. Clearly the $29.86 charge by Charlie O'Donnell is problematic. I'll have to look into that one!

But on a more serious note, I see this recurring $16 transaction for Been Verified. I am sure I signed up for that service at some point to check it out for some reason. But at this point, I'm not using it and I should turn it off.

BillGuard is great for exactly this kind of thing. And it may also help with truly fraudulent transactions. I haven't run into any of them yet on my four cards.

BillGuard is taking a number of tricks from the anti-virus and anti-spam markets and applying them to credit cards. They have a database of merchants and know which ones have a bad reputation. They also take all the data from the users interacting with the service and use it to build enhanced reputation data. That is exactly how they do it in the ant-spam market.

The more users BillGuard gets, the better their data gets, and the better the service gets. That's why I encouraged BillGuard's CEO Yaron Samid to make the service free for all the cards you put on the service onstage at TechCrunch Disrupt. Turns out they took that advice and will monetize the service in other ways. I think that's great for users and great for BillGuard too.

If you worry that you are paying recurring charges on your credit cards that you don't need and that you may have fraudelent charges on your cards you don't know about, then BillGuard is for you. Check it out.

#Web/Tech

Bored Of Directors (continued)

I did a few posts on this topic back in 2004 when I was just starting to get this blogging thing.

the original

the followup

the second followup

These posts were inspired by my friend Brad Feld's initial post on the same topic.

So it's not surprising that when Brad, Amy, The Gotham Gal, and I got together for dinner in Paris this past weekend, we got to talking about board meetings. Brad is frustrated with them. I am too. There is too much reporting and not enough discussing going on. And there isn't enough face to face interaction.

One of our portfolio companies has a board of five and the directors are in three locations. Last month we had a meeting where all but one of the directors was in the room. It was the best meeting we have had in close to a year. Near the end of the meeting, I put a fairly meaty strategic topic on the table and we did not have enough time to do it justice. The founder/CEO suggested we reconvene a few weeks later with everyone in the room.

That reconvention happened last week and we had every director in the room and no agenda. We got right to the "big meaty strategic topic" and talked it over for two hours. That was a terrific meeting, by far the best meeting we have had in the company's history.

So what can we learn from this story?

1) get everyone in the room

2) less reporting

3) more discussing

For this to work, the board has to commit to face to face meetings. The CEO has to keep the Board up to date in between meetings so reporting doesn't have to happen in the meeting. And the Board needs to understand the business and the market well enough to be able to have a substantitive discussion about the key issues the business is facing.

None of these are easy to accomplish. Everyone is busy and not enough investors make the committment to understand the business well enough to participate in a serious strategic discussion. If anyone is to blame for bad board meetings it is the VCs and other non management directors who are not doing their jobs well enough. And I plead guilty as charged in this regard. I can and should do a better job as a board member on many of the boards I am on.

But ultimately it is the entrepreneur's board and the entrepreneur's problem. They need to call bullshit on bad meetings, bad boards, participating by phone, and so on and so forth. And everyone in the startup sector should wake up to the fact that too many board meetings suck. We can and should do better. For our companies, for our management teams, for our investors, and for ourselves.

#VC & Technology

The "Fred Wilson School Of Blogging"

Tom Anderson, the Tom we were all friends with on MySpace, wrote a guest post on TechCrunch suggesting that there is a "Fred Wilson School Of Blogging." I'm not sure about a "school" but I do have some points of view and Tom mentions some of them.

Here's how I do it:

1) Have a long form blog on a domain that you own and that is permanent. Like Anil Dash says in the comments to Tom's post, this is about compiling a set of work that is substantial. Anil says:

Based on the past dozen years that I've been writing it, I expect that my blog will in some ways be one of the most significant things I create in my life.

I'm 100% with Anil on this. People ask me when I am going to write a book and I laugh at that suggestion. AVC is more than a book will ever be. It is live, it is deep (in terms of total posts), it keeps going, evolving, and ends when I end.

2) Have a short form blog an a different domain that you own and is permanent. Mine is at fredwilson.vc and hosted on Tumblr. This is where I put the things that fill out the story but don't belong on a long form blog.

3) Participate actively in the social distribution platforms like Twitter, Facebook, and Google+. Build profiles, followers, and credibility in these communities. I use Twitter for broadcast to a wide group, I use Facebook for friends and family, and I'm still trying to figure out how to use Google+. These distribution platforms are great for getting your work out there but I don't personally want to use them as the place where my work is hosted.

4) Build community on your domains. In the case of my longform blog, Disqus is the tool I chose and after that decision, our firm invested in the company. I've seen and used all the various community tools out there and I believe Disqus is the best at building community on long form blogs. In terms of community on short form blogging, I think Tumblr has done the best job and that is why it is growing like a weed right now.

5) Engage everywhere. That means on Hacker News, other blog communities/comments, Twitter, Facebook, Google+, etc. This takes a lot of time. Too much time. But I get so much value back from doing it that I make the time.

The most important part is to engage. The second most important part is own your online presence. Marco Arment has a great post on this point. He says:

If you care about your online presence, you must own it.

So if there is a "Fred Wilson School Of Blogging" this is it. It works for me and it can work for you if you are willing to invest the time and energy.

#Web/Tech#Weblogs

Financing Options: Convertible Debt

MBA Mondays are back after a one week hiatus. Today we are going to talk about convertible debt. Convertible debt can also be called convertible loans or convertible notes. For the purposes of this post, these three terms will be interchangeable.

Convertible debt is when a company borrows money from an investor or a group of investors and the intention of both the investors and the company is to convert the debt to equity at some later date. Typically the way the debt will be converted into equity is specified at the time the loan is made. Sometimes there is compensation in the form of a discount or a warrant. Other times there is not. Sometimes there is a cap on the valuation at which the debt will convert. Other times there is not.

There are a number of reasons why the investors and/or the company would prefer to issue debt instead of equity and convert the debt to equity at a later date. For the company, the reasons are clearer. If the company believes its equity will be worth more at a later date, then it will dilute less by issuing debt and converting it later. It is also true that the transaction costs, mostly legal fees, are usually less when issuing debt vs equity.

For investors, the preference for debt vs equity is less clear. Sometimes investors are so eager to get the opportunity to invest in a company that they will put their money into a convertible note and let the next round investors set the price. They believe that if they insisted on setting a price now, the company would simply not take their money. Sometimes investors believe that the compensation, in the form of a warrant or a discount, is sufficiently valuable that it offsets the value of taking debt vs equity. Finally, debt is senior to equity in a liquidation so there is some additional security in taking a debt position in a company vs an equity position. For early stage startups, however, this is not particularly valuable. If a startup fails, there is often little or no liquidation value.

Friends and family rounds, which we discussed earlier in this series, are often done via convertible debt. It makes sense that friends and family would not want to enter into a hardball negotiation with a founder and would prefer to let the price discussion happen when professional investors enter the equation.

The typical forms of compensation for making a convertible loan are warrants or a discount.

Warrants are another form of an option. They are very similar to options. In the typical convertible note, the Warrant will be an option for whatever security is sold in the next round. The Warrant is most often expressed in terms of "warrant coverage percentage." For example "20% warrant coverage" means you take the size of the convertible note, say $1mm, multiply it by 20%, which gets you to $200,000, and the Warrant will be for $200,000 of additional securities in the next round. Just to complete this example, let's say the next round is for $4mm. Then the total size of the next round will be $5.2mm ($4mm of new money plus $1mm of the convertible note plus a Warrant for another $200k). The total cost of the convertible loan is $1.2mm of dilution at the next round price for $1mm of cash.

A discount is simpler to understand but often more complicated to execute. A discount will also be expressed in terms of a percentage. The most common discounts are 20% and 25%. The discount is the amount of reduction in price the convertible loan holders will get when they convert in the next round. Let's use the same example as before and use a 20% discount. The company raised $4mm of new cash and the convertible loan holders will get $1.25mm of equity in the round for converting their $1mm loan ($1mm divided by .8 equals $1.25mm). Said another way $1mm is a 20% discount to $1.25mm.

Convertible notes also typically have some cap on the valuation they can convert at. That cap is anywhere from the current valuation (not very common) to a multiple of the current valuation. Recently we are starting to see uncapped convertible notes. These notes have no cap on the valuation they can convert at.

Startups typically think about raising capital via convertible debt early on in the life of a startup. They want to move fast, keep transaction costs low, and they are often dealing with a syndicate of angel investors and it is easier to get the round done with a convertible note than a seed or series A round. While these are all good reasons to consider convertible debt, I am not a big fan of it at this stage in a company's life. I believe it is good practice to set the value of the equity early on and start the process of increasing it round after round after round. I also do not like to purchase or own convertible debt myself. I want to know how much of a company I've purchased and I do not like taking equity risk and getting debt returns.

However, later on in a company's life convertible debt can make a lot of sense. A few years ago, we had a portfolio company that was planning on an exit in a year to two years and needed one last round of financing to get there. They went out and talked to VCs and figured out how much dilution they would take for a $7mm to $10mm raise. Then they went to Silicon Valley Bank and talked to the venture debt group. In the end, they raised something like $7.5mm of venture debt, issued SVB some Warrants as compensation for making the loan, and built the company for another year, sold it and did much better in the end because they avoided the dilution of the last round. This is an example of where convertible debt is really useful in the financing plan of a startup.

My guess is we will see the use of convertible debt, particularly with no compensation and no cap on valuation, wane as the current financing gold rush fizzles out. It will remain an important but less common form of early stage startup financing and will be particularly valuable in things like friends and family rounds where all parties want to defer the price negotiation. But I expect that we will see it used more commonly as companies grow and develop more sophisticated financing needs. It is a good structure when the compensation for making the loan is fair and balanced and when the debt vs equity tradeoff is useful for both the borrower and lender.

#MBA Mondays