Posts from VC & Technology

AVC regular Charlie Crystle asked me this question yesterday in the comments:

Fred, it might be helpful to some of your readers to explain when a startup should seek angel vs seed/early stage VC. 

If I need $250,000 to get to 100 customers, or $1 million to get to X, and I can raise both amounts from either Angels or VCs, where do we turn? 

And let's say both have significant interest, and the terms are the same, which is a better choice? (I no longer have an opinion on this, having gone both directions).

There are really two questions in here. The first is when you should SEEK angel vs VC and the second is if you have the option of taking money from both what you should do.

On the first, I believe entrepreneurs should seek angel money when their product is not yet complete, is not in the market and thus they cannot demonstrate real market traction to investors. There are multiple reasons for this and I'll try to articulate the most important of them.

A company without a product in the market is a very risky proposition. Some VC firms will invest at this stage but I am not sure its entirely appropriate for VCs to invest at this stage. Our firm will do it when we are backing a serial entrepreneur with a super strong track record that we are very familiar with. Otherwise, we stand on the sidelines and watch with interest but no capital at risk. A syndicate of angels, each with a small amount of capital at risk in the project, is a much more appropriate source of capital for a company at this stage because the risk has been well syndicated among the group.

Angels are also more hands off and I believe hands off investors are better for a company where defining, building, and tuning product is the primary exercise. VCs have a responsibility to their partners, both the partners in their firm and the partners who fund their firm, to be highly engaged in the business. So like it or not, they are going to be engaged in the business. I think it is best when that engagement is applied to a product that is in the market and gaining traction, and building the business is the primary exercise.

Finally, selling a VC on a concept on a whiteboard is a very hard sale. It is extremely time consuming with very little chance of success. Selling an angel on a concept is much easier. So simply in terms of where you should spend your time raising capital, angels are a better target in the "concept to product" stage.

The second question, what to do if you have the option of taking money from both sources on the same terms, is more interesting in many ways.

My answer is do both, if you can. When we participate in seed rounds, we most often do it by ourselves with a syndicate of high quality angels. We have done this at least a dozen times now and it works extremely well. We behave as if we are one of the angels and try to be relatively hands off. And we hope that the angels will add value just as they do in their other syndicates where there is not a VC firm involved.

But when the company needs another round of financing, we are there to provide more financing. Sometimes the angels follow in the successive rounds. But mostly they do not. It really doesn't matter, because we can fund the company on our own as long as the capital requirements are modest.

This is our preferred model and we have used it with great success. I think it benefits entrepreneurs the most as well. There are a number of VC firms that use this model. I first saw it practiced by Brad Feld about a decade ago in the seed deals he was doing in the Boulder area when he was at Mobius and I admired it immediately.

If for some reason, you must choose between VCs and angels, then I would choose a VC firm, as long as you have a very good relationship with the firm and the specific individual who will be leading the investment from the firm. In almost every situation, you are going to need more than one round and VCs can and will do multiple rounds and angels often cannot.

I will end this with a comment on the emerging seed and super seed fund models. They exist somewhere between angels and VCs and some are growing and turning into full blown VCs as I have mentioned recently in another blog post on this topic. Seed and super seed funds are "institutional angels" and as such I would mostly categorize them as angels. But many of them do have more capital at their disposal and can, at times, provide additional rounds of funding. So in some ways they are a hybrid. A syndicate of a seed fund or super seed fund and angels is a great way to go if you can put that together. A syndicate of a VC, a seed fund, and some angels might even be better.

To finish this post, I think entrepreneurs should target angels and seed funds when they are pre-launch but if they have the opportunity to pair a VC firm with angels and seed funds into a single syndicate they should do that because it will provide most stable funding platform for the business going forward.

There are a growing number of resources for entrepreneurs on the web, but certainly one of the very best is Venture Hacks. And their AngelList service is particularly useful for entrepreneurs trying to get angel rounds done. I found myself recommending it to at least a half dozen entrepreneurs this past week.

I particularly like this case study of the BlockChalk angel round on the Venture Hacks blog. For those who aren't going to click thru and read the whole thing, here's a quick summary.

Joshua Schachter had already committed to invest in the BlockChalk angel round and he suggested they use AngelList to fill out the round. That resulted in commitments from Mitch Kapor, Thomas McInerney, and Josh Stylman. But then Josh Stylman introduced BlockChalk to Chris Dixon and Eric Paley who joined the round. And then with the strength of that syndicate in place, AngelList added Satya Patel, Michael Dearing, and David Liu to finish off the round.

What this shows is that the old model of angel deals is alive and well. Angels love to share deals with each other. It is how angel rounds come together. But AngelList adds at least two things to the mix. First, it adds a place where the deals can come together online. And second it adds people to the mix that would not be part of the offline deal sharing networks that already exist.

I am on AngelList. I see all the deals come together. I don't personally invest in angel deals in the web/tech space because of potential conflict with USV down the road. But even so, I find it immensely useful to see what companies are getting traction in the angel market. It's part of my radar/early warning system. And it is entirely possible that we will decide that USV needs to participate in an angel round that is coming together on AngelList, although that has not yet happened.

So if you are putting together an angel round, particularly if you already have it partially raised but need to finish it off, I strongly suggest looking into AngelList. It's a great service.

Mark Suster has a great post on calculating valuation and the things that VCs can throw at you to make the deal better for them (I guess I should say us) than it actually looks. Go read it. It's complicated stuff but you should try to wrap your head around it. I've written a bunch about this as has Brad Feld and other VC bloggers have too. The VC world is changing. We are talking about this stuff, explaining it, and discussing it. That's progress.

But here is the thing. Terms and term sheets are a necessary evil of the venture business but most venture returns don't come from terms. They come from terminal values. Meaning the size of the exit. One deal often returns the entire fund. The next three to four deals return it again. The rest of the portfolio might return it again and if you can do 3x gross, you'll raise another fund, and another, and another.

In my talk with John Battelle yesterday at Geo Loco, where I said some controversial and partly tongue in cheek things that were widely reported, I did talk about this. And I wish it was as widely reported as the sound bites. What I said was that there are only a few things that really matter in a venture investment. The first is the amount being raised, the second is the dilution to the entrepreneur and the ownership the investors are buying (largely the same thing), and the third is the relationship between the investor and the entrepreneur. Everything else is pretty much noise.

I do care about and want a plain vanilla one times liquidation preference because I think it is fair. If the company is sold for less than the valuation that we invest at, I think it is fair that the investors get their money back in that scenario. Any multiple of liquidation or participation should be avoided at all costs by both sides. VCs often use those tricks to bridge valuation gaps but I have come to believe you should resolve valuation gaps with compromise or just don't do the deal if the gap is unbridgeable.

I think the VC business is changing in many ways and one good way is that more and more VCs are thinking less about terms and more about terminal values. And that is best for everyone.

Last night my partners and I hosted a fundraiser for NY's senior Senator Chuck Schumer. I've written about my fondness for Chuck on this blog before and I remain a fan and supporter.

Chuck told a story to a small group that had assembled before the larger event. He said that he was meeting with the CEO of Deutsche Bank and asked him "do you think the US will be the world's leading economy twenty-five years from now?" The Deutsche Bank CEO said "of course." Chuck said "not many americans feel that way right now." And the CEO said "America is the only place in the world where anyone, no matter what race, religion, background, can be accepted in business and society and realize their dreams and make it to the top. That doesn't happen anywhere else."

I might disagree with the CEO just a bit. I think Australia and Canada are very similar to the US in that regard. But his point is important and worth blogging about, which is what I am doing.

A welcoming society is our history and that is the special sauce that the US brings to the world economy. We welcome entrepreneurs large and small in the US and support them and celebrate their success and forgive their failures. And I am so very proud that I am a citizen of this great country.

But we have turned inward in the wake of 9/11 and the "war on terrorism." And that is hurting us. The terrorists have achieved their goals if they turn the US into a country that no longer welcomes the best and brightest from anywhere with open arms.

So I was thrilled to hear Senator Schumer's optimism last night that we will get "comprehensive immigration reform" in 2011, after the midterm elections. I hope and suspect that will include visas for science, technology, engineering, and medicine (STEM) grads. I hope and suspect that will include the startup visa. I hope and suspect that will include a lot more H1B visas.

Immigration reform is one of the most important issues in the startup political agenda which also includes net neutrality, patent reform, and a number of other important issues. I know that many of you share my passion for this issue. Let's keep up the pressure on our elected representative to do the right thing and give us comprehensive immigration reform as soon as possible.

Tereza, an AVC regular and active community member, wrote a blog post yesterday proposing that someone start XX Combinator, a Y Combinator style startup accelerator focused on women in their 40s.

Here’s the basic argument:

Y Combinator participants are for the most part very young — in their early 20’s. This is not when women would be most inclined. Women who start businesses like to know what they’re doing, and be trained and experienced in it. That takes up our 20’s. We have kids in our 30’s. Our entrepreneurial sweet spot is around age 40. Conventional tech investors are not really into this group and the metrics they look for are really hard for these people to hit. Most of the (few) women’s businesses that go big were funded by friends & family or strategics, not traditional angels and VCs.

She also points out that the Y Combinator program is purposefully focused on hackers and that is not a term often attributed to women. So Tereza proposes that XX Combinator come pre-populated with hackers, kind of like Betaworks is.

XX Combinator is a cute name and makes the point well. But I suspect a different model is required if this were to work. First, it is not so easy for 40 something women to move to silicon valley for three months. Second, if you have a team of hackers in-house, then you are an incubator more than an accelerator program.

But Tereza is right about a bunch of things. First, there aren’t enough women entrepreneurs. There aren’t enough women VCs. There aren’t enough women developers. The startup ecosystem is largely a man’s world and as a result, we see a lot of certain kinds of businesses and not enough of others. People are drawn to scratch an itch. If it is a 20 something developer, then they are scratching a certain kind of itch.

I know what Tereza is working on. I’m not sure if it is cool to talk about it here so I won’t. But it is the kind of idea a women in her 40s would be working on. And it is not an idea a 20 something man would likely work on all by himself.

Tereza is not alone in her evangelism. The Gotham Gal, who talks to and works with a lot of 40 something women entrepreneurs tells me that this group is “breaking out.” She told me about a conference in NYC this fall that she is involved in that is targeted at this group. And she told me last night that TED is working on a conference for women. Brad Feld wrote a great post yesterday about this topic. And he links to an excellent Eric Reis post that also articulates the need for more diversity (especially women) in the startup sector.

So maybe the time is right for an effort to build one or more efforts focused on helping women get started. These startup accelerators need a leader. Y Combinator has Paul Graham and his partner Jessica. Tech Stars has David Cohen and his partner Brad Feld. Seedcamp has Reshma and Saul. Betaworks was started by John Borthwick and Andy Weissman. So we need entrepreneurs to create these efforts, not committees, governments, or companies.

And we need entrepreneurs with a plan to deal with the realities that Tereza lays out. If there are entrepreneurs out there with the idea, the plan, and the passion to do this, please contact me. I’d be happy to help get something like this rolling.

Forums have been around for as long as I have been on the Internet. I've always found forums useful for finding out "how to" information. But its always been a hit or miss experience. And I've always used search (google mostly) to find the forum post with the info I need.

Our portfolio company Stack Overflow is attempting to change that. As they have done with programming tips and techniques at StackOverflow.com, they are bring social networking and game mechanics and a number of other important changes to the forum model to create vertical communities that allow people to solve each other's problems for each other.

One vertical that has literally hundreds of forums on the Internet is gaming. I'm not that much of a gamer but I watch my son. When he needs a cheat code or wants to find out how to conquer something in a game, he goes to Google and does a search, finds a forum, and finds his answer. There is a huge amount of traffic to gaming forums on the Internet for exactly this reason.

So Stack has launched gaming.stackexchange.com to bring the magic that exists on StackOverflow to the gaming vertical. I'm optimistic that gaming will turn out to be a big vertical for Stack. Gamers love to earn points, badges, and status. You don't have to do anything more than spend a week with my son watching him accumulate foursquare points in europe to see what points do to a gamer. And now gamers will be able to earn status and reputation by sharing the knowledge they have with each other.

If you are a gamer, check out gaming.stackexchange.com and let me know what you think. It is early, the service just launched in beta this week. So there won't be a lot of content up right now. But the mechanics are in place and you can get a feel for it.

There have been quite a few posts written about this meme in the past few weeks. 

I think that Paul Kedrosky got the discussion started with this post. Chris Dixon wrote an interesting response. And yesterday John Boyd wrote a thoughtful post on the topic.

John makes a point in his post that I want to second and add to. He says:

While many businesses require a lot less capital to start, they don't require less capital to grow.

John's comment made me think about a blog post I wrote three and a half years ago called "Web 2.0 Is A Gift, Not A Threat, To VCs." If you haven't read that post, I would urge you to go read it. I blog because it helps me think through a lot of issues we face in our business and that post was really useful to us over the past several years of investing.

Here's a chart from that post:

This is an entirely theoretical chart. There is absolutely no real data behind this chart. That said, it does reflect our experience investing in about thirty "web 2.0" companies over the past seven years.

What this chart says is that it still takes on average $20mm to get a web startup to sustainable positive cash flow. But the vast majority of that capital will be required after the business has "traction."

What has changed in technology venture capital is not so much the total capital requirements, but when they are required. This is very good news for everyone involved. It means entrepreneurs that don't have to take expensive dilution early on in the development of their business. And it means that entrepreneurs can raise the big money later on when their business is worth more. It means that entrepreneurs should be able to keep more of the companies they start. That is good for everyone.

It also means that VCs don't have to take big risks early on. They can write checks in $250k and $500k sizes. It means that when the businesses develop into winners or likely winners, they can write the bigger checks like $3mm or $5mm or even $10mm. This is good for the VC business. Less writeoffs, more capital deployed into the winners and less into the losers. 

Where this all gets interesting is the point at which it is clear that the business is going to be a winner. Let's look at our portfolio company Foursquare as an example. We invested in a ~$1mm seed round last summer, investing $500k. By that time, Foursquare had already launched and was growing nicely. Dennis and Naveen had built the service all by themselves and had just lured Harry onto their team. They needed no capital to do that. In fact they did not even have a bank account when we went to close our seed investment. That seed round was highly competitive and Dennis and Naveen could have raised money from dozens of investors. A year later, Foursquare is scaling quickly, adding 1mm new users in the past three months. They need a lot of capital now. And they were able to raise it, $20mm on their terms, a few weeks ago. As competitive as the seed round was, the large round was even more so. The company added one new investor, Andreessen Horowitz. And our firm and OATV got to invest a bunch more into Foursquare. 

Clearly Dennis and Naveen used the capital efficiency of web startups to their advantage. They did not need any money to get the service built and launched. They scaled the service to 2mm users and the employee base to close to fifteen people on just over $1mm of seed capital. And they got the capital they need to scale it to a much larger business on their terms. That's how it is done these days.

And the seed investors, USV and OATV, got to put a little money into the business early on and then got to write a big check when it was clear the business was going to work. At least it is clear to me that the business is going to work. I much prefer doing it this way than putting a ton of capital into the business early on before the outcome is reasonably clear.

But there are two places you don't want to be in this new world. You don't want to be the VCs who wanted to be in the "big round" and didn't get to be in it. The deals that work get very competitive when it is time to raise real money. That's a problem for VCs who don't invest at the seed stage and are betting they can get into the deal in the "first venture round."

You also don't want to be a seed fund that is invested in a company that hasn't scaled yet but is out of money. Then what do you do? You can write off the investment or you can put more money in. Or you can find a VC firm to invest. But what if the company isn't far enough along to attract VC money? 

Very few entrepreneurs will execute as well as Dennis and Naveen did over the past year. Most will need a longer runway before their business scales. And that is an issue for the seed funds. They need to get bigger or find a "bridge" to VC for those companies that take a bit longer.

I think we will see both things happen. First Round Capital, the grandaddy of the web 2.0 super seed funds, has now evolved into a firm that is twice as big as our firm in terms of investors and they have about $200mm in total capital under management. And I've met a couple investors who are talking about creating "seed bridge funds." I think that's a great idea.

Will the seed market crash? I don't think so. Will it evolve and change and look differently in a few years? Absolutely. We are still figuring out to evolve the VC business to reflect the change in financing needs of entrepreneurs and we aren't done by a long shot.

Related articles by Zemanta

• Seed Deals Account for 26% of Early-stage Web Investments (gigaom.com)
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• Is There a Super-Angel Crash Looming? (gigaom.com)

I exchanged some blog comments with Tereza yesterday. She's starting a web company and is raising angel money. She said she did some phone pitches against her better judgement and they didn't work out. I advised her not to do them anymore.

Here's my thing about phone pitches. They aren't very effective. I hate taking them and almost never do. I don't think they allow the entrepreneur to show themselves very well which is the most important thing of all.

And it is so easy to say no over the phone. There's no real human connection. It's easy to pay half attention or less on the phone. It's easy to fake that you are listening when you are not.

I admit that I am really bad on the phone. I always have been. It's not a medium that I like very much. So I am probably worse than the average investor. But even so, I think doing phone pitches is a mistake and you should avoid doing them.

I do think a short phone call introducing the opportunity at a very high level and making the case for an in person pitch is an important thing to do. You can accomplish that in a few minutes or less. It's basically an elevator pitch. But don't agree to do the whole pitch on the phone. Ask the investor make time for you in person to do that. That will determine if they have sufficient interest for you to invest your time with them.

And what about a video chat on skype or another similar service? I do think a video chat is sufficiently better than a phone call to make it a semi-viable alternative. If a plane ride is required to see an investor, then a skype/video chat is a decent first step. But again, you should do it with the objective of getting an in person meeting. 

But if you can visit the investor in person without getting on a plane, I think you should always opt for that over a conversation over the phone or skype. There really is nothing like the in person, face to face meeting when it comes to fundraising or any kind of high level sales effort.

Fundraising is such a hard thing to do, particularly for first time entrepreneurs without a track record and an investor following. Don't make it harder by putting a wire between you and the investor.

The streets are empty in NYC this July 4th weekend and it seems like everyone is at the beach. The Gotham Gal and I are getting ready to head to Italy for a week on Sunday night. Summer is here and I can feel the pace of work life and city life slow down.

Many of our companies experience a slow third quarter because people aren't working at quite the same pace in July and August and it is hard to get it all back in September. And many entrepreneurs and investors I work with assume for the same reasons that the summer months are a bad time to be raising money.

I don't think the summer months are a bad time to be raising money. It's a different time to be sure, but not necessarily worse. We see a lot less incoming activity in the summer months so it may be the best time to get a VC's attention. If everyone else thinks it is a bad time, then the contrarian in me says it is a good time.

I just did a quick query on our portfolio and we made our first investments in eight of our twenty-seven active portfolio companies during the third quarter. Three of our investments were closed in July. Three of our investments were closed in August. And two of our investments were closed in the first couple weeks of September.

Eight out of twenty-seven is thirty percent of our portfolio, and that is north of the twenty-five percent of the year that the summer represents. So our firm has been more active on new investments during the summer than we are on average.

I suspect that if you look at the VC industry as a whole, and there are plenty of services you can use to do that, you will find that there really isn't a summer slowdown in investing activity.

But as I said a bit earlier in this post, the summer is different. And if you plan to be raising money this summer, you need to plan for some things. First and foremost, people will be on vacation, as I will be next week. So you it will not be as easy to get meetings in the summer. You will need to plan ahead a bit more. And when you do get meetings, there will not be as many partners in attendance. So you may need to visit the most engaged venture firms in your process a bit more than you would other times of the year. It may take longer to get a full partner meeting scheduled and when you show up, some of the partners may be on the phone from vacation spots around the world. It may be harder to get them engaged.

Due diligence is also a bit harder to do in the summer months. The people the VCs need to talk to to understand the investment and the people are more likely to be away. So anything you can do to help schedule those calls and meetings will be much appreciated by the VCs.

The bottom line is it takes a bit more work on your part to run a fundraising process in the summer months. But the benefit is you may well find that you are seeing a more relaxed set of investors, who are spending a bit more time on the golf course, and have clearer heads. If you extend your timeline by a month or so, dedicate a bit more effort to scheduling and quarterbacking the process, you will find a receptive audience with their checkbooks open.

The thing to remember about VCs, and all sorts of professional investors, is that we get paid to invest capital. It is what we do. So just because it's a slower time of the year, doesn't mean we aren't still doing our job.

If your company will be running out of money at or before year end, you should be raising money now. Do not let anyone convince you to wait until "everyone is back from the beach in September." That is too late. Do it now.