Month: March 2007
We’ve decided to start the Boulder version of the OpenCoffee Club. The club is quickly becoming an internation club that has local franchises. Saul Klein was the brains behind developing a forum where entrepreneurs, developers and investors organize real-world informal meetups to chat, network and grow. In other words, people in the venture capital world get to hang out, meet each other and learn from one another.
We’ve set up a site if you want to keep track of the schedule and encourage as many people to come as possible. We intend to meet every other Tuesday at 8am.
So if you are interested in a “live” version of AskTheVC, or just want to come and hang out, we’ll see you there.
Question: While valuing a private company and arriving at a valuation do VCs take into consideration a discount for lack of marketability. If at all, how do they objectively arrive at a figure for such discounts?
All of our deals have a lack of marketability in their securities. Startup companies, by definition, don’t have a trading market. We don’t figure this into our valuations, as it is just part of the business of investing in these types of ventures.
One note to consider: over the past few years, there have been several firms that have formed that will purchase private company securities. So, in fact, the marketability of private companies has actually improved over time. That being said, it’s still not something that we factor in.
Q: What tips do you have for startups who aren’t in any of the usual vc hotspots like the Valley, NYC, or Boston?
Some people believe that the real estate adage “location, location, location” is sacrosanct when starting a company. While there is no doubt that it is easier to find your way in a well-known entrepreneurial community, companies get started (and flourish) everywhere. Following are some suggestions for getting started if you aren’t in one of the usual VC hotspots.
Don’t worry about it: Presumably you live where you want to live. If you don’t, consider moving! However, if you are where you want to be, realize that building your business – and your life – go hand in hand.
Be realistic about the available resources: Every community that can support entrepreneurship (and basically every MSA in the US can) has its strengths and weaknesses. Usually these are defined by three things: (1) local universities and research programs, (2) major companies in the area, and (3) historical vectors of entrepreneurial activity. Be realistic – if you want to start a new biotech company and you live in a city that doesn’t have any graduate-level life science research, no anchor biotech companies, and no history of creating biotech companies, the odds are stacked against you. On the other hand, if you live in a telecom rich region and you want to start a new OSS for IP services company, you are probably in pretty good shape.
Find the local entrepreneurial ecosystem – now!: It’s easy, is usually right in front of you, and often simple to access. Find an advisor who is a successful local entrepreneur and is plugged into the scene. Go to every local “entrepreneurial” event, especially those linked to regional or national organizations. Don’t be shy asking for help – the worst someone can say is no.
Don’t try to get investors to do unnatural acts: Assuming you are looking for capital, focus your energy on two categories: (1) local investors – either angel or VCs and (2) VCs that are interested in the specific business you are creating. In category #2, “software” is not a specific business – you need to be a lot more granular than that. Your chance of #2 is enhanced by a relationship / investment with someone in category #1, so make sure you focus enough energy on that early on.
Don’t play the “we can be virtual” game: While being virtual can work for some businesses and some entrepreneurs, it’s not the cure all for being in a geography other than “the top tier.” If you make progress, you will reach a point relatively early where you want everyone on the team to be in one place (or your investor will.) If “being virtual” is natural for your team, that’s cool – go for it – but don’t use it as a justification for geography.
Question: I’ve done angel investing for the past 8 years. I most often invest with people I don’t know or am referred to. I have invested a few times with friends and it has always been hard to be tough on them as a shareholder, so I’ve stopped which is too bad since I have some smart friends. Any advice for investing in a friend’s company?
This reminds me of the cliche “some of my best friends are angel investors.” While I understand that it can be difficult to be an angel investor in a friend’s company, it surprises me that you’d actively seek out “non-friends” to make angel investments in.
I’ve made over 50 angel investments since I started investing in high tech companies in 1994. Some of them have been in companies run by friends; many of them have been in companies run by people I didn’t know at the time I invested. When I look historically at my economic outcomes, some of my biggest successes were in companies where I didn’t know the people involved prior to becoming an investor while others were with close friends. My failures correlate similarly.
Over time, one thing has remained constant: almost all of the people that I’ve invested in – including those that failed – have become friends. And – in many cases, I’ve backed them again (and again.)
If you asked an entrepreneur I’ve invested in about my behavior – in both success and failure – I think he’d tell you that I was supportive, helped whenever and wherever I could, but was always direct with my feedback, even if it meant tough love. I try to just spoke my mind, be as clear as I can be, and do my best.
Ultimately, I think it’s a mistake to shy away from investing in friends (especially if you have smart ones.) The key is to be confident in your ability to communicate clearly and – when delivering tough, difficult, or critical feedback – to do it in a constructive and thoughtful way. And – some of my best investments have been in people I’ve become close friends with through my earlier investments with them, regardless of the outcome.
Question: We are considering selling our VC-backed company. It may not be the optimum time so valuation is a question. My board has asked me to proposed a management carve out plan as a retention tool. What do I need to consider in formulating this proposal?
While management carve out plans were rarely used before the Internet “bubble,” they’ve evolved over time to have fairly standard terms. In general, you need to consider the amount, form of consideration, how the proceeds are distributed and implications on escrow terms.
Amount: Without knowing more about your particular situation, it’s hard to give you guidance on the particular percentage that is reasonable. Normally, these plans give the participants between 5 and 10 percent of the aggregate proceeds of the deal. I’ve also seen higher and lower. The proceeds are usually decreased by any amounts received by the participants under the liquidation preference structure.
Form: Plans should distribute the same form of consideration to the participants as the rest of the stockholder base. However, they should always have a clause that allows cash to be paid out in case the acquiror prefers this, or if you are in a situation where people would otherwise receive fractional shares.
Distribution: Proceeds under the plan can be allocated by the board, by the CEO, or a combination of both. Normally, you see the CEO proposing the distributions and the board reasonably approving his / her plan.
Escrow Considerations: One piece of negotation is whether or not the management carveout should be subject to escrow provisions. It seems fair that it should, but the question is what happens with respect to indemnification obligations that go beyond the escrow. Should management have to take cash out of their bank accounts to cover these amounts? It’s definitely a case-by-case situation, but make sure that you address this up front, not at the time of the acquisition.
One other item to consider is whether any payouts under a plan like this will trigger any “golden parachute” (280G) situations. Ask you lawyers and your accountants to do this analysis early on so that you can deal with any potential problems. What’s 280G, you ask? See our earlier post.
Today, our partner Chris Wand is our guest blogger of the day.
Question: I am a VC, what do I do now? When I left university I got lucky & landed a job working as an analyst for a VC firm. Fast forward a few years & now I’m left wondering what to do. There don’t seem to be any roles in the industry at the next level. I’m good at technology without much development experience & strong on operational metrics without any operational experience. All advice gladly accepted!
Implicit in your question is the statement that VCs aren’t qualified to do anything other than be VCs. And while it’s tempting, I’ll resist the urge to pander to those among us who believe that to be the case…
I’d encourage you to focus on the core skills that you have acquired during your time as a VC and then figure out where else those skills are relevant. Your work experience may not position you perfectly for that next gig, so your challenge is to help your future employer see through your prior job title to understand what skills and passions you do bring to the table.
When I think of junior VCs that I know, their skill sets often include strong quantitative and analytical skills, market research skills, etc. Seeing a lot of business plans and helping analyze various investment opportunities can hone your business sense, and–let’s face it–being a good VC generally requires at least a modicum of people skills (if only to deal with your fellow VCs <g>).
If that sounds like you, then your next jump could take you into consulting or investment banking (both of which rely heavily on quantitative, analytical and research skills). Or it could take you into a junior operating role in finance, business development or corporate development where you’ll have the opportunity to learn the ropes from someone with more experience.
Recognize, however, that when you switch gears, sometimes you end up having to downshift a little bit at first in order to get your foot in the door and prove your worth. Given that you’re still early in your professional career, I wouldn’t get hung up about potentially taking a step backwards. Focus instead on what you’re good at and what you really want to do.
Craft your resume to highlight the most relevant skills, comb your network for any and all introductions you can find (that’s where you’re likely to have the most success), and focus on finding an opportunity that will continue to expand your skills and build your experience, even if it feels like a bit of a step back.
Question: Does a Board of Advisors provide much value to a startup company? Would having a Board of Advisors have any impact, negative or positive, on angel or venture capital funding?
It’s a lame answer, but “it depends.” We’ve seen the effectiveness of these boards skew all over the map. We’ve seen some that are quite helpful with strategic direction, sales, marketing and business development and we’ve seen others that are simply faces on a website. If you go through the trouble of creating one, make sure they are really champions for your company and will be there to answer your calls. Sometimes the more of a luminary the advisor is, the less likely that they’ll have time to really impact your business.
As for an advisory board’s affect on attracting investment, it’s not really a factor. Clearly it’s not a negative if you have a board of relevant advisors, especially ones that have prior successes in a similar sector. That being said, most venture capitalists will choose a company based on the management team and the company itself, not on who has decided to take an advisory role.
My personal opinion is that if you have some high quality people who are willing to put in the time and who knocking on your door, you might want to consider creating an advisory board. I wouldn’t go out and spend much time looking to form one, however.
Question: Under what conditions would it make sense for a pre-seed stage CEO to give a board seat to his co-founder CTO/VP Engineering? What might be the positives/negatives? Especially if the CTO/VPE has more experience with dealing with VCs than the CEO?
If you think your co-founder would make a good fellow director, then put him on the board. With a company as young as yours, do what’s best to run your business and don’t worry too much about what potential investors may think later. When you decide to take some venture investment, you can sit down and decide what makes sense for the board at that time.
While helpful that your co-founder has some relevant VC experience, it’s not necessary for him to be on the board in order to interface with investors. Most of my board meetings have company executives who regularly meet with us who are not on the board.
The FeedBurner Venture Capital Network has expanded to 71 bloggers (with a reach over over 200,000 daily subscribers) by the addition of Todd Jacquez-Fissori. I’ve known Todd since he lived in Boulder and worked at Boulder Ventures – he’s now at Siemens Venture Capital and has started a new blog titled The Outright VC. Welcome Todd.
Once again we have a guest blog from Will Price at Hummer Winblad. We appreciate Will’s efforts in both writing a post on planning for M&A as well as introducing some MBA-speak into AsktheVC (hint: BATNA).
Question: How do you plan for M&A? Trying to build our company, thus far we went the regular path – market research, sales projection models, expenditure / P&L models, potential products/product lines and the like (text book?), but many people we met told us (“shouted”) that we should plan for a strategic partnership/ M&A, how do you do that? Should there be a special business plan?How does a P&L look in that case? How do you plan the selling of your IP to a large company? Selling after you have a finished product? Selling the company after initial sales? Letting the company grow a bit more? Is it good practice / healthy to plan your business on somebody buying you? Will it be acceptable to prospective investors/ VCs?
Plan for Independence. There is a famous VC saying, “companies are bought and not sold.” Accordingly, the best “plan” is to plan for success as an independent company.
The company’s operating plan, technology road map, and executive team should not focus on unnatural acts, in the hopes of attracting a buyer, but rather on building a company with the potential for independence. Companies built to “flip” often flop. They often flop due to the fact the team is not truly committed but, instead, looking for a quick buck. Bad motives drive bad behavior.
A fundamental concept that helps focus management on building to independence is optionality, or BATNA – which is MBA-speak for “best alternative to a negotiated agreement.” BATNA is a fundamental tool for understanding negotiating leverage and strategy. If you work to ensure you have a BATNA – for example continued independence or a higher offer – the company is able to negotiate from a position of strength. If no BATNA exists (i.e. the choice is between a fire sale or running out of cash), the company is at the mercy of the buyer and the negotiation becomes an exercise in Russian roulette. Always have a BATNA.
While the security software market is an extreme example, it is far more probable that a successful tech company will be bought rather than go public. Accordingly, while no special plan for sale should be developed, it is highly logical to expect M&A to emerge as the path to liquidity.
While VCs believe “companies are bought and not sold,” acquirers tend to believe that “successful partners make the best acquisition targets.” Successful partnerships are characterized by
- a history of successful joint customer engagements,
- successful technical integrations and co-deployments,
- a joint roadmap,
- co-marketing and sales traction, and
- management teams and team members with a track record of collaborating to reach shared objectives.
A great example of the partner-to-buy model is SAP and Virsa, although there are many such examples.
Keep Good Records: Finally, M&A is a diligence driven exercise. The final cliché is that “good record keeping makes for good diligence and good diligence makes for expedited outcomes.” Good records include:
- Articles of Incorporation/company charter
- all Board minutes, contracts, signed employee assignment of IP forms
- capitalization table
- option plan records
- prior financing documents
- audited financials
- patent filings
- documentation relating to litigation, assessments, or claims
Any material gap in records will either 1) delay the sale process and/or 2) will lead to a higher escrow to offset potential liabilities that may “appear” post-close.
In summary, all clichés are common sense and the M&A related clichés noted in this post are no different:
- build companies for independence (always have multiple BATNAs),
- partner well,
- keep good records