Month: July 2007
Today’s great VC post actually comes from a lawyer (who represents VCs and VC-baked companies). And he brings good news. (Does that ever happen?).
Q: We’re a small startup with an innovative product in the social-networking / communications / UGC monetizing realm, at a pre-alpha stage of development. We have a number of potential deals on the table, the most attractive of which is to raise a large sum ($4mm) through a private placement with an investment bank. This deal has no strings attached, comes with a very high pre-money valuation and would cover two years of operating costs – SOUNDS GOOD TO ME!
Every VC we’ve met with expresses what seems to be prejudice against investment banks and the strategy we are considering, pointing out that they, the VCs, are the “smart money” with the “contacts” and “experience” as well as some other arguments as to why we should give up WAY more of our company to THEM for WAY LESS money.
What’s your word on this conundrum? My partner and I have talked to a number of entrepreneurs and they all say “stay away from VCs, take the money and run your business!” In fact, most of the people we talk to have had very negative experiences with VCs and question the notion of “smart money” altogether.
A: (Jason) It goes without saying (but I’ll do anyways) that I think reputable VCs are indeed smart company builders who will provide learned guidance in how to build your business and provide much more to your success than just money.
I’m not here to bash raising money from investment banks – plenty of our companies at some point in their lifecycle do just that, but consider some of the advantages raising money from a VC versus an investment bank:
– Venture Capitalist will add a lot more value as board members being professional small company board members;
– Venture Capitalists will price your deal accordingly for the funding round. Banks have been known to price early rounds too high and thus making future rounds very hard to consummate without diluting your first investors;
– Venture Capital financing will normally bring 1-3 shareholders to your company, whereas investment banks tend to bring many different individuals. Consider information requests, annual meetings and issues involving dealing with individual shareholders if your business does not scale as planned; and
– The bank may not be able to raise the money. It’s not investing personally, rather attempting to find others to invest in your company. If they fail, you’ve wasted a lot of time and money drafting a PPM, etc. – documents that you wouldn’t create if funding via a venture capitalists.
As for “no strings attached” – I’m not sure what you mean, but banks only get paid if they get the deal done, so make sure they have your interests in mind, not just theirs.
One last point: I’m not sure where you are located, but in our neck of the woods, I think most entrepreneurs have had positive experiences with the VCs. Again, you need to make sure they are reputable, but most professional VCs dealing with sophisticated entrepreneurs have good experiences together in both successful and problem-esque companies altogether.
We get quite a few repeat questions – ones that we’ve answered before. Just to remind everyone, we have a search box on the right hand side of our blog.
Q: I understand from your term sheet series that Venture Capitalists get their legal fees paid for by the company they are funding. I have a term sheet with a legal fee cap, but now my VCs are trying to increase the amount saying their legals fees are running higher than expected. What do you see as standard VC / investor side legal fees for Series A and Series B deals?
A: (Jason). I’m probably going to live to regret this post, as I’ll end up angering some lawyer friends of mine, but here goes…
I think a good number for a Series A financing is $25,000 or less for the VC lawyers. While hourly rates have increased significantly over the past decade, so has the sophistication and standardization of financing documents. Therefore, the prices for financings have not increased that much over time. If the company’s and VC’s lawyers are experienced and aren’t over aggressive, negotiating the documents shouldn’t be too hard.
The most time goes into the due diligence process, so it’s important that the company has its house in order and pertinent documents well organized. If they company is sloppy, legal fees will definitely be higher.
All of this being said, we’ve only seen one or two deals in the past 4-5 years that have gone over the cap.
I’m sure this post will raise other questions regarding legal fees, so let me anticipate a couple of them and answer them below.
Q: How much should it cost of later rounds?
A: Given that you are most likely going to use the prior round documents as starting points for drafting, all you are paying for is updated due diligence fees, so it shouldn’t be anymore (and maybe less) than the earlier rounds. If you have a new investor coming into the round as the lead, they may want to do all the diligence from scratch, so it could still be a $25,000 or so proposition.
Q: How much should it cost for recaps / down rounds, etc?
A: More. Think $35,000+. These are complicated deals, with shareholder mailings, consents and a lot more “hoops” to jump through.
Q: How much for debt / bridge financings?
A: Less. Think $15,000. These are even easier deals to do and the diligence is much less.
Q: What do I do if my VC is trying to increase the fee cap along the way?
A: Find out why they are asking for this. When we’ve increased the cap mid-financing it has been because either the company wasn’t well prepared for the financing, there was something “abnormal” found in the diligence, the deal turned out to be a lot more complicated than expected, or the company counsel were pains in the butt. Find out what is going on besides inefficient cost overruns of investor counsel.
Q: How much should the company pay its lawyers for financings?
A: This is much harder to estimate. Depending on how much “heavy lifting” the company lawyers have to do to prepare the company for the financing and how involved they are in responding to diligence requests, there can be a range. Additionally, the company lawyers draft the documents. The documents should all be mostly “off the shelf” but expect to pay at least double what your VCs are paying for your own counsel to run the process and respond to all of the comments and inquiries.
Well – maybe more often than sometimes. Bill Burnham has the great VC post of the day up titled Understanding Why Your VC Is Acting Crazy. Simultaneously, in a deeply rational post, Peter Rip has a Being John Malkovich moment and lets us inside his head with his post titled The Teqlo Adventure.
There have been lots of great posts about “how much should you raise” going around the blogosphere these days. Dick Costolo of
FeedBurner Google has an excellent one up this morning titled Series A Financing: How Much to Raise? In addition to a great rambling essay on how much to raise, Dick also reminds all entrepreneurs about the reality of revenue ramps:
“First, let’s address the hypothesis that the company will make money soon after launch. Irrespective of whether we’re talking about profits or just top-line revenue here, I would caution that it almost always takes longer to ramp your top-line than you think it will. Everybody walks into a venture pitch with their three year financial projections that have a lousy first year, a strong second year, and a monster third year. The truth is that even most ultimately successful tech startups have a slow first year, a slow second year, and then you get your spectrum of third year results ranging from really-taking-off to continued-doldrums. It just always takes longer than you think to launch, grow, ramp sales, close deals, etc.”
I spent some time this afternoon hanging around with my friend Jonathan Weber who runs the online publication New West: The Voice of the Rocky Mountains. He said he’d been asked about the story of starting New West so many times that he’d written a FAQ titled The New West FAQ for Online Community Journalism Entrepreneurs. I find FAQ / stories / essays like Jonathan’s thousands of times more instructive than my pontifications, so I encourage you to take a look, especially if you are an online community journalism entrepreneur.
(Brad): I got an email from Donna Murdoch at The Keystone Equities Group in Philadelphia taking me to task for the post Jason wrote on 1/17/07 titled Are There Venture Capital Brokers? Donna – who I do not know – didn’t like our perspective and suggested a different point of view. I encouraged her to write a point-counterpoint type of post for AsktheVC which follows. Donna – thanks for taking the time to express your perspective.
From Donna Murdoch at The Keystone Equities Group
I’m in Philadelphia and I stumbled across an article in Ask the VC today – which didn’t agree with the use of brokers or consultants for early stage funding. I would like to pose a contrary point of view. Yes, I am an Investment Banker. But I still love the true start ups and earlier stage companies, where an entrepreneur’s enthusiasm provides a rush of endorphins.
I was surprised to read the article saying that VCs turn our deals away because of what we do. We do a lot of M&A and work with expansion stage companies – but we do also raise money for earlier stage companies. How would they know how to do it?
Maybe in Silicon Valley, where everybody and their friends are starting companies. But in areas like Philadelphia – where most people have JOBS…..they have absolutely no idea how to do it or what funds even exist outside of the 2-3 everybody here knows so well.
These entrepreneurs need to get themselves ready for a capital raise and just don’t know how – how far along in the beta do we need to be? What should my PowerPoint look like? Do these projections look realistic? And how do they know where to go, what VC firms might exist, let alone be interested in their business and focus?
Point being – while you might be right in “Ask the VC” about companies in areas where start ups are the norm – and where Rock Stars prevail – in geographic locations where they are looked at with raised eyebrows for taking risk and it is often their first time – there is no peer group to consult. Sometimes “consultants” (Investment Bankers like us) might be the only option.
Most likely the presentation the VC hears from a Banker will be clear and concise, and they can assume they are only being called because the potential deal is a good fit. Does one who knows how to build a community based alternative energy website or power generation asset management software tool – also need to know how to follow the 10/20/30 rule? (maybe they do – I am just posing the question, not answering it). Considering the fact
that raising early stage capital is a one time thing (usually), should so much time be spent learning a whole new business? Perhaps they need the support, expertise and connections that aren’t as readily available in some communities.
My personal feeling is that if you can find a small firm with knowledgeable professionals like us – who have a good comprehensive knowledge of your industry and feel the heartbeat underneath it – why not spend the time and effort on the development of your company, rather than embark on a brand new learning track. It could be a good
Q: We received $150k from Friends and Family, and now we’re “on the board” – starting to show up on searches, getting a sale or two a day, and maintaining some growth. We have created a business model that is very scalable and now we’re doing everything we can to grow ourselves. We know that we will most likely need another round of funding – when should we start seeking that? And how much can we expect to get?
A: (Brad): The cliche “there is no time to start like the present” applies. It sounds like you’ve got something that is starting to work nicely on a relatively small amount of money – early stage investors love to see this. The key is to know how much money you really need to get to the next level and to target the right investors for this. See some of our posts in the Fundraising category for more context on this.
The amount you can expect to get isn’t the right question to ask. You should determine how much you need to get to the next level and then go try to raise that amount. “The next level” is subjective and should be defined by you – what do you think your next major “value creation” point is? This should be linked to you business and financial plan and will be an important part of qualifying prospective investors (e.g. if you need $2m, you will likely be pitching different folks than if you need $20m.)
Question: When pitching a site, what are the distinctions between the seed and early stages of development? Any information about number of users, progress through product development, and progress developing executive team would be greatly appreciated.
A (Brad): Not really. Seed usually refers to the very earliest stages, although it’s hard to define a clear distinction between the two. In both seed and early stage, it’s typically expected that some part of the equation will be missing. The team might be incomplete, the product might be a prototype, the number of users might be constrained by be a closed alpha. In all cases, the definition of “seed” vs. “early stage” is kind of irrelevant – it’s well understood that you are at the very beginning of the process.