Month: February 2008
Today’s great VC blog post once again comes from Fred Wilson and is titled Conviction and Discipline. Having made a lot of investing mistakes in 1999 and 2000, I learned this lesson many times over. It’s also consistent with the Fantastic Notes from an Interview with Warren Buffett that I posted on Feld Thoughts earlier this morning.
Two great VC posts today. The first is from my partner Seth Levine titled The power paradox and discusses "power" (not that kind that runs your computer.) The second is from Rick Segal and is a look inside the spooky place he calls his mind/space/time for how to get his attention as a VC.
One of the questions we get often is whether or not there is a central clearinghouse or hub (social network?) where VCs and entrepreneurs can connect. The idea is that VCs would find good deals and entrepreneurs would find funding. The answer is "no." Lately, on top of the questions, I’ve gotten several business plans that seek to create such a network. So why aren’t there any? And if not, should there be?
I’ve always been pretty negative about the idea. In general, I think there would be a natural adverse selection to those who would populate the network. Here’s why:
1. Great VCs already have more great deal flow than they can fund. Therefore, they will not be interested in such a clearinghouse and will "opt out" from participating. Also, keep in mind that there is always a higher hurdle to fund a deal that hasn’t been started by someone whom the VC doesn’t have some previous experience with. If the best VCs opt out, then likely, so will the best entrepreneurs.
2. Repeat entrepreneurs (who have had success in the past) already have a VC network. They’ll likely opt out because they already know VCs from their prior successes. In fact, most of these types of deals are done quietly without a lot of shopping around. This assumes that the entrepreneur liked his/her VCs at his last company. If not, it will still be very easy to find backers for a previously-successful team. Successful founders are always hot properties.
3. First-time entrepreneurs who have executive-level experience are at most one degree separated from a VC network. Even first-time folks who have been part of a successful startup probably got enough "air time" at board meetings to get to know the investor syndicate and thus have their own network. If not, they can usually gain access through their former CEOs and other management executives.
4. It’s not really that hard to find VCs. Unlike 10 years ago, there are many more VCs out there and many of us have our email address on our web site. It’s not that hard to just email and ask!
So, who is left to be a part of a community like this? It looks like first-time founders / unsuccessful repeat entrepreneurs who don’t know how to find email address on the web. Yes, I’m being a bit glib, but the bottom line is that I’ve never thought that the "best of the best" would end up a part of such a community and is the reason why there isn’t one today and probably not one tomorrow.
Q: Do venture capitalists require audited financials from the companies they’re considering for an investment? Will “reviewed” financials suffice? For that matter, how do acquirers think about audited financials? Will they help speed an acquisition or is it overkill?
A: (From guest writer, our partner, Chris Wand).
We have a requirement that all of the companies that we’ve invested in get full year-end audits from an audit firm we’re comfortable with. It doesn’t necessarily have to be one of the big national firms (such as PwC, Ernst & Young or KPMG); in many cases we’re comfortable with a reputable regional firm with strong capabilities and resources. However, a small shop with a handful of people or a solo practitioner isn’t like to make the cut from our perspective.
Most entrepreneurs who have grown their business beyond a basic startup stage (i.e. they’re generating more than nominal revenues and have more complex or significant operating expenses) will find it helpful to have audited financials when talking with venture capitalists, since that just takes the entire issue off the table. However, not all venture capitalists will require audited financials before investing in a company (even though virtually all venture capitalists will require their companies to be audited after the investment).
Ultimately it’s a judgment call as to whether we (or any other venture firm) would require audited financials before making an investment. If it’s a small, early stage company with a handful of employees, a relatively low expense base and nominal revenues, we’re probably not really valuing the business (and hence our investment in the business) based heavily on the company’s historical financial metrics, so audited financials aren’t that important to us.
On the other hand, if a meaningful part of the valuation dynamic of the business is the company’s historical financial metrics (i.e. the company is arguing for a certain valuation based on market multiples and the company’s revenues), then we need to make sure that the financials are properly presented in order to get comfortable making the investment. The same could probably be said if a company had weird expenses (i.e. issues of capitalizing vs. expensing certain expenses, etc.) but that’s less of a specific concern for us given the types of businesses we invest in and the fact that we view cash outflows as more indicative/important than expenses (using the accounting meaning of that term) for early-stage companies.
As for being prepared for an acquisition, you definitely want to have audited financials before you embark on an M&A process. We find that very few acquirers (and certainly not large public acquirers) are eager to acquire a company without seeing audited financials before signing the deal. While I’m sure there are exceptions, it’s generally too significant of a diligence item for an acquirer to overlook. So it becomes a question of whether you want to get your financials audited now or whether you want to be under the gun getting an audit when you’re in the midst of an M&A process.
If you think an M&A process is likely at some point in the near-to mid-term, then you should get audited financials rather than reviewed financials, since again that keeps it from becoming a distraction (at best) or a barrier (at worst) to a deal.