Month: April 2008
Q: I am the co-founder of a startup that is currently in the process of trying to raise an early stage venture round. We recently brought on an advisor who has been incredibly successful in our space and has made introductions to dozens of potential partners and VC firms where he is an investor. He has all the right relationships, but we gave him low double-digit equity to get him on board (his demand). The equity vests over a period of time and I stay up at night thinking about (1) if we should kill the deal and (2) what a VC will think of the founders when he/she finds our how much we gave up to get this individual to help. To further complicate the situation, the advisor (who is very wealthy) has taken a pass on investing his own capital and this has been a sore spot for any VC looking at our deal. How do you think we should resolve this situation.
A: (Brad): My immediate reaction is "ugh." You’ve been taken to the cleaners by your "advisor" – low double digit for introductions – even if they are the right ones – is radically overreaching.
A typical advisor like the one you describe will get around 1% of equity vesting over at least a year (usually two) in exchange for being an active advisor / board member. As part of this, the advisor should be willing to invest something in whatever financing you raise (at least $25,000 – preferably more) to show some personal financial commitment to your endeavor.
Since you have a vesting agreement in place, you at least have an option to kill the deal. I suggest you start with a frank conversation with your advisor. Explain that you really appreciate his involvement to date. However, you’ve gotten two consistent pieces of feedback: (1) his ownership stake is much too high for his role and (2) you are getting resistance from the VCs he’s introduced you to because he’s not willing to at least put a trivial amount (for him) of cash into the deal. Rather than create a conflict out of the gate, you should ask him for help addressing / solving the issue. At the minimum you’ll force him to address the issue.
If he’s constructive and thoughtful, you might have a chance to modify the deal so it’s more reasonable. If he reacts emotionally, you know what you are dealing with and have a choice to make.
So today’s "great post" comes from er… me. :) Okay, so my partner Ryan and I did a podcast last week with Larry Nelson of W3W3 and our conversation covered both the intellectual property and patent issues we’ve faced as investors in high-technology companies. We definitely have a love/hate (ok, mostly hate) relationship with patents, so if you are interested in hearing (or reading) more, check it out here. Note the excellent intro and outro music, or the "bumper music" as Larry refers to it — it is from Soul Patch’s latest album and is therefore straight from Jason’s and my personal intellectual property collection
Q: What I haven’t seen among the blogs, and what I’m hoping you can shed some light on, is how early stage companies go about finding and attracting the right talent.
It’d be interesting to hear from you (probably in blog form, I’d reckon) about how the companies you invest in find their talent. Do they hire mainly from within their network? How would a company go about finding a generalist, meaning somebody that’s capable of coding one day and going on a sales call or working a trade show the next? Sites like Monster and Dice aren’t set up to find those people, but there must be a need.
A: (Brad) I find it fascinating (and awesome) that you are asking your question backwards. Most of the time the question people in your position ask is "how do I find a job in a startup?" Kudos on going one level deeper!
There are several ways startups find their early hires. The most common is to aggressively hire within their network. I’ve found this to be the most useful (as have you – apparently from your past). Great people tend to run in packs and enjoy working with each other again so when this works it has very high leverage.
While friends are great, new blood is often helpful, especially if you are looking for either specialized talent or very generalized talent. The more specialized the talent, the broader the net should be as you want to be the attractor. Don’t limit yourself to a few online job boards – hit them all, and don’t forget Craigslist and your friends / companies blogs (especially if they are widely read). Put an email footer on all your emails. Get the word out. Since you are looking for specialized talent, you should be able to filter quickly based on resume plus phone interview as to whether or not the person fits through your talent filter.
In contrast, if you are looking for very generalized talent, this approach won’t work. In this case, posting to online job boards is likely a complete waste of time and will generate a high noise to signal ratio. In the generalized talent case, you need to work your network even more aggressively and go after all the second order introductions that you can (e.g. people you know that might know someone). I’ve even found third order introductions (e.g. people that you know that know someone that knows someone) to be useful here. The higher quality the introductions (e.g. people that have worked together, vs. "I just know this guy") the better.
If you are on the other side of this (e.g. the one looking for a job) get the word out to YOUR network. Random inbound resumes to VCs and companies rarely produce much (unless they are a response to a specific job inquiry.)
Bill Burnham has today’s best VC blog of the day titled 4 Things to Do After You Get Your First Term Sheet. As a special bonus, the second best VC blog of the day is Fred Wilson’s post titled From Messes To Successes. Fred had a post in him titled "From Moths to Butterflies" but he liked the ring of the esses better.
Q: How important is having a partner? As a sole entrepreneur that’s investigating venture capital, is having a partner typically required? What are the justifications to requiring a partner?
If I pursue a venture capital firm without a partner or team, is that a show-stopper? Can I explain that finding a partner is difficult, or are there no options at all?
A: (Jason). In my opinion, it is mandatory to have a partner and / or team to raise venture capital. There are several reasons for this:
1. No single person can do everything. Everyone needs a partner to balance out his/her actual or perceived weaknesses. I’ve not met anyone who can do absolutely everything from product vision, executing on a plan, engineering development, marketing, sales, operations, etc. There are just to many mission-critical tasks in getting a successful company launched. You will be much happier if you have a partner and / or team to back you up.
2. It’s not a good sign if you can’t get others to get excited about your plan. It’s hard enough to get venture capitalists to write checks to fund your company, so if you can’t find other team members with the same passion and beliefs as you, this is a warning sign to anyone that might want to fund your company.
3. If you don’t have a team, what is the venture capitalist investing in? Just as important as the idea is the team executing it. In fact, I think most VCs would tell you that they’ve made money on "B" ideas with grade "A" teams but that many an "A" idea was left in the dustbin due to a substandard team.
The one exception would a repeat entrepreneur. If the venture fund has had a good experience with an entrepreneur before and believes they can build a solid team post-funding, then he / she has a chance to get funded as a sole entrepreneur.
Q: Does having an H1B founder (among other non-H1B founders) inherently prevent a startup from being funded? For example, what if a U.S. citizen creates the company which receives funding, and then applies for the H1B founder to join as a regular employee and then issue a founder-sized portion of the company stock?
One possible problem is that the founder will be working on the idea in their spare time while employed, but at least in the state of California this isn’t a problem if the H1B founder’s work isn’t related and he does it on is own time and resources. Are there other issues? I’m just trying to figure out the general "gotchas" of an H1B founder (who is sufficiently skilled and productive to make it worthwhile to have on board).
A: (Jason) I am not an immigration lawyer, so the "gotcha" part of your question isn’t something that I can answer, be I can provide the VC perspective. The answer is "no." Having a H1B co-founder is not inherently a problem to get funded. So long as the co-founder can work full time and provide comparable contributions to the company, then VCs shouldn’t care.
A couple things to consider:
1. Timing of grant. If the grant is only going to occur upon the issuance of the H1B visa, then you should consider the timing issues of your grants being made at a different time than the other founders (and potentially at a higher price);
2. Timing of the visa application. It seems like the U.S. is running out of H1B visas earlier and earlier every year. You should take this into consideration when forming the company and sponsoring the application. Short answer: get this done early in the year before the visas are exhausted.
Good luck with your venture.
Q: I self-financed and run a profitable Internet based start-up with more customers than I can handle. I can take the business to where it needs to be without outside funding. However, it will take much longer to grow organically. I’ve considered working with financiers for guidance and capital.
What is the best route to take? I’m in a position where I have several VCs interested and their terms are different. Do I go with no money? The best money terms? the best guidance?
A: (Jason). Venture Capitalists bring 4 types of "capital" to any transaction: Monetary, Social, Interpersonal and Experience.
Monetary is simply money – a checkbook, if you will. Social is the network and connections that a good VC can bring to the table. Interpersonal is the capital that VCs bring that allow them to mentor their investment executives. It also helps them to be helpful board members. Experience is just that- having been there and "done that" time and time again.
The question to ask yourself is which of these types of capital you need more? Is it all about the money, or do you really need help that you don’t have inside the company? And which one of your potential VC suitors do you find better equipped to provide this non-monetary capital?
We’ve found that many of the companies we invest in are more interested in the non-monetary capital that we can bring to the table and we are quite proud of that fact.
Q: What type of structure have you seen where the VC agrees to fund over some time period 18-24 months and up to some level.
A: (Brad): These are commonly called "Tranched Financings." The typical approach is that a VC commits to fund a specific amount in multiple "tranches" based on the company achieving some milestones. For example, assume a $10m financing broken up into two tranches – an initial $5m investment on day 1 and another $5m investment after 12 months assuming the company "releases a product with performance characteristics acceptable to the investor."
There are numerous derivatives of this case. The valuation on each tranche (or price per share) can be held constant or can vary (typically increase) for the second tranche. The trigger (what causes the second tranche to get funded) can either be under the VC control (similar to a put option) or the company control (similar to a call option). The amounts for each tranche can vary (they don’t have to be the same) and there may be even more tranches (I’ve seen situations where there are monthly tranches over a twelve month period.) Finally, the characteristics of the trigger vary widely.
An alternative approach is to have a warrant attached to the financing round that is exercisable at the discretion of the investor within some time period. This serves a similar purpose to a tranched financing, but gives the investor more control and potential option value in the case where the company is acquired early before the warrant expires.
Tranched financings tend to come into play more frequently in downside cases where a company and its investors are trying to extend the company’s life either to an exit event or another financing. In these cases, the investors want to run a single process within their firms for getting approval for an investment, but then want to maintain control over how much money they invest at any given time in case the deal goes completely south (leaving the flexibility to decide to pull the plug in the hands of the investor.)
Occasionally tranches are used in the early stages of investments although more recently I seen the "warrant approach" instead of a tranched approach.
Q: One of your deal screens that you mentioned was “comfort with the people involved.” What do you say to the entrepreneur when that is the main factor that steers you away from a deal – e.g. the situation where there is a clear sense of discomfort in your gut with the ability of the founder to be an effective CEO, and yet that CEO doesn’t recognize or admit his/her own weakness?
A: (Brad) There are actually three cases here: (1) I like the deal and the founder, but don’t think he can or should be the CEO, (2) I don’t like the deal, but I like the founder, but don’t think he can or should be the CEO, and (3) I don’t like the deal or the founder (or – usually – I don’t feel any connection to the founder.) Let me address each of these separately.
Case 1: I like the deal and the founder, but don’t think he can or should be the CEO: When I realize this, I immediately sit down with the founder and have an open discussion with him about this. For example, shortly after I started spending time with Greg Reinacker (the founder of NewsGator), I realized I really wanted to back him, but not if he wanted to be the CEO. Over dinner early in our discussions, I told him this directly. I recall him being guarded in his reaction (I’m sure he was thinking something like "who is this asshole?") I explained my point of view, was clear that I would completely understand if he wanted to be CEO (in which case I wasn’t a good candidate for funding), but encouraged him to talk to some other people "like him" (who I viewed at "CTO / founders from central casting.") Greg went off, thought about things, talked to a handful of folks, and came back a few weeks later and said something to the effect of "Brad – you are right – I don’t want to be a CEO – let’s go find a great one together." Needless to say I went ahead and funded NewsGator and have had an awesome time working with Greg, the CEO we worked together to identify and bring onto the team (JB Holston), and the rest of the NewsGator crew to create an awesome company.
Case 2: I don’t like the deal, but I like the founder, but don’t think he can or should be the CEO. In this case, I pass quickly but offer to give the founder (who is often someone I know from another context) some constructive feedback if he wants it. If he takes me up on it, I try to be very thoughtful in delivering a direct message that he should have a different role than CEO. I’m clear that identifying and bringing on a great CEO won’t change my view that I’m not interested in funding the company, but that I think it will help him be more successful in building the business. This is the most difficult case for me because it’s a one way, open loop situation. I’m delivering bad news and difficult to hear feedback, but I’m not providing any future willingness to engage as an investor. Occasionally I’ve encountered a negative response from the founder and in one case I changed my mind after a CEO was brought on board and ended up funding a company, but usually my directness and candor is acknowledged and appreciated.
Case 3: I don’t like the deal or the founder (or – usually – I don’t feel any connection to the founder.) This is the simplest case for me. I pass and usually don’t give much additional feedback. In most of these cases, if I didn’t feel a connection to the founder, he probably didn’t feel a reciprocal connection to me and we generally each just move on.
Q: What do you expect to see from an entrepreneur whom you don’t know or have a casual introduction to before scheduling time to listen to a pitch? A one-pager? A complete powerpoint? A classic business plan or a casual one?
A: (Brad) While everyone is a little different, I’m pretty simple. Optimally, I’d like something to play around with (e.g. a simple web site or software demo / prototype.) If the company is pre-web site / demo, then a short executive summary is always better than a ppt for me – I’d rather read what the person thinks, than try to interpret it from a ppt. However, I’m happy to get a ppt of any length since I’ll just page through it quickly. I’m also happy to just get a couple of paragraphs describing the business and the background of the people involved as I can usually decide from there whether it’s something I would be interested in spending more time on.
I have no interest in seeing a business plan or a financial model for an early stage company pre first pitch.