1000 Flowers Bloom

Closing a termsheet is unnecessarily complex

I came across a great post by Dave McClure about how the process through which you get to a signed termsheet is way too complex and I TOTALLY AGREE. His comments about VCs and lawyers needing to innovate and remove the reams of paper and make the terms simpler to understand are spot on. I wish that it would happen but I think that there are huge barriers.

The big problem is that the alignment of interests is really off. The level of complexity advantages both the VCs and the lawyers.

Dave talks about how VCs are advantaged over entrepreneurs because they do these transactions all the time while entrepreneurs only go through the process only once every 5-10 years.

The piece he didn't talk about is that lawyers are incented because they get paid hourly to make things complicated. They are also incented even when capped to show how good a job they do by generating reams of paper.

The stack of paper - It's impressive. You feel more justified paying your bill. Too bad its not useful.

Y Combinator & TechStars - Not a good deal for Entrepreneurs?

So I've heard about YCombinator for a while and just read about Techstars on TechCrunch.

What I didn't know is that they take a substantial equity stake in your company for the money that they give you. From Techcrunch - the Y Combinator folks take basically 1% of your company for $1000 and TechStars takes the equivalent of $1% of your company for $3000.

I think that this is a bum deal for entrepreneurs. Here's my logic:

According to the National Venture Capital Association the average post money valuation for a early to seed stage company is a little over 12 million dollars (see page 3). Let's say that VCs take an average of 50% of the company so that is a 6 million dollar pre money valuation.

In the Y Combinator model seed companies that they fund are worth $100k. In the TechStars model the seed companies are worth $300k. I'll grant these seed funders the benefit of rounding in their favor.

This means that companies that Y Combinator is funding are at a 60x discount to what a VC is funding companies at. Techstars isn't so bad at only about 20x.

Granted that seed stage startups are a lot riskier than A round startups are, but are they really 60x as risky?

I know that not everyone has this option but I'd rather go beg/borrow the money and take a shot at growing the business that way instead of giving up that kind of equity position.

Traction = Funding?

I was just reading a post by Fred Wilson on the Union Square Ventures Blog about how he is looking for consumer web companies and enterprise web services companies to have traction (aka some level of market adoption) before he invests in them.

It makes a lot of sense why you'd want to do that since in my experience it's usually the market risk that ends up killing the companies which have failed. Seeing a company get market traction before investing certainly reduces the risk on the part of the investor.

A few things that I think this philosophy misses:

1. Some ideas require real capital in order to get to a stage where they can see market traction.
2. As more and more new companies compete for attention the bar becomes higher and higher to get that attention, potentially requiring more capital
3. Once there's enough traction, almost any VC will invest. At what point do you jump?
4. If an entrepreneur had enough market traction they might not need the money...

Having said all that. It is undoubtedly true that you can get many (most?) services off the ground on angel capital.

Raising Capital 101 from an Entrepreneur's Perspective

Brad Feld, Fred Wilson and other VC bloggers have blogged a lot about terms within a termsheet and what they all mean. I have to say that by far the best series of articles on the mechanics of raising capital is by Fred Demmler.

I would say that this is a must read and must understand for entrepreneurs. It covers great topics like how a cap table works and how to think about investment in your company.

Congratulations to Radar Networks

Congratulations to Nova Spivak and all the folks over at Radar Networks for announcing their A round. They're in that annoying state called stealth mode so they're not talking about what they're working on but knowing Nova and the brainpower on his team it's something big.

I'm going to tag this Web 2.0 just to annoy him. ;)

Congrats guys!

Free Consulting from VCs?

Josh Kopelman writes about how VCs can provide free consulting to startups. I'm starting that process now and I have to say that when the VC is being candid that he is right.

The things I've been hearing during our sessions have all made me think hard about what we are doing and why we are doing it. It's tremendously useful when the VCs pick apart the business and really challenge the thinking. If a VC is being candid with you in their feedback then it's super useful.

I've heard stories from other entrepreneurs where they have been turned down for an investment by a VC but never got the feedback about why that happened. That's just not useful.

It's fine if the VC feels that there is some flaw in the business, whether that be product, strategy, team etc. and decides not to invest. Please please please be honest with the feedback though. Let us know what it was that you thought wasn't working. A generic blowoff doesn't do the entrepreneur any good. Don't worry about hurting my feelings.

If any of the VCs we're talking to are reading this please - if you're going to say no to us, let us know why. You won't hurt our feelings and we'll respect you more the next day.

Full Disclosure - Josh is an investor in Aggregate Knowledge.

Enterprise Web 2.0 Continued

Wow - some great comments on my last post. Rather than keep the discussion in comments I thought I'd post it up in the main area.

Brian Magierski generally agrees with me and points out SocialText and JotSpot being the exceptions.

Roy Kim makes the point that most enterprise apps and consumer apps are two totally different worlds. He goes on to say that there are several factors that go on to make it much more difficult for a company to develop a product with a short cycle and release. He also goes on to make a provocative statement - that just because we don't see the projects on TechCrunch doesn't mean they're not there.

Pete Cashmore makes a similar point to Roy that most blog readers are users and so want news about things they use.

I agree wtih Roy and Pete that enterprises are much slower to adopt new technologies but if you look back in the hey day of enterprise software back in 1998 and 1999, enterprise companies were the hot thing. You had companies like WebMethods etc. coming out of the woodwork. Why aren't we hearing about those kinds of companies now? I don't believe that it's just because Enterprise adoption is slower. It was slower back in 98-99 as well.

Could it true that most Enterprise Web 2.0 projects simply aren't being blogged about but that they're really out there?

One way to figure this out is to see who the VCs are funding. My experience in talking to them about Aggregate Knowledge is that they are actively looking at a lot of consumer startups as you'd expect they would be. It's not clear to me if they are actively not looking for enterprise deals or if maybe they aren't being approached by enterprise startups because consumer sites are "in". Are entrepreneurs doing consumer sites now becuase it's easier to raise the money for that?

I'll be talking with a bunch more VCs over the next few weeks so I'll report back with what I find.

Why is Web 2.0 only about Consumer Sites?

One thing I find strange about the whole Web 2.0 phenomena is that it is largely consumer oriented.

If you take a look at TechCrunch you notice that the vast majority of the services and companies being launched are for end-user consumers. Tom Evslin just wrote a post about how to pitch to VCs and I've got to say after reading it - that makes a lot of sense for consumer companies but certainly not for enterprise companies. Seems like no one is really thinking about enterprise companies right now.

Where are all the Enterprise Web 2.0 companies? Dennis McDonald is the only one I know of who is even studying enterprise adoption of existing technologies but who else is creating them?

Why are Series A rounds always for 50%

I ran across a fantastic blog post that hit close to home today - Death, Taxes, and Series A Cap Tables that explained an enduring mystery to me, why do the majority of series A rounds take 50% of the company no matter what the size of the round is?

It's definitely been something that has been on my mind as Aggregate Knowledge and Zvents are figuring out fundraising strategies.

It really doesn't matter how far you are along (unless you've got really significant traction) you'll always get 50% of the company and the VCs will take 50%. The only question is how much will they give you? 3 on 3 or 5 on 5? In my mind the logical of the post is that you should go raise money early rather than try to make a few more milestones.

The problem is that there's certainly part of me that doesn't believe it. I've always believed that if we get enough traction early that our valuation will certainly increase when we raise our round.

The conclusion of raising money early also gets to the runs counter to how new Web 2.0 companies are being funded. Typically it seems like a small amount (< 500k) is raised to get to point where traction is shown and then a buyout or an A round occurs. A scary thought is that the bar for an A round might be that you have to go get your <500k, show some real traction and still only get 50% of the company! I would be very curious to hear what other's experiences are on that.