Venture Hacks

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Todd Vernon, the CEO of Lijit, has written a great article on raising money from angels. I especially like his taxonomy of angels:

“The Family Investor: The Family Investor is likely not really a classic Angel Investor at all but rather a supportive family member that “knows you”. Their motivation is likely out of support (sometimes guilt), but their basic investment thesis is they trust you. For me these are the worst type of investor because you likely have intimate knowledge of their financial situation and whether or not they ’should’ be investing. Likely, they have no inherent feel if your idea is good or not, but may have changed your diaper at one time or another and have overcome that experience to hand you a check for $25K or $50K. Personally, I like this category of investor the least because the investment is totally emotional and personal – and that sucks in business. But based on the financial situation of the individuals involved and the relationships this can work ok if everyone comes into the situation with their eyes open, but go out of your way to make sure.

“The Relationship Investor: The Relationship Investor is probably one or more co-workers from a previous gig or business friends you have known for a while. They may or may not understand what your new company is doing but they have had a track record working with you. They want to be supportive, but are looking for a return. You won’t lose them as friends if things go bad, but the investment for them is likely not ‘trivial’. In my experience these are good Angels to have, again as long as their eyes are open going in. These people can also be wildly supportive of you in terms of finding employees and other resources.

“The Idea Investor: The Idea Investor is probably very familiar with the space your company is targeting. These are in some ways the very best types of Angels because to some degree they validate your idea. There investment is based on the Idea and there is little emotion around the table (always good). If you can get them onboard they can open doors into partner relationships and just generally good advice. You will spend most of your time convincing the Idea Investor that you and team are the right people to attack this problem (as they likely don’t have a strong relationship with you or the team). Often an influential Idea Investor makes a good early board member for the company.

“The Once Removed Investor: The Once Removed Investor is likely connected through a personal or professional relationship with either the Relationship Investor or the Idea Investor. They likely don’t know you, and they likely don’t have a clue if your idea is good or bad but they have translated the trust in the investment to the person they know. This is a great way to get additional Angel Investors onboard, but without a solid Relationship Investor or Idea Investor it just isn’t going to happen.”

Read the rest of Todd’s article, it’s great.

Via: Ask the VC.

We usually quote other people’s genius in our Twitter feed but, once in a while, we throw in a tweet of our own. Here are a few of the popular ones:

You don’t need permission to start a company. From investors, co-founders, or anyone else.

Trying to recruit while you’re in “stealth mode” is like punching yourself in the balls (see picture).

Better to do the right thing wrong than the wrong thing right.

Sales: Always be closing. Product: Always be releasing. (Sam Purtill replies, “Engineers: Always be coding.”)

Advice is for learning, not copying.

Don’t ask investors what they think. Ask your customers.

Competitors copy success, not ideas.

Traction speaks louder than words.

By the way, I figured out which tweets were popular by looking for entries that people “liked” in my FriendFeed.

Image Source: RobbinsSports.

A reader asks:

“My question is how do we value a company with no sales? I understand it’s an arbitrary valuation but is there anything we can possibly base it on? Is there a “default” valuation for companies in a seed round?”

We’ll answer this question with some questions (and answers) of our own:

1. How much money do we need?
2. How do we set a valuation from this budget?
3. How do we express our valuation to investors?
4. What’s the range for seed round valuations?
5. How low do seed round valuations go?
6. How much money can we raise in a seed round?
7. How much dilution should we expect in a seed round?

1. How much money do we need?

First, figure out how much money you need to run at least two experiments^*. Then tack on 3 more months of runway so you can raise another round before you run out of money. This is the minimum amount of money you should raise. For example, let’s say you need $100K.

^* Your experiments should be constructed such that a positive result will let you raise more money at a higher valuation.

2. How do we set a valuation from this budget?

Now decide what percentage of the company you will sell for $100K. Pick a number between 10% and 20% of the company’s post-money. You can go below 10% but that probably means your valuation will be too high or you will raise too little money.

For example, let’s say you’re willing to sell up to 15% of the company—that’s your bottom line dilution. This implies a bottom line post-money valuation of $666K.

3. How do we express our valuation to investors?

Finally, tell investors that,

“We think we can make the company significantly more valuable if we raise $100K—that’s our target. And we’re willing to sell up to 10% of the company to reach that target.”

10% is your aspirational dilution. It’s the lowest dilution you can justify. It’s the lowest dilution you can say with a straight face.

Notice that you didn’t explicitly state your valuation. Combining the dilution (10%) with the amount you’re raising ($100K) implies a post-money valuation of $1M. But the valuation is not explicit. This gives you room to raise your valuation if you raise more than $100K (and we suggest you raise as much money as possible).

4. What’s the range for seed round valuations?

If $25K buys 1% of company, your post-money is $2.5M—that’s on the high end.

If $25K buys 5% of company, your post-money is $0.5M—that’s on the low end.

5. How low do seed round valuations go?

Y Combinator has set new lows for seed round valuations. They get away with it because they also set new highs for helping seed stage companies.

According to the YC FAQ, they buy about 6% of a company for $15K-$20K. So the post-money valuation of their investments is $250K-$333K.

But don’t fixate on valuation. Low valuations aren’t bad if you keep the dilution down too. 6% dilution is very low if the company makes a lot of progress with $15K-$20K.

6. How much money can we raise in a seed round?

If you sell 20% of your company at a $2.5M post-money, you raise $500K. That’s about the maximum for a seed round. Beyond that is Series A country.

7. How much dilution should we expect in a seed round?

Take as much money as you can while keeping dilution between 15-30% (10%-20% of the dilution goes to investors and 5%-10% goes to the option pool).

Compare this to a Series A which might have 30%-55% dilution. (20%-40% of the dilution goes to investors and 10%-15% goes to the option pool.)

A seed round can pay for itself if the quality of your investors and progress brings your eventual Series A dilution down from 55% to 30% (for the same amount of Series A cash).

Don’t over-optimize your dilution. Raising money is often harder than you expect, especially for first-time entrepreneurs.

Smart investors don’t over-optimize dilution either. They want to buy enough points to own a good chunk of the company. But they want to leave the founders with enough points to keep them highly motivated to build a lot of value for the founders and investors alike.

Finally, if you’ve made it this far, please enjoy the following presentation:

Here are a few of the brave investors who have joined the Venture Hacks community. I’ve also included descriptions of the types of companies they’re looking for:

Josh Kopelman from First Round Capital is “looking for companies that find new uses for existing data sets.”

Mitch Lasky from Benchmark Capital says, “I still believe in mobile.”

Marc Hustvedt, an angel investor, is “looking seriously at IPTV.”

Aydin Senkut, an angel investor at Felicis Ventures, has a “focus on early stage consumer internet companies.”

James Cham, from Bessemer Venture Partners, is “looking for companies that see the commercial opportunities in inference engines.”


We’ll highlight other investors (and startups) in an upcoming post. Browse the community while we’re in private beta or request an invite to help us test the site.

In 4 Things to Do After You Get Your First Term Sheet, Bill Burnham, a former partner at Mobius and Softbank Capital, writes,

“I’ve recently been involved in helping a couple companies with their first major round of VC financing. It’s actually been pretty interesting for me because I have historically been on the other side of the table. In addition to generating several stories worthy of “The Funded” and getting a better appreciation of the trials and tribulations that entrepreneurs must go through when trying to raise money, I also gained a better appreciation for just how important it is to properly manage the “end game” of a VC financing.

“What is the “end game”? The End Game generally takes place after you have gotten a term sheet, but before you actually sign it. How well you manage this process can make a big difference in the actual terms and pricing you ultimately get, so it pays to approach this process as thoughtfully and diligently as you do any other part of fundraising.”

“With that in mind I present 4 things that you should definitely do after getting your 1^st term sheet:

“1. Get a second term sheet: It may sound flip, but this is the single most important thing you should do upon getting your 1^st term sheet. Nothing loosens up a VC’s purse strings or makes them more flexible on a particular term than the threat of competition. Without competition (real or perceived) you have very little leverage against a VC. Now getting one term sheet, let alone two, is tough enough, but getting two must be your goal and you must not waiver in pursuit of that goal even you after you get the 1^st one. The biggest problem most entrepreneurs have executing on this strategy is that they have mismanaged the sequencing of their fundraising. Many entrepreneurs make the mistake of pursuing an “in order” fundraising process whereby they take one meeting, run that process to its logical conclusion and if that doesn’t work out try to get a meeting with another VC. VC fundraising must be pursued concurrently! You must put as many irons in the fire in as short a time as possible so that all the firms start the process at roughly the same time. As firms progress through the process, you should do your best to try and “herd” them along by trying to slow down the ones pushing ahead and speed up the ones lagging behind. The ultimate goal is to ensure that when you receive your first term sheet you have several other firms that are very close (within a week or so) to potentially issuing their own term sheets. Proper sequencing ensures that you are not forced to take an inferior “bird in hand”.”

Read Bill’s great post for the rest of his suggestions. He agrees with everything we’ve been writing about, so he is obviously quite brilliant.

Summary: Raise as much money as possible. With these caveats: (1) maintain control at any cost, (2) monitor your liquidation preference, and (3) act like you don’t have a lot of money. Also understand that if you do raise a lot of money, you will have to (1) “go big or go home” and (2) make a lot of progress if you ever want to raise money again. Alternatively, if you would rather maintain your exit options, at least raise enough money to run two experiments.

How much money should you raise? As much as possible—with some caveats. But hey! don’t take our word for it.

Two investors’ opinions.

Eugene Kleiner, Founder of Kleiner Perkins:

“When the money is available, take it.”

William Janeway, Managing Director of Warburg Pincus:

“Failure to execute operationally is not the only source of risk; every venture is also subject to volatility in the price and availability of capital due to the volatility of the stock market. After the collapse of the Internet Bubble, many promising companies foundered because their funding dried up.

“By contrast, our biggest successes at Warburg Pincus (VERITAS, BEA) have come from inverting the normal venture funding model, with the visionary investor as company co-founder… And we have supported the multi-year process of building a sustainable business by underwriting all of the capital needed to reach positive cash flow, thereby not only enabling management to focus full-time on the business but also insuring against the risks generated by a volatile stock market…

“In the post-Bubble world, long-term financial commitments are required to fund the ventures that will fulfill the long-term technological vision and implement the long-term commercial promise of the Internet Age.”

Two founders’ opinions.

Mike Ramsay, Founder and CEO of Tivo:

“One of the reasons that TiVO is thriving today is that we were well-capitalized. We were able to power our way through the downturn—that early 2000 period when [our competitor] Replay went away. We were capitalized enough that we knew we could ride through it. While we had to make a few adjustments at the company, there was never a question that we were going to survive. We knew we were going to survive.”

Marc Andreessen, inventor of the bendy-straw:

“So how much money should I raise?

“In general, as much as you can.

“Without giving away control of your company, and without being insane.

“Entrepreneurs who try to play it too aggressive and hold back on raising money when they can because they think they can raise it later occasionally do very well, but are gambling their whole company on that strategy in addition to all the normal startup risks.

“Suppose you raise a lot of money and you do really well. You’ll be really happy and make a lot of money, even if you don’t make quite as much money as if you had rolled the dice and raised less money up front.

“Suppose you don’t raise a lot of money when you can and it backfires. You lose your company, and you’ll be really, really sad.

“Is it really worth that risk?

“…Taking these factors into account, though, in a normal scenario, raising more money rather than less usually makes sense, since you are buying yourself insurance against both internal and external potential bad events — and that is more important than worrying too much about dilution or liquidation preference.”

Make sure you read Marc’s full article for his caveats: How much funding is too little? Too much?

Guidelines to consider no matter how much you raise.

No matter how much money you raise,

1. Maintain control at any cost.
2. Monitor your total liquidation preference and avoid liquidation preferences above 1x non-participating. You will have to sell the company for at least the liquidation preference before the common stockholders see a penny.
3. Raise enough money to run more than one experiment. Some companies need 12 months of runway to do two or more experiments, others might need 24 months. Seed stage companies that can’t raise enough money to run more than one experiment should keep their burn down to extend their runway.
4. Act like you don’t have money.

Guidelines to consider if you do raise a lot of money.

If you do raise a lot money,

1. Understand that your investors will have very high expectations. You have will have to “go big or go home”.
2. You will have to make a lot of progress with this round if the company ever wants to raise money again.

Alternatively, if you would rather keep your liquidation preference low and maintain your exit options, at least raise enough money to run two experiments.

Raise too little money and you may go out of business when you run into trouble. Raise too much money and you may make less (or zero) dough when you exit. Take your pick: disaster vs. dilution.

Image Sources: Marty Katz for The New York Times, SFGate, Wired.

The latest great quotes from the VH Twitter feed: twitter.com/venturehacks (RSS):

Kleiner Perkins

“Entrepreneurs do more than anyone thinks possible, with less than anyone thinks possible.” – John Doerr

“If the reason you’re taking on a mission is for the money you’ll make, I believe you’ll fail.” – John Doerr

“Where most entrepreneurs fail is on the things they don’t know they don’t know.” – Vinod Khosla

“How would you compete against yourself?” – Vinod Khosla (ppt)

“We are in the company building business, not in the ‘deal’ or ‘capital’ business.” – Khosla Ventures

“The great danger of dealing with venture capitalists is the ’slow maybe’.” – John Doerr

“We never ‘vote’ against management teams in our board role, except in making CEO decisions.” – Khosla Ventures

“All start up companies have one thing in common–they all get in trouble. It’s how they and you on the board handle their trouble that separates the winners from the losers.” – Tom Perkins

Peter Drucker

“You cannot build performance on weaknesses. You can build only on strengths.” – Peter Drucker

“One does not start with facts. One starts with opinions.” – Peter Drucker

Warren Buffett

“I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.” – Warren Buffett, explaining bad investments

“When the phone don’t ring, you’ll know it’s me.” – Warren Buffett, explaining how he might say ‘no’

“If you are a professional and have confidence, then I would advocate lots of concentration.” – Warren Buffett

Sundry

“Succeed and you are a brilliant visionary. Fail and you are a delusional loser.” – Don Dodge

“You don’t need permission to start a company. From investors, co-founders, or anyone else.” – Venture Hacks

Read more quotes in the VH Twitter feed and my personal Twitter feed: twitter.com/nivi (RSS).

Thanks: To James Cham for the Tom Perkins interview.

This is a great slide from John Doerr’s talk at Stanford:

It’s a little hard to read but it’s worth a squint. Or just watch this 4 minute video where he lays it out:

Every article about Recommended described the feature better than our launch post. Here’s a few snippets we particularly liked.

From Mark Hendrickson’s article in TechCrunch:

“Entrepreneurs and venture capitalists can use the sub-site, simply called Recommended, to track who and what others think highly of, and to indicate their own affinities as well.

“It’s structured much like Twitter—users set up profiles and subscribe to each other, then review recommendations made by others and make recommendations of their own.

“The overall idea behind Recommended is to lubricate the process by which members of the startup community network and determine who and what is popular.”

From Eric Eldon’s article in Venture Beat:

“While the service is very much a work in progress, the simplicity of the connections—and the fact that you’re connecting with influential people—makes this a promising service.”

From Carleen Hawn’s article in FoundRead:

“It is really straightforward, simple and stupid. It’s like RSS for deal flow,” Nivi told us this morning… “All startup deal flow is done by email and phone now—a push model. This is like a pull model,” Nivi explained.

“Founders no longer need to spend weeks or days lining up reference calls for potential investors: just hand over the URL of your Venture Hacks profile…”

From Ashkan Karbasfrooshan’s article in HipMojo:

“I asked Nivi about the service and in typical elevator pitch fashion, he replied “it’s match.com for investors and entrepreneurs”.

“While I am not sure if we need one more social network to join or profile to create… the financing matchmaking process remains full of friction and inefficiency…”

Finally, from Bijan Sabet’s (Spark Capital) tumblelog:

“I’m now alive in the world that [Venture Hacks] created. Very cool site.”

Browse Recommended or request an invite while we’re in private beta: Recommended.

In The Psychology of Entrepreneurial Misjudgment, part 1: Biases 1-6, Marc Andreessen kindly interprets an essay from Charlie Munger’s book, Poor Charlie’s Almanack:

“Mr. Munger’s magnum opus speech, included in the book, is The Psychology of Human Misjudgment — an exposition of 25 key forms of human behavior that lead to misjudgment and error, derived from Mr. Munger’s 60 years of business experience. Think of it as a practitioner’s summary of human psychology and behavioral economics as observed in the real world.

“In this series of blog posts, I will walk through all 25 of the biases Mr. Munger identifies, and then adapt them for the modern entrepreneur. In each case I will start with relevant excerpts of Mr. Munger’s speech, and then after that add my own thoughts.”

I started making a cheat sheet of Marc and Charlie’s key points—I thought I would share it with you. It’s a handy reference once you’ve read the full article.

(For another great article on cognitive bias, see Cognitive biases potentially affecting judgment of global risks.)

1. Reward and Punishment Super-Response

Once you realize how much incentives influence human behaviour, you need to assume their influence is even bigger than you think. Never think about something else when you should be thinking about incentives.

“If you would persuade, appeal to interest and not to reason.”

– Benjamin Franklin

Incentives are so powerful that every incentive should have a counter-incentive to restrict gaming of the first incentive.

2. Liking and Loving

Liking and loving something conditions you to (1) ignore faults of and comply with wishes of the loved, (2) favor people, products, and actions associated with the loved, and (3) distort other facts to facilitate love.

Wanting to be liked by your teammates impedes you from firing people and making unpopular but good decisions.

3. Disliking and Hating

Disliking or hating something conditions you to (1) ignore virtues in the disliked, (2) dislike people, products, and actions associated with the disliked, and (3) distort other facts to facilitate hatred.

Startups should focus on their customers, not their competition—whom they may dislike.

4. Doubt Avoidance

Execution is often better than further contemplation:

“A good plan, violently executed now, is better than a perfect plan next week.”

— George Patton

Believing that something will happen, and convincing others that it will be so, makes it more likely to happen.

While a hypothesis is still doubted, wise entrepreneurs know whether (1) persistence and iteration will prove the hypothesis, or (2) the hypothesis will not be proven and additional testing is a destructive waste of time—a new hypothesis is required.

Related: Realists vs. Idealists: Thoughts about Creativity and Innovation and Decide To Do Something That Will Probably Fail, Then Convince Yourself And Everyone Else That Success is Certain.

5. Inconsistency Avoidance

Have strong opinions, weakly held. New and correct ideas may not be accepted simply because they are inconsistent with existing ideas.

Your existing ideas may be unknown to you. They may be hidden assumptions. We often make hidden assumptions about unknown unknowns.

If existing customers in the market aren’t ready for a product that is inconsistent with their behaviour, go after customers who aren’t in the market because they can’t afford the existing product or don’t have access to it. See The Innovator’s Dilemma and The Innovator’s Solution.

6. Curiosity

Insufficient curiousity prevents you from learning. Hire curious people and discover your customer’s true needs—not what you think they need.