Saturday, March 27, 2010

The 7 types of angel investors - what is right for your startup?

I have been advising a number of companies with their funding rounds and a frequent question that has come up is what sort of people should they bring into their round.

The answer of course is not cookie cutter. It depends on what sort of help you think you will need most as a startup (e.g. BD intros? Hiring help? Product feedback? Help raising the next round?).

In general, I think most investors fall into the following classes (and many angels are in multiple of these categories - as are most of the people mentioned below). A good financing round, especially if it includes multiple angels/investors would optimally have people representing more then just the below:
  • Connectors. These people know a lot of people and typically used to work in sales or BD before becoming an angel. They can help a lot with intros or some advice on structuring a deal that will make or break a company. They are in the flow of information and deals and can provide you with competitive insights and early information on customers that is crucial to your success. Most top tier venture funds provide this function. Ron Conway and team are legendary for their span of network and the fact that they know everyone.
  • Product People. These people are very smart on product and can give you specific advice on UI, viral loops, etc. Note: a lot of people claim they are good at product (i.e. everyone has an opinion) but I think the set of people who are very good at this is quite small. Roelof Botha and David King are two examples of people who have excellent product feedback.
  • Tacticians & Builders. These are usually recent or current entrepreneurs or operators. They don't give you the banal high level advice about e.g. hiring ("always hire the best") that all your other angels will give you - they will actually make 10 intros to strong candidates and then give you the magic tip on how to close the top candidate. Most angels and investors are great at the high level strategy, but don't add much value here. This skill set is actually rarer then one would think and an important one.
  • Smart Business People. How do you think about what you are doing as a business? How will you make money? What pricing schemes should you try? When should you turn on monetization at all? How do you build a brand for your company and what sort of marketing should you do?
  • Domain Expert. This investor has worked in an operating/general management or product role in the industry you are looking at. They can give you industry specific tips, insights, customer intros and advice that would have taken you months to discover. They often decrease in value over time as you learn the industry and detail, but early on they can help enormously.
  • The Brand. These angels don't add much value besides having a brand name. Best case it helps boost your funding announcement. Worst case they will have terrible advice delivered with enormous confidence. Make sure to vet people before adding them to your round.
  • The Filler (AKA Dumb Money). You are trying to raise a $1 million convertible note and have $700K committed. You are exhausted with fund raising and want to just go back to building product, which is what you love to do. So you bring in folks who can write big checks that you don't expect to add much value. Obviously it is much better to bring in someone who can help out, but pragmatically it is good to have available capital to fill out the round if needed, as long as it is not from people who will actively decrease value. (by taking up your time with needless asks to meet up, refuse to sign documents needed to e.g. raise the next round etc. etc.)
This title is in all caps on purpose. If your co-founder is equivalent to your husband/wife, this makes your board member your mother-in-law, and your other investors close relatives (cousins, uncles, etc.).

Just as the investor will do diligence on you, you will need to make sure other people the investor has invested in *love* that angel or VC. For the lead investor ask to talk to their references. For other investors do the same where possible. This is obviously time consuming, but whoever you bring on board will be helpful, or detract from the company, for potentially the lifetime of the company.

I will write another blog post later on doing diligence on investors...

Any types of investors I missed?

Thursday, March 11, 2010

VCs & Starter Stock - Why & How to Ask for "FF Shares"

This blog post was inspired by a question I answered on Quora....

What is Starter Stock or "FF-Shares"
  • A class of shares separate from common stock that entrepreneurs can receive when founding a company.
  • These shares can be sold into a financing round allowing an entrepreneur to cash out a subset of their shares without impacting the value of common stock (which is usually worth about 1/4 the value of preferred and, if vanilla common stock is sold into a financing event would negatively impact option grant prices for employees)
  • Starter stock works by being a special share class that converts into preferred stock being sold at the financing event
  • This is a recent innovation, so some lawyers even at well respected firms may not know all the details about Starter Stock. Orrick is a law firm with a lot of expertise around Starter Stock. Ping me if you want an intro.

Why Would You Want Starter Stock?
Ooga Labs posted a good summary as to why every entrepreneur should want Starter Stock or FF-Shares. The gist of it:

You are going to be working your butt off for many years and your life will change a lot. Taking a small amount of money off the table in a big financing round will impact your life substantially with minimal impact to the company if done right.

Do VCs Support the Use of Starter Stock?
Starter stock is gaining more and more acceptance by the venture world, particularly if it represents only a fraction of the stock that the founder receives (e.g. 10-20%).

Some funds have embraced this wholeheartedly (e.g. Founders Fund) while others are slowly adopting it as more and more entrepreneurs ask for it (I recently helped one entrepreneur negotiate Starter Stock with a VC who had not done it before).

Unfortunately, a subset of VCs argue against Starter Stock, much to the entrepreneurs detriment, without real upside for the company (and hence the VCs ROI)

Arguments some investors make against Starter Stock are:

  • The entrepreneur should not have liquidity until everyone has liquidity (i.e. incentives should be aligned between entrepreneurs, employees, and investors).
  • The entrepreneur should be "kept hungry" to keep them working hard (I think this is really a bad way to think about it -see below)
  • The entrepreneur will get suddenly distracted by the wealth created from selling Starter Stock (since Starter Stock is only a fraction of shares, this is not true)

The arguments for Starter Stock are:

  • The board needs to approve sale of Starter Stock, so the investors will always have a say as to when, and how much of it, is sold
  • The average M&A exit takes 6.5 years. The entrepreneur will have major life changes during the time (e.g. may need to buy a house, send kids to school, etc.). The ability to cash out e.g. $1 million at a high valuation in a funding round allows the entrepreneur to deal with these life changes without forcing them to either leave the company or sell the company to make this happen
  • The majority of the founders net worth will still be in company stock (assuming the company is doing well enough to sell Starter Shares) and he or she will still be hypermotivated to increase the value of the company as much as possible
  • Ongoing financial pressure on the entrepreneur is typically a bad thing. There is a difference between "hungry" and "starving". You do not want the person running your company to eye their dwindling bank account in despair as they may start to act irrationally rather then focus on the long term success of the company.

If You Get Starter Stock, Do It Early
There are tax reasons to get Starter Stock as part of your initial stock grant. Talk with your lawyer to learn more (or, if they don't know much, ask Orrick)

Any entrepreneurs or investors out there who want to comment about their experiences with starter stock? :)

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