Friday, August 20, 2010

20 Questions To Ask Yourself Before Raising Money

As I mentioned in a previous post, some startups may raise money for stupid reasons.  Below are a set of questions I think any entrepreneur should ask herself/himself before raising a round.

Why Are You Raising A Round?  What Implications Will Raising A Round Have To You, The Entrepreneur?

1. Why are you raising money?  It is for vanity purposes or does your business really need it?

2. What would you use the money for?  Is the nature of the business ultimately cash intensive?  (Be creative - are there marketing, inventory, or other costs you are not taking into account?)  Calculate what money is actually needed (do a simple spreadsheet of costs and revenue projected out and see how long it takes to burn the money with various scenarios).

3. What are your goals as founders?   How will raising money impact these goals?

4. How do you maintain control of the company?

5. How much of the company will you end up with after N round of financing?  Calculate this in a spreadsheet.  Then run through scenarios - how much will your stake in the company be worth at the end of the day?  (VCs often say "if we grow the pie, we all win", but if you do the math of dilution vs market cap, that isn't always true for the entrepreneur).

6. How will raising this money impact future options for the company? (e.g. will a "Strategic" investment from Burger King decrease your ability to work with McDonalds?  Will the big venture round block your ability to sell for $50 million if that is your goal?)

How Much Money Do You Actually Need?  What Next Milestone Will The Funding Get You To?

7. What are the implications 6-12 months out of raising e.g. for a seed round $250K vs $500K vs $1 million?  (worth thinking through this very tactical point)

8. What milestone will the funding get you to?  Will this milestone lead to either (a) breakeven or (b) another round of financing where the value of your company is at least 2-3X higher then the previous round?  If the answer is "no", then you need to raise more money, cut costs, or do something different.

9. How do you avoid being over/undercapitalized based on the above (this is more important for larger rounds - e.g. big series A, B, C etc.)

10, How are other companies in the industry capitalized and what implications if any does this have for you? (sometimes this is misleading - e.g. look at all the facebook app companies that raised $ that are now languishing.  The flip of it is if your business is dependent on buying e.g. a lot of traffic, and your competitor raises a warchest to media buy, they could soak up your marketing channels)

11. Did you add 50% padding to the number you came up with to ensure you don't run out of money?

12. What is the macro-economic climate?  Is the economy growing/shrinking and what will it be doing in 6 months?  A view into this can strongly impact whether your company can raise money on better or worse terms in the future (or raise money at all, if the venture markets freeze as they do at the beginning of every recession).

Who Should You Raise Money From?
13. Are you a cash or equity business?

14. Are you goals impacted by venture economics?

15. What are future financing approaches you would be willing to consider?  When will this capital be needed?

16. What sorts of value do you expect the angels or investors to bring besides just cash?  Can you get this value otherwise (E.g. advisors)?

17. Are there alternative sources of funding you have not considered?  (Venture Debt, employees helping to cover costs, having customers pay you for development, etc. - blog post coming on this shortly).

What Do Potential Investors Want?
18. What do your investors or potential investors want?  What are their motivations and why are they getting involved?

19. What would you be willing to give up in order to raise the money?  Equally important - what is your walk-away point (BATNA) at which you would not raise money from these investors?

20. What is their reputation and how have they helped companies in the past?  How have they acted when other companies they invested in hit rough times, or got bought?

Any other questions I should add to the list?  Let me know in the comments section.

Monday, August 16, 2010

Angels vs Superangels - What is the difference?

There has been a lot of noise in the press lately about "Superangels" and how they are a potential disruptor to the early stage venture funds (see also TechCrunch article).  This blog focuses on angels vs superangels and how the two work together. 

    Definition Of A Super Angel - Someone With An Institutional Fund
  • Small institutional funds. Super angels are in part characterized by the fact that most of them are effectively small venture funds who have raised money from limited partners. By "small" I mean fund sizes typically in the ~$5 million to ~$70 million range (these numbers are inexact, and depend on the number of partners in the fund).  This contrasts to "angels", who are investing their own money.  This means angels and superangels may have different underlying motivations in some cases.
  • Partnership structure.  Many super angel funds started off as 1 person investing their own money (e.g. Maples, Aydin, Jeff Clavier) and morphed into a broader partnership as money was raised for an institutional fund.  
  • Motivations for investing.  Ultimately, super angels will be judged by their LPs on financial return.  Given their smaller fund sizes, super angels are less beholden to VC economics so they have more alignment with entrepreneurs than traditional VCs.  Many super angels also invest to give back / help out the next generation of entrepreneurs or for other reasons (see angels, below).   However, it should be noted that super angels are not charitable organizations who exist to serve entrepreneurs - they do have LPs counting on them to generate a great ROI, and this is ultimately what they will be judged on.
  • Investment size. Super angels will each invest anywhere from $50K to a million or so in funding in a given round.  There is a bit of a split between those typically investing $100K-$250K per round, and those that typically invest $500K-$1 million.
  • Board seats. Many of them *may* take a board seat (and *may* step down with a "full" venture round where the VCs take over the investor seat).
  • Value add. They often are very good at providing introductions, strategic advice, etc.  See my blog post on the 7 types of angel investors for more on types of angel value-add. Many super angels are as entrepreneur friendly as they claim, but I have seen at least one act in a negative manner towards entrepreneurs repeatedly.
  • Upstream of VCs or co-invest in Series A/seed. Super angels may often act upstream of, our co-invest with, VCs, although they may sometimes compete with traditional VCs for a seed round.  I have seen many many instances of super angels co-investing with VCs in series A.  Taking a round from superangels will typically help your odds of getting a top tier VC into your series A, rather then hurt it (as recent press articles incorrectly suggest).
  • Lead rounds. The super angels often will help pull together a broader syndicate for the entrepreneur if useful.
  • List of super angel funds.  This list is not comprehensive and is in no particular order.  If I forgot someone - please let me know and I will add them.  Floodgate (Mike Maples and Ann Miura-Ko),  Harrison Metal (Michael Dearing & Erik Rannala ), HitForge (Naval Ravikant), SoftTech (Jeff Clavier), Lowercase Capital (Chris Sacca), Manu Kumar,  Felicis Ventures (Aydin Senkut), SVAngel (Ron Conway and team), First Round Capital, 500 Startups (Dave McClure), Founder's Collective (Chris Dixon et al), betaworks.  

Definition Of An "Angel" - Someone Investing Money On Their Own Behalf
  • Invest their own money. Your plain old vanilla angel is someone typically investing their own money.  
  • Motivations for investing.  Angels can vary quite a bit in the reasons they want to invest in a company.  Their primary motivation for investing may be financially driven, ego driven (i.e. instead of collecting sports cars or pokemon cards, they collect startups), or to give back to the community / help out the next wave of entrepreneurs (these angels are often the best ones).  
  • Investment size.  Angels will usually invest anywhere from $10K to a few million dollars depending on their personal wealth and agenda.  A typical amount to expect from an angel is $10K-$100K with $25K-50K being seen as pretty standard.
  • Board seats.  Traditional angels will rarely take a board seat unless they are either deploying a large amount of capital (with "large" as defined as large relative to the overall round or "large" as defined relative to the angel's personal net worth.).  Anecdotally, it seems that people who have worked as VCs before, or who spend most of their time these days on their investments rather then having an operating role, seem more likely to take board seats with their angel investments.  Some angels may be brought in as a board member to fill the "independent" board member spot when a venture round happens.
  • Value add. There is a very wide variance in angel value add.  While superangels are investing professionally for a living, angels are doing it for other reasons.  Some angels are amazingly helpful (think Reid Hoffman or Marc Andressen before they became full fledged VCs).  Others are spectacularly unqualified to invest and may be doing so because they have excess cash (trust funds, early employee at major company, your local family dentist) or excess time (ditto).  Screen both your angels and super angels carefully! :)
  • May invest in all rounds/financing types.  Since angels are investing their own money, they often have more leeway in what sorts of companies they can invest in and at what rounds (series A, B, C, etc.).
  • Lead rounds.  A handful of especially wealthy or plugged in angels will lead rounds and in some cases have a fund in which they are the only LP.  It is unclear if they should be classified as super angels or not, but they include e.g. Mitch Kapor, Ram Shriram, Russ Siegelman, Marc Benioff, Youniversity Ventures (Keith Rabois, Jawed Karim, and Kevin Hartz) and others.
  • List of angels.  See Angel List for a good cross section of angels.
How Angels and Super Angels Work Together
Within Silicon Valley, angels will often refer deals to super angels, and super angels will often pull in angels to fill in rounds.  Typically the angel/super angel networks are tight knit with the two types of investors working together.  Outside of Silicon Valley, you are more likely to run into angel investors who are not very savvy about starting a business but have access to capital.  These investors (finance guys, trust fund babies, etc.) can often be quite destructive to startups as investors and will be the topic of a future post.

Whether you are dealing with an angel or superangel, you should still chose the types of angels in your round carefully, as well as decide whether to let a venture fund invest.

Any angels or super angels I should have pointed out?  Let me know in the comments section below.

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Monday, August 9, 2010

Is Your Startup A Cash or Equity Business?

There are, broadly speaking, 2 types of ways to build value in a business.
(a) An "equity" based business in which the stock value will grow significantly with time
(b) A "cash" based business, in which the company will generate a lot of cash on an annual basis, but the value of the stock will remain a low multiple of earnings.

Figuring out what sort of business you want to start, (or, in hindsight, have started) impacts everything from whether you should raise money to how to compensate your employees.  A fundamental misunderstanding of what sort of business you have can lead to mistakes that derail the success and potential of the company.

Equity Businesses
  • Raise money:  Raise from angels, VCs, hedge funds, you name it.  Usually you need to invest a large amount of cash (usually from external investors and operations) over the lifetime of growing the business before you really create value and make money at scale.  Hopefully your company will do well and your returns are sufficient to meet venture economics.
  • Employee compensation: Biased towards options and low cash.  You don't want to pay employees a lot as you will have to keep raising money.  Raising money will dilute the equity, which is where the long term value is.
  • Time horizon: The average M&A exit is 6.5 years and most companies take many years to go public.  Value is usually created reasonably later in the companies life.
  • Example companies:  Google, Facebook, Twitter
  • Other key characteristics:  These companies typically have a period where they are not throwing off a lot of cash up front, but rather are reinvesting in growing and scaling the business.  Equity based businesses may lose money for the first few years before emerging as a cash machine as their unique position in the industry takes hold (think Facebook).  Similarly, these businesses often have strong network effects, strong barriers to entry, customer lock in, or other characteristics that make the equity value of the business high.

Cash Businesses
  • Raise money:  Focus on angels / individuals or self fund/bootstrap.  The returns you are likely to expect won't justify venture returns but you will be able to pay out cash as a dividend.
  • Employee compensation: Pay out more of your profits in cash as equity is only a minor consideration - as the equity value of these companies is low (i.e. you can't sell the company for much to other buyers).
  • Time horizon: Often these sorts of business start generating cash quickly (on the order of a few months to a year - think Hot or Not).
  • Example companies: Most of the smaller social gaming companies.  Most GroupOn clones.
  • Other key characteristics:  Often these businesses have lower barriers to entry, fewer network effects, or are focused on small or niche markets with few buyers for the business.
Note, as companies mature they may transition from equity to cash businesses or vice versa.  E.g. Microsoft is no longer a great bet in terms of stock upside, but they do pay a healthy dividend and generate a good ROE.  Similarly, GroupOn is both a cash business (think of all the small GroupOn clones which are instantly profitable) which builds equity value over time via branding, distribution, and scale.