Tuesday, September 28, 2010

Put Your Investors To Work For You

So you found the right mix of angels for your round, successful navigated around venture economics, and all the other issues associated with fund raising.

At this point, many entrepreneurs don't take proper advantage of all the value added investors they spent so much time and trouble courting.  I.e. what is the point of having one of the super angels in your round if you don't make use of her/his help and expertise?

At Mixer Labs (a company I started that was acquired by Twitter in December), I was always pleasantly surprised by how much value meeting with our various investors brought.  Just as you have an engineering team or a UX team, you should think of your investors as your investment team and find ways for them to work for you.  Below are some tips for making the most of your investment team:
  • Investors are there to help you (not for you to "update" them).  Some entrepreneurs spend way too much time meeting with each individual angel to give 1 way updates.  If you have 12 investors, and are meeting with each of them monthly it means you are wasting too much time on investor communication instead of focusing on your startup.  This obviously is not good.
  • Figure out which investors can help with what.  Some investors are much better at (or more interested in) talking about the product.  Others can help with hiring, setting company culture, business development or the like.  Ask your angels what they are good at, and what they can help with.  When the time comes to close your first employee, negotiate that business deal, or figure out the best channels by which to buy traffic, contact the right angel or investor and ask them for help.  
  • Updates should be phrased in ways that let your investors know how they can help you.   Rather then meet with all your investors regularly, the best way to keep them up to date is to send an occasional email update.  These updates could simply be "Hey, we launched our alpha, sign up here and give feedback" or for later stage companies can be monthly or quarterly emails (e.g. tied to board meetings) with an update on the business.  With each update, I would suggest having the 3-5 key asks you want from your investors.  E.g. is there a company you need an introduction to?  Some feedback on a part of the product?  A key hire you are looking for?  Ask explicitly for help with this at the beginning of the email.
  • Mini board/advisory board.  If you don't have a board, you can use 1-2 of your favorite angels as a lightweight version.  I.e. you can ask them to meet at some regular interval (e.g. every 6 weeks) to discuss some key things that are on your mind regarding the business.  You can make these slides light, but it is still worth emailing the content a few days in advance so the angels can think through the key issues.  Come prepared as you would for a board meeting - what are the top 1-3 things that are on your mind and how can they help you think these issues through?  Is it the product?  Hiring?  Distribution?  Sales cycle?  Work with your key investors to work through this.
    • Side note: You can also do this with people who are not investors - e.g. key industry people that you know/respect who can help.  In this case they can either be formal advisors or people who come in more for a one off discussion of a key topic they know a ton about.
  • Semi-annual investors all-hands.  One thing we did at Mixer Lab was to get all our investors into one room to discuss our key issues.  This is similar to the mini-board meeting described above, except we invited everyone to it.
    • This led to great group brainstorming, as various investors bounced ideas off of us and each other.
    • A side benefit is the angels get to network with one another, which they enjoyed.
  • Calendar reaching out to key investors.  When you are working heads down on your startup, you often forget to tap into your network for help.  Put a reminder on your calendar to reach out to key investors on key topics with some regularity.  You can always skip actually contacting them, but it is good to be reminded.
  • Don't be shy.  Don't worry about asking your investors for specific help.  It could be an intro to a company they know, to help close an employee, or to meet to discuss the terms of a deal you are working on.  You should be up front and ask for help where its needed - that is what they are there for.
Our investors were extremely helpful throughout our early days as a company.  Even then, I don't think we utilized them as effectively as we could have.   Hopefully the tips above will allow you to make the most of your investment team.

Any other ideas on how to make the best use of your investment team?  Please add your thoughts in the comments section.

You can follow me on Twitter here.

Wednesday, September 15, 2010

Are You An Alcoholic Yet? Or, The Great Startup Rollercoaster

This post has appeared as a guest blog on FounderDating, which brings together entrepreneurs with different skill sets to start innovative new companies.

Startups are by their nature extremely stressful.  At a large company, the company itself has momentum.  With a few exceptions, if one person (or team of people) were to suddenly disappear, the company will continue to coast for (potentially) multiple years before the effects may become evident

Thought experiment - imagine if the (multi hundred person (?)) Microsoft Office product and engineering team suddenly disappeared (kidnapped by aliens?).  The sales team could keep pushing the existing product for many years without customers noticing.  Microsoft could still generate ridiculous amounts of cash off of the product, with no one actually working on it.

In contrast, at a startup as the entrepreneur if you stop pushing, everything immediately comes to a halt.

There are times when you need to push much harder then others to get over a hump that reminds me of activation energy from chemistry.   Early on these events can be exhilarating, but with time some of these high anxiety / workload moments can really wear you out. They may include things like:
  • Hiring the first employee
  • Raising money
  • Getting the first N users
  • Acquisition talks
  • Getting sued
  • Pivoting
  • Getting N users for the new pivot product
  • Figuring out a business model
  • Etc. etc.

As a friend of mine put it, if a year into your startup you are not an alcoholic, you must be doing something wrong.

So how to deal with all the stress?  At Mixer Labs (a company I started that was acquired recently by Twitter) I tried to do the following:

  • Make it fun for everyone.  Startups are hard work.  Find key things to celebrate - e.g. for Cinco De Mayo we bought a pinata.  We created our own day off in April called Numa Numa day.  We did team hikes.  We worked from a pub (with wifi) and drank Guinness every few weeks on Friday afternoons.  We rented out a ski cabin in Tahoe for a week and did half days snowboarding and half days working.  Everyone on the team was working really hard, so we wanted to make sure we found simple, cash conservative ways to reward everyone while also creating a fun environment for ourselves.
  • Change context to decompress.  After a while, working 7 days a week is exhausting.  Make sure to take a weekend off to go to another city with your significant other.  Or, go see friends and do a long walk.  Changing context (even e.g. walking through San Francisco Chinatown if you are in SF) will help you take a break from the constant focus and worrying entrepreneurs face.
  • Do your best to maintain key relationships.  I had to cancel a pre-planned family trip with my girlfriend in order to work.  She was super understanding (she is amazing in general!), but the startup lifestyle can really stress relationships.  Try to find ways to connect with loved ones on a regular basis as their support will help get you through tough times - and will help with decompression!  Buy your girlfriend flowers or take your boyfriend to Sausalito.  Find a way to connect and be with one another.  
  • Get sleep.  This is self explanatory.  Try going without caffeine for 30 days - it will make a BIG difference and force you to sleep when tired.
  • Exercise.  This will help you decompress and clear the mind.
  • Have a hobby.  This may be hard if you are working maniacal hours.  However, even something you do 20 minutes a day can have a huge positive impact.  By making progress on something other then the startup, you can feel like good things are happening in life even if work is especially tough.
Startups are stressful but very rewarding.  If you don't find ways to cope with the stress you will burn out or blow up and the work environment will deteriorate rapidly.

What do you think?  Any ideas for how to decompress or deal with startup stress besides alcoholism?  Let me know in the comments section.

You can follow me on Twitter here.

Monday, September 13, 2010

The Fundingpocalypse: Your Mom Wants To Angel Invest!

You know how your mom or great uncle with the car dealership really wanted to buy Yahoo! stock in 2000 so they could "get in on this thing called the Internet all the kids are talking about"?  You know how that marked the height of a funding bubble?

I spoke over the weekend with an angel I know.  He has been getting random phone calls from people who "want to learn to angel invest".  These are people who have never started a company or worked at a startup (well, maybe Google when it was a few thousand people).  They seem to have no real interest in company formation other then they know a bunch of people talking about how great it is to be an angel.

I think it is a clear sign of the fundingpocalypse.  Yes folks, there is an early stage funding frenzy right now.

You can follow me on Twitter here.

Friday, September 10, 2010

Party Rounds: How The Crappy Economy, Y Combinator, Angel List, and Super Angels Have Changed Fundraising

In a prior post, I discuss how Party Rounds differ from Led Rounds, and how to raise a Party Round.  In this post I explain what is driving Party Rounds and discuss their implications for entrepreneurs, angels, and VCs.

In the last 12 months two big shifts have happened:
  1. Seed valuations for many companies have gone up dramatically (e.g. 50-100%)
  2. More and more seed rounds do not have a lead investor.  I.e. the terms are being set by the entrepreneur as part of a "Party Round" (a term first used by Rafael Corrales).  
As I explain below, this shift is one with implications to angels, VCs, and entrepreneurs.  This shift has been in part driven by Y Combinator, AngelListthe rise of super angels and the changing economy/lack of good investment opportunities.  

Why Are Party Rounds Suddenly So Common?
Two years ago, it was rare to have an entrepreneur set his or her own terms.  The following things have changed:
  • More Angels.  There are more angels actively investing in private companies today than at any other time I have seen.   This is driven by three things:
    • Y Combinator.  Y Combinator has been holding days such as Angelcon to educate people about angel investing and to connect them to super angels or others who have good advice and insights on investing to pass on.   Y Combinator also invites a wide range of angels to demo days, where they have a chance to interact with and invest in startups they potentially would never have met.  This opens up a whole new pool of capital and expertise for the angel investing world and I think this is a very positive trend for the overall entrepreneurial ecosystem.  With increased angel demand, entrepreneur supply is worth more.
    • AngelList.  AngelList has further democratized fund raising.  By tapping into a broad network of angels for every potential investment, AngelList similarly makes it easier for entrepreneurs to raise more money from a wider range of people then they could have previously reached.
    • "Its the Economy, Stupid".  A lot of rich people don't have a good place to put their money that will provide a great return.  The stock market has been flat to down over the last N years, bond yields are poor, and there is not a good place to park cash (this is increasingly true for pension funds etc. as well as even overall venture returns are poor).  This means that angel investing is a way for people with a lot of money to deploy capital with the hope of a better return.  (Thanks to George Zachary from CRV for pointing this out).
  • Super Angel Funds.  Super Angels investment strategies typically support Party Round emergence as -
    • Many super angels won't take many board seats (some exceptions exist, e.g. First Round Capital, Harrison Metal, and Floodgate have all taken board seats in a number of instances - they also tend to invest much larger amounts in fewer companies then the average micro VC / super angel).  The reason is that if most super angels make 20-30 investments a year and have e.g. 50+ active investments, the individual super angels don't have time to sit on any boards.
    • Smaller capital deployments.  One class of super angels invests $50-$250K per round.  This means 3-4 super angels and 10-15 regular angels can invest in a $750K round.   No one has enough skin in the game or individual bargaining power to set terms.
    • Lots of capital suddenly in the market.  Super Angels have recently raised a crap load of capital to invest.  I can think of $X00 million in funds that have closed recently - all this capital needs to go somewhere.
  • VCs acting as super angels.  In order to get option value on a broader set of companies, some VC funds are investing like super angels in seed rounds.  VCs are even less valuation sensitive then super angels for seed investments in which they invest small amounts (e.g. $100K), which means valuations can be driven even higher and even more capital is available for the same deals.
The net takeaway is that there is not just more money chasing the same deals, but rather, there is more money that (a) won't lead rounds or ask for a lead or board seat and (b) in some cases (e.g. new angels flooding in) doesn't understand angel economics in a very sophisticated way (i.e. most of these people will lose money in the next few years).

Implications of Party Rounds For Entrepreneurs, Angels, VCs

Implications for Entrepreneurs:  Net positive.
  • Upside:  More capital = more negotiating leverage = better deal terms and control for the entrepreneur.
  • Downsides: 
    • All the capital flooding in means some not-so-great companies are getting funded.  Rather than get locked in to a bad idea via successful fund raising, some entrepreneurs' time may be better spent on other products or ideas.  This is especially true for the oversubscribed company that raised $1 million instead of $500K and ends up spinning it wheels for 6-12 months longer than it otherwise would have (the flip of this is it gives more time to pivot as well).
    • The increasing number of less sophisticated angels may mean more hand holding / time spent managing an investor who is on over his or her head - do your diligence and only take money from people ready to lose it investing in your company.
    • High valuations in seed rounds may negatively impact future fundraising dynamics.
      In 18-24 months lots of companies are going to go under as their existing investors don't have the capital or where-with-all to re-up for the company.

Implications for VCs:  Net Positive
  • Upside: Despite all the press about super angels vs VCs, all this capital sweeping into the seed stages is good for the venture community.  I cannot think of a single major internet company that has not needed to raise multiple rounds of funding - which is where the VCs come in.  All this activity means in 12-24 months VCs will be able to cherry pick the very best companies for series A/B investment.   The others will likely wilt on the vine.
  • Downside: The valuation inflation in the seed rounds will lead to inflated expectations by entrepreneurs for their Series A.  It will be interesting to see how this will play out once bargaining power shifts back to investors in later rounds (since there is a small set of collusive players in the traditional venture world).

Implications for Angels:  Net negative (but they don't realize it yet)
  • Upside:  Angels who are not as well networked now have more access to companies and investments.
  • Downsides:  
    • Party Rounds are hurting angel economics.   Seed rounds are starting to hit low series A valuations - but with seed level risk.  A lot of small fry angels will likely lose quite a bit of money in the coming years - or their return on investment will be lower then it would have been without the Party Round dynamics.
    • Party Rounds also means angels are less likely to have an investor take a board seat to work with the startup on key issues.
    • Many Party Rounds are being done as capped notes.  This means if the company raises at a valuation lower then the cap then the angel will convert at the low market cap - even though they took on all the early risk.  Even worse, if the company gets acquired and there is straight conversion with acquisition, the angel will *lose* money on the exit (as opposed to an equity financing, where the angel will often get their money back).
I leave you with this quote from Keith Rabois, which has interesting implications for the above:
"The companies I have traditionally seen do best over the long term had lead investors for their seed rounds" - Keith Rabois

What do you think?
a) What other trends are feeding all the Party Rounds?
b) Is this a good or bad thing for entrepreneurs, angels and VCs?

You can follow me on Twitter here.

Wednesday, September 8, 2010

Party Rounds: How To Get a High Valuation For Your Seed Startup

A major shift has happened in the last year - entrepreneurs have gone from led seed rounds to "Party Rounds".  This shift has non-trivial implications for the venture industry which I will explain in another blog post (in which I will also explain what is causing more and more party rounds to occur).

This blog is focused on:

(a) The difference between a Led Round and a Party Round
(b) How you raise a Party Round

Led Rounds (Old Model) vs Party Rounds (New Model)
  • Led round.  (The old model)
    • Who sets the terms:  A single investor sets the terms of the round in negotiation with the entrepreneur.  Usually the investor is one of the larger $ amounts in the round or a professional investor.  Other investors then co-invest on these terms, often after being pulled in by the lead investor or the entrepreneur (the "syndicate").
    • Board seats.  The lead investor may or may not take a board seat depending on what they and the entrepreneur decide.
    • Representing the investors.  The lead often represents the overall set of investors in the round.  So if e.g. the entrepreneur wants to sell the business, she may often discuss it with the lead investor rather then having to tie in to all investors.
  • Party Round.  (The emerging model)
    • Who sets the terms: The entrepreneur sets the terms, often by bringing on smaller investors with no leverage first to get early commitments for the round.  
    • Board seats.  Board seats are usually not given out.
    • Representing the investors.  There is typically no one investor who represents the overall investor pool.  Or, a "Brand name" investor will tell the entrepreneur what investors in general may want.
    • Valuation: Party round valuations are often 50-100% higher then led rounds.  This is due to the fact that no single investor invests enough to have the leverage to negotiate down the terms.  Similarly, the way a Party Round comes together often precludes the ability to any one investor to negotiate or set the terms (see below).
      • The net impact of this is that an entrepreneur who before would have raised at a $1.5-4 million valuation is now raising at a $3-6 million pre-money valuation.

How to Raise a Party Round and Get a Better Valuation
In the not-so-distant past, there were a handful of major angels or funds who would lead rounds.  An entrepreneur would have to negotiate terms such as valuation with this small set of potential leads.  Once a lead fell into place, other investors would follow on into the deal.  The small number of potential leads meant that:
  • There was higher likelihood of collusion amongst investors in setting price - people were more likely to know who the entrepreneur was also talking to
  • Entrepreneurs had fewer options from which to raise capital - which meant they had less leverage over market cap or other deal terms

Today, it is increasingly typical that the entrepreneur raises a round without a lead investor.  Furthermore, the entrepreneur can get much better terms (e.g. a much higher valuation) in a Party Round as follows:
  • The entrepreneur finds 3-5 smaller angels willing to put in money on terms set by the entrepreneur.  
    • These angels are typically ones who traditionally have not had much deal flow, or do not invest professionally, or alternatively, are investing more for status/to give back than for financial return.   This means they are less valuation sensitive in many cases.
    • These investors do not have the leverage (or in some cases the interest) to negotiate a better deal. 
    • These angels may still be value added money, or e.g. previous entrepreneurs known by more prominent angels (so they may still provide social proof beyond just the money committed).
  • The entrepreneur uses the money committed by smaller angels to set terms with larger angels.  
    • By raising from these 3-6 lesser known angels, the entrepreneur raising the round now has say $200K out of $500K in capital committed for the round.  The entrepreneur can now go to professional investors / super angels (who normally would have had more leverage) and say "I have set terms and have a big chunk of capital committed.  If you want to invest, you need to do so on these terms".
    • Many institutional angels have a model in which they make 30+ investments a year.  Part of their premise is by investing in a large portfolio of company, they will hit the 1 company that will return the fund many times over (e.g. the next Facebook or Google).  The super angels do not want to miss out on a hot opportunity, so may be less likely to negotiate at this point.
  • Wrap up the round.  
    • Once one or two prominent angels agree to the terms, many of the others (both large and small) will follow.   The round is now closed and in many cases overcommitted, causing the entrepreneur who planned say $500K to raise $1 million for their seed.
I will discuss why Party Round have emerged, as well as the pluses and minuses of these rounds in another post.

Thoughts?  Do you think Party Rounds are good or bad for the entrepreneur?  For the investors?  For the tech community?

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