Category: startup

Enterprise Venture on the East Coast

In 2011 there were 58 enterprise seed deals done in New York and Boston representing $21 million of capital being put to work. Two years later those numbers were up to 73 enterprise seed deals and $33 million. Deals up 26% and dollars up 57%.

The numbers are more impressive for Series A deals. In 2013 enterprise deals rose 73% to 57 from 33 in 2011 and enterprise dollars rose 159% to $342 million from $132m in 2011.

It’s safe to say the upward trend is continuing into 2014. So far there have been $243 million dollars invested in 85 deals (combined Seed and A) in New York and Boston through Q2.

Contained in that sample are companies I’ve come in contact with like:

  • Datadog which Crunchbase reports has raised $22.4 million from 9 investors.
  • Hadapt which Crunchbase reports has raised $16.2 million from 2 investors and was acquired for around $50 million.
  • WorkFusion which Crunchbase reports has raised $22.3 million from 4 investors.
  • Evergage which Crunchbase reports has raised $6.3 million from 8 investors
  • MortarData which Crunchbase reports has raised $3.2 million from 5 investors.
  • VisualRevenue which Crunchbase reports has raised $2.2 million from 7 investors and was acquired for around $10 million.

Just in this small sample there are couple nice mark ups and a couple exits at decent multiples. And of course there are many more successful companies I didn’t mention and plenty of time for them to be wildly successful.

I expect a couple things to happen:

  • I expect some of these founders and other senior guys to build other enterprise companies here on the east coast.
  • I expect some larger enterprise tech companies that have engineers here on the east coast to break out and do their own thing here on the east coast.
  • I expect some of the entrepreneurs from Cornell and Columbia and NYU and MIT and Harvard to decide that they would rather be closer to their customers and not move to the valley to start their companies.
  • I expect the support ecosystem that nurtures these types of companies to grow.
  • I expect the support ecosystem that nurtures these types of companies to grow.

In short, I expect the trends we are seeing in enterprise tech startups on the east coast to continue. And I look forward to being part of it.

Impacts on Seed Stage Returns

Let us say you gave an angel/seed stage investor $100 to invest in 100 different companies in $1 increments.  The odds are that fifty of those investments will yield a return of less than $1 each – meaning you won’t even get all (or possibly any of) your money back.  This is according to a Kauffman Foundation survey done a couple of years ago.  It’s not to say that the returns from the asset class are bad.  In fact, the study found that the average return from the asset class is 2.6x the investment in 3.5 years or about a 27% IRR.

So what are we make of the above facts?  Well… investors need to offset the negative IRR investments with investments that have really high IRRs.  Seven of those 100 investments are likely to return more than 10 times the original dollar.  That’s the offset.

In order to do better than average ideally you want to do two things to improve your returns: decrease the number less than 1x returns and increase the number of >10x returns. Luckily Kauffman provides a blueprint for that as well.  According to their survey, the 3 factors that positively impact angel/seed stage returns are:

  1. a rigorous due diligence process (to weed out bad outcomes from the start),
  2. a high level of experience and expertise in the investment sector (to lend any investment context to the environment) and
  3. being a helpful mentor once you do invest in the company (to help the company avoid operational errors that can be especially dooming as a company is first started).

As I look at my process, there are a couple of things I do to keep my thinking on track and aligned with this guidance.

First of all, I only invest in what I know.  I know enterprise technology.  I covered it as a buy side analyst, I covered it as a sell side analyst, I worked with it when I ran corporate development for a public company and my current employer RTP Ventures, invests in enterprise almost exclusively.  I often see what I think are amazing deals in Internet or eCommerce or B2C spaces and regardless I pass.  For one thing, I don’t know what I don’t know and could easily miss something when evaluating a deal.  For another, since I probably know little, I can’t be very helpful to the company as they go through their stages of development.  And finally, I don’t have very many good connections to ‘follow on’ investors in most other tech sectors.  So I agree with Kauffman.org when they say stick to your knitting.

The second important part of the process for me (and the first for Kauffman) is diligence.  Everybody should have their own diligence list and process that they go through methodically for every deal they do.  Certainly it is harder at the angel/seed stage because ether is just not as much to diligence.  However, when I’m first looking at a company I think through a decision tree that looks something like this:

decision treeThis is to just make sure that I’m weeding out deals that have high level issues.

The next thing I do is put the company/deal through a rating system.  This is a way to compare deals that might otherwise be like apples and oranges.  It is also a way to dig in on some things that might otherwise be intangible.  And finally it is a good record in case you need to look back on deals.  Skyler Fernandes at Simon Venture Group was the first to share his document here.  I modified his document for my own use.

And then of course I do proper diligence, which means compiling documents, talking to employees and customers and industry experts on the finer points.

The purpose of diligence should be to uncover all the issues that define the risks.  If you know what those are you can then decide if you are comfortable with them.

And once the investment is made, that’s when the real work starts.  By my estimation a seed stage company can make maybe two small mistakes or one medium mistake in the 12 to 18 months that the seed stage money is meant to last.  Any more than that and the next funding round becomes difficult.

That’s why proximity to the investment is important.  An investor should want to stay in contact with the teams that have been invested in and see what is going on.  It’s best if you can grab a coffee or a breakfast with the entrepreneur and talk.  Talking about obstacles, pitfalls, best practices and experiences is the best way to help prevent early mistakes. That’s one of the biggest parts of mentoring.

Mentoring is the third important factor in successful seed stage investing.  Hopefully in your career you have helped to build a business and have some operational, product and financial experience that you can bring to bear.  In the beginning getting things on track and keeping things on track is the most helpful thing you can do.

The Kauffman can be found at: http://sites.kauffman.org/pdf/angel_groups_111207.pdf

Mounting Obligation

If you follow the New York startup scene (and Brooklyn in particular) you probably know the today was a big day.

Mayor Bloomberg announced an academic and private-sector consortium to create the NYU Center for Urban Science and Progress (aka CUSP) in Downtown Brooklyn at the old MTA headquarter building.  Over the next five years, 370 Jay Street will be reconfigured into a research and science campus.  Approximately 150,000 square feet of the space will be designed for classrooms, offices and laboratory space, with an additional 40,000 square feet programmed for the creation of an incubator for businesses spun off by CUSP or CUSP-related research. The remaining building space may be used by NYU for the future expansion of CUSP, other academic uses or for commercial tenants who are seeking to locate near CUSP.

The academic partners of NYU and NYU-Poly are City University of New York, Carnegie Mellon University, University of Toronto, University of Warwick, and Indian Institute of Technology Bombay.  The private industry partners include two Lead Founding Partners – technology giants IBM and Cisco – who each will provide $1 million a year in financial and in-kind support. There are also four Founding Corporate Partners – ConEdison, National Grid, Siemens, Xerox – who will provide $500,000 a year in financial and in-kind support to CUSP, and three Founding Consulting Partners – AECOM, Arup, and IDEO -who will provide up to $150,000 per year of consulting services at cost.

First classes are in a year in a Metrotech leased space.  First classes in the refurbished building are in 2017.  Today’s press conference is here and the press release is here.

You have to admit that this in combination with the announcement of a Cornell Engineering campus on Roosevelt Island (made this past winter) is a serious commitment to engineering, entrepreneurship and technology.  And… it’s not clear that the Mayor is finished working deals with other interested Engineering schools.

Also today the results of a survey done by the Brooklyn Tech Triangle, in partnership with The DUMBO Improvement District announced the results of a survey they took.  They have identified over 500 innovation firms (I have no idea what that means, but I guess that they have some technology or startup type affiliation) in the the Brooklyn Tech Triangle.  They also figured out that of the commercially zoned real estate in DUMBO (the heart of this area) only has 3% vacancy.

This brings us to the mounting obligation in the title.

We, as a tech community, have an obligation for build an ecosystem worthy of the talent that is being home grown.  We have to build great tech companies where these newly created engineers can learn the ropes.  We need to have an entrepreneurial culture that makes the best talent choose to come and stay in NYC. We must be able to match the access to capital, mentors and industry leaders that the best technology centers in the world offer. It is on us to do this.

More importantly the political leaders have created an obligation to provide the environment for startups to thrive.  That means:

  • Infrastructure – high quality access and connectivity to the cloud.
  • Favorable tax treatment
  • Good public transportation
  • Commercial zoning for technology companies
  • etc.

How could the local government make such a large investment in becoming a technology education center and then let that talent go someplace else, because the condition weren’t right to start their company?  The answer has to be –  they can’t.  With the announcements of the last couple months, promises have essentially been made that must be followed through on.  To not do so would be a shame and a waste.

I do think that elected officials know that they have promises to keep.  And I think they intend to do so.  But I also think that we have an obligation to make sure they follow through.

Navigating Angel Groups

A seed round is often times a good idea either after a ‘friends and family’ raise or in place of it.  A seed round tends to have less strings attached.  People always say the clock is ticking once you have taken a Series A from a VC.  A seed round is serious, but typically you haven’t proven you idea can work – you are still kind of testing it. So often times it is just more appropriate.

One of the reasons Angel groups are a good source of seed funding is not because of their skill or professionalism but simply because of the concentrated access to self-identified investors that they provide. Finding 10 to 20 angels willing to write a check of, for example $25,000, from an entrepreneurs own network would probably take quite a bit of time, even if the ‘hit rate’ on a percentage basis might be higher. So the odds of raising a seed round of between $250,000 and $500,000 seem higher and additionally the time commitment of the entrepreneur is likely lower than in a 1:1 meeting scenario.

Conversely, the value of an Angel group to its members is that they get deal flow. More sources of deals means more investment choices and ought to mean better investments and better returns.  It actually doesn’t, but that’s a different blog post.  The point is that for an entrepreneur pitching to an Angel group is a competition.  Entrepreneurs may not be thinking about it this way but they should.

As an insider here are some hints that can help improve your odds of winning this competition:

1) Market to your audience.  That means know your audience and don’t try to use a one-size-fits-all pitch.  Simple right?  Apparently not always.  Check out the individual bios.  Ask what the groups other investments have been.  Meet with a member of the group 1:1 before hand to understand some of the quirky do’s and don’ts.  Chances are you’ll find out that the group is old and white and male.  That’s changing slowly, but it’s still true today.  That means keep the initial interface with the group at a high level. Don’t go diving into the intellectual property as some entrepreneurs are prone to doing.  Use analogies.  I’m not saying this crowd is simple – they are not!  They are not all that tech savvy especially across lots of categories.  Finally, plan for less presentation and more Q&A. Let the investor be in the driver seat.

2) Keep the message simple. If the presentation has a bunch of ‘eye charts’ or lot’s of builds, or even too many slides, that is a sign the message hasn’t been boiled down to its essence.  Ben Franklin once wrote a letter to a friend concluding it with something along the lines of  “I’m sorry this correspondence is so long, it would have been short if I had more time to consider it.”  Essentially this means don’t brain dump!  Think about what is most important and how it is best said.

3) Find a champion within the group.  Let’s say you are one of 20 companies getting screened, one of 10 presenting to the Angel group and 1 of 3 that gets brought back for final investment consideration.  Think about how terrible those odds are.  Three opportunities to get nixed, lost in the shuffle, fallen through the crack or not properly remembered and considered.  I estimate that a good idea gets unknowingly screened out monthly.  So find a champion within the group. Get someone to help you keep your pitch alive by reminding the group about your business and why it is different and good.

4) Help find a lead investor. This one seems weird but it can be really helpful.  A bunch of times an Angel won’t be as good at valuing a startup or deciding on a term sheet.  If there is someone out there willing to set the terms and the valuation that accomplishes  two things: lets the group know that there is conventional wisdom that this is a good idea, and also helps make the investment decision easier for the rest of the investors by providing some guidelines about what the investment will look like.  Of course, finding a lead is the hard part, but Angel groups tend to be better at filling out the round than being in the driver seat.

I’ve seen a lot  of blogs that talk about how the deck should look and what the presentation style should be.  I think you should take that advice as well.  But, if you truly have a good idea for a business and you work the system I think your odds go way up.

More About Silicon Valley

 

I spent the week in the Valley last week.  I hadn’t really been there with a VC hat on. I’ve spent most of my career thinking about public companies as a Sell Side analyst and as a strategist running corporate development for a public company.

 

Anybody who knows me, knows that I’ve been really excited about the large steps forward that the New York venture scene has taken over the past 18 months or so. However my view has tempered recently by both the recent data on the deal environment and by my trip.

 

The recent data points

  1. The National Venture Capital Association put out data that showed that NY did fewer deals and at lesser volume in Q4 than in Q3 and that Boston really is the number two locale for venture in terms of deals and volume in 2011.  This is clearly a step back for NY or, more likely an inflated sense of the steps forward.
  2. The return on venture investment declined for the fourth consecutive year (see below).  This is probably cyclical, but there is undoubtedly damage to be done to the number of VCs and the amount of investments to be made. In fact, a plurality of U.S. venture capitalists believe venture investment and fundraising will decline in 2012.

This is probably bad news for the 54% of U.S. 18-34 year olds who want to start a business as per a recent Kauffman Foundation survey because it means funding will be harder to get.

What this means to me if you are an entrepreneur is ‘get funded while you can’.  Prioritize your company’s future existence over the value of the business.  Or as Mark Suster would say, “when they are passing the hors d’oeuvre try, take two and save one for later”.

The trip

I went for a predictive analytics conference, but also to reconnect with folks I have done business with in the past.  So I went to the conference.  It was fine.  While I was there, I learned about another conference called Launch. I was able to get into that conference with the help of a company I know here in NY.  BTW thanks guys for saving me a grand.  There were 40 brand news companies there at least. It was cool to say the least.

On my way there, I past the venue that Apple was introducing the latest iPad.  There were a gaggle of tech journalists there covering the event.

And then the next morning, in the convention center next to my hotel, there was a Game Developers Conference with thousands in attendance.  All this in a 3 block radius of San Francisco over 18 hours.  And that’s just what I knew about.

The point is the shear size and scale of what is going on in Silicon Valley is so vast that it will be a long time before NY deserves to be thought of in the same way.  I’m not saying I was diluted into thinking there wasn’t a big gap, I’m just saying once you see it up close you realize how much work and effort needs to be done to build a ecosystem of funders and fundees that is truly self-sufficient and provides built-to-last value.

My point here is do what you can to make hay while the sun still shines!

 

Angel Valuation & Return

How can an angel value a company that has no revenue or customers?  There are a couple ways that have been devised but none is very good.  Still, angel investors want to make investments so they have to work with what they’ve got.

In truth an angel doesn’t have to do a valuation calculation.  Most angel rounds these days are notes that convert into preferred shares when a VC comes along and provides a “professional” valuation.  This works because the angel gets some interest (which is nominal but better than nothing) and then gets to convert into preferred at typically a higher valuation at a time not too far into the future. Also, the preferred might be at some discount (say 20%) to the price the next investors are paying.

However, angels should want to do a couple high level valuation calculations so that they can get a ballpark estimation of expected return.

First things first… the practical determinant of valuation is always the market.  If the market is hot the valuation will certainly be a little higher.  But beware, markets are cyclical.

Median – the median pre-money valuation of venture capital seed-stage enterprises has varied annually over a narrow range between $1.7 million and $2.5 million since 2002.  Experienced investors will compare the calculation of other methods to the median as a check for reasonableness.

Berkus Method – this method starts with a valuation of $0 and adds $500,000 for each of the following items:

  • Good idea
  • Prototype built
  • Good management team
  • Strategic relationships in place
  • Product at rollout or early revenue stage

That means the top valuation should be $2.5 million.  Sound familiar?

Scorecard Method – choose factors (team,  TAM, technology, etc) and assign a weight so the factors add up to 100%.  Then rate the startup on each factor with 100% being the norm (ex. a strong team might get 125% of the norm).  Multiply each weight by the factor value and add them up.  This sum is a multiple that gets applied to market rate for pre-money.  For the NYC area the recent median has been $2.0 million. As the example below shows, the pre-money valuation is $2.25 million.

Discounted Cash Flow (DCF) – DCF utilizes cash flow projections plus a terminal value for the business in future years, discounting them to the present as Net Present Value – the higher the risk, the higher the discount rate.  If you really want to use this method go here.  But I wouldn’t for two reasons: first projecting 5 years of cash flows of a startup is ridiculous and second, I recently did this for a company that has been in business for several years (going for a series C) that had great projections and the partner I was doing this for said,”we don’t really use that in venture. the P/E guys do and the public equities guys do, but we don’t.”  That’s good enough for me.

So that is a good place to start on valuation.  What about angel return?  Here’s a couple things to keep in mind.  The basic rule of thumb is angel investors are targeting 5 to 10 times return on their money in 4 to 8 years.  See the table below.

 

So what does this mean?  It means angels are seeking investments that can grow revenues to at least $50 million within four to eight years on a median valuation.  It means they are expecting a market value of the company in excess of $100 million.  And that building companies with revenues sufficient to create $100 million in market value in four to eight years typically requires much more capital than is normally invested in seed/startup rounds, or in other words, the angel investor is going to get diluted. Dilution sucks, but it is a necessary evil.  That is why angels need to be disciplined and frank when dealing with entrepreneurs they are going to back.

It gets harder… angel investing follows the 80/20 rule.  80% of the return of an angels investment portfolio are going to come from 20% of the investments (sometimes even less).  So the really do have to be home runs to make up for the ones that didn’t work out.

Plus, there is an early negative return bias.  The other day one of RTPs partners mentioned the old adage “lemons sour quickly”.  That means early on (about 2 years) in an angel investment portfolio, the angel investor will probably know what investments won’t work out, but it might take 8 years for the really great companies to develop. So an angel is losing money for a long time until all of a sudden there is a nice return.  Or not.

Here’s some more resources to help you think through valuation:

Angel Capital Association
Angel Resource Institute
Bill Payne Angel Valuation Analysis
Dave Berkus Method
Common IRR’s and their multiples
The VC Method

Startup Product Mantra: Laid, Paid, Made

This week I referred to something I read in a post by Dave McClure back in December on two separate occasions when discussing the importance of building a product that can have an impact in the marketplace.

The first time was at a coffee with a respected marketing consultant.  She expressed frustration that one of her startup clients really just wanted to build ‘cool stuff’ and figured the sheer coolness of it would be enough to eventually figure out the business model.  She seethed that this team had “a solution searching for a problem.” She wondered how to snap them out of this ‘build it and they will come’ mentality.

The second time was in a discussion about Pinterest.  A successful CTO I spoke to said, “you know I like Pinterest, but I don’t really understand the valuation”.  For those who don’t follow these things, Pintrest recently raised a $27 million Series B (total of $37.5 million raised) at a rumored $200 million pre-money valuation.

In both cases I simply repeated what Dave said, ‘great products and do 1 of 3 things: get you laid, get you paid, get you made’.  Consciously or not this was reference to Maslow’s Hierarchy of needs – first physiological (food, water, etc.), then safety, then love and belonging, the esteem and finally self actualization.  It boils down to: Laid, Paid, Made.

To me the context of both of the above discussions is driven by the understanding of how a product taps into the psychological and emotional needs of humans.  About a new product, an entrepreneurs should ask his or herself: which of the following does my product do?

  1. help drive commerce by solving a problem
  2. increase the quality or quantity interpersonal relationships
  3. build a persons self-esteem or self-confidence
  4. spark creativity
  5. spark desire
  6. keeps people safe

This might seem obvious, but if the answer isn’t one or more of the above, this is not a product to start a business around.

So if I’m the marketing consultant I ask my ‘cool stuff’ entrepreneurs to have a conversation about the needs that the product fulfills.  I make them tell me how the product gets me laid, made or paid.

And to the CTO I say that Pinterest does 5 of the above 6 things.  Whether the users own the products, movies, books they have pinned they are telling people what they think is cool and what they aspire to have.  Whether they have been to the places or eaten that food they have pinned, they are defining beauty in their own eyes.  Pinterest sparks personal creativity and desire.  In addition it can act as a sales tool for vendors, creatives and designers.  and of course there is a social aspect to it.  So I don’t know if $200 million pre-money is right or wrong, but I can at least understand it.

The point is make sure your product is going to have an impact in the marketplace.

Test Drive

If a picture is worth a thousand words than a demo is worth a thousand slides.

If you want an investor to know how great your product is let her/him take a test drive. Trying something out is way better than hearing a pitch about how it is supposed to work.  Here’s an example:

Entrepreneurs Roundtable Accelerator (ERA) has a company in its newest class called Let’s Wombat.  I have no idea what Let’s Wombat means, but their service is pretty cool.  They create a sponsorship marketplace for what I call micro-events.

What’s a micro-event… let’s say you are planing a family reunion, or a Super Bowl party or an Office Team Building exercise.  Guess what… your group likely represents a demographic.  And there are companies trying to reach your demographic.

Let’s Wombat matches sponsoring companies with micro-events.  Put another way, they help you get free stuff or money for your Super Bowl party if it is a desirable demographic.

I wanted to see how this would work to provide feedback and commentary to the Let’s Wombat team.  So I went on their website and I registered an event.  In this case it was my son’s third birthday party.  The target audience wasn’t bunch of three year olds, but their upper-middle class, hipster parents.  I put in a few high level pieces of information about who was attending and that was it.  A couple days later I was contacted and told that Izze (a Sparkling Juice Company) wanted to sponsor the event.

In this case the sponsorship entailed a couple cases of free sparkling juice.  We had the sparkling pomegranate which was more popular than the sparkling peach.  Going into the event we were a little nervous – we wondered what our friends would think of us pimping out our son for some free stuff.  That was an unfounded concern.  There were no signs or banners or any obligations to do anything other than put out the product for people to drink.  Beyond that, a really interesting thing happened.  I started telling the story of how we got the sparkling juice.  It became a topic of conversation.  People said, “Hey, I like this stuff.”  And, “Will you send us the website?”  The sponsorship took on a little life of it’s own.  People started taking pictures with the product (see below).  I’m pretty sure Izze got it’s money’s worth from the two cases of soda it sent over.

The outcome was that I saw this service work and, in my opinion, it worked well.  At this point I don’t know if sponsors will flock to this company or if it will catch on with event planners, but I do know that Let’s Wombat has created an interesting marketplace where none existed before.  I have seen it with my own eyes.

If you want to make an impression with an investor let them take a test drive!

Underfunded

Ask me if there is an Angel investment bubble and I will say no.  On the other hand, I will also say that there are a bunch of angel investors out there that are going to get slaughtered in the next two years and may never Angel invest again.

Why no bubble? Because there is natural supply and natural demand.  These are genuinely good companies that deserve to be backed by investors who have the means to do so.  There are not too many catfood.com companies getting funded.  Valuations have gotten a little rich, but not too bad and that is coming from the top down much more than the bottom up.

The financial crisis in 2008 caused economic contraction.  A bunch of good, smart people lost their jobs and couldn’t find new ones.  They did what people of ingenuity might do… they created their own job by starting a company.  Lots of smart, skilled people yielded lots of  interesting, viable companies.  There’s your supply.

In October of 2007 the Dow Jones was at 14,066.  By March of 2009 (18 months later) it was at 6,626.  That’s a decline of about 53%.  Since that time it has recovered slowly to about 13,000.  That means there are investors that after 5 years who could still be under water.  The Dow is supposed to be safe, or at least safer.  Over the past decade it hasn’t been.  Investors are saying, forget it.  The risk return is out of whack.  Let’s find something else.  They look at alternative investments.  Angel is an interesting asset class.  There’s your demand.

Natural supply.  Natural demand.  No bubble.

Then why are many Angels going to give up and walk away?  There’s a number of reasons including:

  1. Not enough follow on capital from VCs to keep these investments alive.
  2. Higher barriers to investment exit including high costs of startups going public.
  3. Angel investing is harder than it looks with high failure rates. Lots of first time angels will simply bail out.

A less obvious reason and the one I want to focus on is ‘under funding’.

Here’s a common case study: a company comes into the office.  They show me their technology.  It is top-notch, high-end, built-to-last, datacenter class technology that has real value.  I love it! It is obvious why the idea deserved to get a seed round of funding.  The product is just completed, or close to it.  The team is still just the founders and some technical people or contractors.  The product is about to go into beta testing and has no customers.  There isn’t much of a marketing or a go-to-market plan yet.  They have been heads down building a good product.  The founders say “we either need another $500,000 in convertible debt, to take this product to market, or we need to raise a proper Series A (call it $1.5 million on a $5 million pre). And oh, by the way we gave away 20% of the company to the first round seed investors.”

Guess what? As a VC I cannot invest in this company.  The company did not make enough progress with the seed round to stay on the natural funding progression track.  They were almost there, but ran out of gas before completing the last mile.  They needed to gain a strong expression of interest from the customer for me to invest.

I could blame this on the entrepreneur, but I won’t because it is their job is to know about the technology, and they did a good job with that.  No, this is the fault of the seed stage investor.  They are supposed to know about the capital side of a startup and this company has been left underfunded.  The seed stage investor didn’t tell the entrepreneur what she/he needed to accomplish with the funding proceeds.  Common or not, that is a mistake on the part of the investor.  The result is that the company has been left in funding no-mans-land.

Most likely the current angels aren’t going to step up for a follow on.  They are not geared for that.  New angels will want some percent of the company, meaning 30% or more could be gone before the Series A.  That would mean at least 50% would be in the hands of investors by the time a Series A is done.  The entrepreneur would have taken all this risk for very little return in the end.  On the other hand, a VC is unlikely to want to do this deal.  He/she has no proof that market wants this product.  He/she is unlikely to give the company a valuation that would be palatable to the founders with no customers and no revenue.  If the entrepreneur does except a bad deal to keep the company alive, the personal incentive, again, will be too little.

What are the outcomes:

  • Some of these companies might get saved because the technology is just so awesome that someone will take a flyer on it.
  • A lot of these companies, awesome technology or not, will fall through the cracks. Certainly the ones with average technology won’t make it.
  • Angels, who are sure they backed a winner, will become disillusioned with this process and stop angel investing.
  • Entrepreneurs will take it as a lesson learned and hopefully go on to create something even more awesome, or be flushed out of the system.

So my premise is, it’s not a bubble, but there will still be a lot of Angels forced out of the game.  There are a lot of reasons.  But at least one of them will be their own fault. Underfunding.

If you are an entrepreneur view this as another cautionary tale and beware of who your seed investors are, what they are giving you, what they expect, and what you need to deliver to continue to be funded and successful.

Venture For America

A little less than a month ago I blogged about Code For America.  Part two of that piece is  Venture For America.  It is a program for young, talented grads to spend 2 years in the trenches of a start-up with the goal that these graduates will become socialized and mobilized as entrepreneurs moving forward.  Instead of coding, VFA fellows are tasked with joining a startup. They’re guaranteed a salary of $32,000 to $38,000 anually, and at the end of a summer training program (this year to be held at Brown), they’re matched with startups around the country. Locations vary, but although VFA is based in New York, both NYC and SF were intentionally left off the list in lieu of cities that may have a more difficult time luring talent: think Cincinnatti, Detroit, and New Orleans.

There are some early success stories from this program.  If you want hands on and you are not named Gates or Zuckerberg (meaning you have the innate talent to drop out of Harvard and go on to found a multi-billion market cap company), this could be the way to go.

The upcoming deadline is February 20, 2012, so get on it!