Category: venture

Be an Outlier

Here’s a question I get pretty often.  ”How can I become a VC?”

Let’s start with the premise that there are a lot of well educated, solidly experienced people in this profession.  If you are part of this crowd, your odds are better but probably still not good.  If you are not a part of this group… your odds are terrible, but still not zero.

The way I would recommend going about it is the following:

1) Be an expert in something relevant.  Be the person who knows everything about ‘de-duplication algorithms’ or be a go-to resource on eCommerce fashion sites.  You have to have a way to add value.  If you are doing the same thing as everyone else a) the decision comes down to a credentials contest b) you won’t even get a chance to show your stuff and c) why does a VC firm need you anyway.

2) Know the job.  Even if you have never done the job before, figure out what is required and gain those skills.  Get a job spec from someone hiring and figure out the skills you need.  Maybe that means doing valuations of private companies for free.  Maybe that means understanding portfolio management software (do a demo) or CRM.  Maybe its exit analysis or term sheet negotiation (take a class).  Maybe it’s consulting to startups.  Maybe it’s getting a tangential job so that you have these skills on your resume.  Entrepreneurs often make good VCs.  Corporate strategists also. Nobody is going train you and nobody is going to tell you what to do.

3) Know the ecosystem.  If the VC you want to work at invests in FinTech, you better know all the FinTech companies.  Be familiar with the up and coming startups and the companies that have exited.  You better have as much depth as any one that you might deal with in that industry.  In fact, it’s helpful if you know more than most.  That means not only know about the companies, but knowing people in the companies.  That means networking… lots of networking.

4) Know the community.  There is no VC in the world that will simply look at a handful of random resumes to find their next employee.  They simply don’t have to.  Instead they will hire someone they know and are comfortable with.  They will hire a friend of a friend.  They will hire someone that went to their Alma Mater.  The bottom line is that it not as easy as going on an interview, killing it and getting a job.  So the interview has to start months before you get the job.  Go to the VCs office hours.  Send her something helpful and unique.  Respond to their blog posts with something more than feint praise.  And again NETWORK!  Go to events.  Immerse yourself in the community.

If you are looking at this list thinking “that looks kind of hard,” you should probably forget about it.  If you are thinking, “it’s 11:03pm, now is a good time to get started,” you might have a shot.

Build yourself a map of skills.  Make a list of how you can acquire those skills.  Work backwards from the point of success.  But, above all, make sure that you are developing a unique skill that is of value.  That’s the only way in the back door.

Be an outlier!

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

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.

Speed Dating

Tonight I attended the NYC Venture Capital and Angel Showcase.  It is a much hyped event sponsored by Funding Post among others. I was one of the 37 angel and venture organizations that were there to hear short entrepreneur pitches.  Tonight in particular I was representing NY Angels.

My job was to spend a couple minutes with each entrepreneur to determine a reasonable business opportunity, a realistic view of the capital requirements and decide if there is a potential fit with The New York Angels.  If the answer to these 3 questions turned out to be ‘yes’ I needed to make sure that the entrepreneur was invited to put their information into Gust, (the portfolio management system many angel groups use) and given a proper screening by the broader angel group.

Here are my stats: in 80 minutes time I screened about 20 companies (about 4 mins. per).  Of those 20 companies, 4 were strong candidates, 2 were questionable and the remaining 14 were either not properly developed, not properly pitched, unrealistic or a bad fit.

One might expect that a 20% plus hit rate is pretty high, but in reality that is low.  The reason is that these entrepreneurs had to pay for the privilege of pitching investors.  That means they should have been bringing their ‘A’ game – or else they were wasting their money.  And if they had all been top-notch pitchers, chances are the hit rate would have been higher.

Here’s what I was looking for:

  • Concise description of the business – if the investor consistently interrupts you while describing the business you are not concise enough.
  • High level competitive differentiation.  In the world of ‘speed dating’, the answer should be “We are most differentiated by X”.  That’s it.  No more unless asked to elaborate.
  • How do you generate revenue?  This is not an answer that needs context.  Advertising. Subscriptions. Direct sales.  Then wait for a follow up.  Let the investor drive the conversation.  He/she knows what they have to find out to qualify an investment.
  • Back of the envelope math.  Be able to answer some financials like expected revenue this year, expected revenue next year and normalized gross margin and operating margin. The investor is just trying to get an idea of how profitable the company can be.
  • Most important: How much are you raising? Again, just answer the question.  The correct answer is, “we are raising $xxx,000 to build out our xyz.”  The incorrect answer is, “well that depends…” or “I’d like to know what you think”, or “I’m open to a conversation.” And it is absolutely not, “I’m not really raising right now.” As an entrepreneur, know what you want you to accomplish and the inputs required to do so.  Have a vision.

Of course there are many more potential question including:

  1. Tell me about the competition.
  2. How do you expect to exit?
  3. What’s the IP?
  4. etc.

But if an entrepreneur can’t perform strongly on the bigger questions above, the subsequent questions don’t matter.

What I find is the entrepreneur knows a ton about his business and wants to communicate everything.  This is not a situation where a brain-dump works in the entrepreneurs favor. Stay short and sweet and leave them wanting more.

Moral of the story… if you choose to speed date, be prepared to do it well enough to get asked for your digits!

What the heck do you really know about building a company?

Finally got a chance to get back to my reader list today.  It’s been over a week, so I had kind of a build up.  That really is the great thing about readers and blogs, they wait for you instead of being swallowed up by the news cycle.

The first thing I did was crank up my Findings.  If you don’t use it you should.  Go here and install it: https://findings.com/ Undoubtedly you will want to collect things you read  fast and easily.  Yes, you can book mark, but this is the best way I know of to get right to what you want.  I go back and re-read my findings pretty frequently. They become kind of like entrepreneur mantras.

For whatever reason, alphabetical or of most interest Fred Wilson’s blog (A VC) is at the top of my list.  About the second or third item was a guest post from someone I’m sure I’m supposed to know who goes by JLM.  It was an awesome, short, sweet description of how to draw up a business model and execute a plan to build it.  Hence the blog title.  This is mandatory reading.  Go here: http://bit.ly/ywhcPC and read it.

I guess I could have tweeted about this.  I saw Mark Suster do that.  It just seemed to me that it was worth ending up in someone’s reader and hopefully marked with someone’s finder.

One more thing… please answer this quipol question.  Thank you.

p.s. Best of luck to Giants over Pats.

Interesting News

If you looked at this blog before and checked out the About section, you would have seen that I am sole proprietor of a small consultancy that focuses on small technology startups. I have a background in the public markets as an analyst, strategist and a deal maker. Recently I’ve become more engaged in the angel investment community and gotten to know some of the folks doing seed and early stage investing.

Well, an opportunity has arisen for me to put all of these skills and interests to work while actually collecting a salary.

I’m very happy to announce that I have joined RTP Ventures here in New York. I’ll be responsible for deal sourcing, valuation analysis, term sheets, etc. etc. RTP Ventures primarily focuses their investments on datacenter software technology and secondarily on Internet technology.

RTPs investments include early stage companies through revenue generating ones (Series A thru Series C) and do not necessarily have a vertical focus.

Of course I very excited to be an integral part of the New York venture community and hope that my experience will inform this blog as it goes on.

You can reach me at berg@rtp.vc, but please don’t send me any business plans. Start with an introductory email if you think there is a fit. Else continue to reach me here at Brooklyn Startup.

That’s it! And of course I’ll update the About section….

VC Blog’s I Read

I was talking to my blog co-founder the other day about what we should put in the blog roll.  I told him that I would send him a list.  Then as I thought about it more it seems like kind of a waste of space and way too long for a scroll on the side of the blog.  I also figured that almost everyone looks at the same blog sources on venture capital so there wouldn’t be a whole lot of revelations to those reading this.

What I decided to do is write a post that lists what I read.  You can bookmark it or add it to your reader or whatever.

Additionally, I’m always looking for new sources of interesting thoughts, gossip and information. So I hope that my sharing this with you will lead to 1) the first comment down below 2) you will share some of yours with me.  Hope this is useful.

Tell me what I’m missing. Thank you.

btw – It has been nice for NYers to have a team in the Conference Championship game for each of the last 4 years.  Even nicer to actually win one.  Go Giants!