A Venture-Backed Start-Up Founder

Wasting time at a start-up

One of the most incredible things I have discovered about every company I have ever had any inside knowledge of is how much time is wasted.  Big companies are MASSIVELY inefficient, and waste an incredible amount of time.  This leads to the potential for small, efficient companies to do a lot with much less resources.  The problem is, people waste a TON of time starting a company, too.

Here is a non-comprehensive list of 10 things, in no particular order, that I have done when starting a company that ended up being a complete or very nearly complete waste of time. 

If you are considering doing any of these things, think very carefully if this is the most important thing you could be doing right now and if it is if YOU are the person that has to be doing it. 

1. Spent many hours of time deciding on the name of the company.   I've determined after doing this several times that the name of a company is completely and utterly irrelevant unless it is just RIDICULOUSLY offensive or hard to spell/use.
2. Wrote a complete business plan.  This just got outdated within a few weeks and there is never an ongoing motivation to maintain it as a living document because it produces no ongoing value for the company.
3. Attended numerous industry conferences.  Until your company is at a point where you are selling product and forming partnerships, going to industry conferences is a nice feel-good thing to do and often quite enjoyable but ultimately is a waste of time and a distraction. 
4. Obssessed over the market. A certain level of understanding of who the players are is very important, and keeping up with what the competition is doing is critical.  But, there are HUNDREDS of companies in all sorts of tangential spaces to you and you could spend all your time just understanding what everyone else is doing and leave not enough time to be doing it yourself.
5. Wrote a full manual for a v1.0 product.  The early early adopter users don't need complete documentation and with the product evolving so quickly it has been a complete rewrite very quickly anyways.
6. Worked with marketing consultants on strategic positioning.  You probably won't do this pre-funding but are likely to get sucked into it once you do get funded.  It always seems like a good idea, but almost always a complete waste of time.  The only people that will figure out where your company is headed is people in your company.
7. Kept the company financials updated. It is amazing how much time you can spend, even as a small company, just paying bills and using QuickBooks and printing out your weekly and monthly balance sheets and financial statements.  Obviously you need to pay your bills and know how much money you have, but either outsource this to an accountant or do it yourself spending the BARE MINIMUM amount of time possible to ensure you aren't broke or bouncing checks. 
8. Posted job listings to Hotjobs/Monster.  You will get THOUSANDS of responses when you post a job listing, it will be a massive sink time doing the first and second level filtering of the resumes before you even get to a phone screen of someone, and ultimately you discover that "A" players do NOT get jobs off of job sites.  You can find some good B players there, the typical disgruntled employee or unfortunate guy who just got laid off.  If they were an A player, they would have A player friends all over town who are DYING to hire them, and wouldn't be hunting for a job on job sites.  I could do a whole other post on how to hire people into start-ups, so that all I will say about this for now - DON'T USE JOB SITES.
9. Opened an office.  This is a tough one to list, because having everyone at your company in an office is an amazingly productive thing to do.  BUT, I have wasted a TON of time finding office space, getting all the necessary furnishings and services running on it, and then maintaining it.  As a small company there are various alternatives you can consider that may provide space and services for you, like incubators and executive office spaces, but they are generally more expensive than doing it yourself, and since you are very cash constrained, once you hit more people than you can manage in your garage you may need to get your own office.  Don't confuse opening an office with actually doing something productive with your business.
10. Raised VC.  This is counter-intuitive.  You need to spend some time to successfully raise VC, but you actually will end up doing a better job raising VC if you spend your time concentrating on your business and not on actually raising the money.  Every hour you spend thinking about, planning, and raising money is one less hour you are moving the real business forward, and one less thing you have to extol to the VC when you end up in front of them about how great your company is. 

Things on this list end up wasting time because they fall into one of two categories.  Some are FUN, and you get caught up in the fact that you like doing it and it feels good and don't realize you are not really being productive.  Others are NECESSARY, and so you spend time doing it rationalizing that you HAVE to do it, even though you could do it half as well in 10% of the time and it would be sufficient.

Good Comments

I know I usually don't read comments on blogs I read, but there have been some comments on here that are probably even better than my original posts, so if you aren't a comment reader, either, take a quick peek at these 2:

http://venturefounder.typepad.com/a_venturebacked_startup_f/2005/12/illegally_start.html#comments

http://venturefounder.typepad.com/a_venturebacked_startup_f/2005/12/extracting_cash.html#comments

Picking a Market

One of the biggest factors in how successful you will be raising early-stage money from a VC is what market your company addresses. VCs want a BIG market, but also an UNTAPPED market - a billion dollar opportunity that NOBODY else is aware exists. Of course, no such markets exist. The trick to a VC picking a market is finding a market that is small enough right now that there aren't a lot of people in it, but that is about to explode in growth so that their company will generate tens and tens of millions of dollars in revenue within a few years. The problem is that as soon as market starts to pick up steam, it becomes a HOT VC investment area, at which point there are 500 companies all seeking VC funding with almost identical business plans, and you have a hard time getting differentiated from all that noise.

When you are starting a company, figure out what part of the market curve you are in. Are you starting a company in a NON-EXISTENT market that you believe is about to explode, are you the 3rd, 4th, 10th company to raise VC in a market that is already on the up-tick, or are you trying to be something different in an already over-invested market. Depending on where you are will help to refine your strategy for talking about the market. I have been raising money in all three of those categories. It is funny that you can never really win an argument with the VC on the market. You will immediately go from the VCs telling you that this is not a BIG market opportunity, to them telling you this space is over-invested in and too noisy.

The ideal situation for you to be in for raising VC is to have been in 'stealth' mode for a while (if you've been out consulting for a while that is a perfect opportunity to have been 'secretly developing your technology') building your product so that by the time you talk to them you are FAR ahead technology-wise of 1 or 2 competitors who are also early-stage, recently funded companies with a little but not much market traction (from big name VCs that make the VC you are talking to stand up and take notice).  Although you are unlikely to ACTUALLY be in this ideal scenario, I would aim in my presentation to present yourself in that mindset.

When top-tier VC invest in a deal all the other top-tier and mid-tier VC get shut out of the deal and if you can present them an option that looks in some ways BETTER (so like better technology but maybe you don't have the same executive management or relationships as that other company) you may make them very happy. On the flip side, if you are in a market where the VC has already PASSED on 10 of your nearest competitiors, you are going to have a hard time.

Extracting Cash From Investors

I am a firm believer that founders should attempt to extract as much cash as possible out of your venture-funded company.  I wouldn't recommend you saying this as one of your goals to potential investors, but there is an implicit understanding that part of what you get in return for taking an investment is a well paid job with a reasonable salary.

When you own the whole company, it really doesn't matter if the value in the company is in it or out of it, but once a venture investment is incoming, the reality of the situation is it is very unlikely that a founder will make a 'little' bit of money out of the company.  If the company has an exit that exceeds liquidation preferences and investments, you will make a whole lot of money, and if the company fails or has a downside acquisition, you will make very little if anything. 

There are a couple of ways you can extract cash from investors.  What I have found the primary barrier to getting money is NOT the VC themselves, but the relationships with other founders, angels,  and members of the management team.  Once you bring other people into the company that are involved in the fundraising process, you have made an implicit agreement with them by giving them stock or options or whatever it may be, and it may put you in a difficult position to try and usurp part of an investment for yourself.  Once you take a small friends & family or angel investment, you've committed yourself to start having a fiduciary responsibility to the company and so you can't INVENT things that go to your personal benefit anymore.  So do it BEFORE you take those initial investments (and just structure them all so the angels don't have to pay any of it).

First, I often read and have theorized about FOUNDER'S SALES, where an investor actually BUYS stock from a founder as part of an investment.  It is generally accepted that VCs HATE to do this, and it is nearly impossible to achieve except as part of LATER stage deals.  I haven't given up hope of some day accomplishing a founder's sale, but it may be a long shot.  If anyone can give me any insight for how a founder can actually make this happen in Series A/B fundings, TELL ME PLEASE!

Let's talk about more realistic options for you to deal with...

DEFERRED SALARIES...  Most investors ALSO don't like to see deferred salaries on your books for the founders.  I also have never been paid a deferred salary from a financing.  I would put a deferred salary for yourself on the books before you hire the first other person in the company.  Make it a low and definitely under-market salary (like 40k or something) so you making an obvious concession even though you do have it. It is very easy to knock this out in a financing when an investor objects to paying it (and they very likely will), but it is a negotiating point to start with on your side, and it is impossible that you will get any deferred salaries paid if you don't have it in your financials from day 1.

LOANS... As a founder, you NEVER want to structure any money you put into the company as an equity investment.  All you are doing is buying stock from yourself.  Instead, structure it as a LOAN that is due to be repaid, WITH interest, at a fixed date in the future or upon a financing of at least $X.  Write yourself a 1-page Note (you can find templates on Internet).  For some reason, the same investor who will raise holy hell at paying you 50k in deferred salary will have no problem at all at paying back a 40k loan and 10k of interest.  The key to getting a loan repaid as part of financing is for it to be of a trivial value.  An investor WILL raise hell if it is a lot of money relative to what is being raised, but if it is a small amount and that's what the papers dictate, they will probably be fine with it.

EXPENSES... Keep careful records of every expense from the founding of your company that can CONCEIVABLY be considered a company expense.  This DEFINITELY includes things like home office expenses when you are working out of your house, your cell phone bills, your self-insured  health insurance bills ($$$), travel, meals, all the things your accountant wants you to deduct off your taxes.  Since you will probably rack a lot of these up, these should all go into your financials as unpaid expenses.   My experience is that investors are usually fine (again to extent they are nominal total amounts) with paying back your unpaid expenses IF they are on all the financials they received during the due diligence.  Paying back lots of expenses is great because this is tax-free money.

CONSULTING... You probably have some friends that will help you out in various ways starting a company, and probably won't expect anything in return or maybe you did a stock deal with them.  It is very easy to structure compensation that in whole or part triggers a payment upon a financing round closing of a certain dollar amount.  While this won't personally benefit you, it is another way to extract a few thousand here or there from investors, and unlike the expenses where a VC could easily just tell you to nix it as part of the deal, they will feel more obligated to pay these off (and again if its SMALL they won't care).  Imagine the christmas gift you'll get from the friends that helped you out that year!

The biggest part of being compensated is of course your salary.  Exactly how much you will be paid varies a LOT.  Generally what I have found is that VCs hate to give you a number for your salary, they would rather force you to present a number as part of the overall budget and then react.  This is nothing more than a negotiating ploy on their part.  I have underpaid myself in the past just based on trying to have a conservative budget and be fiscally responsible and I consider it a mistake.  Founders are generally THE single most critical person to an entire company, and you should be well compensated not just for that fact but your salary is part of the deal that is also resulting from you giving up a huge amount of equity, control, and very often some type of vesting of your own stock.   A good salary would be something comparable to what you could make if you were hired for the same position you'll occupy at another more established start-up where you got some good stock options but didn't own the company.   Include a bonus in your compensation.

Like any negotiation, I recommend with your salary that you START HIGH and let an investor bring you back to earth.  Amongst founders I have discussed it with, a typical post-Series A salary range seems to be from 100k for underpaid founders to 200k for very well compensated ones.

Sole Founder

The first company I started I had several co-founders.  After that experience, I decided to strike it out on my own as the sole founder of my next start-up.  Here is why...

There is one core reason to start a company by yourself: CONTROL.  Having control means a lot of things at the early stages of a company.  The most obvious part is there is no pie of equity to split up, its all MINE MINE ALL MINE.  However, that is a pretty dumb reason to start a company by yourself.  Moreso control is about having a company that grows, operates, and runs the way you want it to.  It means not having to compromise.  It takes a certain kind of personality to start a company on your own, where the idea of being self-motivated and a 'self-starter' are taken to the extremes.

I discovered early on starting a company with other people that nobody was perfect and nobody was the same.  I had an idealistic picture of everyone working together in perfect harmony towards our common goals of building this company, but the fact was that everyone had their own lives and building our company was just one part of that life for each of us, and to varying degrees.  The greatest friction amongst the founders came from the different degrees, at different points in time, that each was willing to dedicate towards the company, and the different expectations that each had in what their roles and responsibilities would be as the company evolved.  The concept early on was that everything would be equal, but in the end nothing was remotely equal.

I have had an absolutely fantastic time being the SOLE founder of a company.  It would have been great if I had other people from day 1 I could have shared some of the experiences with, but I have been able to hire great people along the way who have picked up that slack.

I think starting a company with others can be a great idea and a great experience.  If I started another company, I would strongly consider having one or two co-founders with me, and here is what would be my keys in joining forces with them:

1. A Player - Since I'm a venture-founder, I would only start a company with someone who would be, at face value and upon further examination, highly attractive to investors.  This means everything from good references to good education to good resume to good networks.
2. Complementary NOT Clone - I wouldn't start a company with myself as a co-founder.  I already bring all those skills and experience to the table.  I would look for someone who has different skills and experience that they can bring to the table, so that working together we make a more complete team.  I wouldn't work with someone who would want remotely the same title as I would later on.
3. Prior Work Relationships - I would only start a company with someone I have worked closely with in the past.  This is the ONLY way to know that you would actually work well with this person.  I wouldn't rule out friends, but I wouldn't use a start-up as the opportunity to work with a friend for the first time.
4. A Clear Boss - I would insist that there was clearly a boss in the founding team.  It might end up being me, or it might end up being someone else, but someone will be in charge, and everyone will understand that fact.

If I didn't find people that met all those criteria, I would probably not worry too much about it and just go out on my own.  The fact is the further along your company gets, the BETTER the opportunity you have to attract great people to join you, maybe even people you could not have attracted based purely on your own resume, personality, and idea.

Illegally Starting a Company

I have probably broken numerous laws everytime I started a company.  For sure, I didn't follow the advice any lawyer would give you about how a company should be started.  I had another entrepreneur call me recently who was starting a company and wanted to know what he should do about incorporating.  Here is my advice...

There are 3 major legal issues you deal with between the time you start a company and close a round of VC if you are going to raise outside investments (angels, vc, etc) BEFORE you are a revenue-generating company... 

1. Incorporating
2. Agreements with people that work for/with you.
3. The investment papers

Lawyers are a complete and utter waste of money when you are first starting a company.  Your resources are extremely constrained and all the money that goes down the lawyer pit brings no value.  The general rule of thumb I follow is do not hire a lawyer until there is an external force that requires you do so.   You don't need a lawyer just because you are going to put up a website or start developing a product.   I'm sure lawyers strongly disagree with me here.

I have in the past done all of the following when starting a company in the incorporation realm...

• Signed a limited partnership agreement with co-founders spelling out exactly who was putting in and getting out what.  My first lawyer had a near heart attack when he saw I had done this, but it worked out exactly as I desired, making sure all founders were on exactly the same page.
• Had a general lawyer who was a friend of family and had no experience in high-tech or venture fields incorporate as a S-corp as a favor.  My high-priced lawyers later laughed at how this was done.
• Used an online incorporation service to form a corporation for a few hundred dollars.
• Used a major law firm with a large portfolio of venture-backed high-tech companies as clients to incorporate and setup the legal entity for a $7500 retainer and using a good bit of that money.
• Used a major law firm to 'fix' my embarassing online incorporation and create a proper legal entity for a few thousand dollars.

The one thing you find out very quickly is that no matter how badly you embarass yourselves with your new high-priced lawyers once you actually have a growing business showing them what you did in the past, for a couple thousand dollars they can fix it all and make you as good as new.

The key to making agreements for stock or equity is to make sure you have contemplated all of the 'exception' cases.  For example, it is not uncommon to have a founder join a company early on and then drop out of the company before you get very far.  You need to make sure that it is very clear exactly who owns what in those situations.  I could make an entire new post on how multiple founders should allocate stockbut the key points I highlight here are make sure to at a minimum spell out exact amounts of stock and vesting schedules.   If you have founders putting in small amounts of money for additional stock, document exactly what they should get for that money, though if you expect to raise capital it will be better to just make most of your expenses debts that the company owes to you so that the company pays you back later on for it.  From a legal perspective the important part is DON'T waste thousands of dollars getting a lawyer to make sure all the founders agree on how stock is being given out, just make sure you have in writing what you are all agreeing to, and a lawyer can come along later and make agreements that legally reflect that pretty easily.

You will come to a point where you will actually need a lawyer.  If you are raising a small amount of money, like taking some angel money, well then your angel can probably direct you on what you should do from there, but most likely you will need to square away all your finances and spend a few thousand on getting a good convertible note written for that investment.  If you are getting close to raising real VC money, then you need to RUN to the best lawyer in town. 

I have received a term sheet for my company from a VC without having a lawyer, and it created a real problem, because I realized looking at all the terms I didn't want to sign anything without a lawyer providing me a review of it, but I didn't have a lawyer to review it, and the VC wanted an answer pretty quickly.  I learned my lesson from that to have a lawyer setup BEFORE you get that far.

I wouldn't call anything I have done in the past perfect - far from it.   When I start my next company, here is what I am going to do...

Since I have an established relationship with a lawyer that I have generated 6 figure billings for, I have the first part of my plan done, which is to start a relationship with your future lawyer BEFORE you give them any retainer or work.   You want to go meet with one of the high-tech lawyers involved in VC and M&A activity at the best law firm in your town. 

A good lawyer can do a lot of things for you for free as an early startup: help you recruit early employees, introduce you to investors, and generate sales leads.  So don't be a stranger to them.   They WILL also heavily push and prod you to do a few simple and cheap (cheap to a lawyer being a few thouasnd dollars) things to establish your legal entity.  This is where you simply hem, haw, and stall them and just flat out say no when you need to. 

Before you do ANY work with a lawyer as a start-up, have very frank conversations with them about your cash situation and get estimates from them on any work that you want them to do. before they do it.  Ask for updated estimates frequently, and do not be afraid to REFUSE to allow a lawyer to do something they want that you really don't need yet.  In large part, lawyers are not interested in you that early on, all they want is to have you standing by so that when you have real legal activity like closing on a VC round they are the ones that rack up that huge bill with you, so use that carrot as your incentive to get all the free help possible when you don't have the money.  Lawyers I have worked with won't do real legal work for free, but will give you lots of advice and help for free, so take advantage of it.  YMMV.

I will avoid creating any kind of legal entity and operate entirely as an individual from a legal perspective until I am going to start revenue generation or take in outside investment capital.  Once that happens, I will call up my lawyer and give them the GREEN light (and have my retainer check for a few thousand sent over to them) and they will whip up my premade company in a box from their legal software in no time flat.

Pitch Meeting Observations

Josh asked about the subtle side of the VC pitch meeting.  So here is part 1 in my list of things I have picked up in doing many many VC pitches that I didn't know in my first...

Looking for reasons to say NO: VC folks are listening to your presentation for a reason to say no.  Almost all the time, a VC will not invest in a company, and most of the time they won't do anything past that first pitch meeting with a company.  All you need to give them is one good reason to say NO.

TRAP Questions: Lots of VC will ask you questions in a very leading way to try and elicit an agreement from you, when in fact if you agree with them they will end up rejecting you.  Part of this is based on them wanting to know if you really believe what you are presenting to them or if you are going to say anything to get them to invest in your company.  Sometimes they will even argue with you on these points.   They also want to try and determine very quickly if you are someone they would actually want to be sitting in a boardroom with.  I have found that what VCs want is intelligent, collegial conversation, not being argumentative and not simply going along with what they think as gospel.  With this in mind, don't think disagreeing with them is going to disqualify you.

Derailing the Presentation: Some VC like to derail presentations very quickly and turn the meeting into a long conversation, while others pepper relevant questions throughout the meeting but basically let you run things.  I usually feel good about meetings when it has turned conversational, but unless you can make most of the points in your presentation throughout that conversation, you may have had an interesting hour but are unlikely to have convinced them that you have a business they want to invest it.  Keep it on track and when appropriate segue back into your presentation or just keep mental notes of covering the necessary points.

Lack of Criticism != Expression of Interest: Some investors are genuinely nice people.  These are the minority.  I had some nice guy meetings in some of my first pitches, and I thought when I walked out of the meeting that it had just gone great - he had nothing but nice things to say about us!  Well, the fact is that the nice guy investors don't say YES to any more % of companies than the rude guys.  One of the things I have learned in making lots of pitches is that the lack of criticism is not an expression of interest.

Know the Portfolio: VC are apt to know a small set of companies very well - companies they have invested in, worked at, or come very very close to investing in.  You should study the portfolio page of anyone you are going to pitch at and know everything public about any company remotely adjacent to what you do, since that is the mindset from which the VC will be viewing your opportunity.  You may always get tripped up here by some stealth mode or unannounced investment - I always ask early on in the pitch if there are other companies in our space they are invested in to find this out and nobody has been offended by that question yet.  A key here is to not get too defensive about how you compare to those other companies, usually questioning there is pretty innocent.  On the other hand, if you ARE potentially competitive to another portfolio company, watch out and expect whatever you say and especially hand over to them to end up at the other company.  Probably 90% of VCs would never even consider handing over confidential information to their own portfolio, but I have personally received competitive pitches and full business plans from friendly investors, so it definitely happens.  If you are going to pitch to someone who is invested in someone who is potentially competitive (if it is direct competition, I'd just drop it, but there is a big gray area) I would be very careful in giving out any materials in the first meeting.   Asking for a NDA is a sign of an amateur entrepreneur, and probably will just get rejected, and even if it is signed as a small company you have no way to enforce it, so forget it.

Valuation = 1.5 x Amount Raised

MD asked a question about valuations.  There are two kinds of valuations you need to be concerned with when raising money - how much you actually think the company is worth (now or at some exit in the future) and how much the pre or post money valuation will be for the round.   In some perfect theoretical world, those two numbers might be similar, but usually they are not remotely related.

I have been asked many times in a first VC meeting about valuation expectations for the round.  In my experience, the correct answer to this question is a vague remark that you do not have any hard number in mind, you understand the stage of company you are in, and that you are just looking for something that is reasonable given the stage you are at and market as a whole.  I have never, ever, ever named a number.  If you get more questions on values or exits, I would just pivot the conversation over to talking about comps - other companies that have recently had exits, what their multiples on revenue was and how that compares elsewhere in the market, and then you can go back to your revenue forecasts.

If a VC perceives that you are hung up over the valuation of the company, they are not going to see you as someone they want to deal with.  They want to invest with reasonable people.

VCs will do their own math eight different ways and see what all those numbers add up to for yoru valuation, and then ultimately they will take however much you are raising, and they will want to take somewhere between 25%-50% of your company for that.  When you get into later rounds, this math changes, but in early stages, the valuation of your company is MOST dependent not on your product, your revenue forecasts, or the market, but on how much money you are raising.   Take the exact same company and raise $1M for it and you are going to have a $1.5M pre-money valuation, and go raise $5M and you will have a $7.5M valuation.

Since the valuation is basically completely out of your control as an early stage company founder, just forget about it.  The truth is, it really doesn't matter a whole lot to you.  As a founder, you own a HUGE part of the company, and if the company is even modestly successful, you will make a boatload of money, and if the company fails or just barely eeks an exit out, you aren't going to get much out of it.   The only time the valuation will really matter for you is when you end up in that purgatory of exiting for something but not a ton more than what you've raised in capital, and in that case things like preferences are a whole lot more important than the valuation, so THAT is what you should really be caring about.

To get into a discussion with a VC in early meetings about the valuation is a big mistake.  The negotiation over the valuation really doesn't begin until you get a term sheet.  It is pointless to argue about it anyways before that, because they'll just screw you on the terms like preferences before you've seen them (but funny I've never had a VC ask me what preferences I was anticipating in my first VC meeting).  The only way to really make a massive change in a valuation is to have multiple term sheets to play off each other.  If you don't have that, then you are going to have a relatively modest range to negotiate, but by the time you've gotten a term sheet, you have a firm that is REALLY interested in your company, and to the extend you are being reasonable and level-headed, they are going to show you a little wiggle room just to kick off the relationship on a real positive foot. 

Most first-time founders would have already sold their company for the amount of the pre-money valuation investors will offer them, if they could have done so.  This leads to a real, but unspoken, conflict between founders and investors, as the investors absolutely have no interest in selling a company for no profit.  As the company grows, new employees and new management gets stock options, which on top of the preferences of the investors and the small amount of stock they have makes a small exit very unappealing to them as well.  Eventually, the will of the founder in this regard is squashed.  Since nobody wants a founder who has such a small goal that is obviously in conflict with everyone else involved in the company, you should do everything possible to conceal the fact that this was ever true.  Harping on the valuation is one way that VCs sniff out founders who are thinking small. 

My final thought... don't fool yourself to think that the valuation a VC firm gives you has any bearing on how much your actual company is worth. 

I'm not planning on commenting on all the different ways you can value a company or how a VC might do the math or explaining what a valuation is.  If you are interested in that, some links: http://www.ventureblog.com/articles/indiv/2003/000200.html
http://www.tdbellenterprises.com/blog/2005/09/08/valuation-executives-versus-venture-capitalist-2/trackback/
http://www.infobaseventures.com/valuation-model.html

If you like my posts, please leave comments in here or even better link from your blog so I can get some readers :).

VC Question: Consulting Revenue Value?

This is the first of many of the questions I'd like to have some real VC answer, either in comments here or on their own blogs (add a comment with link if you do)...

Does consulting revenue in an early stage product companby have positive or negative value?  And I'm not talking about services bundled around the area or product you are building or selling, just plain old contracting work. 

I had a discussion about this before with another company founder - my contention is that VC are not fooled in the least to think that you being able to generate revenue by consulting has any bearing on being able to sell a product, and in fact just the opposite is the case - that by demonstrating that you are spending substantial amounts of time outside of building the product and company, you are in fact showing a lack of committment to your company and that essentially you are working part-time on what they are funding.  That goes against the VC wisdom that they want you have lots of 'skin in the game'. 

To summarize the opposing viewpoint, its that by showing consulting revenue you can more easily bootstrap the company and show to the VC that you don't NEED their money, thus making them fall over themselves to give you money.   Building a 'customer base' from consulting shows you have some target prospects for the product, as well.  Feel free to expand on this if you take this viewpoint...

I have personally done some consulting work when starting a company but I did it almost exclusively off the company books as far as the VC was concerned (whether you want to use your company shell to deal with billing, liability, and tax issues is a completely different question and for that purpose it may be useful to use your company) and they only saw bits of that revenue deep in due diligence when they were looking through historical financials.

Blowing your fundraising with bad references

One of the often overlooked but critically important aspects of raising a venture round is to make sure that you have GREAT references.  Customer references are of course very important, too, but this post is about personal references.  This is a good topic to ponder because the way that VC firms will check your references should be the same way YOU are checking references with everyone you work with, or you may be in for an unpleasent suprise.

A single bad reference for a key member of the founding team IS going to be a dealbreaker.

VC firms do LOTS of reference checking and unlike most company fact-checking references, they aren't going to be happy with an HR department reference or by peers.  If you look at your resume objectively, it should be immediately obvious who they want to see the references from.  It is usually going to be a CEO, board members, or a VP at a larger company that you worked for at your last 1 or 2 positions (or whatever the big successful company you were at that gave you the crazy idea you could start a company yourself).

Here are my top tips for how to not blow your VC deal over personal references:

1. Check Your Own References

Do not give a reference that you don't know is going to be a good one.  Having a frank conversation when you are warming the reference up to know that the VC may be calling them is a good honest approach to this to try and root out what might be.  Find a real, but friendly investor, like an angel who may already have invested or that you know well enough to ask this as a favor, to call the references up and do a reference check on you. 

2. Be Honest Before the Reference Checking

Make sure there are no misconceptions the VC could possibly have about what your prior positions, responsiblities, or results have been that may be contradicted during the due diligence. 

3. Expect Back-Door References

VCs always want to find the people that you DON"T give as references to talk to, to find out the real story on you.  If you have any skeletons in your closet, be honest with yourself about who they are, what they might say, and come up with a strategy to try and mend those bridges or have a strategy so that when the investors knock on that persons door it will not be a dealbreaker. 

4. Know Your Key People

Even if you personally think bringing someone onto a team would be great, look at it from an investor viewpoint.  If they are bringing baggage along with them of a bad break-up in the past, expect VC are going to find out about it and it will affect you.  One way to deal with this if the person is a founder is to minimize their role in the organization so that the investors won't know to care about them (eg take them out of the management team), but the key here is that you need to consider not just someone's resume but how they manage their relationships with former employers. 

4.1 Don't Hire People Who Have Been Fired

There is a certain characteristic of employees who get terminated in the workplace.  And I'm not talking about getting laid off because of downsizing or reorgs or m&a, but real either personality or performance driven good old fashioned firings.  Often because you have a personal relationship with someone you just overlook it and honestly take their side - their boss was an idiot, etc., but you won't get that same level of trust from investors.  The corollary to this is that anyone who can't see that handwriting on the wall and get out in a softer exit from a company may not be ready for a management role.  Of course there are exceptions here and great people get fired all the time, but you are probably trying to rationalize that YOUR guy is one of those 1% and be realistic and realize there is an issue here.

5. Cultivate Your References

If you are working in a company now, your boss, whether it be a CEO, a VC firm on your board, or whoever, is critical to the future of your next start-up.  Keep that in mind and it may change your decision-making process when it comes to making tough choices.  Building long-term sustained relationships after the employment ends is an important consideration.

You get the idea.  THINK about references, it is one of those things it can take years to build up a solid set of and not long to ruin.

Waiting for term sheets

The hardest part of a founder's life is after you have set out to raise funding for a round, and before you get the first term sheet.  There must be fifty ways to pass on a VC deal and I've seen most of them.

A miniority of VC are clear and communicative.  If they decide to pass, you get a quick, short note with the details.  These guys are the best and make me want their money more.

You got the ignore, doesn't return calls, no action being taken, at which point your venture deal doctor officially declares it dead. 

The opposite is even more heart breaking, the lets do a TON of due diliegence, talk to everyone in the company, customers, prospects, etc., and lets get in a big room and talk strategy, and at the end of it, nothing comes. 

There are a few easy ones I like to get.  We are invested in a competitive company (I never would have walked in door if that co was actually competitive you ass), market size isn't big enough (and we only invest in multi-billion markets that our companies can be 1 or 2 in explaining why every co in our portfolio has 5-yr revenue targets well over $100M and maybe 1 porftolio company performing at that level). 

The best one I have heard recently though, was, the suggestion that the technical details in our presentation were far too detailed and we needed to step back and give a pitch as if I was talking to someone who knows nothing about our market at all - him.

Being this is an advice blog, here is the advice.  If you are throwing a 98mph curveball in the strike zone every pitch, and for the next hitter that comes up, your catcher stands up after he catches it, comes up to the mound, and politely asks you to slow it down and put the 40mph change-up down the center for him, you have a decision to make: slow, fast, or right to the head.

Though I have never intentionally hit someone in a vc meeting, it happens more often than you'd think in my mind. 

Company failing? Raise Money!

I know a lot of founders set out from day 1 to raise VC.  I have been one of them.  I also know that a lot of founders set out from day 1 to NOT raise VC.  I have also been one of them.  The allure of not raising VC for me was pretty simple - if I could build a business worth a fraction of the value and at an exit end up with the same return, and it seemed to me like building a business worth say $20M that I might would get the majority of the proceeds from was an order of magnitude easier than building one worth $100M that I might end up with 20% of. 

My business was a failure.  Product development took longer than I anticipated and those early sales that would fund the company didn't materialize as quickly as I would have liked, and eventually the early employees wanted to be paid real money (not to mention I wouldn't have minded to halt my personal hemmoraging of cash as well). 

I was honest with myself when that point came.  I had given it my best shot, worked hard, and come up short.  It was time to move on and get a real job.  And that was the moment that I started crafting the investor pitch that led to closing a venture investment in the company.

The value-added investor lie

Scott Maxwell has a nice post on how companies should go about selecting their VC firm.  He makes some excellent points on what to do when you have luxury of selecting the VC firm that is right for you.  To read and listen to the VC firms, the money you get from them is secondary to the VALUE-ADD they provide.  The reality is, most founders just want their money.

I am not a founder who can pick the phone up to the Top Tier firms and have them bang down my door with their term sheets.  If you are one of those people, or you are a founder and can attach your star to one of them, count your lucky stars.  Every round of money I have raised I have been focused on raising the money so I could build my business.  The decision was not about who could provide the most value-add, it was who was willing to write the check first.  I have ended up stumbling into situations where multiple options became available, but even then it became about the amounts and terms attached to the money that ultimately drove the decision-making process.  The fact is, I've gotten really lucky finding investors in some cases who really did add a bunch of value after the fact, and ended up with pure money and no value from other investors, but not once has that been how they were chosen.

I have a bunch of friends who are founders of other companies, and it seems like this is the norm, not the exception. 

So pay attention to what Scott said, because that is exactly what you need to do to convince a VC that you are interested in the value-add they can provide.  You need to carefully cultivate the perception that you are a hot commodity and that you can afford to take your time and be choosy, because that is the story that investors want to hear.  I didn't ask for this to be the game, I'm just learning this is how it is played.

So don't think there is something wrong with you if the reality of your existence is you just want their money and it is very important to you that you get their money.  Ultimately, investors are smart folks and they know that is true even when it is best left unsaid.

Biography

A little more background on who I am...

I have started 2-3 companies, I am one of the techie guys.  Over the course of my start-up career, I've raised in the neighborhood of $20M in capital, spread over at least 6 rounds of funding which have ranged from small friends & family money to VC funding rounds in the many millions.  I have been basically in non-stop fundraising mode for my various companies for the last 6 or 7 years (that is a slight exaggeration), with some brief respites to try and build the businesses.  In doing so, I have been the primary man pitching the story to many, many investors.

For you early adopters out there, I am enlisting you to help the blog out.  ASK me a question in comments that you want a honest response to.

Do we need another venture blog?

I am an avid blog reader and have been kicking around the idea of starting this particular blog for a while.  I am in particular a big fan of the various Venture Capital Bloggers out there, and have learned a lot from them.  You see, I sit on the opposite side of the fence.  I am an entrepreneur, a founder, a co-founder, and a bunch of other titles of, over the last couple years, starting pre-bubble and continuing to today. 

I see a lot of the venture capital issues, in general and the hot topics of the day, being addressed from the VC side of the fence, but there seems to be a lack of folks sitting on my side of the table that shares their side of the experience, and also have a forum to openly report on their own experiences.  Certainly there are other people doing this, but when founders blog it tends not to be about the venture-raising and interacting parts of their business, it is the technology, the business, the product, etc.. Which makes perfect sense, in fact it is bad form as a founder to be admitting that one of the real things you spend time on and think about is the VC-side of your business, but if you guys are anything like me, the FUNDING and the VC is something that is a big part of your life.

The problem I think founders like me have in blogging is that the things going on today in your business with respect to funding is as confidential as it gets, and so its difficult to talk about in a public forum.  Asking questions and sharing your real experience is not always pretty and not always possible except in in retrospect, and by the time you can write the book on your VC experiences, it is no longer timely information.  I have a lot of questions, opinions, and experiences that would not necessarily endear me to the venture community.

For that reason, this blog is anonymous.  Even though I am not publishing my identity, I am still not going to reveal anything that is ACTUALLY confidential I am dealing with, but not having my identity obvious will make it a lot easier to share a lot of my thoughts and feelings without fearing the implications. 

I would like to invite other founders that are raising or have raised VC to join me here and participate in the blog.  If you like the concept, shoot me a note and we'll get in this together.  Until then, its just me. 

Now let the blogging begin...