The Curve and the Wave

Despite being out of the direct VC world for the moment, I’ve still kept in touch with some of the companies I used to work with. If I was still at the seed fund, we’d be reaching the point now where many of our early investments would be going through the so called “attrition phase” (we employed a serious spray and pray philosophy for the first few years).

I met up with one of the founders of such a company earlier this week, and heard about where the company’s at, how they’re running pretty close to the end of their runway, and really approaching that valley of death that a lot of VCs have been talking about recently (specifically saying that more companies need to meet their fiery deaths there). 

I remember when we did the investment in that company. I remember what I was enamored with about it, why I liked the tech, the founding team, etc. and I still to this day would put my money behind them. Yes it took longer to pull together the revenue traction they needed, its just starting to come to fruition now, a full year and a half behind schedule. But the thing is, I still believe in this investment. I still don’t think it’s a bad investment. I would still give them my money today. In fact, two years later, I would be even more eager to give them my money now.

Talking to this founder really hammered home how early they were. Not just in terms of tech development which took longer than they anticipated (hey, they’d never done this before, and we didn’t know enough to know how long those timelines take), but in terms of where the market was. What this company was selling was totally the future. It still is. But it was 4 years to early. I still have no doubt that someone could take this same start up, and make a killing. Someone probably will.

Sadly, it won’t be them. A lot of startup literature talks about how companies and ideas need to be the future, be ahead of the curve. But I think in the case of this company, that’s not true. This company was too far in the future, and too far ahead of the curve. The market is just now starting to catch up. Don’t get me wrong, there are a variety of mistakes that also got made in terms of running a business, but none of these outweigh the fact that they never found product/market fit because ultimately, the market just isn’t there yet. 

More than anything, when I look at this investment, I think it that the lesson at the end of the day is not to be too far ahead of the curve, but to ride the wave. Yes there’s lots of strategy involved in marketing, crossing the chasm and all that. And I do still believe that startups need to be ahead of the curve to be successful. But so much more of it is timing, and understanding whether the market is ready for that next big innovation. 

Life on the other side of the table - my reasons for jumping

As a follow up to my post from a few days ago, I figured I should explain in further detail why I felt that this was a good idea. Its not that I don’t to be a VC any more, its that I want to make the jump to a private fund. In order to do that, I need operations experience. 

I lucked my way into a VC job. It was a government VC job, as I highly doubt a private fund would have hired me with my experience at that point, but it was a VC job nonetheless. I learned a ton, got a taste of what the industry was like, and was hooked. 

I made a point during my time as a government VC, to network and observe lots of non government VCs. I read their blogs, attended their talks, and in some cases, got lucky enough to actually work with them. What I noticed was that all of them had operating experience. They had all at some point run their own businesses, started their own start ups, and some lucky ones had gone through exits and knew what life after acquisition was like. I realized that this was something I needed if I wanted to make the jump from public to private. 

The company I joined is actually one that I helped manage when I was a VC. I was an observer on their board for almost 2 years so from a strategic oversight perspective, I knew them pretty well. There are already some differences I’ve noticed and there’s definitely going to be a transition from being a solo operator, which is what VC is, to working on a team again, but its a challenge I’m excited for nonetheless. 

Ultimately whether this company succeeds for fails, I’m going to learn a lot. This company is well set up for the type of experience I’m looking for so hopefully it’s a good fit. 

Operating Experience, the logical next step

So, I am leaving my position as a venture capitalist, to join one of our portfolio companies. This is terrifying. I have a really amazing job, an opportunity for advancement, and yet, I’m leaving behind an incredible amount of job security, lifetime job security, to join something that has an 80% rate of failure and no revenue. 

This should be fun! 

Warning signs

This is a follow up to that post I wrote a couple months back, when I finally issued my first term sheet. We’re now into the closing of this deal and the process has definitely made me reflect a bit on how to better chose companies for investment. I wanted to share some of those reflections here. 

The reason I originally wanted to do this deal was because I loved the technology. It was the next generation of something that is already filling a need, and doing it exponentially faster and better. The team that built the product is absolutely brilliant and clearly hard working. I got enthralled in the technology, researching the space, the competitors, the other applications for this truly “platform” product. 

I forgot to spend time with the people. I did way less diligence on the team in terms of personality, coach-ability, and hustle. Theres a marked difference between working hard and hustling, and they came off as incredibly entitled the further we got into our relationship. 

At this point, our money is in, and the commitment has been made. I don’t regret doing this deal, let me be clear. And I do think that these are incredibly smart and lovely people. But now when I reflect on it, I think that we both got really excited about what they’re doing and they liked working with me because I was as passionate about the technology as they were. But technology is only one piece of a start up. The other piece is the business. 

Where our relationship is now is not the correct division of responsibilities. They are increasingly expecting me to take care of the business piece, to tell them what to do. This is not what your VC is for. The thing with entrepreneurship is you’re meant to figure out how you want to run your business, thats a desire that you have to have. Your VC is there to share best practices and guide you in the right direction but at the end of the day, you, the entrepreneur needs to make those decisions. 

I think it will be an interesting road going forward, but nonetheless, a good lesson for next time. 

Navigating Legalese

So. What happens after you issue a term sheet? The Legals begin. 

In a deal, the major agreements that require legal input are the Shareholders Agreement, Subscription Agreement, Debenture (if you’re doing convertible debt), and the Restricted Rights  Agreement (sometimes called a Founders Agreement). 

Lawyers are expensive. In some markets, fees are split between the VC and the Company, in some markets, the Company or the VC foots the entire bill. Either way, no one wants to see a fifth of their investment get eaten up in legal fees (it happens more than you think). 

Its important to make sure what ever legal counsel you chose understands that your relationship only works if they don’t nickel and dime you for every call, email, or question you have. Especially when starting out, you’re going to need a lot more help understanding legals than you probably want to pay for. 

So, how do you get free advice from a lawyer? I actually got this tip from my father who used to be one. Basically, he told me to interview lawyers before deciding on one, and make sure that you spend the first twenty minutes of the interview talking about anything but work, the deal, or what you actually want. Then you can start working your way into the conversation you intend to have, and make an informed decision based on their advice. And always make sure you pay for the coffee. 

If you build a good relationship with a lawyer, they’ll usually get involved at the term sheet stage, free of charge. They will also be way less antagonistic toward the other side’s counsel because they know you, what you’re looking for, and how you build your relationships. This is extremely beneficial for two reasons, one because it expedites the negotiation process and two, because it keeps costs reasonable, while making sure they still to an amazing job. This is because you’re now in the repeat client business. They want you to keep working with them, so they wont fleece you on legal fees, nor will they spend any less time on your transaction. 

Being a Lead Investor

I finally closed a deal that took maybe a little longer than it should have (in the process of closing this deal, I also started and closed a follow on investment in one of our companies, and started another closing for a new company). 

While there has been a bit of mud slinging back and forth about how long this has taken and who’s fault it is, at this point, I’m very happy that its done. There are definitely some take aways from this one which I’ll list below: 

Keep the lawyers out of it » As much as possible. If you disagree with something in a document, the first thing you should do is call your investor and talk to them. Once you agree on the intent of the term, then you can direct your lawyer to draft as such. This may sound counter intuitive, but let me explain. A lawyer’s job is to protect their client. That means that any time you want to make a change, they’re going to tell you everything you’ve just exposed yourself to by agreeing to that change. The way to keep a transaction going smoothly is to talk to your investor about the provisions and protections you want, and then make sure that your counsel drafts the provisions in this way too. Sometimes things get lost in translation and you may all have to jump on a call or two to iron things out. But the best way to do things is to ensure that you and the investor agree on the intentions of terms and then stick to those. This is not to say that you should not trust your lawyer, but, especially when you’re first starting out, you need to really be clear about what you want from a deal. Term sheets are non binding, and drafted agreements always have more clauses than the original term sheet had, but if you let two lawyers iron out an agreement, its going to cost you an arm and a leg, and will take an eternity to finish.  

If you’re the lead investor, LEAD » I learned this the hard way. The basic etiquette of investment syndicates is as follows: the lead investor takes point on the deal. They decide counsel, they communicate with counsel, and they notify the other investors of the various changes as the agreement changes. As a lead investor, your job is to review docs for anything that is a glaring problem for investors in general terms (eg. no investor board seats), as well as anything that you need in there to fit your investment philosophy (for example, if you need liquidity for your fund in 5 years to pay back Limited Partners, you probably need a retraction right at year 4). Lawyers will always circulate docs to the syndicate (all investors). As lead counsel, your job is to make your changes, copy everyone on comments, and send it back, to keep things moving. It’s not your job to herd cats and wait for the entire syndicate to make their comments - they trust you to catch the basics and its their responsibility to make sure nothing contravenes their investment philosophy/LP agreement terms. If you’re part of a syndicate and not the lead, its your job to speak up on draft iterations so that your comments are incorporated. No one wants to hold up closing because they haven’t read the agreements until signing. 

These are the two big things I’ve learned. I could devote an entire post to legal and seeking legal advice, and I just may in the near future… 

Having a moment

I feel like today is the day I officially became a venture capitalist. I got to issue my very first term sheet, all by myself. No its no the first one I’ve written, nor will it be the first negotiation I am a part of, but it is the first deal that I will lead by myself (with adult supervision of course). I got to hand it over officially too. Pretty thrilling! 

Yes, I know after almost a year here that this is the easiest part of my job. Same with writing the cheque. The hard part is building a company. Still, I do want to take pause and savor this moment. It’s pretty exciting to think that a year ago, I had just finished reading Brad Feld’s Venture Deals and was still trying to grasp the concept of pre-money vs. post-money valuation. 

I’m definitely having “a moment.”

Government as VCs

This is a post I’ve been thinking about for a while. Its come up quite a bit in recent weeks, for a variety of reasons; what I’ve been reading, the discussions I’ve been having, observations at various events and probably also because I’ve almost completed my first year as a VC and I’m getting reflective. What convinced me I should write this post was reading this article. 

There are two concepts I want to address in this post: 

  1. What Business does Government have in Venture Capital 
  2. The attitude in the Start Up community that Government is “bad”

What Business does Government have in Venture Capital

When I started at my fund 11 months ago, one of the first things I was told was that our goal is to work ourselves out of a job. To me, the picture that was painted was that our fund is part of a grand experiment in our region to see if Venture Capital in the region is really necessary/viable. The hope that was illustrated to me was that eventually this fund would be privatized, or we would all gain a good enough track record that we could raise our own private fund in the region. 

The words “startup” and “venture capital” have only become mainstream in this area in the last five years. A couple big exits have made our region boom with passionate entrepreneurs who have great ideas for businesses. At our fund, we spend a lot of time with private VCs to learn from their experience and emulate best practices in our own fund. We also play the role of educating the region about these best practices, so that our companies are prepared to leverage private capital. 

What’s become apparent to me is that it is more likely for our fund to become privatized than it is for anyone to go out and raise their own fund. There are some angel groups that have managed to organize and invest regionally, but from what I’ve seen, it would be extremely difficult to find people in the vicinity willing to become LPs in a decent sized fund. 

The Attitude in the Start-up community that Government is “bad”

I know that the start-up community aren’t the only ones who think government is “bad”, tons of people, myself included, complain about government. However, anytime we make a decision that someone doesn’t like, inevitably the complaint is that we’re too much of a government organization; too slow, no vision, unqualified, stifling innovation, not founder friendly, giving handouts, etc. 

I will contend that there are varying degrees of truth to some of these items but certainly not all. We do lead investments, and are quite happy to do so. I wish we were faster at making investments, but from all of my co-investing experiences, we’re on par with our private sector colleagues. 

We certainly don’t do handouts, nor are we unusually tough on founders. We have a very good track record in terms of investment, and we continue to make good choices where our pipeline is concerned. We invest in things that we can see getting follow on investment from the private sector as well, because we believe that it’s important to leverage private capital, especially with government money in order for a company to be successful.  

We definitely lack experience in that we’re quite new to the game, and are climbing a learning curve, but the fact is, talk to any private sector VC and they will tell you the same thing. Each deal is different. You’re always learning. That’s one of the best parts of being a VC. Its also one of the best parts of being an entrepreneur. 

In the end, we are are also filling a void. Many of the things we fund are extremely innovative, but way too early for an institutional investor to look at. Its not because they’re bad investments, its because they’re deemed “too risky.” The fact that we’re able and willing to go earlier means we get to work with some amazing companies. At the end of the day, that’s the goal of this whole business. 

I live in Peter Pan Land
Silicon Valley serial entrepreneur

My venture investing career has three phases all roughly 6-8 years long. The first, at Euclid, was software to internet. The second, at Flatiron was internet to bubble. And the third, at USV, has been web 2 to mobile.
Fred Wilson

How VCs add value to their companies

One of my potential future entrepreneurs (a smart one at that) asked me the other day what I was going to bring to the table besides just the money. I definitely got a laugh out of how bluntly he brought up the issue but was instantly appreciative of it. He demonstrated that he had done his homework, and would be doing diligence on me in the same way I am doing diligence on him. Which by the way is what smart entrepreneurs do.

In the vein of an earlier post that I wrote, here are a couple of things that a VC should do to add value to their companies: 

  • NetworkA VC’s biggest asset is their network. A default strategy for VCs when their companies arent performing is to introduce the entrepreneur to people that might be able to help out. VCs also help recruit talent to your startups. Their job is to sell their portfolio companies at conferences, events, demo-days, and any other events or meet-ups they might attend. Its important for entrepreneurs to note which VCs are likely to have networks that might be helpful to them when they’re fundraising. In some cases, the brand name of the fund investing in a start up can help the company to attract talent/interest/future customers/fundraising as well. 
  • Mentorship - this is important, especially for first time entrepreneurs. Mentorship and helping to develop people and companies is a big part of the job. This can mean anything from taking a panicked phone call at 3 am, to exhaustive white-boarding sessions to bounce around ideas, to ensuring that entrepreneurs get into accelerators or other programs that might help them along in their start up journey. 
  • Operations and Strategy - VCs generally manage more than one company, which means that they have fairly extensive experience in terms of Operations and Strategy. Its also becoming the norm for a VC to join a start up at some point in their career and really get hands on Ops experience. This contribution is especially helpful during board meetings and external strategy sessions which, depending upon the stage of the company, can happen bi-weekly at points. 

How a venture fund works: The Basics

What is VC? The lifecycle of a fund

I realize that, despite having kept this blog for a number of months, and using it to chronicle my learnings about venture capital, I haven’t actually explained what venture capital is or how the lifecycle of a fund works. I’ve dropped tidbits here and there but I figure its time to link this together in a full on post.

So here are some of the high points of how it works:

  • Venture Capitalists (Sometimes called General Partners) look for commitments from High Wealth places (Banks, individuals, funds)
  • Most funds operate on a 10 year lifecycle. You have five years to spend the commitments, and five years to return them.
  • Usually 2% of the fund is allocated for salary, to pay employees, and overhead. Then there’s a 2% management fee (both of these are yearly). So on a $100 million fund, you have $80 million to invest, and $20 million to cover expenses (you have to commit it all by the 5 year mark).
  • When you look at statistics, funds usually spread to a 3-4-3 scenario: 30% of fund investments tank completely, 40% are lifestyle businesses, 30% are “homeruns” if you’re lucky.
  • Most funds commit to return 8% to their LPs at the end of the 10 years. The VC gets to keep 20% of what’s left. 

In my next post, I’ll talk more about basic strategies around deploying funds, and what entrepreneurs should be aware of. 

How to Say No

This is the most important thing I have learned so far as a venture capitalist. A lot of the time, this is what you do. Awesome things like learning about new technologies or talking to really smart people or serving on boards, or hanging out at the latest tech event are only about 30% of the job. They become more central to everyday VC life when you get into the portfolio management phase of your fund.

At the beginning when you’re deploying capital, you’re just hearing pitches, receiving business plans, and a lot of the time, saying no. Even when you walk down the street, people just stop you and want to pitch you. When I was in San Francisco a couple months ago, a VC I was talking to complained about being pitched once when he went to the grocery store with his daughter.

In the Pitch – First of all, its important to have dynamic pitches, to ask the entrepreneur lots of questions as they’re pitching to you. The nature of your questions and their responses will also help prime them for how you’re feeling, especially if you’re leaning towards a “no.” You don’t ever say no in the pitch, and I’ve heard of VCs throwing people out mid-pitch which I honestly think is bad practice and makes you look like an asshole. Everyone deserves to have their idea considered. How long they deserve to be considered is a different story. Post pitch, if you brought the deal in, you owe not only a “no” to be delivered at least via phone, but its also good, especially if you have gotten to know the company to provide at least some constructive feedback. Not pages and pages, but 5-10 bullet points.

Business Plan/Cold Reach out – review it. You never know what you might find. Honestly, 90% of them are garbage, I have yet to receive a good cold reach out. Theoretically its because you need some context to really understand what’s going on. A lot of them are just terrible. Because they came in cold, its fair to follow up with an email. Sometimes I like to call, if I’m not 100% certain, just to get a better feel for the person over the phone.

Walking down the street – this one is at your discretion. Because you’ve been cornered, its your personal time, you get to chose when/how you want to exit. Usually just throwing them a card and saying you need to run works, or if you’re really not interested, you can bluntly say so on the street.

One final thought, be aware of how the community you work in operates. Here, the tech community is very small, you need to be sensitive to how you turn someone down. You also don’t want to be disparaging because you want the entrepreneur to come back to you when they move on to their winning idea.