by Mark Davis

I recently had lunch with Gary Kats, a friend from business school who has gone on to work as a tech banker. As part of our chat, we discussed the current exit environment and how it has affected the four types of exits: M&A, IPO, Secondary and Recapitalization. During the course of that conversation, it occurred to me that it would be worthwhile to outline each type of exit and provide some thoughts about how these fit into the venture capital model.

M&A:

"M&A" refers to "Mergers and Acquisitions".

In an acquisition, one company buys another, taking a controlling stake of its share and the rights to the assets. While these are structured in a number of ways and selecting a structure involves numerous considerations, the key variables boil down to: 1) whether or not the buyer takes on the liabilities of the company being acquired, and; 2) the types of assets being used to purchase the company (e.g., cash or stock).

In a merger, two companies are combined, each being treated more or less as an equal. While combinations called mergers happen all the time, they are rarely actually mergers of equals. Even if the financial structure portrays a picture of two equal companies being combined, one of the two parties typically takes control of the other in one way or another. Most often, control is determined by the board or management structure. The CEO that is selected to lead the combined entity typically keeps all of his lieutenants around, squeezing out the other company's management team.

Most VC exits (especially in recent years) are realized when portfolio companies are acquired by larger, often public, cash-rich companies. These transactions are typically structured such that the buyer assumes the portfolio company's liabilities. Venture investors typically expect this, as they do not want to be responsible for paying off debt after the transaction.

Additionally, VCs have a strong preference for selling portfolio companies for cash, rather than shares of the acquiring company. There is good reason for this preference: the value of the buyer's shares can change over time, reducing the effective purchase price. Furthermore, if a buyer elects to pay with its shares, its management may believe that their company's shares are overvalued.

IPO:

IPO or initial public offering is another of the four types of exits. In an initial public offering, a company first sells a portion of it shares in a public market, such as the NY Stock Exchange or the NASDAQ.

By "going public," a company sells a portion of its stock to investors that are entitled to freely sell their shares over the specified exchange. Through the exchange, they can sell directly or indirectly to virtually any buyer in the world.

It's worth noting that not all of the company's stock is publicly accessible at the IPO. Companies typically sell only a portion of the company to investors through the public exchanges.

What makes IPOs so special is that subsequent public offerings are less risky for the company as they have more information about the stock's pricing once shares are being freely traded and priced by the market. During the IPO, the company's investment bankers are tasked with creating a small marketplace and identifying clearing prices for the initial shares. After those shares are sold, the buyers can transact them freely, yielding prices that reflect the valuation applied by more buyers and sellers, creating a price that is truly reflective of the market's estimate of the company's value.

VCs, entrepreneurs and others often participate in the public offering, meaning that they include their shares in the group that is sold to the market. This enables VCs to exit at least a part of their investment – shares are converted into cash which can be distributed to their limited partners.

VCs generally like exiting through IPOs. While IPOs present investors with some liquidity risk, as insiders are often subjected to lock-up periods during which the investors and entrepreneurs cannot sell their shares on the market immediately after the IPO, IPOs offer VCs several advantages. First, public companies remain going concerns, enabling VCs to take credit for investments that they made (potentially) long into the future. An IPO not only offers a VC a merit badge that can be promoted to entrepreneurs and limited partners, but it also enables the VC to leverage its contacts at the newly public company to help future portfolio companies in many ways (from acquiring customers and partners to initiating acquisitions).

VC Pre-MBA Hiring...

by Sarah Tavel

A couple of months ago, I posted on my blog that Bessemer was looking to hire a new pre-MBA Analyst. More than 650 resumes later, we are thrilled to announce that Brian Feinstein has accepted our offer to join us as a full time Analyst. Welcome, Brian!

Having finished what feels like an epic recruiting process, it is interesting to look back at the process. Notably, of the more than 650 resumes we received, we conducted 42 first-round interviews (~6%), seven second-round interviews (17% of the 42), and eventually extended one offer (14% of the seven, but 0.15% of resumes submitted!).
To anybody reading this post who is applying for a pre-MBA role at a VC firm, this funnel may seem intimidating. So how can you get an edge? In particular, how does one get a first-round interview? So here is my "one-woman's take" on some tips I can think of post-recruiting to give you a slight edge:

1. Your interest in entrepreneurship and technology shouldn't start at the interview

This one may be a bit of a personal bias; some VC/PE firms looking to hire a pre-MBA likely wouldn't prioritize this. But I can’t help but notice that Bessemer has had six full time Analysts, and five have been involved in entrepreneurship in one way or another. I'm not saying you need to start an internet company, but I do think involving yourself in the entrepreneurial or tech community will give you an edge. People who do tend to rise to the top during the application process, and I think it is because of their passion not just for venture capital, but for the entire ecosystem.

1. Before you apply: Understand the role (and know yourself)

Pre-MBA VC jobs are heavy on the sourcing and researching, light on the tie-breaking votes and corporate jets. Expect to spend a majority of your time reaching out to CEOs of private companies in order to source deals for your firm. If this is not something that you think you can get excited about, that's okay. Don't let the allure of VC blind you into taking a pre-MBA role. Instead, pursue another job that makes you more passionate (or your MBA)… venture capital will always be there. If sourcing is something that you can get excited about, emphasize this in you cover letter or work in relevant experience in your resume. We are more likely to interview someone who we think is applying eyes-wide open.

1. Be persistent

Sourcing requires a great deal of persistence. If sourcing is something you think you could be passionate about, show your persistence during the interview process (and however you can in your resume). For example, if you read a job posting for a VC firm, Google all the Partners in the firm and find which ones have blogs. Then email one or two of them. Make a smart comment about one of their blog posts, mention you saw the job posting and are extremely interested in the role, and oh heck… a little well-placed flattery never hurt anyone.

1. Do your homework

It always impressed me to speak to a candidate who had clearly done their homework. I don't mean they had a long list of exciting private companies they are familiar with. Instead, they knew some Bessemer portfolio companies, they read some of the Partners' blogs, and they had a basic understanding of what the VC process is like. So do your homework – it shows initiative, curiosity, and your interest in the role. (And it doesn't hurt to show that you did your homework in your cover letter.)

1. Be Googleable

Charlie makes a similar point when he says "make a digital home for yourself." Blogging is a great way to show who you are and demonstrate that startups and technology are something you are passionate about (tip #1). For some firms, this tip is the application process.

Last but not least: Know what we're looking for and customize your resume to that

Tips #1-5 all feed into this tip which is: Don't use the same resume for every job you apply to.For example, applying to a pre-MBA VC role is very different than applying to a pre-MBA buyout firm role. While the LBO recruiter might drool over a candidate's investment banking background, we tend to get more excited by leadership experience such as starting a new successful club at your school or being the captain of your sports team. Customize your resume to highlight certain strengths specific to the job to which you are applying. Keeping this is mind should give you an edge in snagging that first round interview.

by Healy Jones

As an associate at a venture capital firm, I get to spend a lot of time speaking with entrepreneurs about their startups. Talking with founders and entrepreneurs is basically what motivates me to get out of bed in the morning; usually I find learning about new business ideas and technologies pretty freaking awesome. However, I can appreciate that most founders would likely rather interface directly with a partner instead of spending time with me. After all, I am not a decision maker, am not on the firm's investment committee, and - given that the VC business is an apprenticeship business - am still in the "learning" phase of my career. However, entrepreneurs seeking venture capital should realize that the junior VCs can be either roadblocks or valuable allies in the search for funding.

This is a post on best practices when you have to deal with a junior VC during your funding search. I may be able to convince you that junior VC's are not a total waste of time by the end of these post! (I hope that these come across as helpful and not overbearing or pompous and welcome your feedback.)

If you find yourself in a conversation with a non-partner VC your goals are pretty simple:

1) Get that person's fund raising advice. Regardless of your opinion of junior VCs, we do see a lot of new investment opportunities and often have a decent idea of what other funds may be active in your space. Have we seen any other companies in your space raising funds? How are VCs in general reacting to companies in your industry? Are there other funds that are likely to be interested in what you are doing? Ask if the pitch is good or what could be added to make it better. Every junior VC will have opinions on this… imagine hearing dozens of funding pitches in the same industry - you'd have opinions on what works best too!

2) See if you can get any market intel. Earlier this week I had breakfast with a young VC at a nearby fund. He's spoken with 42 companies within a very specific financial technology vertical in the past month. I'd say his fund is interested in that space, and I'd also bet that he's got some decent opinions on where the general market is headed. Has he built a company in that space like you, the startup founder? No. But he's likely got some very current market intel and it might be worth seeing what you can learn if you're having a conversation with him.

3) End up with a meeting with one of the fund's partners. This is the most important goal (duh). Time is the enemy of the VC, and our partners are looking to us as the junior VC to help them be more efficient. This includes rejecting companies that do not fit the fund's or partner's investment profile and asking basic the questions that the partner would want to know before walking into a meeting. I hate rejecting people, but I have to do it. (Incidentally I've noticed that I tend to do it on Fridays, since I put it off during the week because it's so painful.) I also have occasionally had the partner reject a meeting that I'd like him to take. If I really like a company I'll push pretty hard. This is where I become your advocate within the fund, and if you've shared with me a great fund raising presentation I will use it as a valuable tool to convince the partner. Last week, a company that I had been speaking with presented to one of our partners. This partner did not initially think a meeting made sense because he thought the market was uninteresting. Because I knew this partner would reject the meeting out of hand (based on the company's space) I had several conversations with the CEO to prepare for MY pitch to the partner on why he should take the meeting. We put together solid backup information, which I used in conjunction with a presentation that the CEO developed, to get the partner to take a meeting. The meeting went well and now we are starting preliminary work on the company - something that never would have happened if I hadn't been the first person to interact with the company. Even as a junior guy, I can be helpful in the fund raising process. (However, for every company like this there are several that get rejected; fund raising is still a brutal process.)

Obviously your most important goal when talking with a junior VC is to get to a partner. Just like it makes sense to know your customer when you are starting a business, it also makes sense to figure out what is motivating the junior VC with whom you are speaking.

Personally I get pumped up by cool technologies (that's why I've got four computers; one is usually on the fritz because some alpha/beta program I'm goofing around with didn't exactly work as promised.) I get inspired by experienced managers who are doing something risky and young founders who are figuring it out for the first time. I like to work with people who are doing something new and I enjoy helping get it going - working with entrepreneurs in our office is a ton of fun. There is nothing wrong with feeling the VC out for a minute and trying to develop a bit of a connection - it works in many sales situations and isn't a bad idea when first interacting with VCs either.

There are also other underlying goals that your junior VC likely has that he or she likely won't mention. I am trying to build a career in the venture business. This is freaking hard, and includes needing to impress my partners with my decision making. In other words, sometimes I need to say no to companies because I know that my partners will not be interested in a meeting or conversation. I don't want to look like I've got bad judgement.

Another underlying pressure felt by many junior VCs is a strong need to make investments. A young VC who hasn't closed any deals isn't a VC - he's just a guy who spends too much time on the phone and at breakfast meetings (or a gal, but you know what I mean.) This means I'm likely quite hopeful that your business is the diamond in the rough that will somehow make my career. Despite this hope, I also realize that most companies I speak with are not going to receive investments from my fund.  

I also have a huge need to be time efficient. I'm certain this can be perceived as me being rude (I apologize, I know it is rude sometimes), but I just have too much going on. For example, this week I am conducting diligence calls and meetings for two different investment opportunities, helping build a financial model for a young startup and doing some business development work for an existing portfolio company. I'm also trying to reach the founders of a payment processing company, "Certapay," but I can't find even find them! These things are all really interesting projects, so I'm not complaining. I'm more suggesting that I may not be prepared to take a breath and focus on you (and the dozen or so other new leads I talk to this week) in the way that I should and that you deserve.

So, given those underlying goals and constraints, how can you maximize your chance of maximizing our interaction? What can you do to cut through the clutter and appeal to my desire to find the next big thing?

Santa's Perfect Pitch

by Guy Kawasaki

Jeremy Hanks analyzed Santa as an entrepreneur in his post called "Santa Claus: World's Greatest Entrepreneur.". I loved what he did so I crafted a venture-capital pitch for Santa to illustrate the kind of deal that venture capitalists would fund in today's economic conditions.

1. Problem. Parents need a method to influence their non-compliant kids throughout the year. This is a universal problem beginning at approximately age three and continuing up to the teenage years.

2. Solution. Outsourced bribery via jolly old man who gives candy and toys to nice kids and lumps of coal to naughty ones.

3. Business Model. Revenue sharing with toy companies and candy companies, licensing image to retailers, and royalties from multiple movies, songs, and publications.

4. Underlying Magic. Ability to deliver toys to all the kids around the world in one night, make reindeer fly with near zero-carbon footprint, enter homes through chimneys, know what every kid wants, and know whether every kid has been naughty or nice. Zero support issues due to omniscience. Completely lead-free materials. Over fifty patents filed.

5. Marketing and Sales. Current SEO methods yield 15,700,000 hits in Google. Partnerships with toy manufacturers, candy companies, and retailers to increase Santa's brand awareness for mutual benefits. Deep inroads into western literature. Creation of long-lasting brand awareness by working with grandparents. You can track market penetration in real time too.

6. Competition. Jesus or none, depending on your world view.

7. Team. Proven CEO with hundreds of years of experience. In addition, there are Mrs. Claus, non-unionized elves, and flying reindeer including one with a red nose. All work for free with no stock options. North Pole production facilities are also free.

8. Projections. Total addressable market of two billion children. Conservatively, 1% market share means twenty million children.

This is the kind of deal even the most jaded venture capitalist would jump at. Be sure to give me the first shot at the deal if you're Santa. Merry Christmas!

No Suggestions; Just Results

by Mark Reiboldt

I have written a number of times about the different backgrounds and experience of people in private equity and venture capital, specifically what type of experience makes a better private equity investor.  I think each person within this space has a different opinion and different reasons for their argument, but I thought this Financial Times article from last week on consultants in private equity was very interesting and relevant to the discussion.

The idea explained in the article is that the private equity world is looking to management consultants for the primary source of value creation in the investment process.  Finding value in market returns is no longer about uncovering trends in equity pricing and market volatility.  The article sites a quote from someone saying that value creation will no longer be about financial engineering; instead, it will be about addressing the fundamental efficiency of a business, in efforts to organically increase value from the bottom up. 

The underlying argument here is that even though a lot of investors have found ways to twist and turn value out of companies in recent years, essentially "wringing out" whatever value there was to offer, things will not be so easy going forward.  There are only so many ways to engineer the markets. There comes a point where you just have to drop all of the fancy algorithms and trading programmes, roll up the sleeves, and dive in the ditch with the companies you're investing in, to ultimately create value the "old fashion way."  This is what private equity is all about and it's part of the reason why many people have turned away from the public equity markets, in order to allocate more resources in building companies organically, thus hopefully interjecting "pure" value, rather than the faux stuff that has developed in recent years.

It is from this argument that I have developed my theory on how private equity firms can be more effective.  There is a mentality among many young MBA types who think that since they know all of the tricks Excel has to offer, then surely they can engineer ways for a company to be profitable.  Many of these folks worked in the investment banking industry, where they lived in a 5 by 5 foot cubicle for five years going blind from looking at computer screens as they were building various types of valuation and pro forma financial models.  What many of these people failed to learn (and what b-school didn't teach them to do, because you can't learn it in a classroom), however, was how to manage and grow a business once you've made the investment in it.  Many of them thought that if their financial models looked "pretty" enough going into a deal, then surely it would have to turn out exactly how the data in the schedules predicted.  Then, here came the curve balls from the market ... "oh, wait, you mean to tell me the markets aren't efficient, after all?" was the story the look on their faces told. 

The large buyout funds have been bringing in management consultants to help them find/create value in portfolio companies for years.  Indeed, KKR has worked with all of the big names on all of their deals.  And of course, there's Bain, who spun-off their own private equity business after realizing they could make so much more money implementing their own efficiencies for companies they owned, rather than just making recommendations to clients who often never implement the recommendations or never fully realize the value of what was delivered.

That's mainly for the larger PE buyout funds, i.e., the funds that embark on $500 million+ LBO's, taking on billions of dollars in debt, only to flip companies relatively soon after taking them private.  However, in recent months, I have debated whether or not consultants make good investors in early stage companies, specifically as venture capitalists.  Of course, this is a much larger discussion, because there are different sides to the arguments, where people only with entrepreneurial experience believe that you need to be an entrepreneur in order to be a good VC, while former consultants who have gone on to become investors argue their time doing billable work for clients led them to be able to build better businesses as investors.  And of course, those of us who have both entrepreneurial and consulting experience realize that nothing really prepares you for the work a start-up requires, but every bit of experience negotiating challenges in any sector, industry or business line will teach valuable lessons that should help in the long run.

Ultimately, I tend to agree with some of the arguments made in the FT article.  I think management consultants can be very effective in creating value for both business owners and investors in general.  To be honest with you, if I am looking for ways to overcome challenges involved with growing my business in this market, you can rest assure that I will welcome assistance from qualified advisors.  Moreover, if I raise capital or take on equity partners in this marketplace to help grow my business, then I am going to be looking for a party who has more to offer than deep pockets.  There's just too much involved and it's too hard to remain competitive - cash won't solve all of a company's problems in these markets.

However, there's the other side of things.  Management consulting firms are known for heavy price tags and light results.  Many consulting firms have a reputation of not skimping on any billable hours, but the deliverable for the client is a glorified template.  This is a stigma and a stereotype; however, unfortunately, neither are undeserved for some firms.  I have talked to many executives from Fortune 100 companies who said they've worked with all the largest names in consulting - McKinsey, Bain, BearingPoint, Booz, Big Four, et al - and the reputation of these firms are all the same, i.e., that they are primadonnas that delivered marginal results.  Of course, some experiences are better than others, but managers often reach a point where they forget what the consultant was supposed to do, yet they never stop paying high fees. 

Needless to say, consultants better be willing to do whatever they have to do, in order to overcome this reputation in these markets.  I believe that you have to respect Bain (and Mitt Romney) for putting their money where their mouth was, because they ultimately were willing to take on the risk of getting in the trenches with their clients by bearing a portion of the risk.  With Bain Capital, they said that they would go out and find companies where opportunistic investment presented itself, take on the debt/risk of investing in that business, and then working with the business to acheive growth and value over the long run.  They no longer acted solely as consultants, making out-of-touch and unrealistic recommendations; they couldn't afford to run up unreasonable bills and fees; they couldn't advise any questionable practices, because in the end, they didn't get paid unless their companies performed well. 

So, while I agree with the argument that says many consultants can really help create value for businesses, I also believe that unless consultants are prepared to share some of the risk their clients face, they will never be brought down to the reality that is involved with negotiating the challenges that this market poses.  Does this mean consultants should only work for equity or am I insinuating that all consultants should be private equity investors (i.e., taking on large debt/risks) and allocate cash to their clients?  Of course not.  Not only does that model often not work, it clearly wouldn't be right to demand such a thing.  However, I do believe that if we are expecting management consultants to really contribute to "creating value" in this market, then they are going to have to "invest" with their clients, in one way or another.  How that "investment" looks is likely to be determined, and of course, will be determined differently in different situations.  But, the point is, consultants must do more than just be "advisors" with no skin in the game.  I would be leary of anyone making any recommendations about something that they either don't fully understand or aren't completely committed to delivering results, rather than suggestions. 

Perhaps that should be my firm's slogan:  No Suggestions; Just Results.  Eat your heart out, Accenture!

Investing In Thick and Thin

by Fred Wilson

A few weeks ago at Le Web, I participated on a panel made up of VC investors. There was a really good discussion about what next year holds for venture investing.

The moderator Ouriel asked if we would be cutting back our investing in 2009 and I replied that we did not plan on doing that.

I went on to explain that the venture business is very cyclical and that I've seen at least three and possibly four cycles in the 22 years I've been in the venture business. But I don't feel that its possible, or wise, or prudent to attempt to time these cycles.

Our approach is to manage a modest amount of capital (in our case less than $300 million across two active funds) and deploy it at roughly $40 million per year, year in and year out no matter what part of the cycle we are in.

That way we'll be putting out money at the top of the market but also at the bottom of the market and also on the way up and the way down. The valuations we pay will average themselves out and this averaging allows us to invest in the underlying value creation process and not in the market per se.

Eric Archambeau of Wellington Partners was on the panel and he described some research work he and some associates did a while back. They went back to the 1970s and charted for each year through the late 1990s the number of venture backed companies started that year and the number of $1bn revenue companies and $500mm to $1bn revenue companies that emerged in each 'vintage year'. The result of that work, he explained, was that the number in each category was relatively constant year after year with no discernable pattern and certainly not correlated with or against market or economic cycles. Interestingly, the data was not correlated with innovation and technology cycles either.

This says to me that, like the lottery, "you got to be in it to win it" and staying on the sidelines is not a wise approach in any market environment.

Mike Moritz was quoted in an SF Gate piece today making a similar point (which inspired this post and its title).  He said:

"We've always invested through thick and thin. In fact, we prefer to invest in thin"

It is easier to invest in thin times. The difficult business climate starts to separate the wheat from the chaff and the strong companies are revealed. With many investors on the sidelines (particularly corporate buyers/investors and 'momentum' investors like hedge funds and the like), there is less competition to invest in these 'winners' and the prevailing valuation environment means you get more equity for your dollar invested. That's quite a recipe for success.

But its not a lot of fun to be operating in the 'thin times' even as an investor. Most good firms have a portfolio full of companies that will be struggling to stay afloat and the VCs will spend more time working with their companies in this environment. And when we get an opportunity to put more capital to work in a portfolio company we know and love in this kind of market, well that is often the best investment of all. Note that SF Gate piece mentions that Sequoia just led a big new round in AdMob which if I am not mistaken is an existing Sequoia portfolio company that is a top mobile ad company. Look for more of that sort of thing in this market.

As I've written here recently, I see no signs that the venture market is drying up. Its changing, for sure, and if you aren't running a company that's emerging as a clear winner, its going to be tough to raise money in 2009 from anyone other than your existing investors. And look for them to be more cautious, more diligent, and less generous than they may have been in the past few years.

There's money out there in venture land and its going to get invested in 2009 and its going to get invested wisely for the most part. At least that's our plan and I'm confident we can execute on it.

Perfect Your Pitch

By Brad Feld  

As a venture capitalist, I'm constantly on the receiving end of pitches from entrepreneurs looking for capital. While there are plenty of different mistakes you can make, these are the ones I see over and over.

1. Not knowing your audience: I invest in early-stage software and internet companies in the U.S. I'm always amazed when someone reaches out to me to invest in a telecom company, a retail products company or a biotech firm. Do your research and make sure the venture capitalists you target invest in what your company does.
2. Asking the venture capitalist to sign a nondisclosure agreement, or NDA: This is a stupid idea perpetuated by lawyers. Most venture capitalists will not sign an NDA, so all you're doing is putting up a barrier to get their attention and demonstrating your naivety.
3. Sending a 74-page business plan in the mail: This might have been the right approach in 1972, but today you should start with a short e-mail introducing you and your company. If you must, include a short (four pages or fewer) executive summary. Make it easy for a venture capitalist to either engage or say he isn't interested. If the venture capitalist is interested, he'll inform you of the next step in the process.
4. Spamming 150 venture capitalists with a "Dear Sir" e-mail: If you do send an e-mail, make sure it's personalized. Remember to target your audience first, and then personalize your e-mails to that person. Oh, and if my name is "Brad," please don't start off with "Dear Fred."
5. Name-dropping other venture capitalists: If I'm interested in your company, I might ask you who else you are talking to, but don't start off by name-dropping. It probably won't have any positive benefit, and if I know the other folks you are talking to, I might reach out to them. If I hear they are lukewarm or, worse, have no idea who you are, you just blew it.
6. Listing 27 advisors but only one co-founder: Advisory boards, especially at the very early stages of a company, are generally useless. A few key advisors who have deep domain knowledge or experience in your industry are great, but a long list of lightly engaged people who have well-known names but aren't helping you diminishes your credibility.
7. Using the wrong materials at the wrong stages: When you are raising money, you should have an arsenal of presentation materials ready to go. However, dumping it all on the venture capitalist with one big thud is rarely effective. Instead, provide access to a demo or PowerPoint presentation so I have the option of reviewing it and talking with you instead of getting pitched.
8. Thinking there are rules that apply to all situations: Each venture capitalist is different. Learn what you can beforehand so you can tune your approach to each venture capitalist.

Angels - Keep It Simple and Fair

by Brad Feld

10 Tips On Negotiating With VCs

VC survey: Market will look up … in 2010

by Anthony Ha

There's a tough year ahead for venture capitalists and entrepreneurs, according to a new survey from the National Venture Capital Association. Respondents predicted venture capitalists and entrepreneurs alike will have trouble raising money next year, and that the market for initial public offerings (IPOs) won't open until 2010.

More than 400 venture capitalists participated in the survey, which was conducted between November 24 and December 12. Those VCs said they'll probably invest less money next year than they did this year — 61 percent predicted total venture investments will fall by more than 10 percent. That's discouraging, since venture investments have already been falling, but not surprising, since most of the fundings this year occurred before the crash of the financial markets. A majority of the VCs also said they expect to fund the same number of companies or more, so the bigger effect may not be on the number of fundings, but on the amount each startup can raise.

The NVCA's announcement repeats on a theme we've been hearing frequently — that the best startups will survive and emerge stronger when things pick up; NVCA President Mark Heesen says the downturn will be a period of "Darwinian change." He also notes that VCs should be encouraged to invest as they perceive  competition falling away and valuations dropping.

Nearly all respondents (96 percent) said venture firms will have more trouble raising their own funding next year. A slightly less overwhelming majority (85 percent) also said institutional investors will be reducing their backing of venture capital as a whole.

VCs predicted that international investments will be affected, not just fundings in the United States. Startups looking for early-stage and seed investment, as well as companies in the media and semiconductor markets, will probably see the sharpest drop in funding, while cleantech funding may actually go up.

How to pick a fund

by Larry Marshall

Somebody has been running around the valley trying to educate entrepreneurs with ways to qualify VC funds. Now it's important to ask questions and show interest in any interview process, but here's the problem: Asking the VC, How big is your fund? Are you investing currently? Or even the better educated, what percentage of your funds are currently committed? generally causes two reactions--

1. Why didn't you do your homework on us before you came to pitch us? and
2. Do you think I'd be wasting my time listening to your pitch if I wasn't actively investing?

Now #2 may not always be true because sometimes VCs hear a pitch out of courtesy to a trusted contact, or a favor to another firm, or just to get better educated. Generally the size of the fund isn't hard to find, it's usually on the web site. The date it closed is also often mentioned--most funds have a 4-6 year investment period, so if it closed anytime in the past two years you are on safe ground.

More importantly, you should have done your homework on the partner in question, not just the fund. Does that fund do medical device, or lasers, if that's your deal? What about the specific partner? Have they built a company or done several deals in your space? Are they likely to have deep contacts and domain expertise in it?

These are simple questions, and easy to answer just using basic web research. Leverage your service providers, especially in the Valley. Everyone from your landlord to your lawyer will know a firm or two, and most of them will know who's investing. Your lawyers will have access to the venture databases, and can fill in the blanks on the questions above on fund size, and so forth.

There are also profiles to partners and funds. The classic profile is replace the CEO with a seasoned exec.--quite a few of the top tier firms have this systematic approach to investing. If you are particularly sensitive to this issue, you had better get over it, or don't pitch those firms.

You want to pick a VC partner who can really be a partner, someone you can build a trusted relationship with and ideally become lifelong friends with. There are a lot of entrepreneurs (and VCs) that are about as sincere as the IRS in trying to "help you." I've said before that raising money is like getting married, so the insincere entrepreur or VC is to be avoided. It takes time to build a lasting relationship, and to build trust. The adversarial approach doesn't help here, i.e. some VCs expect you to beg for money (and I admit I was always a bit cap in hand when raising capital--it always amazed me that someone would give you millions of dollars to fund just an idea). And on the entrepreneur side, we are looking at all offers and we'll pick the best one. I don't want to be part of a competitive bidding process to find a partner (investment or otherwise) I want to invest in things where I can add unique value, and with companies who can create unique value. If valuation is the only metric for fund selection then entrepreneurs should go first to a credit card, then friends and family, then a bank, then high net worths, then angels, but frankly never to VCs.

What's harder is to guage the spirit of each firm--ideally, you want to talk to entrepreneurs who have taken $ from this fund, especially from the particular partner you are interested in. This is another reason why CEO forums/networks are so powerful, because it provides a great resource to qualify VCs in addition to giving a self help group for first-time CEOs. Fortunately, we have a great benefit from the carnage of the tech bust--because we have a four-year historical perspective on what the VC funds actually did to support their companies during this time vs. what they said they would do ;-)

Fuck the VCs

Trust the VC (Famous Last Words?)

by Jeff Bussgang

Alan Blinder (former vice chairman of the Federal Reserve) is one of my favorite economists.  His book, Hard Heads, Soft Hearts, outlines a compelling philosophy in economic policy - whereby a tough-minded, analytical approach is applied to solve difficult social issues.

Thus, I read his recent NY Sunday Times article on the central role that trust plays in capitalism with great interest.  "The new president's most fundamental job," he writes, "is to restore the people's confidence that the economy will perform -- for them".

Translating this mantra to the start-up world is a thought-provoking exercise.  Do the principals in the start-up economy -- the entrepreneur and the VC -- trust each other?  In these economic times, tensions can flare over strategy, burn rate and performance.  Tough conversations and arguments over tough issues is natural, but if there isn't a foundation of trust between these two parties, the start-up ecosystem fails, just as our markets fail.

Trust often breaks down in the VC-entrepreneur relationship when either side senses that the other isn't being straight with them.  The telltale signs for a VC to not trust the entrepreneur is when they see an entrepreneur:

• Get more defensive during tough times, rather than more transparent.
• Avoid confronting tough issues, rather than forcefully raising them early and often.
• Blame poor performance on others, rather than embrace accountability.
• Focus on their own situation and wealth equation, rather than focus on shareholder value.

On the flip side, the entrepreneur worries that their VC isn't being straight with them when they see a VC:

• Disengage in the details during tough times, rather than engage more vigorously.
• Be a pollyana when things aren't going well, rather than providing realistic assessments and tough feedback on performance.
• Seek to apply general formulas (e.g., let's implement the Sequoia Manifesto!), rather than cater their response to the specific situation.
• Focus on their VC fund's situation and agenda, rather than the portfolio company's.

Successful corporate chieftans turned philosophers, such as Jack Welch (GE) and Bill George (Medtronic), have identified authenticity as the key success factor to leaders.  I would suggest entrepreneurs VCs (not often necessarily thought of as leaders!) face a similar standard.  If your VC or entrepreneur can't pass the "Authentic Leadership" test, you are in trouble.  Bill George points out authentic leaders are those that:

• Are true to themselves and their beliefs.
• More concerned with serving others than their own personal success or recognition.

• Engender trust and develop geniune connections with others.

Restoring trust in our economy and government for Americans and the broader world community is a monumental task for President-elect Obama.  We VCs have the (admitedly smaller but still critical) task of navigating these tough times by demonstrating to our two major customers - our entrepreneur and our investors - that we are worthy of their trust.

What's The Value Of My Startup?

by Jason Mendelson

I regularly get questions concerning how venture capitalists value companies.  In fact, there seems to be an increase in the frequency of this question to me personally and through AskTheVC. 

It's not an exact science.  On top of that, there isn't a broad enough market to come anywhere near a public pricing mechanism.  (Insert joke about current public market chaos here).  VCs typically take into account many factors when deciding how to value a potential investment.  You'll note that few of them are quantifiable into hard numbers and at the end of the day, the VC and company must agree on an exact number in order to get a deal done.  So what are some of the factors?  In no particular order, I present the following:

1. How mature the company is

What stage is the company?  Early?  Late?  Pre or post product release?  Customers?  Pre or Post Revenue?  Other major milestones?  Hopefully it's clear that the later stage company (if all goes well), the higher the valuation. 

2. How much competition there is with other potential funding sources

More is better.  If I feel like I'm competing with other VC term sheets, then the valuation will likely be higher.  I would offer caution to not overplay this card unless you truly have another interested party.  I've seen this situation a number of times where the company overplays its hand and doesn't get their fundraising done and loses face in the process.

3. Quality of the management team

With a great management team, risk is taken out of the equation.  In fact, many VCs believe (me included) that even the best idea fails without an excellent team.  The more this quality team is built out before financing, the higher potential valuation you might get. 

4. How the valuation plays into a particular VC's investment thesis

If a VC is an early-stage investor, they'll be used to lower valuations than someone who invests in later stage deals.  This bias will have a large effect on the process.  I've seen companies that have received term sheets from both types of investors at the same time with wildly different prices. 

5. How much the VC thinks the company in particular wants that VC

VCs bring much more to the table than money (hopefully).  If a company wants a particular VC to fund their company (either because of domain-specific knowledge, prestige, nice offices, etc.) the price for that particular VC may be lower than others. 

6. Numbers, numbers, numbers

Yes, the numbers matter too.  Whether it is past performance or predictions of the future, these all play in.  Revenue, EBITDA, headcount, etc. all factor highly into the process.  That being said (at least for early-stage companies) don't believe everything your MBA professor told you about DCF and other financial analysis.  Especially at the early stage, the only thing that I know about your financials is that they are very wrong.  So the financials have limited applicability to hard number crunching but are very telling of how the management is thinking about their business. 

7. How big the market is

This one is pretty self explanatory.  Bigger equals better for valuation.

8. Potential acquirers

Again, this should be easy to understand.  If there are many natural acquirers for your company, this only helps in the valuation discussions. 

9. Competition

Valuations received by your competitors can potentially make a case for you receiving a similar valuation or at least have a small "market" to compare your company performance to.  This argument is of different importance depending on who your VC is.  Some care a lot about competitive metrics and some don't value them at all. 

10. Current economic climate

Bad climates normally lower valuations.  It seems to effect later stage fundraising valuations more than early-stage transactions. 

11. Previous deals

A particular VC's experiences and biases will have a large effect on valuations they will present you.  Part of a VC's job is to be good at pattern recognition.

12.  Other

There are other things as well, including the tried and true "I know it when I see it" analogy.  Part of all of these exercises are truly black box. 

Please note that I cannot give specific advice to folks on how much their company may or may not be worth.  I only know one thing about attempting this exercise - I would be wrong.  And you would not be happy with me.

It takes our group many meetings, much diligence and market analysis in order for us to arrive at the valuations we offer potential portfolio companies and even this is not an exact science.  For me to attempt this exercise for a company that I am not deeply involved with would be futile.

At the end of the day, it's all about getting a transaction completed and whatever that number ends up being, is a rough approximation of what the company might actually be worth at that point in time. 

Or maybe it's completely irrelevant.  :)  But at least you got funded.  Good luck out there.

Can governments become good VCs?

by Ouriel Ohayon

There is a new trend i am observing in the VC industry: governments are trying to get into the business. In Israel this is something that has been there for a while with the Chief Scientist organization, which is a good complement to institutional VCs as we know them.

Today the Guardian announces that the UK government is announcing a 1 billion pound fund to support technology startups. After having twitted that news i received several answers that this is something that is also happening at different scale in other European Countries: in Spain (a 50/50 private/public fund is being created), in Ireland this has been started a year ago but seems to take place, France has tried to implement that with some "special credit system" but this is not really a VC, and i heard several rumours they are considering creating one.

So is this the new trend? Are government getting into the VC business for real? Is that a good news?

I know in Israel this has been a good supporting arm for innovation, but not enough. I think this is a good news for early stage startups that will find a new source of financing in those tough times. But a good VC/investor is not just about money. Expertise and industry network are also key. Investing is a tough full time job. After two year, i am only beginning now to understand what i should understand. If governments want to get into VC they ll have to accept the rules: management speed, light decision process, openess,....Which is quite different from how most governmental institutions are run.

Another way to look at it would be to consider governement as LPs (Limited Partners) that would invest in current existing VCs and let those who know do their job. But this also has to be done carefully and make sure it goes to VCs that have a good track record.

I am afraid that this apparent good news, will put on life support companies that should die anyway because they are not sustainable. If those government funds are working like a financial medication system without smartness added to it i am afraid this will only delay what should already happen: the disappearance of unsustainable companies. On the other side i think there is a great opportunity here and i think that if done right (expertise, connection with existing VC world, ...) this could be a great asset for any country working on it.

Tomorrow i am moderating a panel at LeWeb on funding during recession with Top investors/VCs like Fred Wilson and Jeff Clavier. This is one the topic i will address along. It is part of a bigger chapter entitled: new funding sources for entrepreneurs in which you can also find Corporate VCs (Google, Intel, Blackberry fund, iFund, Facebook FbFund...) and Universities (Stanford,...).

Which investors to avoid

by Georges van Hoegaerden

For over 10 years I've built and managed growth for early stage innovation in Silicon Valley and more than ever do I believe that building real disruptive customer value is more important than trying to time an acquisition opportunity. You may too, unless of course you are a gambler and firmly believe that the $3 red-white-blue slot machines in Vegas consistently yield the greatest returns. I will not argue the outcome.

Acquisitions remain nothing more than a welcome diversion on your way to building the largest technology empire. And even now when IPOs have dried up any focus away from building your empire is damaging. Real disruptive innovation is resistant to economic aberrations and a consistent focus on customer value remains your only rescue.
I believe that IPOs for technology companies will return (and subsequently spur more pre-IPO acquisitions), albeit not with the same players. Real companies can only be built by real entrepreneurs, with real disruptive products supported by real investors. New participants (on both sides) with higher moral values will be the ones to restore trust in the technology industry and subsequently public stock markets that want a piece of it.

Today, the VCs are stuck with a product of their own aristocratic making. Commoditization of investment philosophies since the 1990s has generated technologies that can best be described as sexy-cool rather than disruptive and meaningful (with a few exceptions). It paved the way for get-rich-quick entrepreneurs that are skilled in feeding the dogs the dog-food, rather than support the real entrepreneurs that have a dissenting view of the world.

So, assuming you as an entrepreneur are for real, how would you recognize an investor that is not. Here are some of my anecdotal recommendations:

1/ Avoid an investor who blames his quick response on ADD
Attention Deficit Disorder is an illness, not a skill. Recommend the investor to consult a doctor.

2/ Avoid an investor who does not carry (or seriously considers) an iPhone
The iPhone is the biggest innovation in consumer electronics in my lifetime (so far) and if your potential investor does not understand its ramification to the technology ecosystem as a whole, it is unlikely he will get yours.

3/ Avoid an investor who cannot price your company ahead of you.
Any technology investor should be able to price the value of your disruption. Ask the investor for the valuation and if he is close to your target, you can share with him your cost model and where you are today on the trajectory. Cost model and stage (the risk) are a discount to the disruptive value, the ability to build the technology is merely a commodity. In Silicon Valley technology is not the risk, but market entry with sufficient disruption is. Walk away from investors that incorrectly evaluate the risk model.

4/ Avoid an investor whose partners you can't stand
Investors in a fund make decisions collectively, they need partner consensus before they can invest - just like in politics (more on that later). A firm with a partner you don't like should be taken off your VC prospect list, as you cannot risk the influence of the bad apple to your company's future. Develop your personal blacklist (as we did) based on fundamental people principles.

5/ Avoid an investor who wears his education on his sleeve
Wearing a Super Bowl ring means you made it in the real world, wearing an Ivy League ring does not. I wholeheartedly agree with Craig Venter that later stage education (without operating experience) in general is a deterrent to creativity and innovation or the ability to spot and spawn it. The majority of Silicon Valley investors are remnants from a bull market, echoing beliefs that are founded on skewed business principles.

6/ Avoid an investor who asks really dumb questions and is proud of it.
I never thought dumb questions existed until I ran into one investor who proudly blogged about how other entrepreneurs simply walked away from him, making his life easier. We walked away from him too.

7/ Avoid an investor who thinks he knows your industry better.
Even in the unlikely scenario he does, you should still walk away. Investors that know industries better than the entrepreneur should have become one. So either the investor is better informed (which should send you back to the drawing board) or he thinks he does (which becomes a pain in board meetings). Investors see a lot of things that don't work, rather than discover the opportunities that do.

The bottom line is that we recommend entrepreneurs not to squander their great ideas with the first investor that waves money in their face. Real disruption does not become extinct quickly and so you literally have years to find a great investor out of the 790 firms that exist in the United States.

Thankfully the get-rich-quick money schemes in technology are drying up, so make sure you, as the entrepreneur, also have the integrity to build real disruption that spawns real and lasting customer value for years to come.
I look forward to helping develop new investor 2.0 and entrepreneur 2.0 strategies with you.

Advice for startups seeking venture capital

By John Tozzi

Landing venture capital is tough for startups, even in a good economy. But given the ongoing financial crisis, how hard is it for early-stage companies to get funded right now?

Venture capitalists say entrepreneurs face a much higher bar than in recent years. They liken the downturn to a period of natural selection, when weak businesses will fail but strong ones will prosper. New companies that prove themselves now, they say, are better positioned to thrive when the economy recovers.

"Almost by definition the entrepreneurs who have the moxie to walk through your door in tough times tend to have better ideas," says Mike Goguen, a VC with Sequoia Capital in Menlo Park, Calif. Goguen says many of Sequoia's best-performing companies have been founded around down times. Today, VCs report seeing stronger proposals from more serious entrepreneurs than in years when the economy was stronger.

Venture firms are still investing, and they emphasize that they have plenty of money to back good business ideas. But funding has slowed. U.S. venture funds invested $7.1 billion in 907 deals during the third quarter of 2008, down 7% from the prior quarter and 9% from the third quarter of 2007, according to the MoneyTree Report from the National Venture Capital Assn. and PricewaterhouseCoopers.

"The funnel for dollars is becoming smaller and smaller," says Mark Heesen, president of the NVCA. VC funds also have to commit more time and capital to help existing portfolio companies weather the downturn while the potential for exits through acquisitions and initial public offerings has greatly diminished, he says.

Cash Flow Proof

For entrepreneurs running startups, the game has changed. Speculative business models won't get funded, says Bob Ackerman, co-founder of Allegis Capital in Palo Alto, Calif. Companies need to demonstrate that their value proposition is real, and that they can hit measurable benchmarks toward generating revenue and positive cash flow, he says. In an environment where consumers and businesses are cutting spending, entrepreneurs need to ask, "Is this a company that absolutely must be started now? Or could this wait a couple years with no apparent penalty?" Ackerman says.

Startups also need to prove they can build lean organizations that use the money invested efficiently to get to profitability, says Pascal Levensohn, founder of Levensohn Venture Partners in San Francisco. "A year ago, somebody would have walked in and have been told that they shouldn't be asking for less than $5 million for a Series A because otherwise it's too small to get institutional venture capitalists interested," he says. Now companies should be prepared to discuss the minimum amount of money they need to validate their business models. Once the concept is proven, Levensohn says, larger follow-on investments can help it scale.

Entrepreneurs seeking investments should also be prepared for lower valuations. As other sources of financing vanish, VCs enjoy a buyer's market and will expect a larger share of equity from companies they invest in, says Heesen. It's a silver lining for venture funds: "There are very, very good deals out there if you have the time and the money to be investing in them," Heesen says.

Timing It Right

With that in mind, some entrepreneurs are waiting longer to raise capital if they can afford to, says Divya Gugnani, entrepreneur-in-residence at FirstMark Capital in New York and CEO of culinary Web site Behind the Burner.

"The value of their company goes up when they spend six months or a year getting it off the ground," says Gugnani, who is also a venture capitalist. Startups that can bootstrap long enough to turn their ideas into products and demonstrate revenues will get better valuations, she says. "More people are being more intelligent about when to raise the round."

Companies with enough capital right now should use the downturn to strengthen relationships with customers and potential future investors, says Aassia Haq, CEO of online talent marketplace Alumrise. She says her four-person Plano (Tex.) startup has enough funding from angel investors to operate well into 2009, and she is not actively trying to raise money now. "We start with fostering ties and relationships, and those things take a long, long time to come to fruition," she says. "I think a great investment in this economy is to continue to meet smart people face to face."

But those startups strong enough to succeed now shouldn't wait to seek funding just because of the economy. "Please do not think that because the economy's bad it's a bad time to start a company if you have the right idea," says Sequoia's Goguen. Businesses born during the downturn will need to operate more efficiently and deliver more value to customers than companies launched during boom times, but they'll be stronger for it. "The toughest environment forges the strongest companies, and the toughest entrepreneurs are the ones who tend to show up these days," says Goguen.

A tip for entrepreneurs raising money: Don't make an investor wrong

by Andy Sack

I recently had a conversation with an entrepreneur about possibly investing in his company.  The entrepreneur asked for my opinion on the opportunity.  I told the entrepreneur I was interested in the business but wasn't willing to invest yet because he hadn't brought the cost of customer acquisition down enough (i.e. he needed to innovate on marketing). 

His reaction turned me off: he spent the next 5 minutes telling me why the cost of customer acquisition didn't materially matter and why I was wrong....or focused on the wrong thing. I appreciated his spirit of argument....but I really didn't want to argue with him.  (Differing opinions are welcome but argueing is a pain in the ass)

I wanted to interrupt him and tell him that my opinion was just that -- my opinion. It's neither right nor wrong....but whatever you do, don't fight with me and position me as wrong. I'll just retreat.  It's a delicate balance for an entrepreneur to make a convincing pitch in any environment and that balance has gotten harder to maintain in this environment. However, it's all the more important to make sure you guide your investors to coming to the right conclusion -- a big part of keeping that balance is making sure that you give the investor the space to have their opinion, to change their mind, and ultimately to make a choice of whether to invest or not. 

Business plan on a napkin?

by Larry Marshall

So I'm sitting around the corner from our office, having breakfast at Il Fornaio, listening to the conversations around me and watching the entrepreneurs pitch the VCs on a Tuesday morning--The entrepreneurs are the ones carrying laptops and waiting impatiently – the Aussie entrepreneurs are the ones in suits ;-). Dado is here on time and talking animatedly about a new chip idea, sketching a business model on a napkin as the entrepreneur looks on and then starts to argue back ... its an interesting lesson in valley culture – VCs adding value? If you sit here every day for a month, I swear you would get a completely different view of how to pitch, plan, and execute a business.

There are basically seven things VCs focus on in evaluating a business: Team, problem (customer's pain), solution (product), opportunity (size of pie), unfair advantage (technology or biz model), and competition. I know that's only six ...

You should be able to communicate all these in a first meeting, with 10 Powerpoint slides (and one of those 10 is the title slide). You know the Samuel Clemens comment "I had send a long letter because I didn't have time to write a short one." It's very hard to encapsulate a business into 10 slides, but even harder to do so in a single sentence, or on the back of a napkin.

This does not mean you replace the business plans of old (well I for one could do without the 25 page appendix of financials that never turn out anyway), but the objective of your first meeting, is to secure the second. I know a famous VC here who, when confronted with confusion from an entrepreneur, will say "stop, here's my business card, I'm going to the bathroom, while I'm gone write your business plan on the back and we can review when I get back."

If you can do this (or on an Il Fornaio napkin), then you really understand what's important about your business – that crystalization is what makes it worthwhile, it's what shows them your ability to focus on the art of getting things done and subsequently gets you funded (or at least into the next meeting).

Now there are well prescribed formats for VC pitches – look at any VC website. And I agree that a common structure makes it easier to focus on what's being presented, but I also think a pitch has to be tailored to the style of the person giving it – if you present someone elses idea of a pitch it will diffuse your passion and make you less credible. Last week I listened to the same pitch more than 10 times given by each of two founders; it was amazing how credible the technical founder sounded when talking about how he developed the product by spending 10 years in an industry creating the same solutions for customers who didn't really understand what the underlying problem was – he described the epithany (the "ah-ha" moment), and it fell into place – he was not polished, not stylish, and he didn't even use the carefully manicured slide deck, but these were actually getting in the way of what he wanted to say.

You must be customer-centric. If you can answer every question about your business from a customer's point of view, you will not only show that you understand who is really funding your business, but also that you are already moving from the typical tech leadership of a startup to the customer intimacy phase of a rapidily evolving company.
Remember, given that most humans (who said VCs were human?) can only remember three things from any presentation, you are up against it trying for seven, so make it easier with a few focused slides and well chosen words ;-)