Lifestyle vs. Investment and Angel vs. VC

by Tony Wright

Last night I spoke at Seattle Tech Startups. Given that lots of people who go to these meetings tend to be wantrepreneurs (aspiring startup folks), I focused on early decisions that need to be be made. Do you shoot for a great lifestyle business or do you aim for a grandslam? Services biz or product biz? Bootstrap it, find angels, or court VCs? And when you answer all that, how do you settle on an idea when you have lots of them bounding around in your head (for this part, I liberally borrowed from Ev Williams’ great post on evaluating startup ideas, which I posted a riff on a while back).

After my short presentation, there were some really fabulous questions. Two of 'em kept me thinking and I wanted to expand on the answers a bit. Here they are.

Question (paraphrased): "Given that takinghuge piles of VC money both has the dangers you describe and and firmly closes the door on most early acquisition opportunities, why are people still going after big VC?"

My response was two-fold at the time. First, there are some ideas that require a lot of money– as an example, I mentioned a local northwest guy who is working on a really cool electric motorcycle… It'd be hard to imagine getting that business off the ground with $500k of angel money. I also mentioned that some entrepreneurs look at their valuation as a score. Taking $4m on $12m post-money is essentially saying that, on paper, your company is worth $12m. Feels pretty cool, I suppose.

Two more things to add here.

First, I think people chase VC because it's available. Angels are purposefully elusive– they don't exactly hang out a shingle saying, "I've got $50k burning a hole in my pocket". VCs, on the other hand, have a web site, and processes to handle/process deal flow. They almost always want to lead the investment by negotiating terms and putting in a big chunk of the money, while angels sometimes shy away from leading/negotiating, but are happy to pile on with other investors.

I think there is a big hole to be filled here by institutional investors who aim at a larger number of smaller deals (something that most VCs can't handle because they have too much money under management, take too long to do the deals, and have too few people to sit on boards). There are smaller funds out there that are starting to fill the "early/small" niche (with $250k-$1m investments) but they are rare and (from an outsider's point of view) are buried in interesting startups to invest in. The good news is that they're seeing great success, so more are popping up every day. If you want to see a good list of folks who are really looking at early-stage/lower-dollar deals, here's a great article profiling a few. You'll notice a decided lack of 'em in the Northwest. Madrona is mentioned but I think they very rarely do a deal less than $1m.

Second, B2B. Despite Web 2.0 hype, there is tremendous money to be made with B2B software. Going the B2B route requires a sales engine or some clever distribution innovation. If you're spinning up a sales team, that requires LOTS of money flowing out of your business (salary, commissions) before you recognize revenue for their efforts.

Question #2: "Can you talk about how to decide whether a business/idea should fall into the "lifestyle" category or the "get funding a go big" category?

My answer last night centered around overall magnitude of the idea. Could you imagine it being the next Google/Facebook/Salesforce.com? Is it that ambitious? Can you set out milestones where you end up selling for $100 million? I also mentioned that how much you NEED is important. If you can "run the experiment" for $500k to see if your market/team/idea are as good as you think, raising $10m is silly. If you can roll those same dice taking no funding and working on weekends, raising ANY money might be silly.

What I want to add: Think about how you fit into recent investment trends. Investors closely follow trends. Most seem to focus on trends and recent acquisitions that you're already reading about– the top tier ones often try to anticipate what's going to be the next trend. Imagine yourself pitching your idea to someone who religiously follows and tries to anticipate trends. Will their eyes light up? To my amateur eye trends that are important out there right now are: Ad networks, widgets, casual gaming, video advertising, iPhone/mobile apps, Facebook/MySpace apps, social aggregation, and (of course) anything that could credibly take a shot at killing Google. Am I missing any? There are a few tired trends that probably still have legs with some investors like niche social networks, social news sites, photosharing, etc.

If you're outside these trends, that's okay (we certainly are, though we think that productivity/information overload is a meme that is growing like gangbusters). It just means that you're going to have a harder time raising money and you'll need a bit more traction to pique VC interest. We're just about ready to close our angel round with a fairly platinum-plated group of investors, so it's certainly do-able. I'm just glad our founders all had hefty personal bank accounts to allow us to grow the business over the 3 months of fundraising. I know plenty of people who've needed 6-10 months to raise a round, so be prepared for that if you're bucking trends.

Remember, Google came to a market that had well-funded mature players at a time when a lot of really smart people were saying that search was a dead business where you couldn't make any money.

Another thing to consider on this front is this: Do you have some unique aspect of your business that allows you to acquire new users/customers for zero or near-zero cost? SEO, viral marketing, user-generated content are all fabulous ways to get an organic flow of visitors to your product. VCs love clever distribution wrinkles, and most successful startups have a fabulous (if sometimes accidental) story to tell here.

And finally– the best way to decide whether it's a small biz opportunity or a huge business opportunity is to launch. If you've got something big, the market will start dragging you down the growth path. If it's a big opportunity and you're growing like gangbusters out in the wild, funding isn't hard.

Financial Modeling Tips For Early-Stage Startups

by Furqan Nazeeri

In the very earliest stages of a company building a financial model can seem like a pointless task.  After all, how can I possibly forecast the future?  Garbage in, garbage out, right?

Wrong.

Building a financial model is an important milestone in the life of a successful business.  It means that you have focused in on a particular revenue model and sized the scope, schedule and budget for achieving your business goals.  Having the model gives you the ability to identify, delegate and manage specific tasks while being able to tie them to the big picture.  It gives you an answer to questions like, "why do we have to release v1.5 next month?" and "why can't we buy a booth at this trade show?" 

Don't fall into the trap of thinking that a financial model is "for the investors."  It is, in fact, for you and your team.  It's how you will eventually make money and achieve your dreams.  So with that background, here are a few tips on financial modeling:

1. Don't reinvent the wheel.  Financial models and the basic building blocks thereof are readily available online and through friends and colleagues.  Don't waste your time trying to reverse engineer the fully burdened cost of employees, hosting and facilities.  Instead, use actual costs from comparable startups.  One of the best examples of comparable data is from Redfin posted by Guy Kawasaki.  There are many other good sources.
2. Start from the output and work backward.  For your initial model, you could easily create a 10MB model with 50 worksheets and Monte Carlo simulations, but it will never see the light of day.  Save this for later.  Instead, start with the output first, which in this case is a 30-50 page PowerPoint deck and pro forma financials (income statement, cash flow statement and balance sheet).  You can begin by developing a "blank slide" presentation as well as pro forma financials.  For the presentation, you'll want to identify each key driver of your business on the revenue and cost sides.  On each slide, you should be able to write one sentence or a couple bullet points that explains the key driver.  For the pro forma financials, focus on what line items you will be showing and the period of time over which you will be forecasting.  Once you have these templates, then get to work building the simplest possible model that allows you to reasonably complete the slides and financials.  Your model should have an "assumptions" worksheet that allows you to tweak the key drivers you identified earlier.
3. Be conservative.  There is nothing worse than raising money based on a wildly optimistic plan you hoodwinked some investor into believing.  You won't last past the first year as CEO (and deservedly so) because you'll end up missing plan badly.  It's not sandbagging, it's called reality.  There is a lot of pressure to build a model with $100MM of revenue in Year 5 because that's what VC's fund, but most businesses cannot realistically project this.  If your car has a 4-cylinder engine, don't enter it into a drag race...instead focus on raising money that matches your realistic expectations for the business.
4. Vet your output with trusted third parties.  Once you have your model (remember the output is not the mambo Excel spreadsheet, but rather the presentation and the financial statements) you should set up a few sessions with some experienced entrepreneurs and investors.  Go through the model and be brutal.  At my last company, we called this process "8-Miling."  If you've seen the movie 8-Mile, you know that the climactic scene at the end of the movie has Eminem saying everything bad about himself to his competition instead of letting them say it.  Do yourself a favor and 8-Mile your business before potential investors do it for you.

Top Ten Tips for Navigating Venture Capital

by ChrisFralic

Recently I had the opportunity to be part of a panel at DreamIt on Venture Capital.  The audience was mostly made up of fresh entrepreneurs who hadn't raised money before, so I came up with a Letterman-style list of Top Ten Tips based on my experience of talking to hundreds of companies each year.  Here they are:

10 – Introduce yourself properly – not only when you're in a meeting (names and roles of each attendee before you start), but be sure to use your company name in the subject of introductory emails.   It's always best to be introduced by someone who knows you and knows the firm.  

9 – Show you know something about the firm– Ask a question about how something relates to another one of their portfolio companies, or show that you know something about the firm or person – a little preparation will help you stand out.    If you're sending a blind email, you should explain why you think it might be a fit for this particular firm before you start in with the pitch.  

8 – What problem are you solving?   I think this is one of the most important issues to cover early in any discussion, yet far too often companies don't clearly articulate the problem they are solving in the market.

7 –"I Don't Know" is a great answer to a question if you don't know – Josh's post couldn't say it any better.

6 – Ask about their process – let them tell you what the appropriate next steps are and timing, and let that drive your follow up.

5 – Follow up on introductions – If an introduction is offered, you should treat it seriously and make sure you connect with the other person.  This is often how VC's get feedback from other people they trust, and not following up sends a bad signal.  

4 – No Big Files – If the executive summary or initial meeting PowerPoint presentation is too big (I'd say 3 MB is a reasonable limit), try sending as a PDF instead.  If you must send a large file, better to use a service like this.  

3 – If it's not a fit, ask for advice.    It's fair to ask what the VC would do if they were in your shoes: ask them for their suggestions on other approaches you might take with the business or with the fundraising.

2 – If they say no, be gracious.   The term in venture capital is that they will "pass" on the company – if you hear that it's best to be courteous, ask for any advice/feedback, and move on to the other VC's you're talking with.   Sometimes a company hears no from one partner, and attempts to restart discussions with another partner in the same firm. That’s up to you - I've seen it tried a number of times, but never successfully.  

1 – Make it easy to reach you - include your name, company, email, and phone number – Put it on the first and last page of your presentation, put it in your executive summary, and put it in your email signature.  

Why You Should Avoid Finders

It may be tempting to retain a broker for your next round of venture capital financing, but doing so might damage your chances

by Tom Taulli

When looking to raise a Series A round of venture capital, it's common for entrepreneurs to attend networking mixers. You'll probably find a couple of venture capitalists, and I recommend you engage them. But there are likely to be many more finders (also known as brokers or placement agents).

If you talk to them, I'm sure they'll quickly make an appealing pitch. The finder will mention that his or her golden Rolodex is full of top-tier venture capitalists and high-net-worth individuals. In fact, there will be no upfront fee. Instead, compensation will be based on a percentage of the amount raised, which is called a "success fee." This can range from 1% to 10% or so.

Even though this is tempting, be cautious. You could actually be making things worse for your financing efforts.

Finders' Limitations

First, unless the finder engages in limited activities, there may be violations of federal and state securities laws. For example, financial intermediaries must register with the Securities & Exchange Commission as broker-dealers to raise capital for clients. This involves extensive filings, fees, examinations, and audits.

So what can a finder do? Simply put, the role should be to make introductions. This means it's advisable for a finder to avoid working on presentation materials, talking about the merits of the investment, or engaging in negotiations. Finders can sometimes make misrepresentations or even fraudulent statements, which can imperil a company.

Something else: The securities regulators do not want finders to receive success fees.

True, it's probably a good bet that the government will not crack down on your financing, but the risk is there. If you become enmeshed in a regulatory investigation, the legal bills could become enormous. A probe also could result in fines, cease-and-desist orders, and even a rescission right, which means investors can get their money back (with interest).

VC Are Wary

Moreover, if a finder links you with a qualified venture capitalist, the fee will likely be in the form of equity, which will probably dilute the ownership of the founders. Simply put, VCs do not want their investment dollars to go into someone else's hands (especially to finders).

So it should be no surprise that VCs are wary of dealing with finders. Peter Rip, who is a VC at Crosslink Capital, says a finder sends a clear negative signal: It's equivalent to sending a business plan via e-mail to a VC's Web site.

How about using an investment banker? While there won't be any regulatory issues, the problem remains that investment banks focus on later rounds (Series D and E, for example), and as a result, larger amounts ($20 million or more). Moreover, they usually charge large retainers, which can run $25,000 or more per month (and yes, there are also success fees).

O.K., so what can an entrepreneur do to get some help? Well, there is an alternative to finders. Keep in mind that VCs look for deal flow from trusted people, not hired guns. Such connections may be retired executives, entrepreneurs, and even other venture capitalists.

Build Relationships

To this end, you can establish an advisory board (BusinessWeek.com, 2/1/07), normally compensated at a fraction of what a board of directors is paid, which you can use as a way to build relationships with key people in your industry.

Make it clear to your network that you are in the process of raising capital and that you need some warm introductions to qualified VCs)(BusinessWeek.com, 7/14/08). Again, limit these to only introductions. For the most part, VCs want to hear the pitch from the founders.

Jason Green, who is the founder and general partner at Emergence Capital, told me that advisory board members are a key source of deal flow—and that the highest-quality ones are former executives of companies Green has funded.

To incentivize your advisory board, you should obviously provide some form of compensation. This is usually done using stock options. A typical approach is to make a grant that vests over a four- or five-year period. Furthermore, the equity amount ranges from 0.25% to 2% (depending on the stature of the board member).

Finally, you should also consider your angel investors, who might be active in the VC community (and certainly have a vested interest in getting more capital). Consider the example of Sam Blackman, who is the CEO of Elemental Technologies. One of his angel investors made an initial contact to Voyager Capital, which ultimately led to the firm co-leading a $7.1 million Series A round.

Should I Pay My Lawyer A Success Fee For Venture Capital Intros?

by Jason Mendelson

Q: My lawyer is asking for a "success fee" for a referral to a potential investor in my business. Since he'll be doing the legal work, he's offered to charge only 3% on the amount funded (solely from this one contact) as opposed to a 5% that a typical investment banker would charge (even though he's not an investment banker himself).

As this is the first venture I'm actually raising capital for, I am simply unfamiliar with this practice in the legal world. Is this a common industry-wide practice? Should I be wary of this offer? Although I don't feel like he is trying to take advantage of me in any way, it does feel a bit like he's trying to double-dip.

A: (Jason)  Without sounding too unprofessional, I want to vomit.  This is egregious behavior by your lawyer and you should not accept paying ANYTHING to him for introducing you to potential investors.

First of all, it's part of a lawyer's job to introduce you to any investor contacts he may have.  If you get funded, he gets paid and gets to bill you throughout the lifetime of your company.  If you don't think he is already making enough money, see my post on start-up lawyer compensation from my personal blog. 

Second, while investment banks may offer you a deal at 5% (and in my experience this can be negotiated down), individuals who find money for you (normally called "Finders") normally charge in the 1-2% range, so his quote is at least 50% too high.

Lastly, venture capitalists prefer to invest in deals without finders.  We don't like funding a company that has to pay someone part of the deal proceeds.  We want our money to be used to operate and grow the company.  You will see many VC term sheets that have provisions that specifically call out the absence of finders fees. 

So yes, your lawyer is double dipping.  And that is stating it very nicely. 

Rate your VC - The elements of a great venture capitalist

The Science & Art of Term Sheet Negotiation

by Furqan Nazeeri

I recently got some comments on a blog post I did a while ago from Yoichiro "Yokum" Taku, a partner at Wilson Sonsini Goodrich & Rosati and the blogger behind Startup Company Lawyer, on my post about evaluating one or more term sheets.  By the way, SCL is a great blog and I highly recommend it as a resource.  If you're looking for a quick education on startup legal issues so you can have an efficient conversation with your own attorney, this is the place to go.

Yokum gave me the following feedback:

At first glance, my initial feedback is that you have overvalued the RORFR/Co-sale and (non-cumulative) dividend rights.  All deals have a ROFR/Co-sale and they are rarely invoked as a practical matter.  West coast deals have non-cumulative dividends, which makes a dividend preference meaningless.  Also, I think that the relative weighting of liquidation preference and anti-dilution is a bit off.  I think that liquidation preference is significantly more important than anti-dilution.

This got me thinking that I should report my original treatise and see what folks think.  So have a read of the below post.  What do you think?

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By the time I was in the 9th grade, I had been playing chess for a few years (as in I knew the rules) but I didn't play seriously and more often than not I lost.  Then one day at the library (remember, pre-internet) I happened to find a book on chess.  So I read the book and almost overnight I became one of the chess "stars" in high school.  In one of the funnier incidents, I started playing chess during lunch hour and was "hustling" money which on one occasion resulted in a kid pulling a knife on me after I relieved him of a few bucks.  True story.

What was it in that book that allowed me to take advantage of the situation?  Well, there was a lot of basic stuff, some general rules and even some strategy, however, the most useful bit of information, initially, was a table on the relative value of pieces.  You know, a pawn is worth 1, a knight/bishop 3, rook 5, a queen 9 and the king "infinite" unless it's the endgame then it's more like a 4. Experienced players have a "feel" for this from many games played and they can also break the "rules" by, for example, sacrificing a queen for a rook to get better position.  But these are all things learned from experience and best not tried by a novice.  If you are new to the game, you have no idea.  When you are starting out, having some rules of thumb can make all the difference between winning and getting hustled.

What does this have to do with negotiating term sheets?  Well, I think a lot of newbies get hustled when negotiating term sheets because they don't know the relative importance of the various terms.  Have you heard the joke about the VC who says, "I'll let you pick the pre money valuation if I get to pick the terms?"  My goal here is to provide a framework that gives relative value of various terms on a term sheet and allows you to compare them on two dimensions: economics and control (or as my friend Noam Wasserman likes to say, "rich" versus "king"). In the same way that a chess grand master doesn't need rules of thumb from someone else, if you're a seasoned negotiator of term sheets then this is probably equally useless.  And no, this is not based on any academic or scientific study.  It's based on my own experience and, more importantly, that of a few other experts like Dave Kimelberg (Softbank's GC). 

In my view there are 12 important terms on a typical Series A / B term sheet.  Yes there are other terms and yes sometimes they are important, but if you go with the thesis of keep it simple, then 12 is the magic number.  In terms of rating, the rich/king differentiation is important as different people are after different things so depending upon your motivation you may be inclined to pay more attention to one column than the other.  So without further adieu, below is a table showing them as well as the relative importance:

Here a 10 means it is really important to get as favorable a result as possible on this term, a 1 means it is not so important and a "-" means it doesn't apply (i.e. a zero).  The cool thing about having something like this is you can use it as a tool to compare term sheets (provided you can determine how favorable or unfavorable each individual term is...more on that below). 

The next part of this post is to provide a range of typical results for each term which will give you a means to rank each term in each term sheet with a "1,3 or 5" where 1 is "unfavorable", 3 is "fair" and 5 is "favorable."  If you aren't already familiar with the terms in a term sheet, you should check out the model term sheet (basically a template) put together by the National Venture Capital Association. They have other model agreements too, but you will see with the term sheet that they include various options, some discussed here.  Below is a scale for each of the 12 key terms across the two dimensions:

1. Investment/price.  I think there are two ways you can rank price.  One is to rate it relative to your expectation and another is to rate it relative to similar companies (in terms of stage, geography, sector, etc.).  If you don't have comparables, you can fairly easily get them, for example Dow Jones puts out a quarterly survey of VC deal terms which includes pre-money valuation (send me an email if you want a copy).  If you're less than 80% of your benchmark, that's probably unfavorable, if you are within +/- 20% than that's fair and if you're over 120%, then it's favorable.
2. Board of directors.  This term comes down to simple math.  If you give up and don't have control of the board, that's unfavorable, if it's tied, call it fair and if you control it, that is quite favorable.  BTW, the reason I didn't rate the board control a "10" on the "king" scale is because even when you give up control, your board members are bound by fiduciary obligations to the firm, i.e. they can't do whatever they want.
3. Option pool refresh.  Often time this will show up as a separate term in the term sheet, however it is actually just another bite at the apple in terms of price. Traditionally there is a refresh pre-deal so that after the round the company can execute on its hiring plan without needing to expand the pool for 12-18 months.  You will have to develop your hiring budget if you haven't already.  Given that benchmark and your hiring equity budget, I'd say less than 12 months is favorable, 12-18 months is fair and more than 18 months is unfavorable.
4. Preemptive rights.  As you know, preemptive rights give your investor the right to invest in future rounds.  This is of moderate economic value, however you are giving up some control of future financings.  There is remarkably little variation in how this term gets negotiated, probably because of its relatively low importance in the grand scheme.  I'm told the only area that gets negotiated is whether the investor has an "overallotment right" whereby they can take a portion or all of the pro rata of another investor in the same series who didn't participate.  That said, unless something unusual is in your term sheet, it's probably a 1 for rich and 3 for king.
5. Anti-dilution protection. Anti-dilution is a pretty important economic term.  In terms of the range of possibilities, no anti-dilution would be a 5, broad-based weighted average would be a 3 and full-ratchet would be a 1.  I think the vast majority of deals end up as broad-based weighted average. Very few deals avoid it altogether, but it can be done, particularly in later stage or very hot deals.
6. Registration rights.  Reg rights have some economic value and in theory you do give up some control, but in reality they're close to worthless.  You can push on these and most investors will give in when pressed. You can negotiate when the right kicks in and cutbacks.  But bear in mind that investors will love it if you waste time negotiating this because it is not an important term.  Unless something unusual is going on, I'd rate this a 1 on both dimensions.
7. Drag along rights.  Most deals include drag along rights and like many of the other terms, the key is in the voting thresholds.  I rated this a 1/5 on the rich/king scale. In terms of economics the issue is with regard to a sale of the company where the preferred stock, because of special rights, is indifferent to a deal that would be better for Common.  However, the bigger issue is on the control side of the equation where you could get dragged into a sale that you don't want to do.  So in terms of rating both the economic and control sides, I would say that if the thresholds are such that a single investor can unilateral drag along, that's a 1, if it takes 2 or more investors that's a 3 and if it takes investors plus either a neutral party or Common (you) then it's a 5.
8. Right of first refusal / co-sale. I rated this a 5 because this is essentially a "lock-up" on the founders stock which seriously affects liquidity and thus value.  It doesn't really affect control issues.  If you read the actual section of the stock purchase agreement that describes this term it's several pages of bureaucratic procedures for a sale that in the real world you can't imagine ever occurring (which they don't).  As a result, the only real counter party for selling common stock is the other investors or the company with the investors approval and they're all quite likely to low ball.  Unfortunately, I've never heard of avoiding this term completely, so in terms of how to rate it, I'd say that if you can negotiate a right to sell some portion (say 20% on an annual basis) you're at a 5 otherwise if it's a standard lockup then you're at 3.
9. Dividend right.  I rate this a 5 on the economic scale.  In terms of the range, there is no dividend which is a 5, then there is a simple interest dividend which I'd say is a 3 and a 1 would be a compounding dividend.  For some reason, the dividend rate has been 8% ever since I've seen term sheets.  You can negotiate the rate, but the bigger battle is whether you pay a dividend and how the rate compounds. 
10. Liquidation preference.  This is a very important economic term that doesn't have any importance in terms of control.  The issue here is during a sale, how do investors get paid out.  I'd say about 1/3 of deals have a preference at 1X but no participation, another 1/3 have a preference with a cap and participation and the balance a preference with no cap plus participation and that's pretty much how I'd rate it, i.e. 5 for 1X preference/no participation, 3 if with a cap in the 2-4X range and 1 if with no cap and participation.
11. Protective provisions.  This is very important from a control perspective but not so economically. While there are a ton of these protective provisions, the key ones relate to sale/merger of the company and future rounds of financing. As with other control rights, the key is in the voting thresholds so I'd assess this the same as 7 (drag along rights).
12. Redemption.  Finally, we get to number twelve, redemption rights.  This is an almost worthless economic right.  I've never seen or heard of this being exercised and most investors will acquiesce if you push on this.  Unless you see something unusual, I'd rate this a 3.

Ultimately the individual rating combined with the overall importance of each term will allow you to create a weighted average total for each term sheet on both the rich and king dimensions.  While you wouldn't want to make a decision to take an investment on this alone, it will give you a basic idea of where the strengths and weaknesses of particular term sheets lie.  It also gives some tips for negotiating.  For example, you don't want to waste your time negotiating redemption rights and attorney's fees and instead, you want to go to the core of what's important to you on the rich/king scale.

Finally, I'd love to hear feedback from folks.  How would you change the ratings?  Are their other key terms?  Feel free to comment on this post or send me email.

Venture Capital Loves Virtual

by Stacey Higginbotham

Startups selling virtual goods and offering virtual experiences are raking in the venture capital these days. Perhaps it's the fact that virtual gifting hit the mainstream in 2007 or because people are worried about the impact of business travel on the environment, but the virtual world is beginning to get its share of real dollars.

In the first half of 2008, virtual worlds raised $345 million in venture investment, according to data from Virtual Worlds Management, a media company that covers the industry. And while it may be easy to dismiss the virtual economy as frivolous or scoff at the idea of attending a virtual trade show as useless, deriding the intangible misses a crucial point about today's culture: A lot of it is happening online.

From World of Warcraft to relationships built on Facebook or MySpace to intensely personal blog entries, we are using the web to extend our real lives into virtual ones. It makes sense that an army of startups will follow us there, ready to supply us with tools that make our virtual lives more productive or enhance our virtual status. So even as Google struggles to monetize video advertising on YouTube and social networks pray for higher CPMs, there is money to be made selling virtual swords and trade show booths.

Given that gaming, all the way back to Dungeons & Dragons offline to World of Warcraft online, has long pushed the envelope when it comes to building virtual worlds, it's easy to see why their players are among the most comfortable buying and selling binary-based goods. Since games are where a lot of this began, it's where a lot of investment dollars continue to flow. Earlier this week, Social Gaming Network netted an investment, the value of which was undisclosed, from Amazon Founder and CEO Jeff Bezos' personal fund. SGN creates games for social networks such as MySpace and Facebook, and makes some of its revenue from the sale of virtual goods.

Last week Challenge Games, the Austin, Texas-based startup behind the popular casual role-playing game Duels, raised $4.5 million in a first round funding. Ironically it started its very real relationship with its newfound venture backer, Sequoia Capital, after a Sequoia partner attempted to purchase a pack of virtual armor. More than swordplay, sparking those real-world relationships is where the future of virtual worlds is headed as socially networked and digitally savvy generations rise in the corporate ranks.

Research firm eMarketer expects the number of teen Internet users visiting virtual worlds to rise to 20 million by 2011 from just 8.2 million in 2007. Expectations like these are driving investments in virtual worlds largely populated by teens, such as the $11 million Series C round of funding Gaia Online took in this week. That world makes money by selling virtual goods and advertisements.

Despite the hype surrounding Corporate America's embrace of Second Life, which included stories about conducting job interviews in the metaverse and its very own news bureau, there is a business model around enterprises going virtual when it comes to conferences and collaboration. Just ask Cisco Systems, which has been quite busy in Second Life as of late.

According to the 2006 Meetings Marketing Report by the International Congress & Convention Association, corporations spend an average of $107 billion sending employees to conventions and in-person meetings. The number of conventions and meetings that year totaled 1,243,600.

Eliminating some of those costs — and the need to meet face to face at all — is one of the advantages of virtual conferencing, which explains why On24, a webcasting and virtual event producer, raised $8 million in funding on Tuesday. Many gamers and young adults bring their avatars into the workplace and are comfortable holding meetings online. To some this sort of communication may seem awkward, trendy or forced, but that's at least partly because an older generation of workers isn't used to managing online relationships.

The rise of the virtual won't supplant the economy and relationships of the real world, but it will augment them. However, until bringing your virtual wealth and friends with you around the web becomes easier, virtual worlds will remain fragmented and bereft of their full economic potential. True data portability could allow people to create one digital persona that travels the web, paying money to access certain worlds via subscription, but able to leave that world and still seamlessly connect with friends made there. There's still too much real-world work required to link your various avatars and social network in multiple worlds. Solving that problem is yet another venture opportunity.

VC funding either flat or falling

by Stefanie Olsen

Venture capital funding in the U.S. is either flat or dropping, depending on whom you ask.

Major VC trackers came out with somewhat conflicting reports Saturday, though neither one said that VC funding is actually on the rise.

According to one report, from the National Venture Capital Association (NVCA) and PricewaterhouseCoopers (PwC), venture capital investments were virtually unchanged in the second quarter compared with the same period last year.

Venture capitalists invested $7.4 billion in 990 deals in the second quarter, their report said.

In contrast, a report from Dow Jones VentureSource stated that VC investments dropped 12 percent in the second quarter compared with the same period a year ago, with $6.64 billion put into 602 deals--the lowest quarterly deal count in three years.

Jessica Canning, director of global research for Dow Jones VentureSource, said in a statement that despite the drop, "we still saw steady deal activity and investment in the first half of the year, which is encouraging."

Start-up funding shrinks
According to the NVCA and PwC report, more venture firms found themselves funneling money to support later-stage companies at the expense of companies seeking first-time funding. The amount of money sunk into start-ups seeking first-round funds dropped by 12 percent to $1.6 billion in the second quarter. Meanwhile, later-stage deals grew by 14 percent to $3.1 billion because those companies in particular had fewer opportunities to go public. No venture-backed company went public in the second quarter.

The Dow Jones report did not offer comparable year-over-year figures, except noting that later-stage deals came to $3.48 billion, accounting for 54 percent of the second-quarter deals.

Bright spots
Both reports highlighted the bright spots for Internet and clean-tech companies.

The NVCA and PwC report said that venture firms invested $1.53 billion in Internet start-ups in the second quarter, up 49 percent from the comparable period a year ago. Clean-tech companies attracted $883.6 million in investments, a rise of 62 percent. Investments in software, however, dropped by 19 percent to $1.25 billion.

Dow Jones said that the overall tech sector was down, but that Web 2.0 companies saw gains.

The IT industry's deals slipped 27 percent to 286 in the second quarter, compared with 390 deals in same period last year. The new figure represents the lowest deal count since the first quarter of 1997, Dow Jones said.

Likewise, the amount of IT investment dropped 26 percent from nearly $3.5 billion to $2.6 billion. The new figure marks the lowest quarterly investment figure since 2003.

The information services sector, which includes most of the Web 2.0 companies, was the only section in tech with gains, according to Dow Jones. About $688 million was invested in 80 deals, a 20 percent jump over $572 million invested in 94 deals in the same period a year ago.

Solar shines
Another highlight in the Dow Jones report was the energy and utilities industry, which included a surge in renewable energy investments with $650 million put into 26 deals--records in terms in money and the number of deals.

In fact, the three biggest VC deals in the second quarter were related to solar energy, Dow Jones said. SunEdison of Beltsville, Md., raised $131 million--and an extra $30 million in separate debt financing. Meanwhile, eSolar of Pasadena, Calif., raised $130 million, and BrightSource Energy of Oakland, Calif., gathered $115 million.

According to the NVCA and PwC report, the number of acquisitions of VC-backed companies is shrinking. In the first six months of the year, buyouts of venture-funding start-ups fell by 28 percent from the same period last year.

"While IPOs and acquisitions may be rare now, VCs aren't concerned about that," Dow Jones' Canning said. "They're focusing on what's next--and that's reflected in the healthy early stage investment we're seeing in areas like renewable energy, information services and business support services."

What do the right investors do for you?

from This is going to be BIG!

There's often a bit of anti-VC sentiment among the entrepreneurial community.  You hear how VCs just want to smash you down, force you out, control your company.

So when the news was officially confirmed that Twitter bought Summize, I got to thinking about Tweetscan.

Tweetscan came out with their Twitter search earlier than Summize--who changed their product model.   However, it was Summize that went out and took some funding ($750k) from Betaworks. 

Tweetscan seems to have remained a one man show--built by David Sterry, who remarked recently that "Running a search engine is a very hardware intensive task and it's a challenge to keep it fast while providing the results people want."  Tweetscan seemed more like a really interesting side project than an attempt at company building.  Maybe David wasn't looking for anything more.  That's fine.  It was a great project, but clearly now that Summize IS Twitter Search, it will likely become the default.  By the looks of the traffic, it already had:

Not only was Summize able to build a team, but they got some really thoughtful, well connected investors on board.  Their investors and advisors helped them with the decision to focus on Twitter search--which was a reapplication of their technology away from generalized web sentiment.  Of course, not to mention the fact that John Borthwick says specifically:

"The deal started with a conversation with Fred Wilson about how conversational search can evolve into navigation, about how important navigation becomes for UGC as you go mainstream — it concluded with the deal that was announced this morning. Betaworks is now a twitter shareholder, and excited to be one."

So, when your investor is having this kind of smart conversation with an investor in one of your likely acquirers, you're at a HUGE advantage.  This isn't someone pitching your company to get flipped--this was some pretty high level thinking (and outside the valley thinking, I might add).

So while you're protecting all your equity from those big bad investors, ask yourself the question of who's having these types of conversations with key decision makers and thinkers about your company.  "Who's a lot more experienced than I am that thinks intelligently about my company's strategy--and cares about it?"  

THAT's the kind of investor that makes the rest of your equity worth multiples of what it is the moment they take their 20-30%.

How deep are the pockets of your VC?

by John Nesheim

During fly fishing last week in a secret place in the high mountains, I had to dig deep into my reserves of patience and determination, as well draw upon extra physical stamina and clever tactics, in order to catch the fish I was so eager to land in my net. I dug, the reserves were there, and I landed some beautiful trout.

"Who is your investor?" is one of the first questions I ask an entrepreneur who contacts me with questions about his startup.

The answer I am seeking is a response to this question: "How deep are the pockets of your venture capitalist?"

In other words, how much cash is that VC willing to invest in your startup, year after year, when all goes bad, until you finally turn your hard work into business victory (a successful liquidity event).

So you must check out VC candidates before you accept money from them. Here are some questions I suggest you put to the VCs on your list:

• How much cash does your fund have left to invest before you raise a new fund? Often you will find they have only a few tens of millions of dollars remaining. That may be enough for a single two million dollar investment in your company, but what if you need three more rounds of that size before your company turns cash flow positive?
• What is your history of sticking with difficult startups that needed more rounds of financing than were planned? Look for real examples. Talk to the CEOs and founders of those companies. Quality VCs will be glad to give you the contact information so you can investigate and learn. You do not want a VC that cuts and runs (no more investment) as soon as the first bad news arrives (and it will).
• What have been the terms of bridge loans the VC has done within the past two years? Look for a VC that will explain the situation that led to the bridge loan, give you the terms and explain the outcome that followed. Top tier VCs have nothing to hide. The more you know in advance, the easier it will be for all of you when you get to doing your first bridge loan.
• Be aware that angels rarely invest more than once in a startup. They are not deep pocketed VCs, even if they are very rich. Angels are very one time oriented.
• Tiny venture firms are reluctant to put in cash to save a startup. Their fifty million dollar fund cannot afford to take such bets. But a five hundred million dollar fund will.
• Corporations rarely do bridge loans. Like never. So don't count on them to follow up on the bridge when you need them to. They will accept dilution and say goodbye, exit the board and start forgetting to answer your emails.

BOTTOM LINE: Do your research before putting a VC on your target list for your next round. There are more than two thousand to choose from. You can find those that have deep pockets. Put them on your list. They will stick with you during the hard times. They know the real startup world is mostly filled with such difficulties. And they know that bridge loans are a good way to continue growing your startup in a healthy manner. This is part of what you need to know to add to building your unfair competitive advantage. A CEO who knows how to pick VCs for the hard times is a very valuable CEO.

How to Find the Right VC for Your Company

It's critical for entrepreneurs, when targeting venture capital firms, to narrow their search based on key criteria

by Tom Taulli

A few weeks ago, I talked to the founder of an upstart tech company. From what I could tell, his company was a good fit for a Series A venture capital round. However, he wasn't able to get any interest. What was going wrong? Well, it looked like he was targeting the wrong VC prospects.

This is certainly a common problem—and can mean lots of heartache for entrepreneurs. In fact, the funding process can be time-consuming and may even distract a company.

So when you target VCs, it's critical to narrow your search based on some key criteria. Of course, you want to look at those firms with a background in your industry. That is, how many deals have they funded in your category? Next, look at those VCs that are within driving distance. While this sounds a bit odd, it's important because VCs want to be fairly close to their investments. Then study the VC success rate: How many companies have been sold? How many have gone public?

Honing Focus

Interestingly enough, the CEO of Parascale, Sajai Krishnan, used this process when securing a recent $11.37 million Series A round. When he started the process, he had a pool of about 20 VCs. From there, he tried to learn as much about each one, attempting to find those who consistently invest in his space.

This made things much easier in the funding process. After all, there was no need to educate the VCs. Instead, they were ready to talk about some granular details (it also meant Krishnan had to prepare intensely for his pitches).

Ultimately, Krishnan focused on these VCs:

• Charles River Ventures: Krishnan worked with Bruce Sachs, the general partner of Charles River Ventures. Checking out his online bio, you will notice Sachs has extensive operational experience in the network and storage industries. Charles River also invested in EqualLogic (similar to Parascale), which was sold to Dell (DELL) for a cool $1.4 billion.

• Menlo Ventures: Likewise, this firm had a notable exit in the storage industry, which was the sale of Spinnaker Networks to Network Appliance (NTAP). As for Krishnan, he worked with Menlo's managing director, John Jarve, who has been structuring investments in the communications and storage space since the mid-1980s. He was also the lead investor on a variety of IPOs, such as Ascend Communications (part of Lucent), Cavium Networks (CAVM), iBasis (IBAS), SpectraLink, and UUNET Technologies (part of Verizon (VZ)).

Database Details

No doubt, collecting such information can add up and get out of hand. To deal with this, it's a good idea to put together a simple database. There are several easy-to-use online databases to choose from, such as Zoho.

Besides fundings, you might also want to track these other details for your database:

• Company shutdowns: This could be tough information to collect but may slip out in industry trade journals or Web sites.

• M&A/IPO exits: A useful Web site for IPOs is IPOHome. What's more, Private Equity Hub has a section that lists M&A exits.

• VC partners/directors who worked on the deal: Often, they are quoted in the funding press release. I would collect their bios from the VC Web sites.

• Lead investors: They are also mentioned in funding press releases.

In fact, the last factor can be vitally important. A lead investor assembles other investors and also conducts the due diligence and prepares the necessary documents (a process that can be expensive). In other words, if you are pitching to a follower investor, you likely won't get much traction.

Finding Lead Investors

Now, to get this information, you can set up filters with online news services including Google News (GOOG) or RSS news aggregates. Keep in mind many VC fundings are published as press releases, which you can find at PR Newswire and Business Wire (both have RSS feeds).

There are also other helpful Web sites:

• The Deal's VC Ratings

• Venture Capital Update

• The Funded: This site allows entrepreneurs to rate and review venture funds (there are more than 3,700 funds as well as 17,000 investment professionals).

Of course, you can subscribe to premium services. One example, PE Data Center, has subscriptions starting at $325. With it, you get access to an interactive database that includes deal terms, corporate counsel, key company contacts, actual certificates of incorporation, investment history, and even valuations (the deals are searchable by region, calendar quarter, and business sector). To get this information, PE Data Center researches hard-to-get government filings.

Collecting Criteria

And finally, there are some other high-quality premium databases:

• VCPro Database 2008 ($119.95): There are profiles of more than 3,800 venture capital firms (across the world), which include criteria such as types of financing and geographic and industry preferences. The database is updated three times a year.

• The National Venture Capital Assn.'s Online Membership Directory: This database includes 450 U.S.-based VC firms, with contact information and investment preferences.

Ousting the Founder

by Ho Nam

I was shocked to learn this week that Diane Greene, the co-founder and CEO of VMWare was ousted. I was not alone. Except for senior management (who found out very late, the night before) the employees of VMWare read about it, just like I did on Tuesday morning.

I guess $1.3B in revenues, $14B market cap, 50% growth rate and market dominance was not good enough for the board/EMC. One slight miss in one quarter and BANG! You're out. Perhaps the board believed industry pundits and worried about competition from Microsoft. So they brought in a "heavy hitter"...former Microsoft exec Paul Maritz as CEO.

I'd guess that the more likely reason was that Diane Green was a difficult person to deal with. There is no doubt that she was a controversial CEO. It was her way or the highway and she churned through senior execs (especially in sales and marketing). She never gave much respect to the folks at EMC either (who owned the vast majority of the stock - and controlled the board).

Some other hard-headed, "controversial" founder/CEOs that come to mind are Bill Gates, Larry Ellison, and Steve Jobs. These founders may be difficult to deal with but I'd rather go with them than take my chances with a new hired gun CEO.

Over the years, we've observed that it's difficult, if not impossible, to match the passion and commitment that founders bring to their companies. It's not just a job for them. It's deeply personal. The difference in commitment is akin to the differences you might observe between missionaries and mercenaries (or hedgehogs versus foxes).

Look, I have nothing against Paul. I'm sure he's a very smart, capable and hard working guy. But this whole situation reminded me of the time Steve Jobs was ousted from Apple more than 20 years ago.

As co-founder and CEO, Diane Green built one of the all time great successes in Silicon Valley. Very, very few companies ever reach $1B in revenues. Even fewer in the technology industry. Even fewer in the software industry. And even fewer ever exceed $10B in market cap.

Why the hell would you fire her?? No, don't tell me...I've heard all the reasons. VCs oust founders all the time. I've been in plenty of board level discussions around this topic!

It's almost a rite of passage in Silicon Valley. As a founder, you start a company, get VCs to fund you, recruit a "world class" management team...and eventually, find your replacement (or get ousted).

What people seem to miss, however, is that just about every great company ever created - in technology as well as low-tech, was built by a founder (or a CEO who happened to join the company very early in its growth phase) and a team of dedicated people who grew with their companies.

I don't believe in "world class" management in the generic sense. "World class" in what??

What I believe in is people who learn on the job and become - over time - the best at what they do. Along the way, they make plenty of mistakes. But that's part of the learning (and perhaps the luck of it - because the mistakes happen to be not fatal for the survivors).

Think about it. Some examples of great companies led by founders for decades are GE, UPS, FedEx, Wal-Mart, Southwest Airlines, HP, Intel, SAP, SAS, Apple, Oracle, Microsoft, Adobe, Sun, Dell, Qualcomm, Broadcom, Nvidia, Dolby, Amazon.com, Salesforce.com, etc.

There are some great companies where the original founder(s) did not grow the company but the CEO who grew the business to $1B+ in revenues joined very early on in the life of the company (below $10mm in sales): IBM, McDonald's, Starbucks, Veritas, Cisco and Google are examples.

It'll be interesting to see what happens. Even a founder hanging on to the bitter end won't save some companies (i.e. Wang, DEC). But I'd rather take my chances with the founder who built a $1B business from scratch than go with someone new.

The average tenure of the CEOs in our three largest companies is 9 years. They learned on the job. None of them had been CEO before we started working with them. None had much experience in their industry - the market did not exist, and the technology and business models had not yet been invented. But they are guys who took us this far (average sales of nearly $90mm this year) and we will gladly stick with them as long as they still want the job.

I'd rather take my chances with the people who built the business and grew their companies than the "professionals" - the hired guns - the mercenaries - coming in, after the fact, to "fix" things or to "take it to the next level."

We tell all of our companies this - if you want to build the leader in your industry, you have to have the world's leading experts in your field working for you. But do NOT expect to find them outside of your company. Someone senior from the outside won't come in to show you the way. They won't save you.

Think about it. If you can go outside and hire a CEO or other very senior executives to come in to YOUR company and tell you what to do and how to do it - better than you - then you've created nothing special. There is no secret sauce and you have NO CHANCE of building a truly great company.

We like to tell all of our companies this - the world's leading experts in your business will be the people you develop. The young people you hire today will be your future leaders. Five to ten years from now, they will BE the world's leading experts in your business. You will have to figure it out - together - along the way.

Don't count on those mythical "world class" managers to come in to save the day. Not only are there no guarantees, I believe they will end up hurting your chances of building a special, lasting company. If you do try to hire them anyway...good luck. What I will guarantee is this - they will negotiate HARD for a nice severance package.

The Truth About Upfront Fees Associated With Obtaining Business Capital

By Jefferson Mesidor

In business financing, upfront fees are monies paid in advance to any potential lender, investor or intermediary for performing due diligence related matters, such as business valuations, accounting or other professional services to help determine the viability or risks associated with your business project or company. It can also be applied towards the closing costs associated with your funding your business project or company.

To continue, upfront fees, is one of the most controversial areas of business financing. However, if you have ever purchased any type of real estate that required mortgage financing, you would know that the mortgage company requires you to pay for the appraisal reports, home inspections, environmental surveys, and all the associated due diligence fees "upfront" prior to closing. In business financing the concept is the same.

The reason lenders or investors require you to take on all the financial risks associated with investigating your business project or company, is because they don't want to lose their money or time investigating your business project or company.

Yes, it is true that there are lots of predators out there waiting for the opportunity to prey on entrepreneurs and take advantage of their need for business capital by offering bogus services with no intent to provide the services that are being offered. However, in any legitimate business financing transaction, there are reasonable fees that you should expect to pay.

It's important to note, that when dealing with institutional or private investors it does cost them money to properly investigate and research your project in order for them to make a decision as to whether or not they are going to fund your company or business project. These costs include attorney fees, professional fees, third party valuations, and more.

Stop and think about this for a moment. If you're an investor putting up your money into any project, wouldn't you want to have all of the information that's available in order to make the best possible decision that you can?

Moreover, institutional investors and private investors see a plethora of projects every day, can you imagine what it would cost them to properly investigate and research every project that they may have an interest in? That is why the financial responsibility is passed on to you.

Furthermore, there is also that psychological factor. This serves as a safeguard for most lenders and investors. Meaning that, if there is something wrong with your project that you know will cause most investors to back off, you probably won't put your money into doing all of the due diligence work.
Always remember, that the wise investor will always limit his cost in investigating your company or business project because in the end your project may not be as fantastic as it may appear to be and investors don't want to lose money on propositions or proposals.

In my experience I have seen many entrepreneurs contact investment bankers or venture capitalists with the expectation that they will work for free. Imagine walking into an attorney's office and asking them to do work for free? Just as your lawyer, your accountant and for that matter, your doctor charges you a fee for the services offered, an investment banker, venture capitalist, etc. is also paid a fee for the services that they perform.

There are many business finance professionals who advertise various services, such as raising capital and they are paid a contingency amount for successful funding. What that means is, they are usually agents or brokers, and if they find you the capital you require they are paid a substantial fee. That fee is usually between 4% and 10%. That is fine for an agent, but it is not fine with the lender or investor doing all of the work.

In conclusion, do not be naive in your entrepreneurial journey. It will cost you money In order to obtain the capital that you are seeking. Regardless if it is long distance phone charges, travel expenses, business valuations, professional fees, due diligence fees, etc.

Like the old saying goes, "it costs money to make money". When starting or expanding your business, you can get a lot further by simply planning and budgeting in the very beginning for the costs associated with obtaining business capital.

As a young dynamic and energetic individual, I am an accomplished entrepreneur and executive, and writer. With a desire to make a difference and a passion to change the world around me.

Sample Intent Letter

by Rick Segal

I've been asked by a number of people to provide a sample intent letter of the kind I spoke about in the post regarding Term Sheet vs. Intent.  I've modified this and mixed from two recent ones to give you an idea of what they look like from our firm.  Your mileage with your VC will vary.

Dear Dave,

Thanks for taking time out of your schedule to meet with my partners and I regarding NewCo. I know a second meeting is a pain but it went very well. We think you did a good job explaining it and based on the first pass due diligence on the space, opportunity and you folks, we would be prepared to dig in more and see if there is a deal to be had between your company and our firm.

As we discussed, I wanted to outline our intent inline with setting expectations on process, major terms and your questions regarding share structure/value.

First, given the stage of your company, many of the items on the DD checklist I sent you are not applicable. We will waive the environmental hazard waiver, as a rather humorous example.  My expectation is the there are a couple of weeks of calls, material review, and analysis to do.  We have two other files being worked on, one requiring travel to the west, so there will be some interruptions to the process.  In the past, many hold ups are getting the material from the company lawyers and attorney's so I strongly suggest you send the checklist to them immediately and get them rolling. On items that are N/A, they just are so no worries.  We will need to schedule a site visit and would like to arrange interviews with the named parties that we talked about in my office.  My best guess is 10 - 12 business days to get this done at which time, assuming we are all good, we'll lock down the term sheet.  The materials can be electronic. We have a Sharepoint location you can use as an electronic data room or you can send us a CD/DVD, doesn't matter to us.

On general terms:

Assuming we do this deal, we are proposing to issue a Class A preferred share with a 1x liquidation preference, with an 8% coupon. This is a non-participating preferred share and the 8% is not paid, it accrues until the liquidity event which is usually defined as a sale or IPO.  We require board representation. It is mandated by the way our partnership is structured and is not negotiable. As I mentioned to you in our meeting, if this board seat thing is a problem, we should stop now since we can't waive this.  The size of the board is open to discussion, however my suggestion is 1 from us, a common share rep, you(as the CEO) and two independents which we agree on.

We will ask for drag along and tag along provisions which are fair to all of us. When we get to a formal term sheet, they will be outlined in greater detail.  The sample package of VC documentation I've attached can show you want these and other things look like, but every deal will be slightly different. You are free to have your council review this package so you can get a clear expectation of what's coming. Your lawyers can also go into great detail on each item and how to deal with each one.

We have certain items that fall under the category of "matters requiring special approval." Essentially, this is a list of items that notwithstanding the approval of management and the board, you must have our written consent.  Our board seat and vote from the seat does not necessarily give you approval.  In the 8 years I've been doing this, I've never seen a case where we have said yes at the board and no at the firm level.  Even so, I want to be clear on these issues.  Depending on many things we learn over the next couple of weeks, this list will get adjusted but there are a standard set of items that generally go in regardless.  They are:

• You can't change the corporate structure without JLA's permission. For example, you can't change the incorporation location without our permission. The board may want it and you might want it, but if it (for example) could cause a tax problem or some such for our LPs, we wouldn't sign off.
• You can't modify our share rights without JLA's permission.  For example, you can't have a vote and decide to remove our preference even you have the votes or other shareholders to support it. We have to approve.
• You can't incur outside debt (other than operating lines, etc) over a certain amount (to be discussed) without JLA's permission.
• You can't remove us from the board while we own 10% or more of the company.  While this is normally in the Shareholders agreement, I like to call it out so we all know the facets of this marriage.
• You can't modify the shareholders agreement which changes, in any way, our rights.  This is like the second one but we add it for clarity. This usually is the most contentious so we can have a separate discussion about what we will/won't do.  Rigid flexibility, that's my general motto. 
• No third party transactions (over a negotiated amount)  without JLA's permission. This is there to prevent you from hiring Uncle Ned with us actively approving it.

There are other items which you can read about in the enclosed sample pack but this gives you an idea of what to expect.

Valuation:

You asked about where the value would come in.  Generally and seriously broadly speaking, we believe an investment in this space, at your stage and with the additional capital required, best case, will come in at around a pre-money valuation of $6 million.  Again, this is the best case, no brain farts/problems in the DD process. Typically, what will reduce the valuation are these items:

• Budget adjustments. Essentially, we take your model, do VC Voodoo on it, and come back for a discussion. If we agree on the costs, revenue ramps, etc, and they are materially different than what we start with (your leave behind model), the valuation of the company can change. The key, of course, is getting agreement on numbers which make sense to both of us.
• Market data. Sometimes it will take longer and take more capital to get something adopted. If we think there is more (materially more) risk than when we started this discussion, the value can change.  Yes, we are venture capitalists and we are supposed to take risk, I agree. I make this point only to emphasize the materially more part.

Finally, the references. I've provided you a list of all our portfolio CEOs.  As I mentioned to you in our meeting, please do call them all and meet with as many as you can. I believe this is the best way to find out what I (and our firm) can be like once the deal is done.  Ignore all the he is a nice guy stuff and ask questions about what we did/how we acted when there were problems or issues.  I think you will be pleased with what you find out.

I hope this gives you the information you need in order to determine if we are the right fit for you.  Let me know if you have any questions.  I look forward to hearing from you with respect to proceeding.

Thanks again for coming by and letting JLA take a look at your opportunity.

There you go.  As I said, this will change depending on the company, management experience levels, etc.  I have a package of sample term sheets, shareholders agreements, etc, that are also provided so the management team can get a broad overview of the paperwork pile.

I hope this helps many of you in your financing endeavors.

Does your board add value?

by StartupCFO

We had a board of directors meeting yesterday. Done right, board meetings can add tremendous value to your startup. Done wrong, they can just be a waste of time.

I've written before about the ingredients for a good board meeting. While there are several elements, it's all about the people. The profile of the people that you need changes as your startup evolves. In the early stages you will want people with prior startup and specifically sales acceleration experience. Later on, you might want people with public market or legal expertise. At all stages, you want people who have been where you're going.

That is definitely the case with our board and its shown in every board meeting I've attended since joining Tungle. Our board is like a CEO's club. Every member is or has been a President or CEO. Great CEOs have an ability to cut through all the noise and focus on the few things that really matter. In our board meetings, we get the procedural stuff out of the way and quickly get in to the real business. I've only attended two boards since joining, but each time I've been impressed with the quality of the discussion and the suggestions and ideas that came out of it.

As entrepreneurs and managers we're immersed in the details. While we do come up for air and think strategically we're not as objective as a board member who shows up monthly. What you want from your board members is:

• Critical questioning around your assumptions
• Suggestions for new ways to approach your biggest challenges and opportunities
• Confirmation about the biggest priorities
• A push on management to see if we can go harder, faster and think bigger
• Access to people and organizations (their rolodex)

This kind of value add is not only for startups. The best boards, regardless of company size, do this. While Andy Grove was CEO of Intel for example, he took board value add very seriously. Each board meeting was two days in length. And each board member had deliverables and responsibilities. They were a big part of his strategic team.
To be clear, management is driving the bus and is ultimately accountable. Still, your board can and should help elevate the dialogue and clarify the thinking.

Does your board add this kind of value?

Perfecting Your Pitch

by David Feinleib

There is no perfect pitch. When I was raising money, every investor responded to something slightly different. Ultimately, nothing speaks louder than a winning team, product, and market. But a good pitch deck can really help you tell your story.

Each pitch is unique. They vary by category. Content matters more than format. With those caveats, below is the outline for a deck in the B2B space. It's the composite of slides used in pitches that resulted in investment from us.

When it comes to presentation, it goes without saying that the best pitches:

• Tell your audience what you're doing, why the market will be big, and why you will win.
• Provide an imperative and a sense of urgency – they answer the questions "Why now?" and "What's changed?"
• Provide real insight – into the market, customer pain, or a unique approach.
• Hook the investor – with compelling customers or user numbers (unless it's a seed stage deal – even then, potential numbers or customers are helpful).
• Are delivered with knowledge, passion, and conviction by the entrepreneur.

The Outline

0. Front slide
YourCo – Vision Statement or The Leading XX for YY – Your name(s)

1. Company Snapshot
What you are                                                Key Figures
Customer painpoint/Your value prop      Sales (if you have them)
Selected (potential) customer logo's         Recent product milestone
Key accomplishments                                 # Employees

(It's great discipline to have a Company Snapshot outside your deck - a dashboard that you use internally to monitor your business and track progress.)

2. Team
Entrepreneur / CEO
VP Marketing
VP Sales
Etc.

Highlight a few key accomplishments for each person listed. Focus on the core team – that's who your potential investors are funding. If there's a key advisor or two, speak to them.

3. Market Overview – Your Market $X Today, $Y Tomorrow
Insightful market statistics or top players and key stats
The big market you're playing in, even if you're in a small segment of it today
Why it will be big
Why investors should care

4. The "Disruption" or "Driving Force"
What's your insight? Talk about your insight into disruptions taking place in your space.
What do customers care about this?
What's different now than five or ten years ago?
What's changed (human behavior, sales model enabled by Internet, utility computing, how people spend their time, etc.)? Often this is a statement like X combined with Y means…
What is this a must-have?
Why now?

5. Screenshot
Do more than just show your product — use the screenshot to highlight one key element of your approach. For example, take a specific product feature and use it to emphasize a pillar of your whole approach – agile development, ease of use, automation, user-generated content, etc.

6. Proven Success
YourCo is Winning
Key metrics for customer painpoint and your value proposition (value delivered - however you measure it, cost savings, etc.)

7. Business Model
Keep it simple - Illustrate via two or three graphical boxes and arrows
Pricing model
Stats on sales cycle
Chart on number of users/customers/objects/transactions/etc. growth over time (depending on your stage)
Go to market - direct / channel / etc.

8. Your Customers
Customer logo's and compelling numbers, if you have them
If possible, show by vertical or solution area (shows you are thoughtful about and a leader in given areas)
If you have a customer sat number that is compelling, include it

9. How Customers Use Your Product
3 or 4 case studies / use cases on a single slide – what was the use, revenue value, etc.
Use this to really drive home your value proposition, customer pain points/value

10. Product
Key tenets of your product
Relate to earlier screenshot slide – what drives you? Value proposition? Key features? Fast iteration? Ability to scale? Customer sat?

11. Product Futures
Cross of go to market combined with product roadmap
Where things will be when you're bigger – good place to talk about platform/API’s, vertical solutions, partner strategy, mobile, or just your next version

12. Competitive Landscape
Suggest a 2 by 2 matrix with your company in upper right
Pick axis's that highlight your strengths and your competitors’ weaknesses
Put a few companies that are really relevant and speak to them knowledgeably.

13. Your Competitive Advantages
Re-emphasize your advantages over the competition
Why you will win
Don't leave the competitive slide out there without speaking to why you will win

14. Financials - A $XXM+ Business in 5 years
Last year This year Next year (depending on stage)
Use a graphic to show the ramp for next 5 years (include previous years if possible)

15. Use of Proceeds
Size of the raise
What three key things will you accomplish with this round of funding?
How do you capture the opportunity and remove risks that will lead you to a successful next fund raising round? Hiring? Product? Key customers?

16. Backup Slide - Bottom Up Analysis
Bottom-up analysis of the market in support of slide 3, if asked.

Manage Your Time
A big part of delivering a great pitch is managing your time. Investors ask questions – your goal should be to answer these questions but deliver your key points. A good slide deck can help you with the message but also act as a framework to keep things on track for both you – and your audience.

Conclusion
A compelling product that delivers real customer or user value, and an entrepreneur with a vision for that product, is at the heart of every great company. Without a product customers want to buy, or a site users want to use, there is little to talk about. But with that in hand, a great pitch can mean the difference between interest and commitment from potential employees, customers, and investors. As the old saying goes, "always put your best foot forward."

NEVER TELL A VC. . .

by Alexander Muse

Wow, Rick Segal (the Steve Segal of venture capital) is on a roll.  His latest post offers entrepreneurs advice on which questions they should NEVER answer:

• Who else are you speaking to? [Answer: The usual suspects.]
• What pre-money value did you have in mind? [We are looking for a deal that provides great returns for all of us.]
• Can we speak to a few of your customers so we can better understand the value proposition? [No. Customer calls are post term sheet due diligence]

Good stuff. 

Ironically, I have answered all three (to ill effect). 

First, I shared our potential investor list with a potential investor who called each of the other potential investors and held a meeting without us.  It was a nightmare.  I turned my powerful position (i.e. more than one offer) and turned it into a losing position (they all ended up passing). 

Second, I scared more than a few potential investors away (prior to diligence) by suggesting a pre-money valuation that they felt was too high.  Was it too high?  Maybe, but I thought we were negotiating (they were saving time by ending discussions). 

Finally, I let three potential investors call ALL of our clients.  First, it was disruptive to our clients (i.e. they were worried we were running out of money) and second those same investors ended up investing in our competitors…

When raising capital, beware of the 'advance fee' scheme

by Tom Taulli

I recently talked to a business owner who was in the process of raising capital. To this end, she paid a $20,000 upfront fee to a finder (a person who brokers equity investments and loans).

The result? Nothing. The finder said that a variety of banks were not interested in the deal.

Oh, and that $20,000 fee? Unfortunately, that was non-refundable.

With the credit crunch -- and slowing economy -- entrepreneurs are certainly having trouble raising money. But, there also appears to be a rise in so-called "advance fee schemes" (this is according to a recent piece in the Wall Street Journal, which is a paid publication).

In fact, the FBI is investigating the matter (and also has some helpful resources on its website). Although it could actually be pretty tough to prove fraud. Essentially, there must be evidence that the finder had no intention of raising the capital.

So, how can you protect yourself? Here are some tips:

• Verify: Do a background check on the finder, such as by using an online service. Also, does the finder have a website? A real physical address – not a PO Box? Customer references?
• Payment: A small upfront free is OK. However, you should really be paying for performance; that is, a solid introduction to a financing source.
• Contract: Sign one and have an attorney review it.
• Be wary of language like "guaranteed": In the world of finance – especially with small businesses – there are no guarantees. Simply put, raising capital is extremely tough. So, don't get sucked into grandiose promises.

Then again, you must ask yourself: why do you need a finder anyway? After all, if your business is credit-worthy, why can't you go directly to the bank? Hey, many business owners do this successfully, right?

Perhaps a better approach is to hire an expert to help fill out the loan documents and prepare a business plan. For such services, the fees can range from $1,000 to $10,000 or so (again, make sure you do a background check and don't pay the full amount upfront).

Or, on the other hand, you can craft your own business plan. And the good news is that there are many books on the topic – such as Mike McKeever's How to Write a Business Plan – as well as software, like Palo Alto's Business Plan Pro.