Josh Kopelman has a thoughtful post on why he prefers preferred equity instead of convertible debt in seed-stage investments.  I agree with everything he says – definitely worth reading if you are involved in an early stage financing.

I got an email from a blog reader that said “there’s one attribute ‘missing’ from your list of needed characteristics for an entrepreneur – being a good salesman.”  There is no question that being a fantastic salesman (not merely a good one) is a key attribute of entrepreneurial success.  Terry Gold – CEO of Gold Systems – who is a superb salesman (without being “salesy”) – takes it a step further with a great post on hiring salespeople.  Every entrepreneur should read this post carefully.

It’s the last day of the quarter and eerily quiet in my office.  I’ve received very feel emails (and no phone calls) from CEOs of the companies I work with.  Since I talked with a number of them yesterday, I know this means that they are busting their butts to drag the last few deals of the quarter across the goal line before this Friday ends.  Good.

I received the following question last week:

I’ve been thinking a lot lately about the manner in which VCs should hold their entrepreneurs accountable – what should be the proper measures.  Most VCs with which I have experience rightly, I think, avoid making this a numbers-only analysis, as that’s a better measure for larger and more steady-state organizations but not for young and growing companies.  Wondering what your thoughts are here and if you’ve seen anything out there which addresses these points – entrepreneurs should be held accountable, they shouldn’t get a pass simply because “it’s too early” “we’re building value that’s not yet measurable” “numbers don’t matter” etc., but then again, applying ready-to-wear and traditional metrics probably doesn’t work well either.

I’ve always found that quantitative accountability – while difficult in a young company – is critical.  However, I’d add a simple thought – the quantitative accountability must be flexible and the time units used for measurement should be both short and long.

Flexible is a key word here.  Every early stage company I’ve ever invested in had some sort of a budget.  When companies are pre-revenue, they are often very proud of making their budget – which usually means “I have no revenue and I spent less then I said I would spend.”  While this is good, it can be myopic as there are times when it makes sense to spend more then you said you would spend.  Here’s where short and long come into play.  Imagine that you had an annual budget.  On day 1, you’ve got a pretty good idea of how much you are going to spend in the first month.  However, it’s unlikely that you really know how much you should (not are going to – “should”) spend in the eleventh month.  A twelve month expense budget for a raw startup company is too long – too many things will change.  Hence the notion of “short.”

However, many (almost all) companies take longer to develop than expected.  For many companies that I’ve funded, in the “good case”, the revenue curve in year three looks like what they expected the revenue curve in year two to look like.  In a number of these companies, the year three revenue ramp was still very satisfying.  However, if I’d taken a two year view, I would have said the company was failing.  Hence the notion of “long.”

I think if you mix these ideas together – keeping flexible while recognizing that your perspective should often be shortened or lengthened – you can actually use many traditional quantitative measures to hold entrepreneurs accountable.  Of course, the magic is in the application of the modifiers – namely flexibility, longness, and shortness.

I do a lot of short phone calls and meetings.  I try to organize them around “random days” where I spend the majority of the day meeting and talking to people where I don’t have a specific agenda.  Often – they have a specific agenda (which is good).  However, many have no idea how to communicate their agenda – or what they want to accomplish – in either an efficient or effective manner.

I have my assistant schedule these calls for 30 minutes each.  Some take 5 minutes, which gives me time to do other stuff (email, other phone calls); some take 29 minutes.  I’ve learned over the years that there is rarely a reason for a meeting / call to go longer than 30 minutes unless there’s a clear pre-set agenda so – rather than struggle with bigger time windows, I simply stop after 30 minutes and – if it needs to go longer, figure out another time (this rarely happens.)  Interestingly, I’ve tried to get this down to 15 minutes and have not been able to get into a full day rhythm with this – there’s something magical about the 30 minute window (at least for me.)

I had a full day today – 10 scheduled calls, a lunch, and a bunch of random calls and email before I headed out to the airport.  As I was driving to the airport after an ineffective call (due to the lack of good cell coverage on E-470), I was pondering several of the calls I’d had earlier in the day.  One was good (where good is defined as useful to both parties); one was not so good (not so good = not useful to at least one of the parties involved.) 

My post lunch call was the good one.  I had an enjoyable lunch catching up with Jonathan Weber of New West Network and was running a few minutes late.  At 1pm, I got a call and told the person that I was scheduled to talk to that I was running a few minutes late, I apologized, and asked if it would be ok if I called him back at 1:15.  As I was dialing him at 1:15, I noticed that he had just emailed me a WebEx invite.  I clicked on it as he was answering and joined the meeting.  I apologized again for running late, told him I had until 1:30, and suggested we get right into it.  We hadn’t ever talked before and had been introduced a week earlier by a mutual friend.  He reminded me who introduced us, told me he could do the presentation in five minutes, and we could spend the balance talking.  He then told me his goals for the call (simple and well articulated) and dove into the presentation.  He was true to his word and around 1:21 (yes – I looked) we talked about what he’d presented to me.  I asked a few questions and gave him what I hope was useful and encouraging feedback.  At 1:29, he told me that he appreciated the time and would be in touch.  I hung up impressed, interested, and knew I’d be responsive if he ever asks for anything.  I was also appreciative that he was gracious about me being late – I was the one that caused the time to be extra-compressed, yet he was still able to accomplish his goal.

I churned through some additional stuff and then had the not so good call later in the afternoon.  Again, my assistant had scheduled it for 30 minutes, which the other party knew.  I hopped on the conference call at the appointed time.  As with the earlier call, I had been introduced to these folks by a friend (a different one), although I was less clear on what they were up to since it had been a few weeks and I couldn’t quickly look up their web site (they didn’t seem to have one yet – at least not an obvious one.)  We spent a few wasted minutes on pleasantries and then one of them started talking.  After five minutes of listening to a high level description about something that I didn’t understand that had something to do with the company they were working on which was as yet undefined, I interrupted and asked him what his goal for the call was.  After an unnecessarily long explanation, I determined that they were approaching me as a potential investor.  I then asked him to try to be more direct about what his business did, what stage they were at, what they had accomplished, and what big opportunity they were going after.  I listened – with a few questions – for another 10 minutes and still didn’t really understand what they were trying to do.  I decided to change my approach and understand how far along they were.  It became clear that they were very early, had a big vision, but were working hard to get a demonstration system up while looking for short term money (e.g. “within the next 30 days”) to fund them through the creation of the demo.  By the time we got here, 25 minutes had passed.  I communicated that while the general thing they were talking about was something I could become interested in (e.g. it was a software company, not an China-based manufacturer of drill bits), I wasn’t interested in trying to get more engaged at this point based on (a) their geography (I really only want to do very early stage stuff that is close to home), (b) my lack of understanding of what they were going after (e.g. they didn’t “get me” in the first meeting), and (c) their timetable (I wasn’t interested enough to engage at a level now where I could help with a financing in the next 30 days.)  I did offer to reconnect when their demo was ready, take a look, and try to understand better what they were up to.  We then spent the next five minutes in the awkward dance where they were trying to find something to “get me really excited” while I was trying to politely end the call, having made my decision that I didn’t want to spend any more time on this now.  We eventually untangled ourselves and said polite goodbyes.  Hopefully they’ll drop me a note when they have a demo and we’ll take another shot.

Now – the not so good phone call wasn’t “horrible”, it just wasn’t effective.  I don’t mind the couple of minutes of chit chat at the beginning, but it’s real time being wasted for no particular reason.  Since we don’t yet have a relationship, we’re not “catching up” on anything.  I’m often on the receiving end of the request for time, so this becomes the other person’s first impression time with me.  Why waste it with idle banter?  Instead, use the first 60 seconds to get my attention, remind me how we got connected, and tell me what you want to accomplish with the call.  We could have then gotten – in 5 minutes – to the same place we got in 25 minutes. It’s the same at the end of the call – let’s wrap it up, figure out what the proverbial “next steps” are, and get on with it.

Several months ago I wrote a post on the best corporate structure for an early stage company.  I followed it up with a post on S-Corp’s vs. LLC’s.  There were some good comments and these posts generated plenty of questions. 

The other day I got a note from a reader (a lawyer no less) who pointed out that there were several changes on 8/1/05 to Section 265 of DCGL (Delaware Corporate General Law for those of you not up on your legal acronyms) that allow for two important “innovations” in the area of “entity conversions” (yeah – exciting – I know – but important for all you entrepreneurs out there wrestling with where to incorporate and what type of entity you should have.)

The first innovation creates a simpler process for the reincorporation of non-Delaware corporations in Delaware (through a one-step “conversion” rather than through the traditional but cumbersome reverse merger of the non-Delaware corporation into a wholly-owned Delaware sub.) In English – if you are incorporated in a state other than Delaware and want to reincorporate in Delaware – it’s now a lot easier.

The second innovation allows for the one-step conversion of non-Delaware limited liability companies into Delaware corporations.  These conversions/reincorporations have historically required 2 steps – for instance, an Ohio LLC would be merged into a newly-formed Delaware LLC, and then that Delaware LLC would be converted into a Delaware corporation.  Now you can go from an Ohio LLC to a Delaware corporation in one step.  This eliminates one of my main objections to LLC’s that I wrote about in S-Corp’s vs. LLC’s.

As always, please road test this with your lawyer.  I’m just a guy that doesn’t ever make legal recommendations.

Yesterday, I wrote a high level summary of this year’s Venture Capital in the Rockies conference.  I thought I’d give the local press one more day to see if anyone was going to write something substantive about some of the companies presenting.  I haven’t seen anything, so here are my thoughts on the companies I saw. 

24 companies presented in two tracks so the most I could see was 12.  I had a couple of conference calls during the day so I only managed to see 7 of them: Collective Intellect, Confio Software, HomeSphere, Solidware Technologies, iPosi, CreekPath Systems, and XAware.  The only company on this list that I directly have an investment in is Collective Intellect, although I have indirect investments (through VC funds that I’m an LP in) in XAware as well as Collective Intellect.  I’ve listed the companies in rank order starting with the one that I thought was most interesting / did the best job.

Collective Intellect: I backed the founders – Don Springer and Tim Wolters – in their previous company (Dante Group – acquired in 2003 by WebMethods.)  Don and Tim are super second time entrepreneurs, and the way they’ve started up Collective Intellect shows.  Their tag line is “filtering new media for the securities industry” – they are using a bunch of hard core computer science to analyze new media content (blogs, chat rooms, discussion forums) for public market fund traders, analysts, portfolio managers, and quants (i.e. the dudes at hedge funds.)  The intersection of new media, heavy computer science, and the massive hedge fund dollars sounds like a good place to hunt.  Don did a great presentation and announced their round of funding led by Appian Ventures.

Confio Software: I met the CEO and primary backer of Confio – Charlie Sanders – about 18 months ago when he first got involved with Confio and its cofounder Matt Larson.  Charlie’s an impressive guy having been a senior exec at Seagate (and previously Conner Peripherals.)  It sounds like 2005 was a very good year for them as they landed 40 new customers, although reading between the lines it appeared that one or two customers accounted for about 50% of their revenue.  Confio’s market – IT performance management – is a crowded one, but they appear to be doing some unique stuff around digging into the Oracle database layer to look for root cause defects (ah – “root cause” – the holy grail of all APM companies.)  Charlie a super salesman and is determined to scale the business up nicely on modest capital.  He’s off to a good start.

XAware: Tim Harvey, the new CEO of XAware, did a super job of presenting after a mere three weeks on the job.  I generally like XAware – it’s in a market segment (SOA middleware) that I like, understand, and have made some money in.  However, I don’t understand their approach to the business.  While they generated a respectable $3m of revenue last year, it appears that most of it came from financial services customers.  Consequently, I don’t understand why they present themselves as a horizontal SOA middleware provider when they could be kicking ass in the deep pocketed financial services vertical.

HomeSphere: I’ve got to hand it to James Waldrop and his team – they raised money in 2000/2001, survived their market falling apart, focused on growing slower but getting profitable, and have accomplished that.  They now have a respectable $10m business that sells two things: (1) manufacturer incentive and rebate service for through group buying (80%) and (2) construction management software (20%).  While #1 is a solid growth business (and HomeSphere has likely gotten to an interesting critical mass), #2 looks like a flat to declining business.  As a result, HomeSphere is looking to raise $10m to roll out three new lines of business (none of which I can remember a few days later.)  I don’t understand why they’d do this – if I was on their board I’d say “no more money – stay profitable – grow aggressively in segment #1.”

Solidware Technologies: Sue Kunz, the CEO of Solidware, is a firecracker.  I’ve known her and her gang for about a year and watched them do unnatural acts (ah – the joys of entrepreneurship) to get their “Splat Software” up and running.  Splat is an SQA product (software quality assurance) that helps identify software defects through visual analysis of the source code.  I declined to invest last year as I’ve already got an investment in a somewhat competitive company (Klocwork), but I’ve tried to be helpful and encouraging to Sue and her team because I like their style.  I only caught the tail end of Sue’s presentation so I don’t know how she did, but she handled the Q&A nicely.

iPosi: I don’t get iPosi.  They presented a vision for a set of E911 products based on GSM-based location combined with IP geolocation (they are talking to one of my companies – Quova – about working together.)  I listened to the presentation and really didn’t understand either (a) what exactly they were going to do or (b) how they were going to do it.  My brain was working hard when I saw their revenue slide – immediately afterwards my nose started bleeding and I started fantasizing about steep upward sloping exponential curves.  I know – and like – a few of the people involved – I’m sure I’m missing something obvious.

CreekPath Systems: I remember looking at Creekpath in 2000 when it was originally spun off from Exabyte.  I was pretty excited about funding it until one of my partners vomited all over the floor after meeting with the team.  As a result I passed – am I’m glad I did.  They’ve been through a lot of ups and downs and retooled their leadership team – again – last year.  Creekpath is a good example of the endlessly elusive storage success animal (hardware or software) that tantalizes, but eludes, the Colorado VC.  Maybe this will be the one, but as many have gone before them, they have a long road ahead of them.  I keep hearing that none of the storage vendors have this, but then I think about EMC’s software group and just shake my head.

Oh, and Seth and Chris assured me that the skiing on Wednesday was outstanding and the skiing on Friday was social (e.g. not much fresh powder, but lots of friends hanging around, blue skies, and 60 degrees.)

I received the following question last week. It’s a good one – very chewy – and my answer is given from my frame of reference (e.g. a managing partner in a large VC fund).  Consequently, I’m not sure that my answer is either generally correct or abstractable to all situations. How’s that for a hedge? The question is:

Do you agree or disagree with the following scenario as a firm basis for Web 2.0 ventures: Raise $2 to $6 million to be spent over a two to three year period, with an exit of a $20 to $50 million sale to one of the GEMAYANI’s. Would you adjust those numbers significantly, as a general thesis? Is such a venture model an attractive VC proposition, by definition, or maybe merely acceptable in the absence of a more traditional, larger-scale exit (say, raising $4 to $16 million with a $80 to $300 million exit after 4 to 7 years)? What model has the most appeal to you these days? Ultimately, it’s a question of what entrepreneurs should be shooting for. Implicit here is the question of whether Web 2.0 is a short-term window which may close in less than two to three years.

Let’s assume an median case where the $2m – $6m raised gets 50% of the company. In this situation, the VC firm gets half of the exit, which would result in a 5x return in the best success case and a 1.5x return in the worst success case. Of course, both of these assume the exit will occur – this only happens a small percentage of the time, so you have to risk adjust these numbers down by this amount (say 1 in 100 success case, although I’d assert given the number of startups in this domain, it’s probably 1 in 1000 right now.)  So – while the “invest $2m – $6m and return $20m – $50m is a reasonable thesis”, it’s missing the “how many times does this actually happen” multiplier.

While the exit numbers are ok, they aren’t going to move the meter on most VC funds with > $100m under management. While VCs need these kind of exits, they are typically looking for are both higher multiples and higher absolute returns, especially when you take into consideration the discount associated with the probability of success.  So – investing in this general thesis is limiting in a way that won’t be attractive for many VCs.

Now there’s been plenty of blogosphere chatter about how the VC business needs to be revolutionized, how new fund types that are motivated to invest in these outcomes should appear, and how “Advisory Capital” should play a role in all of this. All that is fine – but the second question that’s asked is the really interesting one.  What model has the most appeal to you these days? Ultimately, it’s a question of what entrepreneurs should be shooting for. Implicit here is the question of whether Web 2.0 is a short-term window which may close in less than two to three years.

I’ve always invested with the idea that I should be trying to build significant companies, rather than invest for a quick flip.  Occasionally I end up with a quick flip (and I’m always happy), but – if I see an opportunity to create something large, I’d rather go down that path.  Of course, everything is circumstantial – there is often great fit with an acquirer early in the life of a company and – when this is the case – it’s often in the best interest of all parties (entrepreneurs, buyer, VC’s, employees) sell the company and for the VC to move on (remember – a VC has a limited number of things that he can handle at any given time.)

So – the invest for a quick but modest return doesn’t appeal to me as an investment thesis.  However, I’m sure it appeals to plenty of other folks, including some VCs.  Subsequently, the real answer (from the entrepreneurs frame of reference) is to understand the investor you are working with, what his underlying economic motivation actually is, and ensure that you (the entrepreneur) are aligned before you take the investment.

As to whether Web 2.0 is a short-term window which may close in less than two to three years, I have no idea.  Ask me again in three years.  However, I expect that in three years there will still be an opportunity to create great Internet-related companies.

For the last 23 years, the Venture Capital in the Rockies conference has been the signature fund-raising conference in the Rocky Mountain region.  A full day of presentations from companies looking for venture capital (with the presenters mostly in suits – a rarity in this part of the country) followed by a day of legendary skiing (and – while I don’t ski – this year was phenomenal) makes for a great conference.  320 attended this year – 100 were investors including a number from out of state.

It was fun to look through the list of presenters since 1996 and see the following companies that I’ve been involved in:

1996: Mercury Mail – IPO as Exactis

1998: Email Publishing – acquired by MessageMedia
          Vstream – IPO as Raindance

1999: Service Metrics – acquired by Exodus
          Tellsoft – unsuccessful

2000: Finali – acquired by Convergys
          Service Magic – acquired by IAC

2001: Deuxo – unsuccessful
          Latis – now StillSecure – current portfolio company
          Prosavvy – acquired by eWork

2002: Dante Group – acquired by webMethods
          Npulse (Xaffire) – acquired by Quest
          Wideforce – unsuccessful

2003: F4 Technologies – now Rally Software
          Finali (again) – acquired by Convergys
          Newmerix – current portfolio company

2005: Oxlo – current portfolio company
          Rally (again) – current portfolio company

It was also interesting to see all the companies I haven’t invested in over the years that presented at this conference that have either been successful (oops – missed that one) or unsuccessful (sorry – but I’m glad I didn’t invest.)

Chris Onan from Appian Ventures did an awesome job hosting the conference this year.  He followed a tough act from Chris Wand of Mobius Venture Capital who hosted the preceding two years – and did great.  Maybe they should rename the conference “Venture Capital in the Rockies: By Chris.”

All the local papers have now written up their piece on the conference at this point.  The Boulder Daily Camera had a light weight piece on the conference in general.  The Rocky Mountain News ran two pieces – one that highlighted David Moll – CEO of Webroot (and the article said that he didn’t stay long because he had more important things to do – ouch) and one that announced ITU Ventures new $120 million fund.  The article in the Denver Post was the most substantive, actually highlighting several companies including Collective Intellect, Accucode, and Groople.

Given the lack of actual focus on the companies, I’ll write up a separate post talking about the ones I saw at the conference, offering feedback and (hopefully) constructive advice.