Brad Feld

Category: Management

I got an interesting question from one of my friends / readers that applies to both athletes and entrepreneurs.

Can you share with me what kind of mental “training” you undertake before, during and after competing in a marathon? I understand that training for a marathon involves a lot of physical training. But how do you mentally prepare to run 26.2 miles? And how do you maintain your mental “stamina”during such a long run? Finally, how do you mentally “cool down” after competing?

Anyone that knows me, or has worked with me, knows that in addition to being able to cover a wide range of things simultaneously (dare I use the overused phrase “multitask”), I can also go very deep on one thing for a long period of time.  It’s this second trait that I think is so important for both serious athletes as well as great entrepreneurs.

I’m not really sure how I’ve “trained” for this.  I’ve always enjoyed going after stuff with great intensity – often single-minded – although the normal ebb and flow of most of my life has always involved numerous interesting things going on at the same time.  Being able to quickly shift between the two modes – and recognize which one I’m in – has always been relatively easy for me.

The “pre-event” training seems straightforward – I spend deep, isolated time on my running.  I usually run alone (although I’ll do some long runs with other people), I have a routine I go through before each run, and I set my goal in advance and stick to it.  Building up consistency is key – when I’m resting from a marathon I just run whenever I want to.  When – like now – I’m in a training cycle (I’m running a marathon on Labor Day) – I do my pre-determined schedule whether or not I feel like it.  Occasionally I’ll find myself punting on this schedule – whenever I do I think hard about why and adjust accordingly.  Being rigorous, consistent, and deliberate, while studying any deviations, is the basis for my mental preparation.

Leading up to the race, I have a ritual that I’ve now settled into.  Unlike a baseball batter tapping the plate in the same place (or – if you are a tennis fan – Nadal adjusting his underwear between every point) to focus his concentration, I try not to have them become obsessive tasks that I repeat over and over again.  Instead, I focus on the macro – Amy and I go to the city I’m running in at least four days before the race, we stay at a comfortable place, I eat pasta with marinara sauce and lots of bread for the two days before the race, we drive the course the day before the race, and we go to bed early – even if I don’t feel like it – the night before.

During the race, I break my run into four section – (a) miles 1–6; (b) miles 7–13.1; (c) miles 13.2–20; (d) miles 21–26.2.  Having run seven of these things, my experiences have become very similar.  Section (a) is uncomfortable – too many people, not warmed up, over excited – but I just get through it.  Section (b) is the best – I feel great, I’m warm, I’m happy, and I always feel like I’m in a groove.  Section (c) is the hardest – I’m lonely, I hate this part, I have doubt, my knee feels funny, why the fuck am I doing this again, man this is taking forever.  Section (d) is hard, but satisfying – I know I can run 6 miles any day of the week.  Defining the general parameters of the experience in advance takes away a lot of uncertainty for me – I can concentrate on doing my best within the parameters I’m used to.  And – when the unexpected invariably comes up, I can quickly shift my attention to it.

After the race, I just chill.  I don’t plan anything for two days, I don’t travel, I lay in bed all day the next day (if I feel like it) or I walk around and play with friends (if I feel like it.)  My recovery time has averaged three to five days – it’s getting faster with each marathon.  However, I’ve learned that I shouldn’t run a step for three weeks – I don’t lose any meaningful fitness and – when I start running again – I’m reading to go.

Entrepreneurship has a lot of similar characteristics.  It’s fascinating to watch (and work with) successful multi-time entrepreneurs – create a metaphor around what I’ve described above, stretch it out in time, and it maps pretty closely.  No wonder the cliche “entrepreneurship is a marathon, not a sprint” is so popular.

On this spectacular fourth of July (at least in Homer – it’s 60 degrees and not a cloud in the sky), I was enjoying disk 2 of Atlas Shrugged (I’m about 300 pages in) on my run today.  I’m deep into the section where all the competent people are quitting and walking off the playing field and the looters are ratcheting up the rules, which have the unintended consequence of destroying the world as they know it.  Hank is still fighting it out trying to hold everything together in an increasingly bleak world and Dagny is on her quest to find the inventor of the motor as she naively thinks that will solve everything.  The contrasts of the section I’m listening to lingered in my mind long after my run, especially as I pondered the state of affairs (good and bad) in our country 230 years after our birth.

When I sat back down at my computer, a question a that I got a few weeks ago from a reader jumped out at me.  The question follows:

If you are an entrepreneur leading a start-up, and you are negotiating investment with a strategic investor or VC, what are the standard or most desirable ways to protect yourself personally now that you have the potential to be fired?   Lets say they want to get rid of you in 6 months, and have the ability to do that, what type of parachute or provisions should the founder have on the front end to make sure they are covered in the event of being dismissed or benched?  Issues like whether you can be fired at all or just assigned a new role, severance salary/term and protecting your equity.  I have heard that covering yourself personally is among the most important terms to negotiate in a term sheet as the founder.    If by securing funding you are also unwittingly arranging your own personal demise, what precautions should you take. 

I might have answered this differently if it (a) wasn’t the 4th of July and (b) I hadn’t just listened to a particularly disheartening section of Atlas Shrugged.  While Jason and I covered the basics in our post on Vesting and part of our Term Sheet series, that only covers one aspect of the question – namely that of what is standard and fair in protecting your stock position.  While some VCs and entrepreneurs will try to negotiate employment agreements as part of a financing, I hate these.

If – as the entrepreneur – you are competent – it’s unlikely the premise above is valid.  Specifically, very few VCs invest in a company with the idea of firing the CEO in six months.  While many CEOs get replaced – and it’s often not pretty – it’s rarely because the new investor coming into a company thought – a priori – I want to get rid of this guy right after I invest.

As a result, I think the most effective approach for an entrepreneur is to punt completely on the employment agreement and issue of “employment protection.”  An open, direct discussion with the new investor is key – if the VC believes the entrepreneur should be playing a role other than CEO, get this out in the open in advance of the financing.  The entrepreneur should also do the leg work to understand the history of the investor – is this an investor that stands behind the entrepreneurs he funds or does he have a history of revolving door management?  When things don’t work out, how does the investor behave – is he fair and appropriate?  While you can’t always pick your investor, you certainly can know what you are getting yourself into.

I believe a combination of competence and transparency is the best approach.  If you are an excellent CEO, completely open with your investors about the good and the bad, diligent about trying to make the company successful, and completely open to feedback and constructive criticism, it’s unlikely that you’ll randomly get fired.  If the company isn’t performing, or you are struggling in your role, being open, honest, and proactive with your investors will almost always be much more effective than “employment protection.”  Occasionally you’ll run into “a bad investor” who has nefarious motives, but the world is small and life is short so this shouldn’t be that hard to figure out in advance.

While a cynical entrepreneur might paint this as an idealistic perspective, I’ve found that the real trust between the entrepreneur and investor is much more important than a legal agreement that immediately polarizes people before they’ve even started working together.

A blog reader who I know and have worked with in the past asked me the following question:

I was interested in your thoughts on when entrepreneurs realize they need experienced help and have taken the company as far as they can, when they let go, when they stay too long and the real smart ones that know when to bring someone like me in early and work with me instead of fighting against me.

This friend has been the number two guy in several companies.  In each case, he was brought in by the entrepreneur as the CFO or the COO.  In the situations I’m aware of, he was initially welcomed by the entrepreneur (who – in each case – was the CEO and had an autocratic style), but – after a while, started to have real difficulty working with the entrepreneur, especially as the company outgrew the entrepreneur’s experience base.

As I pondered this question, which would require an entire book to really address it, I realized there was a parallel issue in all the situations I was aware of.  My friend is an extremely capable medium stage executive.  He’s not a raw startup guy, but he knows what to do from 50 to 1,000 people.  In each case that I’m aware of, the entrepreneur “brought him in” to help “get the company to the next level” (where have you heard that before.)  However, the entrepreneur / CEO didn’t really cede control and – when my friend started to put his mark on the company, a very predictable friction occurred.

While I think this kind of relationship is possible, it’s critical that the entrepreneur and the new executive agree on roles and rules of engagement up front.  I think the biggest problem is that during the recruiting process, both sides are selling the other side on their desire to work together and their ultimately flexibility.  Since the entrepreneur is looking to hire and the executive is looking for a job, there’s a fundamental conflict in their motivations and the honest, difficult, confrontational stuff doesn’t come out – until later.

My simple advice to my friend – once you get past the “selling part” of the process and have a real offer on the table from the entrepreneur, go out to dinner (or better yet – get on a plane and go somewhere together for the weekend) and have the real conversation about what life is going to be like.  See if you can get the issues out on the table before you accept the job.  If you can, listen carefully, engage, and see where you go.  If you can’t, you just learned something huge.

Predictably, the same information applies when an entrepreneur is considering a new investor – VC or otherwise. 

I got a great question the other day which highlights the tension that can emerge in an early stage company between VCs and entrepreneurs.

Company X – which is VC backed – has six months of cash in the bank.  Almost every employee could go without a paycheck.  The team is on full pay now – it’s a small team of under 10.  Not taking salaries buys the company another six months.  There is a major launch in about four months.

An option the team is discussing is that if the current investors won’t throw in another million now so they have room to raise money after the results of the launch, they will “self finance” the company by everyone cutting pay if the investors issue a significant additional chunk in common to the employees

What are the issues for the team in doing something like this have you seen it, when not in a “difficult” situation?

While there is no tension yet, here’s a negative view of how this could play out.  The entrepreneurs ask the VCs to put up money – presumably at a certain price – in exchange for buying another six months of runway.  The VCs don’t like the price the entrepreneurs suggestion (presumably it’s too high) and offer to do a bridge loan with warrant coverage or an equity round at a lower price.  The entrepreneurs don’t like this, so they tell the VCs they’d rather go without salary for six months and get stock equivalent to what the VCs would have gotten (at the lower price of course) for their investment.  The VCs don’t like this because (a) they aren’t getting money to work, (b) they are ending up with less, not more of the company, and (c) they potentially lose some of the control over the financing dynamics.  After much handwringing (and wasted time), everyone comes to an agreement on the amount of stock the entrepreneurs and staff get for going without salary for the next six months.

Wind the clock forward.  The entrepreneurs have an “ok” launch, but the valuation for the new round is lower than they expected or there is no outside lead and the VCs start talking about an inside round.  The VCs have no incentive to get the valuation up in this case – they are focused on buying up more ownership, so they’d rather have a lower valuation anyway.  The entrepreneurs are pissed because they just gave up salaries for six months but didn’t end up in the “better” position they wanted.  The VCs aren’t appropriately sympathetic (at least in the entrepreneurs mind) to the situation – the entrepreneurs just made an investment they aren’t getting credit for.

Tension mounts.  No one is happy. 

While it’s a logical trade, it’s an uncertain one for the entrepreneur because there is no way to predict whether or not the launch will be successful, so fundamentally the entrepreneur is buying more runway, but not necessarily for the exchange of more ownership.  Of course, in the positive situation (where the launch goes great and new investors show up willing to invest at meaningfully higher prices) this could work out nicely. 

I’m getting a lot of questions these days about early round valuations – specifically for angel rounds.  While these vary over time, and by segment, most of them tend to settle into a pretty tight range for early stage angel investments.  I’ve talked about the different approaches – either a “convertible debt” or a “light preferred”in the past.  I’ve also stated that I prefer the light preferred approach.

So – assuming you are doing a light preferred – what is a fair price?  I’ve been doing these types of investments for the past 12 years and I’ve investment in companies where the pre-money valuation has ranged from $250k to $5m and the amount raised has ranged from $50k to $2m.  While there are obviously some outliers, the normal range seems to be $1m to $2.5m pre for up to a $1m investment.  I’ve seen this reinforced recently with a number of deals done in this range.

I received the following question recently:

Just want to ask you a question. I’m looking to bring in a couple of advisors for my startup, how much stock and the approximate % of equity should I give that’s fair to the advisors for their invaluable advice? I was thinking of 100,000 shares each that equates to 1% company equity. Can you advice me on what’s the norm?

1% is rich.  In the past, I’ve given some ground rules for equity grants for directors – 1% vesting over four years is at the top end of the range.  Advisors typically (although not always) contribute much less value to a company than directors and their equity grant should correspondingly be less.  Of course, the amount you give depends on a number of factors, including things like your expectation of what the advisor will provide, how much you value this involvement, and the existing capital structure of the company (e.g. larger grants if you are younger, smaller grants if you are a more mature company.)

Usually, you’ll be granting stock options (non-qualified stock options – “non-quals” or NQSO’s) to the advisor.  As a result you should think through vesting carefully.  Many advisors contribute much of their value early in the life of the relationship so rather than giving a grant that vests over four years, you might consider making an annual grant and then revisiting things in a year to see if the relationship is living up to expectations.  A savvy advisor will prefer to get a bigger grant that vests over four years since it will allow them to lock in a strike price at today’s fair market value (FMV) of the stock (which – in the success case – will likely be lower than the FMV in the future).  At the minimum, this will facilitate a conversation about revisiting things annually to make sure everyone’s expectation is being met with the relationship.

I received the following question on pricing stock options recently.

In a post you wrote last year, you said “Let’s also assume that company did a financing and is worth $10.5m post-money (e.g. $3 / share), that the financing was done with preferred stock, and the board determined that the fair market value (FMV) for the common stock is $0.30 / share (common stock in a venture-backed company is often valued at 10% – 25% of the preferred – I’ll leave that for a separate post.)” Could you help explain the justification for the 10% – 25%?

A year ago when I wrote that post, I hadn’t thought much about the implication of the new IRS regulation 409A.  While a draft had been published, it didn’t really catch the attention of the venture community until a critical memo was released in the fall.  As a result, when I wrote the post in mid 2005, I was referring to a typical rule of thumb that VCs have been using since fire was invented to set the strike price for stock options.

The old rule of thumb was to price them at roughly 10% of the price of the preferred shares if the company was a very early stage company.  As the company matured, the percentage would increase, usually slowly, and reach 25% of the current preferred price well before the company was profitable.  In the days when software companies went public, the SEC looked back 18 months to determine “cheap stock issues” and – as long as the board was making an appropriate fair market value (FMV) assessment of the common stock and increasing it over time, with more significant increases occurring as the target date for the IPO drew nearer – all was probably ok (plus – the cheap stock charges were P&L accounting charges but were non cash charges so no one really struggled with them much anyway.)  When the company went public, the stock would now have a market price that fluctuated regularly and stock options would be priced at whatever the stock traded with on the date of the grant.

This approach worked fine for a while. Serious lawyers would even encourage companies to price their options lower than a conservative board might suggest, as they were trained to use the 10% rule. 

With the emergence of 409A, all of that went out the window.  While the board still needs to determine the FMV of the common stock for purposes of pricing the stock option grant, the 10% rule no longer applies.  Instead, a more rigorous analysis needs to take place.  I’ve explained this extensively – with the help of my trusty sidekick Jason – in the 409A series on this blog.

Ironically, now that we’ve been living with 409A for a while, a bizarre unintended consequence has emerged.  In order to comply with the 409A statute while being extra conservative, we have our companies hire an outside valuation expert to do a 409A valuation.  In a number of cases, the FMV has come in at less than 10% of the preferred price (in one case it came in at under 5% of the preferred price.)  Presumably, one of the goals of 409A was to increase the strike price on common stock as the premise was that many boards were setting FMV too low.  Hah – be careful what you wish for.

Following is a question I got the other day.

We have some people who are currently interested in doing a Series A round with us.  They aren’t VC’s – they’re a company in our market who offer a pile of services complimentary to ours (they aren’t competitors, or substitutes.)  In our conversations with them, they’re asking for a Right of First Refusal – I know this is standard stuff, however, they’re asking for a ROFR for acquisition offers, as well.  Their reasoning (which is valid), is that they don’t want one of their competitors coming and buying us outright – they’d want to do it themselves. My question is, in an acquisition scenario, will this type of ROFR cause problems that make us a less appealing acquisition?  What type of issues might we run into in the future?  Any advice?

In our Term Sheet series, Jason and I talked about the Right of First Refusal (ROFR) in the context of a financing.  When a ROFR is requested for future financings, this is a standard term and one that isn’t usually worth negotiating much.  However, it’s an entirely different case if a ROFR is requested in a financing that will apply to acquisition.

While a rational request, it’s very dangerous to provide a ROFR on an acquisition to investors in a financing.  A VC will rarely request this (and – if he does – tilt your head sideways at him as say “huh – why?”)  However, corporate investors (also known as “strategic investors”) will often ask for this.  The theory is almost always the one posited in the question above – namely – we want to invest in you now but want first crack at acquiring you if one of our competitors starts sniffing around.

Good theory; bad implementation.  Giving an early investor a ROFR on an acquisition materially handicaps the company and disadvantages all shareholders, except the corporate investor that is getting the ROFR.  The corporate investor will already have visibility into your company and will likely have a variety of rights (including potentially a board seat) by virtue of their investment.  In some cases, they’ll be aware (by virtue of their board seat) of any potential acquisition activity.  If they aren’t, it’s likely that if you get into discussions with a potential acquirer, you’ll bring it up (carefully – of course) with your corporate investor and suggest that – if they are interested – that now would be the time to consider making an offer for the company.  So – the notion that they’d be left out in the cold completely – while possible – is unlikely.

If you have a ROFR in place, you are in a bad position with regard to a potential acquirer that is not the corporate investor.  Depending on how the ROFR is written, you’ll likely have a difficult time signing an LOI with a potential acquirer without first notifying the corporate investor and giving them a ROFR.  In the extreme case, you’ll need to disclose the terms to them so that they have an opportunity to match or exceed the offer.  In the mean time, you will lose major deal momentum with your new potential acquirer.  In addition, since your discussion with your potential acquirer is likely governed by a confidentiality agreement, you’ll have to tread carefully as to what you discuss or disclose.  This gets even more difficult when you are balancing multiple potential offers and buyers – the logistics of managing the ROFR can get very challenging.

In all scenarios, unless you have developed a negative relationship with your corporate investor, it’s all probably unnecessary anyway.  Since the corporate investor already owns a percentage of your company (typically less than 20%), they have a built in discount on the acquisition based on the ownership position they already have.  While they’d of course love to buy the company at the lowest price possible, the ROFR probably won’t help them accomplish this as any savvy seller will be able to manage the buying process to get the best offer on the table before exposing the ROFR.  All the ROFR does is jeopardize the deal, which doesn’t do anyone any good (e.g. your corporate investor decides not to proceed with acquiring the company but the intervening time has caused the buyer to get cold feet and back off.)

While it’s conceivable the ROFR will reduce the number of companies potentially interested in acquiring your company, this can be managed.  It’s often said that buyers won’t pursue a company that has a ROFR – in practice I’ve found it relatively easy to “trip” the ROFR early in the process and get that out of the way.  I have run into aggressively written ROFR’s that cause me to shake my head as it is possible for the ROFR to completely tie up the seller – but I attribute this to poor negotiation on the part of the attorney’s for the seller that negotiated the ROFR in the first place.

The bottom line is that a ROFR on an acquisition is never helpful to the investee and rarely accomplishes what the investor that insisted on it wants.  My simple recommendation is to negotiate hard on this term – it’s not worth having it hanging around.

The Personal MBA

Apr 03, 2006
Category Management

As a follow up to my MBA post from yesterday, I noticed an article in BusinessWeek titled “Can a Personal MBA Match the Real McCoy?”  Interesting and provocative content, along with a few interesting links for those of you thinking about an MBA.