Category: Venture Capital
On the heels of all the noise around Groupon’s $100m financing at a $7.5b (billion) post valuation, I thought I’d put out a call for “old VC term sheets – prior to 1990.”
My partner Jason Mendelson and I are working on a book titled Venture Financings: How To Look Smarter Than Your Lawyer and VC. The final draft is due at the end of February (feel free to give us your sympathy if you happen to see us between now an then) and based on my previous experience with our publisher (Wiley) on Do More Faster, I expect it’ll be out by the end of Q211.
The basis for the book comes from the Term Sheet series that Jason and I wrote on this blog in 2005. We’ve updated the series for the current reality of 2010 (of which much is very similar to 2005, with some differences), talk about lots of different twists that have appeared, and tell plenty of stories to illustrate what the implications of various terms and financing configurations are.
As part of this, I’m looking for some early VC term sheets. I started by trying to hunt down the original Digital Equipment Corporation term sheet (or letter describing the investment) from AR&D to Ken Olson but came up dry. Today, as I was working on some stuff, I realized it would be interesting to look at some term sheets from the 1970’s and 1980’s in whatever form they are in.
If you happen to be in possession of an older VC term sheet – either for a company that was successful or one that was a failure – I’d love to see it. You can email it to me if easy, or drop me a note and I’ll tell you where to fax it. I’ll make sure I honor your request to keep it anonymous if you want me to (either you, the company, or both) but of course would love the ability to weave it into the book where appropriate.
The latest Brad Feld Amazing Deal is online.
A few weeks ago I was approached by Sympoz, a company in Boulder that is excited about building online classrooms where anyone can take a courses in categories like Wine, Personal Finance, Cooking, etc. The have a nice looking site, and their classes are self serve, at your own pace, in HD. They have forums where you can interact with fellow classmates and teachers. Classes range in price from $39 to $99.
They asked me what I thought, and I told them I thought they should offer up some classes on my Brad Feld’s Amazing Deal Store. They agreed to give my readers a great deal. $19 for any class that in their inventory. And, I’m putting my money where my mouth is – I just bought (using my Amazing Deal site) the Wine Demystified course.
If you have a love of learning, or are looking for an interesting gift, give Sympoz a try by purchasing this deal. You could become an wine expert for less than the cost of a decent bottle.
I’ve been having a blast with Brad Feld’s Amazing Deals which was created by Deal Co-op, a recent graduate of the TechStars Seattle program. Last week’s deal – the Agloves – ended up getting picked up on Lifehacker and the limit of 500 gloves were sold (at 50% off) overnight! As part of the experience, I’m learning a lot about the Daily Deal business, how it works, what the actual economics are, and what the friction points are.
The latest Brad Feld’s Amazing Deal is now online. We’ve got a great one this week. You can purchase a $70 voucher for use on the Trek Light Gear website for $39. Trek Light has lots of great stuff, including some of the nicest hammocks you’ll ever see. We priced this deal to allow you to purchase their best selling Double Hammock, but you can also use it on other gear.
If you are interested in running a deal on the Brad Feld store, helping bring great deals to readers of this blog while helping me better understand the Daily Deal marketplace dynamics, let me know. I’m looking for deals that can be bought online and shipped nationally and that appeal to a high tech audience.
What Percentage of 2010 Seed Deals Won’t Raise The Next Round?
There have been a number of thoughtful “early warning sign” posts in the past few days including one from Fred Wilson (Storm Clouds), one from Mark Suster (What Angel Investing & Florida Condos Have in Common), and Roger Ehrenberg (Investing in a frenzied market).
The seed investing phenomenon of 2010 has been awesome to watch and participate in. The velocity of activity from individual angels, angel groups, seed VCs (the correct phrase for most of the “super angels” which have now raised actual funds), and even traditional VCs has been on a steep climb throughout the year. When the numbers are tallied up at the end of the year (I’m sure someone will do it – and it won’t be me) I expect there will be all kinds of new records set.
But the warning signs from Fred, Mark, and Roger are worth reading and pondering carefully. I have a few choice quotes to add to the mix that I’ve heard over the past thirty days.
- Prolific Seed VC: I only expect that 30% of the companies I funded this year will raise another round.
- Established VC With A New Seed Program: We are planning to make 30 seed investments out of our new fund. We’ll do follow on investments in 10 of them.
In both cases, when I speculate on the next sentence they would have said if they were being direct and blunt, it would be something like “I expect the balance of them will go out of business after thrashing around for a while.” The optimist would have a different view (e.g. that they would be quickly acquired or they would never need additional capital), but anyone that has been investing for a while knows this isn’t the likely outcome for any but a small number of these companies.
Mid-year I felt compelled to write a post titled Suggestions for Angel Investors. When I reflect on that post, my fear is that most seed investors aren’t implementing a “double down on the first round” strategy. Some percentage of seed deals will quickly raise their next round (30% if you believe the two anecdotes above.) Some percentage of seed deals will fizzle out. But some percentage will get stuck in the middle. They will be interesting ideas with solid teams that realize their first idea out of the gate needs a pivot. Or they’ll be in the middle of a pivot when they run out of cash. In the absence of the existing seed investors stepping up and writing another check (without any new / outside validation) it’s going to be hard for these companies to get to the place where they raise a next round financing.
While all entrepreneurs are optimistic on the day they raise their seed round that they’ll be one of the hot deals that easily raises a significant next round, it’s worth starting to plan from the beginning for the case where you “are interesting, but not unambiguously compelling.” In these cases, you need more time and the only place you are likely to get it is from your existing investors. If they are willing to keep investing on their own without a new outside lead, you’ll at least have a chance to get to the next level. But if they aren’t, you could find yourself in a very uncomfortable situation.
I’ll end with Fred’s money quote:
“Anything that is unsustainable will eventually stop happening. And when it stops happening, there will be a dislocation event that will cause people to change their behavior. ,,, When will it stop? Who knows? But be prepared for it to end. And when it does, things will be different. And we should all be prepared for that time.”
Having worked alongside Fred for a long time in a number of companies through several cycles, I can assure you these words come from a place of wisdom, experience, and shared pain.
The new deal on Brad Feld’s Amazing Deals is up and is for Agloves.
As winter approaches, we all need gloves that we can wear and operate our iPhones while walking down the street. Agloves are infused with silver, which allow them to work with any touchscreen device. No more freezing my fingers as I check email outside in the winter.
The deal which runs through the end of the day of Friday is for $9, or half off the retail price (which I happily paid several weeks ago.)
I’ve got a couple more great deals queued up but am looking for more – email me if you have something to talk about. And – if you want your own daily deal site, just tell me and I’ll put you in touch with my friends at Deal Co-op (a TechStars Seattle company.)
I was thinking more about my post from yesterday titled Addressing The VC Seed Investor Signaling Problem. There were a bunch of good comments that caused me to realize that I wrote the post from the perspective of a VC, not an entrepreneur. As I mulled the comments over, I realized something very specific.
If a VC invests in a seed round but then doesn’t invest in the next round, there is a signaling problem, regardless of what the VC does with their investment.
When I read the post carefully, I realized that I implied that the VC firm’s strategy of selling back their seed investment might address part of the signaling problem. In hindsight, it doesn’t address this at all. It addresses a different problem – the free rider problem.
Most VC’s hate when other VC’s act as free riders. A free rider is defined as someone who invests in an early round but then doesn’t participate in future rounds. Note that I explicitly said “other VCs” and not angel investors. Most VCs expect that angel investors will only invest in the first round or two, so they get exempted from free rider status. I also exempt “super angels” / “seed-only VCs” from this – if you clearly define your role as an investor in the first round or two, and you never participate in later rounds, then you won’t end up being classified as a free rider. But, once you start participating in later rounds, the expectation of your financial participation changes.
Early stage VCs are often expected to play at least pro-rata in following rounds. When companies are successful, the early investors often (but not always) back off their pro-rata. But, when companies go sideways or struggle, the early investors are often expected, by their co-investors – to continue to participate pro-rata until the company either succeeds or fails. In many cases, the consequences for not participating are significant and you can get a taste for this from the post on the term Pay-to-Play that my partner Jason and I wrote in 2005.
The firm that I mentioned in the previous post addresses the free rider problem by saying “look, we’ll make it easy, we don’t support going forward so we’ll sell back our equity to the company, entrepreneurs, or angels and get out of the way for new VC investors.” While this doesn’t address signaling, it does eliminate the free rider – in this case the VC that is not going to participate going forward.
When things are going great, none of this matters. But when things aren’t, they matter a lot. If I shift from the perspective of a VC to the perspective of an entrepreneur, I would only want VCs as seed investors who have a proven track record of consistently following their seed investments with future investments. This will never happen 100% of the time – there are definitely seed investments that don’t make it. In addition, there are often cases where the entrepreneur doesn’t have choices and has to work with whoever shows up with a check. But to hand wave over the issue is illogical.
Now, as a VC, I don’t want to co-invest with free riders. I’m exempting angels, super angels, and “seed-only VCs” from this. But if I co-invest with someone, I want to know that they are going to work with us to continue to fund the company, not walk away 50% of the time “because” – well – whatever “because” means.
The collision between signaling and free riders is what creates a lot of dissonance. In the current wave of seed and angel investing activity, we haven’t hit a hard down cycle yet. We will. When we do, these two issues are going to pop to the forefront. Anyone who participates in the early stage investment ecosystem (entrepreneurs, angels, and VCs) should make sure they spend some time thinking about this and incorporating it into their own strategy, before it is upon them.
One of the most common criticisms of VC investors making seed investments is something that has become known as “the signaling problem.” The explanation of this problem is that VCs create a “negative perception” about a company if they make a seed investment but then don’t follow through and make a next round investment. Another way to say this is that a VC creates a “signaling situation” with their seed investment – if they don’t follow on in the next round they are “sending a signal” that something is wrong with the company (hence the label “signaling problem.”)
Last week I spoke with a partner at a large VC firm whose firm has been around for a long time. They have a new seed program (as of a few years ago) after eschewing seed investments from 2002 to 2008. The partner that I talked to told me that they are doing 30 seed investments out of their newest fund.
I was surprised on two levels – the first is that they have a very visible anti-seed reputation. I pointed out that their market reputation was that they didn’t do seed investments nor did they do many Series A investments. He said “we changed that a few years ago.” I suggested that their web site didn’t talk about their seed program; he responded “yeah, we need to work on our web site.”
The second, more important thing, was that I couldn’t make the math work on their fund. I asked them how many of the seed investments they expected to follow with regular first round investments. He said “half of them”. So – 15 of their investments in the fund would come from their seed program. I asked how many other investments they’d have in the fund. He said 30. So they’ll end up with 45 active investments in the fund (high for their fund size) of which 33% came from seed investments.
I then asked how they were going to deal with the “signaling problem” for seed investments they didn’t follow on with. Here he said something that made me pause: “We’ll sell them back to the founders, the company, or the angels at somewhere between $1 and our cost.” I probed on this (as in “seriously, can you give me some examples?”) Without naming names he explained three situations in the past two years where they’ve done this. And, in each case, his firm had decided not to follow on, took themselves out of the cap table, and the three companies were able to raise additional financing (in one case from a different VC firm.)
I thought this was a pretty clever way to deal with this issue. While it doesn’t eliminate the problem created by the signaling issue, it addresses part of it. I don’t know if this firm will follow through on unwinding their positions in 15 of the 30 seed investments they make. I also don’t know how they’ll feel when one of the 15 they decided not to follow goes on to be massively successful and their seed piece, if they had kept it, would have returned a meaningful amount of money to them. But if they do take this approach it seems like they should shout it from the rooftops as part of their VC / seed positioning statement.
I’m not a fan of this “spray and pray” seed investing strategy for VCs. Instead, when we make a seed investment, we don’t treat it any differently than our non-seed investments. Rather than repeat our approach here, take a look at the post How I Think About Seed Investing As A VC that I wrote a month ago. That said, I found the approach of selling back the seed investment at $1 to be an interesting way to address part of the signaling problem.
Last night I printed, signed, scanned, and emailed two signature pages. As is my custom of not keeping anything around, I tore up and tossed the sig pages and then deleted the files. This morning I woke up to an email saying “We didn’t get your signature pages. Can you please send them.” I just went through the same print, sign, scan, and email process again.
This is so profoundly stupid. I sent a note yesterday afternoon in reply to the email thread asking if I was all set to go that said “I’m all set to go.” A bunch of lawyers were on the email thread (mine and the company’s.) We are wiring the money today. Now they have some pretty scanned sig pages also.
There has got to be a better way. Over the last decade, there have been lots of “electronic signature” companies pop up. None have seemed to take root in the corporate world. In the past year, I sold a house and bought a house. In both cases, there was some goofy online thing that I signed with my mouse (my signature looked like a messy “X”) for the offers (to make / accept) but I still had to go to the title company and sit and sign 37 documents to close. Every time I go to the grocery store I swipe my credit card through a little electronic checkout machine and when it’s time to sign, I put a big “X” on the sig line.
When I think about the number of places my actual signature is at this point, it’s a pretty useless mark. But for some reason it’s still important in the legal closing process. This now seems more like a tradition, instead of a useful thing.
While I’m not interested in funding something in this arena (it’s outside our focus), it seems like there’s finally an opportunity to solve for this, at least in the corporate world. I’m not talking about biometrics or retina scanning – just a valid electronic signature that becomes a standard. Maybe someday. Wouldn’t it be cool if they lawyers took this on and tried to solve it?
My partner Seth Levine has a detailed post up today titled Trada – from the beginning that describes the creation and financing of Trada. Foundry Group is the seed investor in Trada and Seth’s post describes one example of what I think is effective VC seed investing.
The meat of the funding story follows:
“Of course coming up with the idea is the easy part. Executing against that idea is another matter. In this case neither Niel (nor I) had any interest in creating a traditional syndicate to fund the company. Instead we quickly put our heads together about a financing (we like to say it was over beers, but the truth is more mundane – we hammered out the details in a 10 minute conversation in the conference room of the Foundry office). We decided that we wanted to bring in some experts to help us with the business and together flew around pitching the business to a small handful of strategic angel investors to pull together a small syndicate that became the initial Trada investor base. Niel and I hammered out a second financing in similar fashion (again around the Foundry conference table, this time without the need for an angel roadshow). It’s a great example of how we like to work with entrepreneurs – especially those that we have a long history with. We like to be involved early (in this case before an idea for a business even existed) and we think of our angel investments as a down payment on a subsequent investment in the business (we’ realize that we need to give early businesses some time to develop).”
The short version is that the seed round was figured out in ten minutes – this was the “Series A”. A few strategic angels were added to this round. We did a second financing by ourselves at an increased valuation – this was the “Series B”. Recently Google Ventures led the a $5.75m “Series C” round.
The terms on the Series A and B were straightforward as Niel Robertson, the founder/CEO of Trada is a sophisticated entrepreneur (Trada is his third company) so he had no patience (nor did we) for silly, complex early stage terms. More importantly, the two key aspects of any deal – price and control – we able to be negotiated quickly between Seth and Niel, partly because of their long history working together which was built on mutual respect and trust.
When we funded the Series A (the seed round) of Trada, we fully expected we were at the beginning of a multi-round journey. Seth does a great job of explaining how it got started – I encourage you to read his post for an example of one of the financing cases where I think a VC can be an excellent seed investor.