Category: Venture Capital
Last week saw an explosion of discussion around seed investing, including plenty of negative comments around VCs as seed investors. While I agree that many VCs are crummy seed investors, I think there are some that are excellent seed investors. This prompted me to write a post titled AngelList Boulder and Some Thoughts on Seed Investing where I promised to write up some of my thoughts on how and why VCs could be good seed investors.
Before I got around to starting, there were three excellent posts that, if you are interested in this topic, are must reads. They are:
- Fred Wilson: Lead Investors, Dipshit Companies, and Funding Every Entrepreneur
- Mark Suster: Understanding a VC’s Seed Funding Policy is Critical
- Dave McClure: MoneyBall for Startups: Invest BEFORE Product/Market Fit, Double-Down AFTER
All three of these posts lay out clear points of view on the authors seed strategy. And importantly, Mark encourages all entrepreneurs to make sure they understand a VC’s seed strategy before taking money, which I strongly agree with.
Before I start talking about good and bad VC seed strategies, I thought I’d explain mine. For context, about 25% of the investments we make at Foundry Group are seed investments. But before Foundry Group, my partners and I were involved in many seed investments, both at Mobius Venture Capital. In addition, I’ve made many seed investments as an angel investor in two time periods,1994-1996 and 2006-2007, and seen many more through my involvement as a co-founder of TechStars. Our strategy has evolved from this experience and is different from my angel investor strategy (which I’ve explained in my post Suggestions for Angel Investors.)
As a VC, I do not differentiate between a seed investment and any other investment that I make. At Foundry Group, we are comfortable investing as little as $250k in a round (a seed investment for us) all the way up to $10m in a round. We think about each investment – whether it’s $250k or $10m – the same way, and commit to participating in the business for the long term.
Specifically, our seed investments are not “options on the next round.” We price our seed rounds as equity investments, always lead or co-lead (as Fred describes in Lead Investors, Dipshit Companies, and Funding Every Entrepreneur), and treat them the same way we would with a $10m investment.
I have three partners and all of us are involved in all of our investments. So, when we make a seed investment, it gets everyone’s attention. We try hard not to smother it with love, but we recognize that we usually each have something unique to add to a seed investment and try to help accordingly. As a result, we are all emotionally involved in the investment (a phrase you’ll see in later posts about this topic) which I believe is both beneficial to the entrepreneur and extremely important to the VC firm.
When we make a seed investment, we fully expect to invest at least the same amount that we invested in the seed round without thinking hard about it. One of our strongly held beliefs is that it often takes several years for a company to find its mojo and we are willing to work through the challenging first few years. As a result, we don’t believe that there is a particularly critical “go forward or not” decision point immediately following the seed round. Now, this doesn’t mean that the follow on round is blindly done – we are very internally critical of the progress a company is (or isn’t) making, but we try to firmly put ourselves on the side of the entrepreneur in this discussion and work together when things start off slowly, or differently, than expected.
At Foundry Group, we describe ourselves as being “syndication agnostic”. This means we are completely indifferent as to whether we fund something ourselves or with other VCs (e.g. each are equally happy situations.) In addition, we are equally delighted to co-invest with angels and super angels, or not. Basically, we are happy in any case, are making a decision to invest independent of anyone else, and defer to the entrepreneur on who they want to have involved.
Finally, we are deliberate about the areas we invest in (our “themes”). We see a ton of seed investment opportunities, but only invest in a few. Many of the opportunities we see are outside of our themes. We have consciously decided to only invest in areas we know well and think we can be meaningfully additive to and constrain our focus to these themes (although the themes expand and evolve with our experience.) This lens allows us to spend the vast majority of our time on companies we are either investors in or likely to be investors in, and limits our time “exploring lots of things that have a low probability of being an investment for us.”
Taking Mark’s lead from his post, I’m going to put up a more specific post on the Foundry Group blog that lays this out in a very specific way. I’ll also follow this post with some examples, as I’ve got seven to choose from: AdMeld, Gnip, Lijit, Mandlebrot, Next Big Sound, Standing Cloud, and Trada. And, in case you are wondering, here are two recent examples of how seed investments blossom: AdMeld Raised $15 Million Round from Norwest Venture Partners and Time Warner and Trada Raises $5.75 Million Round From Google Ventures.
This just makes me want to crawl under my desk and cry for a while. Can you imagine how much it would hurt if you threw that at a lawyer or an accountant and actually hit them with it?
Skadden Partner Completes 409A Handbook: “
Regina Olshan
Erica Schohn
Flashback: Regina Organizes Push for 409A Extension”
(Via 409A Dismay.)
I’ve been in several board meetings over the past month where the companies are having a killer Q2. A year ago everyone was still pretty rattled from the financial crisis and there was plenty of belt tightening, consternation, and general anxiety. By Q409 we’d had a number of companies we are investors in end the year strongly and their growth has continued into Q1 and Q2.
Over the past 15 years, I’ve sat through plenty of good meetings and plenty of bad board meetings. I always try to acknowledge the efforts of individual executives when they’ve exceeded expectations and the full team when they’ve crushed it. I’m not afraid to be direct and critical and I always speak my mind, but I try never to forget to praise people for their efforts.
When I reflect on my peers, some of the best VCs I’ve worked with are amazing at acknowledging the efforts of the entrepreneurs and management teams, especially when they are dealing with complex situations. This praise isn’t gratuitous – it’s targeted, focused, and appropriate. And over the years I’ve occasionally seen it offered up at exactly the right moment.
Unfortunately, the opposite is more common. I often sit through a board meeting and watch in amazement as the VC investors socratically pick away at the management team, asking question after question but offering no substantive suggestions. If the business is having an issue, or the CEO is specifically looking to try to work through a problem, this can be helpful. But in the cases where the company has performed well, this is at best a tedious exercise in wasting everyone’s time. At worst, it’s insensitive and offensive to a management team that has performed well, especially in a tough situation. And often, it’s incredibly deflating and demotivating.
So, fellow VCs and board members, take a moment and remember that when people do a great job, it’s worth spending a moment acknowledging them. Most of the folks I’m working with are busting their asses to create real companies. They are making many sacrifices and tradeoffs to do what they do. A little pat on the back will go a long way, especially after three hours of questions.
I was in a meeting with Rich Miner from Google Ventures on Friday with some entrepreneurs we are working with on a potential investment. While the team isn’t a rookie team, they’ve never worked with VCs before and they’ve been wrestling around the dynamics of how to interact with the two VCs in the room (me and Rich) and the various angels that are part of the seed round we are planning to do.
In the middle of the discussion, Rich used a brilliant metaphor of “VC as produce suppler”. The CEO was talking about how she realized she was the lead chef in the kitchen, but viewed us as some combination between sous chefs, owners, and the diners in the restaurant. This was apparent in the interactions – was she trying to “please us”, listen to us and do what we said, or put us to work? This was made even hard with the handful of angels involved – where did they fit in? And, it was clear that the kitchen was getting crowded.
In this middle of what was a rambling conversation, Rich said “think of us as produce suppliers.” He said something like: “We bring you produce. Some of it will be awesome and you’ll want to use it immediately. Some will be moldy, or won’t fit in your recipes, or you won’t need any more of it. And sometimes we won’t show up. Occasionally you’ll want to put us to work in the kitchen teaching you how to make a new dish with our produce. Other times you’ll politely ask us to get out of the kitchen so you can get some work done. And – ultimately – all of us – the investors (VC and angels), the entrepreneurs, and the employees are the owners!”
I’ve editorialized, but I stopped, wrote it down, and asked Rich if I could blog it. It’s one of the best, freshest, and crisp metaphors for the VC / CEO relationship that I’ve ever heard.
Every quarter, without fail, a bunch of articles appear talking about the venture capital industries investment pace as a result of the PWC MoneyTree report. I used to get calls from all of the Denver / Boulder area reporters about my thoughts on these – that eventually stopped when I started responding “who gives a fuck?”
A few days ago I got a note from Steve Murchie about his new blog titled Angels and Pinheads. I’m glad Steve is blogging about this as he’s got plenty of experience and thoughts around the dynamics of angel investors – some that I agree with and some that I don’t. Regardless, my view is that there more there is out there, the better, as long as people engage in the conversation.
In his post Mind the Gap he made an assertion that “the VC industry has effectively stopped investing in seed stage ($500K and less) and startup-stage ($2M and less) opportunities.” As a VC who makes lots of investments between $250k and $2M, and who has plenty of good friends who happen to be VCs that also make investments in this range (such as Union Square Ventures, First Round Capital, True Ventures, SoftTech VC, FB Founders, Alsop Louis, O’Reilly Alpha Tech, and Highway 12), I thought Steve’s assertion was wrong and I told him so in the comments. He countered with the PWC Moneytree data on Q3 VC investments.
| Stage | Total $M | % of Total | # Deals | Avg / Deal $M |
| Later Stage | 1611 | 33.49 | 168 | 9.6 |
| Expansion | 1610 | 33.48 | 185 | 8.7 |
| Early Stage | 1081 | 22.49 | 198 | 5.5 |
| Startup/Seed | 507 | 10.54 | 86 | 5.9 |
Steve’s response to the Startup/Seed “Average Deal Size” was “WTF??!” While that is the correct reaction, his conclusion (that VCs aren’t investing between $250k and $2M) is incorrect for two simple reasons: (1) the data is the PWC MoneyTree Report is incorrect and incomplete and (2) the interesting number to look at, assuming the data is correct, is the Median, not the Average. If you wonder why, Wikipedia’s explanation is pretty good: “The median can be used as a measure of location when a distribution is skewed, when end values are not known, or when one requires reduced importance to be attached to outliers, e.g. because they may be measurement errors.”
Let’s look at the underlying data in Silicon Valley (that results in the above table) to understand this better. Going to the PWC Moneytree Startup/Seed investments in Silicon Valley for Q309, you get the following:
The first six “startup/seed” investments each raised $10M or more. Now, I’ll accept that these might be classified as “startup rounds” (e.g. the first round of investment) but no rational person would categories these as seed investments. But, for purposes of this example, let’s keep them in the mix. The average is $6.4M and the median is $5.0M. Now, let’s toss out only the ones $10M or great since these clearly aren’t “seed” investments. Our average is now $3.4M and the median is now $2.0M.
I’m still feeling generous (e.g. I’ll waive reason #1 – that the data is incorrect / incomplete – for the time being). Let’s look at the PWC Moneytree Startup/Seed investments in New England for Q309.
The average is $8.4M and the median is $5M. Now, toss out everything above $10M. The average is now $3.9M and the median is $4M.
But it gets better. Let’s take all of the PCW Moneytree Startup/Seed Investments in the US for Q309. There are 86 of them and as we know from the first table the average is $5.9M. But the median is $4M. Now, toss out the ones above $10M. The average is now $4M and the median is now $3M. This exercise – again – assuming the data is correct – shows the difference between average and median, as well as how much the numbers are skewed upward by “startup/seed” investments $10m or more.
I’m not going to try very hard to show that that the data is incorrect, but I’ll give you two examples. The first is FourSquare, a well known seed investment led by Union Square Ventures and O’Reilly AlphaTech. It was a $1.35M financing, has three employees, and occurred in 9/09. This is about as close to the definition of a seed investment as you can get. Yet, PWC Classifies it as Early Stage (plus they got the investment amount wrong as they list it as $1.15M.) For reference, Dow Jones VentureSource classifies this as a seed investment and gets the amount right.
Let’s do another one. This time look at what PWC MoneyTree has on First Round Capital
compared to what Crunchbase has on First Round Capital for Q309.
The differences that I think are incorrect on PWC’s part are that (1) GumGum is missing, (2) CoTweet is classified as Early Stage instead of Seed, (3) BigDeal is missing, (4) DNAnexus is missing (although it looks like it might have happened in Q2 even though it was widely reported in August), (5) Continuity Engine is classified as Early Stage instead of Seed, (6) ClickEquations is missing, (7) Sofa Labs shows up twice, and (8) Sofa Labs is classified as Early Stage instead of Seed. Now Crunchbase is missing Project Fair Bid (even though they reported on it) so they aren’t perfect, but at the minimum the misclassification between Seed and Early Stage is dramatic. Just for grins I looked these up in Dow Jones VentureSource and their data is closer to CrunchBase’s (especially the Round Type), but there are still differences.
Ever since I started investing in 1994 I’ve heard people spouting VC investment statistics to justify different viewpoints. I’ve always felt this was a “garbage in / garbage out” phenomenon. While there are some academics that do rigorous work around this (and understand the difference in importance between averages, medians, and er – statistically significant results), they are few and far between. And – most of the data people actually use and discuss is stuff like the PWC Moneytree Report.
I keep fantasizing that this madness will stop, but I doubt it will. In the mean time, I think I’ll go for an average run at a median pace.
There were some great comments on my post from Sunday titled Being Syndication Agnostic. One of them was from Kevin Vogelsang – he asked the following question:
What are the downsides to syndicating a round of financing for the entrepreneur/startup (assuming the relationship with all investors is a good fit of course)? By syndicating a deal, the entrepreneur gains access to a larger network. This seems to be a big positive. However, there must be downsides (less attention, more interest groups, etc.) Love to hear more on the topic.
While there are plenty of downsides, I’m going to take on five common ones in this post.
Too Many VC’s on the Board: Most VC’s want a board seat when they invest in a company. At the early stages this is usually manageable (although not necessarily desirable). However, once a company has raised several rounds of financing and built increasingly large syndicates, this can quickly get out of control. The largest board of a VC backed company I’ve ever been on was 11 (8 VCs, CEO, founder, one outside director). It was a completely ineffective board. Now, the board size problems can be dealt with by a strong CEO and a strong lead investor who will help the CEO organize the board in a manageable way, but it has to be done proactively.
Too Many People in the Room: This is a corollary to “too many VCs on the board.” If the VC doesn’t get a board seat, they’ll want an observer seat. In addition, most later stage VCs or strategic investors want observer seats. Suddenly even though you’ve managed the size of the board effectively, there are a bunch of people in the room. I’ve been in board meetings with over 20 people in them (I don’t know the exact max, but I’m going to guess it’s around 25 since eventually you run out of chairs.) Not surprisingly, these tend to be weak or inefficient board meetings with separate “executive committee meetings” where the real board meeting happens, and then another three hour song and dance for the benefit of the 15 other people.
Both of these are a natural result of most investors in private companies wanting to have a seat at the table. While a reasonable expectation, it’s important for the CEO and founders to set an appropriate tone and expectations with their investors early on so that there’s actually an effective board, investor, and company dynamic as the syndicate gets large.
Misalignment of Interests: With each round of investment and each new investor comes new expectations. As the syndicate size grows, the chance of interests between parties getting out of alignment increases. This is especially true when each round has different dynamics beyond price (such different preference structures, protective provisions, voting thresholds by class of stock, and various participation caps.) When everything is going well this isn’t an issue, but the minute the business goes sideways (or worse) strange things start to happen. As the situation degenerate, the knives (or flamethrowers) come out. I’ve been involved in situations that resulted in the destruction of companies that deserved to live another day because the investors around the table (which included me) couldn’t get their collective shit together.
Decision Vacuum: This is a corollary to “misalignment of interests.” It’s similar to when I lived in a fraternity at MIT and a dozen of us would stand in the hallway trying to figure out where to go out to eat. This drill could go on for a while, especially if we had a keg of beer (or, er, something else) nearby. Eventually someone stepped into the decision vacuum and said “I’m going to Mandarin – come with me if you want” (well – that was what I usually said – others had different choices). Whenever you’ve got at least four VCs sitting around a table, you run the risk of a decision vacuum forming (queue snarky jokes here). If you are a CEO of a company and you see a decision vacuum developing, grab a bunch of matter and get in the middle of it.
Lame Duck Syndrome: There has been plenty of personnel changes in the “VC business” in the past five years, including plenty of firms that are winding down, have shrunk in size (and let partners go), and have disbanded. However, they are still investors in your company and some of them still sit on your board. In some cases they are just hanging around to “protect their investment” although they have no ability or interest in putting additional capital into your company. Now – some folks in this position are incredibly helpful, but many don’t do much more than show up. And – the more of them like this around the table, the less fun it can be.
Now, there are plenty of other downsides as well as plenty of advantages of large syndicates. If you’ve got additional ideas, or stories to share (especially horrifying ones showing the downside), comment away even if you change the names to protect the not so innocent.
Bijan Sabet started it with a great post titled We Gotta Do A Deal Together and Fred Wilson followed with an equally great post titled Trading Deals, A Lost Art? I’m going to try to add to the mix with this post by describing our strategy at Foundry Group around syndication and explain a little of where it came from. Please read both Bijan’s and Fred’s posts as it’ll provide a lot of context for this one.
At Foundry Group, we describe ourselves as syndication agnostic. Specifically – we are delighted to work with a syndicate of other investors and we are equally delighted to invest by ourselves. Another way to say this is that we are indifferent as to whether or not we have co-investors in a company with us at any stage of the investment cycle. I realize this isn’t the classical definition of agnostic but I think it’s an appropriate use of the adjective form.
Here’s what this means in practice. In an early stage investment we decide whether or not we want to invest and then leave it up to the entrepreneurs if they want to add anyone to the syndicate. If so, and they are someone we like working with or would like to try working with for the first time, we encourage it. If the entrepreneurs just want to get going with us, that’s fine also.
Now, assume there is no syndicate for the seed or Series A financing (e.g. it’s just us). Well in advance of when the company needs to raise the next round we’ll decide whether or not we’ll make another investment. If we are supportive, we are direct with the company, figure out a price we are willing to do it at (we are willing to invest by ourselves at a higher price if we believe the progress of the company merits it), and give the company the choice of having us invest in another round by ourselves or add another investor to the mix. Again, it’s up to the entrepreneur, but we signal our intent clearly and early, are willing to put a term sheet down, and lead the financing with or without a new investor.
Two things make this strategy work for us. We only invest in software and Internet companies. We have a deeply held belief that we can figure out “if things are working” by the time $10m is invested in a company. As a result, we are willing to invest up to $10m on our own to play out the early to medium stages of a company. By the $10m point we have to make a theoretically harder decision, although ironically it’s usually a pretty easy one. The company is either unambiguously on a success path, at which point adding additional investors to the syndicate is easy (since it’s a highly desirable later stage investment) or it’s a tough situation that’s not working out. Occasionally it’s in the middle (e.g. unclear and ambiguous), but not very often.
Some recent examples help illustrate this:
Next Big Sound: We led the seed round and co-invested with Alsop Louie (Stewart Alsop) and SoftTechVC (Jeff Clavier) – two VCs that we love to work with. We could have easily invested by ourselves, and Next Big Sound had a long list of VCs that wanted to invest (more than 5, less than 10). The founders chose the syndicate.
StockTwits: The seed round was led by True Ventures. We decided proactively that we wanted to invest in StockTwits as part of a new theme we are developing and approached Howard Lindzon (the founder/CEO). He was in the midst of closing a follow-on with True. We have enormous respect for True but hadn’t done a direct investment with them (I’ve personally invested in several companies with them) so were extremely interested in doing something together. They reciprocated and we put together a bigger financing than planned (although still a relatively modest amount as Howard isn’t interested in raising a lot of capital) that allowed everyone to be happy with their stake in the company.
Cloud Engines: Cloud Engines had raised some angel money (from well respected angels) prior to our investment. We did the first round by ourselves and recently did a second round by ourselves. We did this quickly because we were thrilled with their progress and this allowed the company to ramp up production to meet demand. We left the financing open for a strategic co-investor although we are perfectly happy to take the remaining piece for ourselves.
The common two themes from this for us is: (a) we only co-invest with people we like, trust, and respect and that like, trust, and respect us and (b) we view it as our responsibility to make a decision about whether or not we want to invest independent of any other investors (VC or angels) at the table.
For completeness, we love investing with Union Square Ventures (we are co-investors in Zynga) and Spark (we are co-investors in AdMeld) and we hope to make additional investments with both of them in 2010.
Ultimately the syndicate is the entrepreneurs’ choice. And our goal is to make the discussion simpler, cleaner, and crisper, so the entrepreneurs aren’t having to guess, or jump through bizarre hoops, or play a difficult VC-centric game as they finance their company.
Three of my VC friends (Santo Politi, Mark Suster, and Kate Mitchell) were on Fox Business’ Capitalist Ad”Ventures” series. The underlying theme of this segment was the characteristics of entrepreneur that VCs look for.
Fox doesn’t seem to have embeds, so you’ll have to use this URL to watch “The Future of Venture Capitalism”.
While Santo, Mark, and Kate weren’t the maniacal crazy people (although I’m sure some will argue that), they were clear about the ones they are looking for. Nice job gang!
VCs say a lot of stupid things. I’m guilty of it plenty and whenever someone calls me on it I try to acknowledge and change. One that I try really hard not to do is say “my company” when referring to companies I’ve invested in – I think it’s one of the most annoying things a VC can say.
I was talking to a VC the other day about a few companies he had invested in. By the third time he referred to one of the companies as “my company” (as in “My company is working on X”, “My company would like to talk to Company Z about thing Y”) I felt myself starting to react. I didn’t really have a relationship with this VC, but I knew that he had never run a company (investment banking post college, MBA, then VC). I realized I wanted to stop him at some point and say “dude – it’s not your company – you are merely an 18% shareholder in the business.” I bit my tongue and had the conversation, but I’ve been thinking about this in the back of my mind ever since.
One of the great lines from TechStars is “It’s your company.” That’s the way David Cohen and I remind the TechStars’ founders that ultimately all the decisions are theirs – the mentors (and us) are providing data, feedback, thoughts, and insight – but not telling them what to do. Sure – a lot of our (and the mentors) language is directive (e.g. I just sent an email to a TechStars CEO that said “you should do thing W right now”) but ultimately the decision as to what to do is the CEO’s.
While I’ve got plenty of rights as an investor, I’m very aware that I’m “an investor.” If you are a CEO or an entrepreneur, I can’t imagine anything more annoying than hearing one of your investors refer to the business as “his company.” Now, if the investor owns more than 50% of the company, I guess this is a legitimate legal perspective, but it’s still an incredibly demotivating position to take.
So – to all my friends out there in VC-land – let’s try to change the language. Some of the VCs I respect the most – like Fred Wilson – diligently refer to investments they make as “portfolio companies” (as in “our portfolio company X"). I often refer to them as “our investment” or “our portfolio company”. Regardless of the approach you take, think about the language you use, especially the impact on the people who are working their asses off every day to make “their company” successful.
Sorry if this feels pedantic to you. It’s now out of my head and on this blog so I can move on. As someone I love likes to say “my work here is done.”