Category: Venture Capital
My friend Dave Jilk just put a copy of Howard Anderson’s MIT Technology Review article “Good-Bye to Venture Capital” on my chair (I thought it was quaint that he put a xerox copy of the magazine article on my chair instead of emailing me the web page – maybe he was trying to tell me something.)
Howard was a founder of Battery Ventures and then YankeeTek Ventures. I met him for the first time in the early 1990’s when my first company (Feld Technologies) did some back office network / software work for Battery. I met him again recently at the MIT Sloan School Dean’s Advisory Council meeting (I’m on the MIT Sloan DAC – among other things Howard is the William Porter Distinguished Lecturer at MIT’s Sloan School of Management.) It was great to catch up – albeit it briefly – and his mindset during our conversation was very similar to what he talks about in the article.
Howard is saying something that a number of veteran VCs are saying – there are too many VCs in the market, too much VC money trying to invest, and a completely lack of irrational expectations, which are a requirement for the long term success of VC investments. Howard asserts that a structural change has taken place, rather than a cyclical chance – VC’s thrive on cyclical changes (e.g. buy low, sell high), but structural changes (e.g. the rules are different) causes a real problem.
Yeah – the markets are rational again – but isn’t that just a cycle (I smiled as a wrote that – at least they aren’t irrationally horrifying anymore like they were in 2002.) While I don’t agree with everything that Howard says, the article is definitely provocative for anyone that is a student of, participant in, or investor in the VC business.
Allen Morgan at Mayfield has a nice series up on his blog about the ten commandments for entrepreneurs. His post today is Commandment #6: Explain Your New Ideas by Analogy To, or Contrast With, Old Ideas.
He’s right. Mostly. At the end of his post, he asks for ways to “categorize the new ‘It’” (if they are VCs). My constructive addition to his post is the notion of the analog analog (also known as the “analog analogue”, but I like my version better).
In the mid 1990’s, I met Jerry Colonna, we invested in a few companies together, and became very close friends. I love Jerry and – while I rarely see him since he’s in NY and I’m in Boulder – I feel connected to him in a way that’s unique. Maybe it was our joint experiences together, maybe it was something we drank one night, or maybe it was merely a cosmic connection – in any case, I smile whenever I think of the things I’ve learned from him and the experiences we have had together.
One day, when we were talking about a deal, Jerry knocked me on my ass by saying “what’s the analog analog?” In true Feld fashion, I responded with a “huh?” Jerry went on to explain his theory of the analog analog (which I’ve written about before) – specifically that every great technology innovation (or technology business) has a real world, non-digital analogy. It’s not the “nothing new is ever invented” paradigm – rather it’s the “learn from the past” paradigm.
I’ve found this to be a much more powerful lens to look through when evaluating a new business than the “technology analog” lens (which is the one Allen is describing in his post). While “Tivo for the Web” or “eBay meets CNN” are useful analogies, I recommend entrepreneurs take a giant step back – out of the technology domain (or at least our current technology domain) – and get to the core analogy – optimally a non-digital one. Then – walk forward from the analog analog through other analogies to the current idea.
Throughout my life, I’ve heard the cliche “history repeats itself” over and over again. This is never more true then in the computer industry. Earlier this morning, I wrote about Ryan’s post on Mr. Moore in the Datacenter and alluded to the migration from mainframe to web to ASP to SaaS (aren’t they all different versions of the same thing?).
All hail the analog analog – the more things change, the more they stay the same (ok – that’s a cliche also).
When I was a kid, whenever my mom said something like “Brad, you sure do have a mouth”, I’d usually respond with “You better fucking believe it.” (which usually elicited a grimace from her, but I know she was laughing inside).
I love giving talks, speeches, and being on panels (although I hate sitting in the audience listening). I gave one in the fall at the 30th Annual Venture Capital Institute – a multi-day conference that’s one of the key “professional education” events for the VC industry. I always ask for feedback from event organizers after any talk I give or panel I’m on. Sometimes it takes a while for the feedback to make its way to me – I finally got the VCI feedback the other day. As I read through my talk specific feedback, I was rolling on the floor with laughter from the specific comments (I’ve italicized the ones that really got me) – they say more about the “style” of the VC industry than anything I could ever dream up. So – rather than try to describe it, here they are. Enjoy.
- Just went a little bit too fast.
- Although one of the best instructors of the program – with excellent delivery & content – I’d encourage the Institute to make it clear what is & is not appropriate language. I found Brad’s inferred style fantastic & nothing offensive – but some may, especially in the southeastern U.S.
- Obviously a very dynamic speaker.
- Dress is disrespectful.
- Subject content may have been a bit too much of a “war story” recounting but brought valuable bits of info to light and addressed issues and options well.
- A breath of fresh air with great experience to share.
- Just a fabulous speaker – really enjoyed the “learnings” he shared from real deals.
- Instruments used not really applicable to our market.
- Very good.
- Poor time management.
- The best so far – actual cases very helpful.
- More time or probably less slides.
- I thought Brad’s teaching technique and personality was a great change.
- Could have spent more time on term sheet.
- Should have allocated more time to this topic.
- Take time for IPO discussion.
- This presentation was helpful, especially the examples of how exits occurred in his experience.
- I would have liked this to be longer – it would have been nice to learn the rest of this presentation.
- Entertaining speaker.
- Case studies were excellent (and helpful).
- Liberal use of the “F word” detracted from the presentation.
- Knowledgeable speaker; would appreciate more examples of problematic exits & pitfalls.
- Great candor in describing the industry. Perfect choice!
- Nice T-shirt!
- Some terms were beyond my knowledge level (liquidation preference – carve out…). I’m new in the business & will learn from my firm. A little crass and sloppy for my taste (in this setting). But clearly a very intelligent businessman with practical common sense – a guy I’d invest in & with.
- Bad language.
- Try to stick to schedule. Useful format & detail. Slightly long-winded. Too much time spent on relatively easy concepts.
- What happened to dress code? Too cute! Is this really the presentation VCI wanted? Language was offensive. Good material but inappropriate presentation.
- Brad was terrific, all-around. Very concise, informative and honest.
- Certainly unique but good, memorable presentation.
- Great content. Having more detailed back up slides would be helpful as take-away’s.
- Very practical/useful discussion.
- Good job at describing very rich information. Very open and responsive.
- Very graphic – held my attention.
Mom – you should be proud – you’ve raised a graphic kid (my mom’s an artist, so I’m sure she won’t miss the double entendre). And – if Tom Peters says “fuck” in public, surely it’s acceptable in business at this point.
I’ve known Fred since the first day I started working with Mobius (called Softbank at the time). My very first Softbank-related meeting was to do due diligence at a company outside Boston called Yoyodyne and I met Fred, Charley Lax, and Seth Godin (the Yoyodyne CEO / founder) in Yoyodyne’s office (I kept looking for John Bigboote in the office but couldn’t find him.) Neither Fred nor I knew each other (nor did we know the other was going to be there), but I remember an immediate first impression about five minutes into the meeting of “smart dude.” Fred went on to start his first venture fund (Flatiron Partners), invest in Yoyodyne (with Softbank – which had a happy ending as Seth sold it to Yahoo! for a bundle well after he had no hair), and build a very successful NY-based venture fund with his partner Jerry Colonna.
Fred and I shortly discovered that we were both MIT grads and I recall one of our first long discussions on a wonderfully warm Boston night as we wandered from dinner in the Back Bay back to our hotel somewhere talking about MIT, getting to know each other, and laughing about how crazy busy things were (this was 1997). I worked closely with Fred and Jerry on a handful of companies (eShare – big success, abuzz – solid success, Mainspring – got our money back, Appgenesys – big failure, Return Path – success in progress) and adore both of them.
I’ve had the pleasure of working very closely with Fred over the past four years on Return Path – which we became investors in together when we merged an early stage company Fred had funded (Return Path) with an early stage company I had funded (Veripost). Return Path and Veripost were direct competitors, were both pre-revenue, and were the only two companies that had been funded to create “email change of address” systems. Fred and I had one of those “duh” moments and worked closely with the management teams to combine forces early, rather than pummel each other before the market matured. Matt Blumberg – the CEO of Return Path – has done an awesome job building the business and I’m extremely proud of the company Matt and his team have created (and hopefully Matt’s happy with the “help” that Fred and I have provided along the way.)
While I know Brad Burnham less well than Fred, having never worked with him, I watched Fred work with his partner Jerry Colonna and see Brad as another perfect foil for Fred. As the cliche goes – “every great partnership starts with two people” – and Fred and Brad seem like a superb fit.
Congrats Fred and Brad!
I attended the NACD Colorado monthly event today in Denver. It was moderated by Mike Platt of Cooley Godward (one of my primary attorneys) and was a good moderated panel discussion on “Board issues dealing with VC directors.” The board had an entrepreneur (Jim Lejeal – CEO of Oxlo), a VC (Don Parsons – Appian Ventures), and a VC general counsel (Jason Mendelson – Mobius Venture Capital) on it. Jim, Don, and Jason put on a good show.
Jim and Mike originally founded an organization called the Colorado Directors Guild several years ago. Their insight and impetus for starting this was to try to build a peer-community of directors for entrepreneurial companies – especially as stuff like Sarbanes Oxley started to put a lot more focus on the care, duties, and responsibilities of directors of companies – both public and private. A year ago, they merged it into NACD which is a well-established national organization with a similar mission.
I’ve been a member / advisor of both the Colorado Directors Guild and the NACD and strongly endorse what the NACD is up to. If you are a director of a company or are interested in becoming a director, I recommend you take a look at NACD’s programs and consider becoming a member.
This morning I hosted a presentation by the MIT Deshpande Center about their program to a group of Colorado VCs. I’m really excited about what the Deshpande Center is up to and will blog about that separately. Steve Halstedt from Centennial Ventures – a long time VC and one of the guys I’ve learned a lot from (we were both on the Raindance board together) – sat next to me and wrote the following down in the middle of the meeting and handed it to me.
Why scientists and engineers, who know so much, make so little compared to VCs (or investment bankers, or trial lawyers) who know so little.
Time is Money
Knowledge is Power
Power = Work / Time (from high school physics)
If you substitute Knowledge for Power and Money for Time
Knowledge = Work / Money
Using a little basic algebra (about the amount most VCs remember) and arranging terms, you get
Money = Work / Knowledge
For a given amount of Work as Knowledge apporaches zero, Money becomes infinite.
This explains the difference in market value between scientists/engineers and VCs.
I screwed up.
I was involved in a merger of two companies in Q4 last year. Post merger, I let both companies slip on completing their audits. I figured we’d do the 2003 combined audit after audit season. In an attempt to save money, the company let it slide into the fall. This isn’t a governance issue – I’m comfortable that both companies are clean – it’s a timing issue – we figured we’d get it done later in the year to save money and just hadn’t gotten around to it.
Recently, this company was approached to be acquired. Due to their concern about SOX, the acquirer is insisting on a 2003 audit (not a surprise). However, their accountants also want final 2002 independent audits through close and 2002 combined stub period audit. A little surprising, but not unreasonable given the size of the transaction.
Independent of cost, we have a time delay as a result of the audits. In addition to the complexity of the various audits required, my company’s previous Big 4 auditor decided that they didn’t have time to continuing auditing this company. There were no technical or legal issues – I’m experiencing this throughout my portfolio – the Big 4 auditors are so busy with public / SOX work that they are billing ridiculous amounts for that they no longer care about VC-funded private company work (or the relationships with the venture firms that they worked so hard to develop between 1997 and 2002.) Our new auditors – one of the next 50 firms – is doing a great job – but they had to start from scratch and come up to speed on the company. The end result is that we’ll probably lose a month in the deal process due to the audit work.
So – the simple lesson if you are a venture funded company is to get your audits done by mid-year every year, no matter what. Since you’ll likely need previous year audit for a Q3 or Q4 transaction, you’re better off getting it done so it doesn’t hang you up in a transaction. Note that you don’t need a previous year audit to close a Q1 transaction and occassionally (but not always) don’t need one to close a Q2 transaction.
So – eat your wheaties. Do your audits early.
Author: Seth Levine, Mobius Venture Capital
Brad’s given me permission to co-opt his blog for the day. I work for Brad (and had a great time recently up in Alaska “working”) which gives me an unusual vantage point from which to consider some of his posts on the world of VC. After reading several of these posts (and of course living in this world with him) I came up with the great idea of suggesting to Brad that he write a post about deal splits and the notion of what investing “pro-rata” actually means. Brad had an even better idea which was to have me write the post (which, of course, made my original idea seem not quite so brilliant).
The question of what “pro-rata” means in the context of a deal seems, on its surface, pretty straight forward. Simply put this question asks how much each investor intends to invest in a financing round. However, as is often the case when you get two VCs in a room and ask them to decide on something, actually agreeing on what this is becomes another matter all together. One investor’s view of the meaning of “playing their pro-rata” is often different from that of another. Unfortunately, in many cases this isn’t discovered until late in a financing process leaving an entrepreneur scrambling to reset expectations and either make up a gap in a capital raise or placate an investor who believed they would get the chance to invest more in a round. Ask most VCs and they’ll tell you everyone knows what pro-rata means (try this – its can be amusing); end up with confusion around this in the 11th hour of a financing and you’ll realize that this is definitely not the case.
The best way to illustrate the complexity of this concept is to take a look at a couple of examples. Take the case of a Series A round for ProRata Corp. Assume the post money on the deal is $8m and each investor, having invested $2m each, ends up owning 25% of the business. Fast forward to the Series B financing and consider two scenarios. In the first scenario there is no outside investor and the company raises $6m. Logically, each investor would contribute $3m to the financing, as each was responsible for 50% of the prior financing round. Note that this would leave them each owning just under 36% of the business post financing – meaning that by some definitions they actually played above their pro-rata amount because they have each increased their ownership in the business. Now consider the same case where a new investor is brought into the mix in the Series B. Assuming this investor takes $2m of the $6m round, is the pro-rata for the remaining investors $2m (half of the remaining $4m)? It could also be $1.5m (which, in the $6m round would allow the investor to retain their 25% ownership). Of course in that case there would be a shortfall. I know this sounds crazy, but this exact situation happened to us about a month ago (and plenty of times prior to that). Each of Mobius and the other existing investor was talking about contributing our pro-rata amount to the financing – our believing that this meant that the two existing investors would split the remainder of the round based on their relative ownership percentage; the other investor believing that they would retain their ownership percentage in the business. In that case Mobius made up the difference – we were strongly supportive of the business and happy to increase our ownership – however if we had not been in a position to do so, the company would have been left with a gap in their financing plan.
This example was actually pretty straightforward. Things start to get much more complicated for a company that has raised multiple rounds of financing, has shareholders who own several classes of stock (common, junior preferred, senior preferred (perhaps with a change in their conversion ratio due to anti-dilution), warrants, etc.). In those cases, what constitutes pro-rata? Even in our relatively simple example where all of the new money in a round is coming from existing investors this a complicated question. Do the shareholders split the round based on their total as-converted common ownership? Do they only count their senior preferred in the calculation? Do they include their entire preferred ownership position? The different methods of calculating pro-rata in this case can lead to vastly different views on investment amounts. This is important by itself, but becomes even more so in the case where a company is doing a down round financing where failure to participate pro-rata will lead to losing preference rights or some other penalty. Interestingly within venture funds this is also an issue, as funds that have made cross fund investments (that is investments in the same company from more than one of their funds over time) also need to determine how to split an investment between funds.
There is no neat conclusion here. The concept of pro-rata participation is something that sounds in theory like it should be pretty straightforward, but in practice rarely is. Out of this confusion, the important point for entrepreneurs and investors alike is to make sure they have a discussion about participation amounts early in the investment process. Discrepancies in expectations can always be dealt with more constructively if there is time to spare, rather than at the last minute.