Currently Obsessed» fundraising

Add logs, pour fuel (VC money), light match (beta release day)

jheitzeb — Wed, 07 Jul 2010 17:16:35 +0000

I often bump into entrepreneurs while they’re in the midst of fundraising. I usually ask “why are you raising money?” and what I often hear is, “because we are running out of money” or “in order to quit my job and so I can hire 3 people” or something like that. The arguments often boil down to “I need to raise money to hire these 3 people, so i can do XYZ, and then I’ll have a business.”

This seems backwards. Don’t get me wrong, unless you have a lot of savings and can afford a lot of personal financial risk, money can be a practical enabler of taking the first step, but STILL: what is it about the core of the business that needs the money? Why is the business pulling you in? Why does the business deserve investment? The most compelling rationale for fundraising focuses on why the startup matters, the early traction it has and how the investment will fuel what’s already heading in the right direction vs. overcoming financial constraints (personal or business).

To use a campfire analogy….

….The best campfires (startups) aren’t the ones where you throw some big logs in (ideas), soak everything in fuel (money raised) and the light a match (beta release day). Those fires can be spectacular and short-lived, flaring up and then going dim again just as fast, and consuming a lot of fuel quickly.

….The best campfires are the ones where you prepare the fire pit, gather and arrange kindling (seed ideas, prototypes), arrange smaller sticks in a pyramid (relationship building for early sales), light a small fire (your proof points) and then make sure that flame is growing (validation). THEN, because now you know you have a real fire, you might choose to add fuel (money raised) to fuel the growth quickly.

My point is that the core of the fundraising argument should be about the business, not about the salaries. I get that the biggest expense of most internet startups in the early stages are the salaries, but still, the justification for raising money has to be about the business concept, not just about enabling the people to overcome their personal financial constraints. Simply saying “I’m building a startup but I need money to get paid” is like saying “We’re building a campfire, but I need gasoline to keep warm” – it doesn’t make a lot of sense in the context of investing. (Alright, this campfire analogy is getting old)

Counter-point: being penny wise and pound-foolish isn’t a good idea either. Sometimes adding fuel can get a great fire going quickly, and struggling along with insufficient funds can be too limiting.
To illustrate, here’s a video of Mark Maunder and I attempting to make a fire without matches (skip to 1:14):

Unexpected Startup Lesson #3: Why You Can’t Read a VC

jheitzeb — Thu, 10 Jun 2010 21:28:18 +0000

This post is the third of a series on “unexpected lessons” learned through my experience as co-founder and CEO of Snapvine, a venture-backed mobile social networking service founded in 2005 and acquired by WhitePages in June of 2008.

When I set out raising our first round of financing, I was excited to have the opportunity to meet and directly interact with many super experienced angel and VC investors, many of whom had substantial industry experience and had been along for the ride on any number of high profile startup successes right from the beginning. This, I figured, would be an incredible chance to get feedback and input on our ideas and direction. I imagined it would be like a business school case discussion, only better, with just 3 or 4 participants — all protagonists.

I was wrong. That’s not how it works at all. Instead what I found was, by and large, every coffee, meeting and partner meeting was a series of largely one-way dialogues covering the basic elements of the pitch (team, market, demo, etc) and some fairly basic questions.

For the most part, the valuable parts were missing: body language, direct feedback, creative suggestions and challenging pointed questions — things that could let me know how the other side thought of the opportunity and things that could help me improve the pitch.

You can’t read a VC.

photo credit: muztiko

I’ve done deals (sales and business development) and I think of most things, from hiring to people management as being essentially “sales” where reading and responding (on the fly) to the other side’s concerns, needs, interests and ultimately reading what they think is paramount. In the case of pitching VCs, I came to realize that these cues were going to be absent.

In fact, when I thought I had a clean read on things, most of the time it was ass backwards. Here is one true story, paraphrased and names withheld:

Scene: at final full partner meeting
9:00am – start of my presentation
9:00am – 9:45am – peppered with continuous stream of semi-relevant interruptive questions
9:45am – blackberry beeps and one partner leaves abruptly
9:46am – second partner seemingly hitches on that opportunity to leave
10:00am – meeting ends. everyone leaves (I’m on slide 8 of 13)
10:15am – (email to team)
“Well, that totally bombed. We won’t be hearing back from them. I guarantee it.”
11:00am – (partner phone call to me)
“Thanks for coming in. Everyone enjoyed the meeting and we are excited to work with you. We would like to put a term sheet in tonight!”

Through two rounds of fundraising and negotiating several term sheets, it didn’t get much better.

Here’s the thing — it’s not that I’m bad at reading people, my theory is that since VCs are getting pitched all day long by so many people, that have grown numb to the usual 2-way feedback process. Also, they have zero incentive to give feedback in the first place. Direct, critical feedback might offend the entrepreneur and cut off an opportunity to invest. And overwhelmingly positive feedback might reduce their negotiating leverage. VCs don’t say “no” they just say “we would like to hear more, later”…it is their way of preserving option value.

Of course not all VCs are like this, which is how, in part, we chose the investors we went with.

Anyway, I’m curious to hear from others who have been through the fundraising process. Did you feel you got solid feedback from investors during the process?

Unexpected Startup Lesson #2: Channel your Inner VC to Understand Startup Valuations

jheitzeb — Thu, 27 May 2010 09:19:40 +0000

This post is the second of a series on “unexpected lessons” learned through my experience as co-founder and CEO of Snapvine, a venture-backed mobile social networking service founded in 2005 and acquired by WhitePages in June of 2008.

Snapvine was my first experience being in the driver’s seat of the fund-raising process, and in the 3 years prior to our acquisition we raised over $10mm in venture capital.

Valuation is an important aspect of VC deal terms, and a major determinant of your ultimate outcome. Or is it? I unexpectedly found that it was more helpful to think about the company valuation as an output variable in the fund-raising equation. It hardly deserves any attention at all in the early stages. I know this sounds crazy, but it’s not.

Photo by pauladamsmith (Flickr)

The typical thought process for a first funding in an early stage startup goes something like this:

“Okay, given our forecast revenue and costs, plus a little buffer, we need to raise about $1 million to get through our first 3 milestones…”
“And given our team, progress to date, IP/Patents, benchmarking against our buddy’s recent VC terms and that other startup that is similar and just sold to AOL last week….I guess we’re worth about $5mm today….”
“Therefore, to raise that $1 million we need, we should sell a slice worth about 20% of the company”

Although this is logical, it’s not how things actually work. Once the VCs have decided that the company can be big (based on its team, product, market, etc), they are mostly focused on their future return, and think about their investment like this:

“I want to own between 30% and 50% when the deal is done, so even if there are future rounds, I’ll still have a decent chunk of ownership”
“The more money I put in, the longer the runway they’ll have, and the greater the chance of success, thus helping me to maintain my ownership and maximize my return”

Ultimately, VCs think about the future value of the company, not the valuation at the time of the financing. That’s a nice way of putting it. You can read more about this on Josh Kopelman’s post. Be sure to check out the links to Fred Wilson’s related post.

Instead of “We are worth about $5m because we have done XYZ and we need to raise $1m, so let’s sell 20%” it’s better to think about valuation as an output variable, like “Let’s raise $2mm and sell 33%, our (pre-money) valuation is therefore $4mm.”

I have to admit, the light bulb didn’t go off for me until I was negotiating term sheets. In one particular negotiation, we went from one valuation to a much higher valuation (like double) in the course of a single day and two phone calls, simply by discussing the “what if” scenario about increasing the total amount raised. The net effect was more money raised, higher valuation and the same percentage of equity sold. It was baffling at first until I realized that valuation is an output and that the focus is on future value. (To protect the innocent: we ended up going with a different investor)

I’m not going to explain the venture math (pre-money, post-money, etc) but it is something you need to know inside and out, because term sheets often have 24-hour expirations and you’ll need to be able to negotiate them quickly. Read more about deal math on Brad Feld’s blog.

For some closing thoughts, I’ll just add that:

Valuation tends to be too much of a focus for most early stage companies. Other factors such as your team, the market you are in, your ability to execute, and in fact other terms in your term sheet are much, much more important to your outcome and financial outcome than is the valuation of your company at the time of financing.
Deals come in all shapes and sizes, and seed stage funds like First Round Capital and programs like TechStars provide flexibility
Explosive growth companies and multi-time successful founders get atypical deals
The other terms (besides valuation) matter too! For example, liquidation prefs. Read Terms that Hurt (Venture Hacks).
Read up on the “unwritten terms” in term sheets having to do with exit multiples here
For bootstrappers, the math is even easier: 100% of the upside goes to you and your awesome team.