Startable - Healy Jones’ & Prasad Thammineni’s Blog

When your startup is raising venture capital or an angel financing round you will have plenty of tough points that need to be negotiated. Some of these are easy for a founder to understand, such as valuation or number of board seats. Other points will represent more of a challenge and startup CEO will be at a significant disadvantage vs. and experienced investor - even if the startup CEO has raised capital in the past. An investor, be it a VC or an active angel investor, will simply have executed more private capital rounds than the typical CEO, and thus will better understand the terminology and implications of different deal terms. Thus, 

You will need an experienced lawyer on your side when raising venture or angel financing

Your attorney needs to be up to speed on current standard “best practices” for deal structures and terms. These terms tend to change over time based on IRS and SEC rulings, crazy (highly publicized) happenings at other venture backed companies, industry-wide investor vs. entrepreneur power dynamics, etc. If your lawyer hasn’t done a number of private, VC investments recently they are likely to be behind the curve. Some deal terms, such as a strategic investor demanding a last look on any acquisition offers on the startup or certain blocking rights held by your preferred shareholders, can make selling the company or raising the next round of financing difficult to impossible. You need someone experienced looking for these sorts of issues on your side! 

Some key terms you need to be very involved with - in particular the company’s valuation and the vesting schedule for the current employees’ shares (there are obviously other items - consult your attorney!) You will need to discuss these sorts of items directly with the investor. That’s not to say that you shouldn’t get advice from your advisers… but these are issues you need to deal with directly with the investor. If these negotiations become testy, well, that’s too bad. As the leader of your company talking to investors these items are your responsibility, and they are also things that you can easily understand without a law degree.

Your attorney should be a hammer (or shield) in negotiating (some) tough points during your financing

For more complicated/technical issues you need your attorney’s advice. You can (and should) let your attorney negotiate with the investors’ counsel directly on a number of these points - mainly the smaller technical points (this usually happens in the stock purchase agreement drafting stage, less so during the term sheet stage). There will likely be some major items that you will need to get involved with. If these issues are ones that are technical in nature than you should use your lawyer as a hammer and say “my attorney will not allow me to accept that term.” I’m not talking about points like valuation - who gives a crap what an attorney’s position is on that. I’m specifically referencing technical provisions of preferred stock or convertible notes or certain things like items in an indemnification agreement. An investor should not get too annoyed if your HIGHLY EXPERIENCED attorney thinks a particular provision is non-standard or that it will likely cause issues in your next round of financing. (However, if an inexperienced company counsel is making mountains out of molehills then you are simply wasting the investors’ time and money.)

Preserving a positive relationship with your potential investor is critical. But, this should not mean that you get screwed over during the investment process. Seek advice from the right lawyer early in the process. Break the points that you want to negotiate into two different buckets: 1) the items you need to have a fair deal - things like valuation, board representation, etc. and 2) items that you need to have a legally intelligent financing. Use the lawyer as a shield when negotiating the legal points, and use the confidence that you have in your startup in negotiating the first category of points. 

I think I’m going to do a whole post later on attorney management. You don’t want your lawyer derailing your transaction or running up outrageous fees. However, you need to make sure your interests (and the interests of your employee-shareholders) are correctly represented. I’m going to try to put some ideas on this in a post later, but I’d welcome any ideas on this topic in the comments!

I’m starting to wonder if startup founders and VCs are even really considering the IPO market as an exit anymore. This is much more of a brain storming post than anything, but I don’t really know if most companies are even positioning themselves for an IPO once they reach a certain size. Usually (and I am basing this off of my experience as a baby investment banker during the dot.com boom) once companies reach the critical size for an IPO they staff up in certain elements: IR and finance/accounting, mainly. I don’t see boards allowing these sorts of expenses right now, even for companies with real scale. I guess these are more expensive things to do these days, given the increased regulatory hurdles required to be a public company, but still I’m not sure boards will allow these sorts of expenses until there is a more open IPO window.

Obviously the markets aren’t great for IPOs right now. My theory is that the investors who loved the small-cap growth tech stocks have left the building… plus the volatility makes it very hard to get an IPO priced. I have no hard evidence to back this up, but I put the blame on those two facts impressions.

Rosetta Stone, the most recent VC-backed tech IPO, seems to be doing pretty well. This is a real business, with scale and profits. I know that VC portfolios have other companies with similar profiles. Maybe the risk of going public is too great right now. If you’ve got a cash flow positive business that is doing fine as a private company then why risk an IPO right now? (Obviously I don’t own any Rosetta Stone shares or know anything about the company other than what I can see from their public filings.)

Android, Google’s new cell phone operation system, is starting to get some traction, according to AdMob’s new Metrics Report. According to AdMob, the G1 (the new G phone) is the number 4 smartphone in the US behind the iPhone and two Blackberry models. 

Phone app developers are going to have to start considering other operating systems. I really like the idea behind RIM’s new app store, and if the G phone get some traction then Apple could face challenges. Now, I’m not suggesting that Apple is about to fall off a cliff or anything like that, I’m just saying that they must keep from being complacent. 

Last September I postulated that Google’s Chrome was targeted more at Apple than Microsoft. I stand by that. More and more it is becoming clear that the next wars between the big web players is going to be 1) mobile and 2) cloud computing. I’m really starting to think that the next browser wars will be on the phone…  and we are in the opening moves of the OS battle. I wonder if Apple will continue to stick with its “own the device and the OS” philosophy - the same one that enabled Microsoft to steal away the PC market.

An article in today’s New York Times on the recent decline in real estate mobility in the US got me thinking on the importance of location, mobility and venture capital. The Times article has a number of realtors, movers and economists freaking out because the absolute number of Americans who have moved recently fell to the lowest level since 1962 - when the nation was something like 40% less populated.

What does real estate have to do with technology innovation?

Location matters.

Successful companies spawn other successful companies. Usually this happens in the same geographic area where the original company was based, for obvious reasons. Entire ecosystems of startups have come from DEC in the Boston area and a number of great companies in the SF Bay Area have been born out of previous winners like SGI. With critical mass these ecosystems become self-reinforcing and can continue to spark innovative companies for many, many years. 

Academic institutions matter and are location specific. The impact of MIT and the surrounding schools on the Boston area is immense! (The same is true for the Stanford ecosystem.) The students and professors at institution will continue to create commercializable technologies and having the right startup attitudes and resources in the area is very important to taking these technologies from the laboratory to the customer.

VCs like to be near their portfolio companies. Certain regions dominate venture capital and angel funding landscape, and startups in these areas have more venture firms to speak with and more options during their funding search. This tends to beget more opportunities for startups in a particular area.

Gummed up real estate market = bad for innovation

If up and coming technology executives can not afford to sell their homes (say they are underwater on their mortgage) and move to a technology eco-center to join great technology companies than the self-reinforcing cycle of successful startups spinning off new startups may slow down. Technologists and managers need to be able to physically move to the best areas if they are to eventually start a new company there based off of the learnings (and hopefully cash) they gained by working for awesome bigger/successful companies.

There is a limited supply of talented sales people and technology managers, and they need to be mobile enough to move to academically rich areas so that they can help commercialize technologies coming out of universities. While universities may be great at coming up with new technology ideas they often need help taking that technology and making it into a product that customers can understand and use.  There needs to be a deep pool of business talent in an area to cope with the massive amounts of amazing technologies created at a place like MIT, and that pool needs to be constantly refreshed with new talent from outside the area. Finally, students and professors need to be able to frictionlessly move to the institution that will support their research. If the real estate market is too gummed up how can this happen?

Since venture firms like to be near their startups, startup founders often move their businesses to be near their VCs. (I know, it sounds crazy but it’s true!) Venture funds do not want a large part of the proceeds to go to paying off moving expenses, including taking care of underwater mortgages, so the startup ecosystem needs mobility in the real estate market.

Basically, startup founders need to be ale to move to the best location for their startup. Certain areas have deep resources; resources that help people start companies. Support groups, recruiters, VCs/funding, experienced lawyers, landlords who understand it is ok to rent out their property to unknown startups, etc. A lack of mobility in the real estate market hurts founders’ ability to move to the best place for their business. Hopefully the real estate market will begin flowing again!

I’d love your comments and thoughts;

Thanks,

Healy Jones

Prasad Thammineni, my occasional co-blogger, responded to my post yesterday with a question on the SBA and venture capital. His question centered around the efforts of the NVCA (the VC’s public policy organization) to get the US’s SBA (Small Business Administration) to allow VC backed businesses to access SBIRs (Small Business Innovation Research grant-things.) Man, lots of abbreviations when talking about government groups!! And yes, the inclusion of my name in the title of this post is a blatant SEO-effort; I don’t want some other Healy Jones to win the SEO battle with these new Google profiles. Thanks, Healy Jones. (Ok, enough with the SEO.)

Prasad’s question:

Healy, I have a related question about VCs and funding start ups. I read an article this morning in WSJ about how VC firms would like the SBA to expand their investments beyond small businesses to venture backed firms. Do you think that VCs are going after the SBA because they are not able to raise enough funds from limited partners or because they some strategic advantage to getting the Govt to back investments? Do you think VC backed firms should be able to tap into the SBA pot?

Basically, VC’s want their companies to be able to access the same types of government funding that other small businesses can get. Since 2003 VC backed companies have not had access to certain government grants controlled by the SBA. Read the rest of this entry »

There have been a ton of reports on the massive drop in venture capital funding deployed in Q1 2009, so there is no need for me to rehash the facts and figures in my blog. I did spend a bit of time cutting up the numbers, hopeful that the drop was concentrated in only one area. When I downloaded the funding report from the NVCA I was expecting later-stage cleantech deals to have been the hardest hit. My thesis was that tourist hedge funds were leaving the cleantech project finance world. I may have been sort of right; late stage and expansion stage deals dropped by almost $4 billion in volume vs the previous year and cleantech was off by almost $1 billion - but that still left a huge % decrease for all other sorts of early stage technology and non cleantech startups. So, it’s pretty grim across the board.

Below are a few observations for the startup founder trying to raise their first venture round in this climate.

1. Fund raising is taking longer than ever. Read the rest of this entry »
   

Over 70% of the founding teams from Atlas’ recent portfolio companies include a critical member(s) who is a 1st or 2nd generation immigrant. 

A few MAJOR caveats on this data: I didn’t conduct a scientific study; it is entirely based on voluntary email responses from our CEOs. I haven’t heard back from the entire portfolio and don’t expect to. I also expect over the next few days to get a few more responses, so the number could change dramatically. I may have forgotten to email some portfolio companies; I was lazy and used a random email distribution list found by someone else here. I defined 1st generation immigrant as not born in the country where the company was founded and 2nd generation as son or daughter of an immigrant. The Atlas portfolio also has a lot of companies in Europe (which actually seems to bring down the average, which I wouldn’t have guessed.) Probably some other stuff too which makes this totally unscientific. But, still, I find it really interesting.

Even if this number comes down on a % basis it is still meaningful. I think it is really cool that talented people can move to places that have the best environment/ecosystem to start companies and try to make their vision reality. There is significant value to investors to be able to back the best people in the best locations; locations where there are other talented individuals, where there is access to customers and partners and where risk taking entrepreneurs are valued. 

The companies created by these immigrants are also creating jobs. Often times these are highly paid positions. If an area is able to attract a critical mass of entrepreneurial minded professionals then new company formation becomes very “cool.” More people feel like they can take the risk and found a company… they have support system and see the examples of success. 

For example, a study conducted by the Kauffman Foundation on the impact of MIT mentions that Massachusetts has benefited from foreign born students starting companies in the state.

More than 38 percent of the software, biotech and electronics companies founded by MIT graduates are located in Massachusetts, while less than 10 percent of arriving MIT freshman are from the state. More than half of the companies started by MIT’s foreign-student alumni are located in the U.S., creating their primary employment and economic impacts here.

I’m not sure that we were going to announce it yet, but it was picked up in the press and I saw that Jeff Bussgang tweeted it yesterday - Atlas and Flybridge recently invested in a company (DataXu) that fits this description perfectly. Technology out of MIT where a critical founder is not from the US; based in Cambridge, MA. 

I think if we are going to continue to have centers of innovation that are the envy of the world then we need to get as many talented entrepreneurs here as we can. It seems to be working for Atlas, and I’m pretty sure it will continue to work for other venture capitalists in the US.

Wow! I’ve made it to 10 tips in my series on simple tips that may sort-of help the entrepreneur pitching their business idea to venture capitalists. Here is tip number ten:

VC Pitch Tip #10 - Technology venture capitalists love demos

Like birds and small children drawn to shiny objects, IT venture capitalists love demos of new products and services. Provided, of course, that the demo works! Clearly this won’t work for some startups… in particular, the animal-waste-to-biofuel entrepreneurs don’t have to bring their digestors to the VC’s office. But, if you can even bring in an example of your solid state storage device for the VCs to pass back and forth, it will make your pitch more memorable.

There is definitely something about seeing a new web app work that gets me excited. I’m pretty sure most VCs have a similar feeling the first time they see something new. You should take advantage of this when seeking capital. 

Your demo isn’t going to get you capital if your startup isn’t viable or if you can’t articulate the business plan. But showing the potential investors that your product works and letting them imagine how the user solve their problem with your solution. Again, sorry for the lame tip. I’m just trying to give the entrepreneur any possible edge they can get when pitching their business to VCs.

My post on the 13th “A written business plan does not get you venture capital” seems to have waded into a world of controversy. Some of the comments left on PEhub (the publication that first brought my attention to the University of Maryland’s professors’ work) were quite angry. I thought it would be interesting to look at some of those comments and respond from a young VC’s perspective. 

Here was one of the comments on PEhub:

What this Maryland study proves is that VCs no longer read or value business plans. Hmm. Wonder if that might explain why VCs have been failing of late in producing $1 billion homeruns, especially by building companies that have the wherewithal to achieve freestanding, sustaining value via IPO exit instead of lesser concerns aimed at quick flip exits by and large to previous portfolio companies… Maybe VCs ought to start demanding and reading business plans once again. Read the rest of this entry »

I was recently pointed at an interesting study by several professors at University of Maryland’s Robert H. Smith School of Business. These professors’ study analyzes the impact of written business plans on a startup’s chance of successfully raising venture capital. Their conclusion (as summarized by PEhub): high quality written business plans do NOT increase the odds of raising venture capital.

The professors are correct.

Your written business plan is not the most important thing

Early in the venture funding process you, as a startup founder, have two simple goals:

1. Get a meeting with the VC
2. Convince the VC to begin diligence on your startup

That’s it.

Far more important than your written business plan is HOW you are introduced to the VC, because this gets you past the first point above. Your best bet is to have been a successful CEO who was previously backed by that VC (yeah, I realize this is probably not you, but think about how much easier it will be the second time!) Your next best bet is to be introduced to the VC by an entrepreneur with whom they’ve worked before. Or, try to find someone on a board of directors with them who will introduce you.

I’m not trying to trivialize this. Read the rest of this entry »