Startable – Healy Jones’ & Prasad Thammineni’s Blog

Ok I’ve got to brag a little here. OfficeDrop recently launched our newest mobile app, the OfficeDrop Android Paper-to-Go app, and we’ve had great success with new users and downloads. I’m working on a post about how SEO may be dying, at least for SaaS services, since the huge majority of our new users are coming from app marketplaces these days. I really think we are undergoing a significant shift in the way people find and buy software and web services… and I’m personally having a ton of fun trying to figure it out!

Anyways, here is some of the recent press OfficeDrop has gotten on our new Android app:

May 18, 2011

OfficeDrop: Scan Docs, Turn Them into PDF & Make Searchable (Android)

Using Paper-to-Go you can scan physical documents using your smartphone’s camera and store these documents … other file formats can be uploaded and processed as well. Read OfficeDrop’s Paper-to-Go Review on makeuseof…

I’m not really sure how I came across this piece of academic research, but Rebecca Zarutskie of Duke University published a research piece in May 2008 called “The role of top management team human capital in venture capital markets: evidence from first-time funds.” Basically, she looks at various qualities of the partners at first time venture capital funds and runs regressions to see if any of those experiences impact fund performance.*

She concludes that VCs with previous venture capital experience, previous experience as startup execs and experience as management consultants make for better funds. Ok, so other than the last piece, this isn’t too surprising. She also looks to see if other things like having a PhDs or law degrees  help as a partner, and she doesn’t find a statistical improvement in exit percentages.

But there is one finding that is statistically significant that I find a little funny:

Funds with MBAs perform WORSE

That’s right, if the partners of a fresh fund have MBAs their fund is likely to do worse than a fund without! The finding is statistically significant.

Is it possible that MBAs make you a worse investor? That would seem like a real problem, since something like 59% of the investors in her sample had them.

Rebecca isn’t really sure how to interpret this finding:

However, I do find, perhaps counter-intuitively, that management teams with more general human capital in business obtained through MBAs perform on average worse than other fund management teams. A possible explanation for this result is that there is an oversupply of individuals of possessing MBAs relative to those with other educational backgrounds who are typically candidates to enter the venture capital industry.

My gut would be that, no, being an MBA does not make you a worse potential investor, but that it might make it easier for you to raise that first fund. And, since the bar may be a little lower for first time funds if the partners have MBAs then the group as a whole may under perform. The reason I’d think it would be easier to raise a fund if you had an MBA is 1) better connections, 2) LPs may like the brand associated with people who have HBS type degrees and well, that’s the two reasons.

Forgive me if someone already wrote about this research a while ago, I just discovered it over the weekend.

*(Her definition of fund performance is the % of deals in the fund that were exited, which is a crude but decent enough metric to make her research interesting.)

Dan Primack at Fortune has a new piece on Union Square Ventures – the fund is out on the prowl for a new fund, and has a great IRR from their first fund. He links to data from a bit limited partner (investor in VC funds) and points out that the other great returns fund in the report is The Foundry Group.

What do these two funds have in common? Well, one key piece is that they both have great bloggers as investors.

So, my question is this a coincidence? Or is there a correlation between venture capitalists who have thoughtful and proflific blogs and good returns?

On the one hand, there is some data here to suggest that these good bloggers are also great investors. I”m sure they boost their visibility with their blogs, and thus their deal flow and overall sexiness as an investor.

On the other hand, a) they also both invest in early stage internet deals, and blogging really appeals to these types of businesses. b) And if the hype on a little bubble in the early stage internet investing world is true then their funds may be enjoying returns from focusing on this space, and thus the blogs may contribute nada. c) And as some of the earliest spotters of the “capital gap” they may be benefiting from the first mover advantage of supplying just the right amount of capital needed by internet companies these days d) And it is possible that people who are good bloggers may be somehow just smarter than average investors (i.e. the two skill sets are just correlated and not causal really).

I’d guess if blogging really helped investors then we’d see more life science VCs and more growth/PE funds blogging. So my thesis would be more that the two funds I just mentioned are doing well not because of blogging, but that blogging was a symptom of all the good things that enabled them to do well recently.

My friend from business school, Matt Soldo, has a well written post on MBAs in the tech startup world, “In Defense of the MBA.”

Matt has held positions with a few different internet companies, and is currently with Box.net. I also know he seriously batted around a few legit startup ideas while getting his MBA as Wharton. So I respect his opinions.

Since I was sort of famously quoted in TC on my MBA experience (and my MBAs and Startups post continues to get good traffic) this is a good opportunity for me to revisit my MBA post from last year.

As OfficeDrop has grown I’ve found my MBA more and more useful. Basic stuff like statistics, pricing strategies, etc are particularly useful. I sure that I could have learned this in a book, but there is something about the classroom learning environment that is good for the way I acquire knowledge.

The connections I made during the MBA are very useful. For example, I wanted to test out an idea for a new verticalized product offering at OfficeDrop. I glanced through LinkedIn, saw several classmates who were in the targeted field and had some quick conversations. I could have done this without the MBA, but it was nice to know that there were people who would pick up the phone. And of course the connections were helpful during our fund raise.

I’ve said it before, but my Managing People at Work class was really good. People, outside of the greedy finance world, are pretty fun to manage because it’s not just about the money. My MBA has provided a structure for me to think about this.

I still wish there had been more emphasis on leading sales teams at Wharton. How is this not the most important skill for almost anyone running a company?

The environment of business school is a real problem for people thinking about starting their own company. So many MBAs run for the safety of things like consulting, banking and big corporate positions (and have their post-graduation jobs sewn up with high salaries by the early part of their second year) that you feel strange trying to do anything different. I know for a fact that this atmosphere pulled some potentially great startup people into the boring safe jobs. My friends at Stanford and Harvard who started their own companies said they felt this pressure there too, so I think it’s safe to say this is a pretty standard MBA program problem.

And, finally, business school loans are the bane of anyone looking to start a company because they destroy so much free cash flow.*

Those are my current, unfiltered, thoughts on my MBA. Just as my position has changed over the past year I’m sure it will change again. Would love your comments, and don’t forget to read Matt’s post!

*On a somewhat unrelated note, does anyone else think that student loan situation in the US is the major cause of the educational cost inflation that we have here? In other words, because the federal government makes loans so easily available it is driving up the cost of higher education? I’m starting to think that government policies may be part of the reason that education is becoming so expensive – flood a market with cheap financing and the asset prices will go up??

When you are an entrepreneur trying to build a product at a startup, you are in a pretty risky place. Usually you are not generating cash flow, you don’t yet know exactly which features are going to be required by the marketplace and you aren’t yet sure how you are going to market/sell the product (i.e. haven’t gotten product-market fit yet.)

Startup founders often see raising venture capital as a way to mitigate the risk of starting a business – basically, they get to play with the VCs money while they work out how to create a real business/get the product working. Having a salary is a great risk hedge (vs. no salary and working only for equity upside); a salary sure beats working for a couple of years w/o cash flow! If you spend the venture capital wisely, then you get to increase your cash burn to more quickly hit your target market and get your product to market. This is pretty much the thought process we had at OfficeDrop when we raised a modest amount of capital. It was becoming onerous to not get paid a salary, and we wanted to invest money in product development and marketing. And in our case, so far so good!

I recently read a post by Fred Wilson on CAPM, which describes the trade off between return and risk. There was a great comment by somebody named Julien, “I would love to hear about the current beta in the venture ecosystem. My bet is that it’s always very high, which induces stress for the VCs themselves, that they tend to transfer down to the startups in which they invest.” In other words, can VCs actually increase the risk of the startup? I believe that they can.

Venture Capital can make a startup riskier

How can this be? I want to make it clear that this is not usually the case – most VCs are actually helping derisk their startups’ business models. But raising money can make a startup more dangerous (for the founder in particular.)

The biggest way a VC can increase a startup founder’s risk is by not participating in a follow on round of financing. As herd animals, VCs look to each other for signals. An existing investor not investing in a subsequent round is a major red flag that something is wrong with the business. That’s why I’ve always recommended syndicating your Series A Round – you decrease the likelihood that no existing investor steps up. (Note that I have ignored my own advice with OfficeDrop.) There are other reasons that a venture capital firm will not invest – such as the fund running out of money or the partner who made the original investment leaving the fund.

IT Venture capitalists usually like to invest in “product” businesses – by product I mean businesses that generate revenue by selling something this is not based on billing out a person at a particular rate. I’m not describing this well, but VCs generally don’t like body based businesses that scale only as people are added (people who get billed out). But contrast this with a business that starts as a service and creates a product based on its own or its clients needs. A service based business can be profitable from day one for the founder, generating cash to pay the bills and cash to iterate to a product that the market wants. Great examples are 37Signals or FreshBooks (I know there is a great interview w/a 37Signals founder about why he doesn’t like VC, but I can’t find it this morning). Think about what would have happened if the initial products they created had flopped. If they had no venture capital, then they would have gone back to having great consulting businesses and maybe would have tried again later to create another software product. But if they had raised VC, their investors would not have been happy with them going back to having a couple of person business that looked like it could generate a couple hundred thousand $ in consulting revenue for the next few years – they would have insisted in putting massive amounts of development dollars into finding the next idea, even if the founders didn’t have a great one at that moment.

VCs also invest money with a pretty specific purpose – to build a company along the investment thesis the founder pitched initially. But if the initial product idea is failing, it becomes the founder’s responsibility to convince the investor that a pivot is needed. A good VC will act as a smart advisor, working with the founder to assess the situation and helping the founder find the right ways to pivot. The best VCs make introductions to potential customers before and during a pivot so that the founder can get smarter before the jump. But a VC may slow down the pivot, trying to get the founder to spend more time and money on the initial thesis. This can happen for a variety of reasons, but some of them may not be transparent to the startup. In particular, if the VC is having to play politics at his/her fund, they may not want to have to go back to the fund’s partnership and admit that their initial thesis was a failure. For a lot of startups, the road to success is paved with a series of small failures (i.e. learning experiences). Hopefully your VC does not mind these road bumps to victory.

Once you’ve raised a lot of money, there can be pressure to spend the cash. Even VCs with a lot of patience want to see their portfolio companies working hard to build a business. Everyone, from VC to entrepreneur, wants to see progress between board meetings. Recently I was hanging out with an executive of a locally funded startup who just admitted to wasting close to $100k on an Adwords campaign that she knew wouldn’t work. Having raised a significant sum of venture funding, the startup is getting pressure from the investors to spend the money to ramp up sales. Because the investors had experienced success with Adwords at a different portfolio company, they aggressively suggested a serious Adwords campaign. However, this particular startup’s space had very expensive PPC, and the basic math of generating positive ROI from Adwords just was never going to be there for the company. VCs need to see growth to justify their investment. I prefer to spend a little money and take a little more time to succeed or fail in my marketing efforts. Many VCs will prefer to spend big to determine failure fast. I’m not sure how much of your company you give up for $100k, but it’s probably a decent percent coming out of the founder’s pocket. Have a good conversation with your investor prior to the investment to make sure you are on the same page in spending the cash.

Venture capitalists make their money with big exits. For most VCs, making two times their investment is not considered a great use of capital. This means that VCs pressure companies to go big, which can destroy a great little business. As I talk about in my post “Don’t Raise Venture Capital,” make sure your goals are aligned with the goals of the investors before you raise money.

Venture capitalists can sometimes push out a founder. Fred once again has another great post, this one on parting ways with a founder.* While this may or may not be good for the startup, it does mean that the founder who gets pushed out will probably no longer vest equity. Since you are no longer working for yourself when you raise venture financing, you can increase your own personal risk if it is decided that you are no longer needed at the startup.

I’m not suggesting that you don’t raise venture capital for your startup. However, I don’t know if most founders consider the baggage that comes along with a check from a venture fund. The right venture capitalist can really help grow your business – but make sure you and your team are ready to go big when you bring all that cash onto your balance sheet.

*Note that I agree with Fred’s thesis; sometimes an early founder can be bad for a business as it grows. I can think of one example where the employees hated working with one of the co-founders of a startup because the co-founder was pretty much a jerk. When you lose great engineers because one of your co-founders pisses off everyone he interacts with you’ve got a problem. I’ve also seen a situation where one of the co-founders started spending a lot of time not working, which really de-motivated the other founders and engineers who were working 80+ hours to launch the product. If someone decides to no longer pull their weight, why should they continue to get paid and own a big % of the business – especially when it is a fresh startup that was just recently founded?

Good news for the New England early stage startup community – venture capital investing rebounded from last year’s lows. $789 million in VC was invested in New England in Q1 2010 vs. only $408 million in Q1 2009. This is a significant pop, and gets us closer to the 2008 and 2007 totals of $872 and $984 million. I’ve pasted in a couple of charts from data I took from the spreadsheets posted on peHUB.

Overall, peHUB says:

Venture capitalists invested $4.7 billion into 681 U.S. companies during the first quarter of 2010, according to MoneyTree data released today by PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters (publisher of peHUB). This represents a decrease in both deals and dollars from the preceding quarter — by 18% and 9%, respectively — but an increase over the first quarter of 2009.

Jason Mendelson has a thoughtful post on why he thinks efforts to harmonize the current plethora of template seed investment funding documents will come to naught. His main point is that getting everyone to agree is an exercise in herding cats and that Brad Feld is going to beat his head against the wall trying to get people on the same page. He’s probably right, although I have found Brad to be a pretty charming guy, so who knows, maybe it is possible.

But who cares?

I don’t see another standardized set of deal documents as solving any real problem.

As an entrepreneur/former VC I see three main goals of standardized deal documents:

1. Reduce the time required to raise capital
2. Reduce the legal cost of executing a deal
3. Make it easier to execute follow on investments by not making a silly mistake/term in your fund raise

Here is why a standardized set of seed documents doesn’t really help the entrepreneur.

1. It’s going to take the same amount of time to get a deal done. Did the NVCA standard deal documents for Series A investments reduce the 30 to 60 day time frame it used to take to close a Series A deal (from signed term sheet to funding) NOPE. It still takes the median deal 30 to 60 days to close. (See my next bullet on how it takes the same amount of billable legal time to close a deal even with the standard documents.) Seed investors are the same way. Some will write a check fast, others take their own sweet time. This time frame is not driven by legal, it is driven by the individual investor. It’s not going to change with another set of standardized docs.
2. Do Series A deals legal fees cost less now that there are the NVCA standard documents? No. Costs have probably gone up. Closing an investment takes pretty much the same amount of legal hours as it always has. Why? Because the cost of having a crappy lawyer work on your Series A deal is too high, so entrepreneurs and VCs go with the best/most expensive lawyers they can find. And the best lawyers need to “add value” so they fight over every random point, because there is that one in a thousand potential circumstance where it will actually really matter. And thus that is why they are good lawyers, always thinking of potential future issues and trying to protect you. And so it’s freaking expensive since all their thinking and arguing time costs a ton per hour. Anyway, the main point is that standardized Series A documents have not reduced the typical legal bill for a Series A transaction and I just don’t see them reducing the legal bill for the typical angel investment. The MO of the investor you go with will determine how much legal effort goes into your fund raise, not the documents you choose off of which to base your deal.
3. Finally, if the goal of the seed documents is to make it easier to raise your next round of funding I think we are already there. (of course, consult your expensive attorney don’t rely on my legal advice.) Any of the currently existing standard seed templates listed by Jason in his post are probably good enough to not blow up your next round of financing. You are much more likely to have your next round destroyed by a difficult personality (either a difficult seed investor not agreeing with something next round investor “needs” or a next round investor insisting on something “impossible” for a seed investor to sign off on) than by something odd in one of the already existing standardized seed term sheets. In other words, the difficult personalities I’ve just cited just as likely to fight over any random term anyways, so one set of standard docs vs another doesn’t really matter. Oh yeah – don’t take my legal advice when negotiating/drafting your deal documents, talk to your experienced lawyer; did I mention that yet?

I think that the legal costs associated with closing a private fund raise are always going to be nuts. The only thing that I know for sure will make it less costly to raise seed funding is to get an investor who is laid back. It really seems like a personality thing to me, not a standardized legal document thing. If investors really want to help entrepreneurs and make it easier for startups to connect with qualified investors. Something like what Venturehacks is doing with their AngelList.

Congratulations to Mike, Bruce, Sandro and Bill of DataXu for raising a Series B investment from Menlo Ventures, a well known Silicon Valley venture capital firm. Atlas Venture and Flybridge, the Series A investors, invested in this round as well. I got to know the DataXu team when I was with Atlas and worked on the Series A investment. Mike has a great team and some solid technology.

I think it is great that important West Coast VCs are making follow on investments in the  Boston area – another prominent investment like this is Scale Ventures investment in Hubspots most recent round. When Boston companies are doing well enough to attract capital from outside the region then you know something good is happening.

Also important – while Boston may the the number 2 venture capital pool in the world, it is nothing compared to the capital available in Silicon Valley. When venture firms from San Francisco supplement local New England funds this means that there is more early stage capital available in the region to support innovation – a really good thing! Let’s hope for some more great companies like DataXu and Hubspot. Actually – let’s try to make them ourselves!!!

Inc has a solid piece on terms to be careful of when raising venture capital. I spent some time on the phone with Darren Dahl, the journalist who wrote the piece, and he did a very good job getting his arms around some of the most important issues I’ve seen entrepreneurs trip over. Raising a venture round is very difficult and confusing terms are one area where VCs have a distinct edge over entrepreneurs. This Inc article is a good resource for founders trying to understand the terms presented to you by a VC.

A good venture capitalist will walk you through the terms after he/she has presented you with a term sheet. You should ask for this if it is not offered to you after you get a term sheet. You should prep with your lawyer prior to this and ask a lot of questions of the VC as they go through the terms with you.

And, while they are really expensive, get a good lawyer for your fund raise!

And this is before the Nexus One!