gordon’s posterous

Dave McClure on His Investment Philosophy

How VCs Look At Term Sheets

Mark Suster is on a roll. Yesterday he wrote a great post on how VCs calculate valuation differently from founders. I spent a lot of time researching term sheets and valuation 3 years ago when raising money for my last company. I wish I had read this post back then; it would have saved me a lot of time. So go read it. Or better yet, watch the video:

In the video, Mark and Kelly Hwang walk through a very useful cap table spreadsheet. If you are an entrepreneur or interested in VC, go download it. Play around with the formulas. Run through different scenarios in your head. Or better yet, create your own from scratch. That's what I did and I think that's the best way to learn it on your own.

Other great resources for learning about term sheets are:

• VentureHacks' archive (specifically Nivi's article on how to make a cap table)
• Brad Feld's “term sheet series” 
• Justin Fishner-Wolfson's Term Sheets 101 presentation

Chris Sacca mentioned in a video interview recently that VCs are being much more transparent than they used to be. And that's a good thing. This is complicated stuff and the more transparency, awareness, and overall education we have on the subject the better.  

Chris Sacca on Helping Founders Take Money Off The Table

In my last post on the many changes happening in the venture capital industry, I mentioned the growing angel and seed fund phenomenon.

Well last night I came across this GigaOm video of my favorite in this class of "super angel" investors, Chris Sacca.

Sacca recently closed an $8.5 million fund to make seed-stage investments through his firm Lowercase Capital. While he is most famous around the Valley for these early stage investments, turns out he also has another fund solely dedicated to buying out the shares of early stage founders. The idea is similar to the later stage funding rounds now common among large tech companies like Facebook and Zynga; it allows founders to take money off the table and continue to grow their business instead of selling it. Yet, Sacca is taking this a step further and is doing it at a much earlier stage.

Here's part of his rationale:

"I think what we're starting to realize is that founders need some kind of comfort, a little bit of a hedge, to make sure that this isn't an all or nothing ... In a big VC fund, you need these massive billion dollar outcomes in order to move the needle. But I feel like if they really want their entrepreneurs to push to that level, they have to give them opportunities to take a little bit of money off the table."  

Sacca then references the Foursquare deal and how Dennis Crowley and the other founders took $4 million off the table out of the $20 million that was raised. He speculates that doing so puts those guys in a place where they're more relaxed and in a position where they can really focus on going out and building the next multi-billion dollar company.

I also love that he refutes the idea behind the phrase "Pulling a Patzer," which is a reference to the story of Mint.com's Aaron Patzer who sold Mint to Intuit for $173mm and is now common Valley parlance for selling too early. He calls the notion "bananas" and I couldn't agree more.  

The whole interview is worth watching, but the part about his fund to buy founder stock starts at around 4:30.  

Again from my vantage point, the benefits of helping entrepreneurs take money off the table are many:

• Allows them to pay off their credit card bills and get to positive net worth
• Gives them a bit of a hedge so they can cover their risks 
• Rewards them for their hard work and sweat equity
• Makes them less likely to sell their company
• Lets them retain control so they continue to grow the business
• And most importantly ... let's them actually enjoy life a bit

I couldn't be more impressed with the strategy and hope it's a trend that continues.  

The Times They Are A-Changin' For VC

One of my favorite VC blogs to follow is Mark Suster. Last week he wrote what may be his best post yet on the many changes going on in the technology venture capital industry.

I agree with the post entirely. One of the most interesting aspects within tech VC right now is the growing angel and seed fund phenomenon. Recently there has been a lot of buzz about on the subject, starting with Paul Kedrosky saying that a super-seed crash is coming. Chris Dixon then responded that the bubble in early stage investing is really due to entrepreneurs getting smarter. Fred Wilson followed with his thoughts in a great post saying the total capital needed to scale a business is still the same (~$20mm) but can now come after the business has traction: 

What has changed in technology venture capital is not so much the total capital requirements, but when they are required. This is very good news for everyone involved. It means entrepreneurs that don't have to take expensive dilution early on in the development of their business. And it means that entrepreneurs can raise the big money later on when their business is worth more. It means that entrepreneurs should be able to keep more of the companies they start. That is good for everyone.

It also means that VCs don't have to take big risks early on. They can write checks in $250k and $500k sizes. It means that when the businesses develop into winners or likely winners, they can write the bigger checks like $3mm or $5mm or even $10mm. This is good for the VC business. Less writeoffs, more capital deployed into the winners and less into the losers. 

Finally, Mark in his post on in the changes in the VC industry, laid out his thoughts on the seed fund phenomenon in the following points:

8. So super angel and seed funds are proliferating – As a result there has been an explosion in the number of amazing early-stage investors such as Softtech VC, Floodgate, Felicis Ventures, K9 Ventures, OATV, Lowercase Capital, Founder Collective, and many, many more.  There are also super angels that are so numerous I’d rather just link to the best list out there, which is VentureHacks’ AngelList.

 9. And VC’s are doing earlier stage deals – And we all know that VCs are doing earlier stage deals.  The most notable is First Round Capital who built their entire fund and model around this type of investment and the notion that exit values in the future will be lower than they were 10 years ago.  They are  also the most innovative new fund to enter the market in the past 10 years in my opinion.  There is also True Ventures that does early stage, seed investments.  And of course Foundry Group, Union Square and a whole host of other firms including my own.  I have written more in depth on this topic in the past.

10. This is producing a “boomlet” or a bubble in early-stage investing.  That’s OK. – This massive increase in seed & angel funding caused Paul Kedrosky to predict that there is a coming seed fund crash.  I don’t know whether there is a “crash” coming per se but I do believe that too much money is going into angel and seed companies too quickly.  I’m OK with this – it feels fairly benign.  But one problem it is causing is that early-stage deal prices are creeping up again higher than historic norms.  This smells like classic froth to me.  So IMHO it’s probably more of a mini “bubble” than an impending crash.

11. But it takes the same amount of money to scale a big business and this is where outsized returns are earned – If you want to build a big business you still need big bucks.  Fred Wilson wrote a great piece on this. He acknowledged the importance of the growing seed fund movement in creating a new wave of cost-effective innovation.  He then profiled his portfolio company FourSquare who started with a very small investment.  But now that it’s time for them to scale they need a lot more capital and therefore just raised $20 million from Andreessen Horowitz.  Think about it – while FourSquare has established itself as the clear market leader it is unquestionable that Facebook, Yelp, CityGrid and many more well capitalized companies will be gunning for them.  Staying “lean” is not an option.  If FourSquare wants to dominate it’s market it’s time to GO FAT.

Mark also talked through these points on video on the latest episode of This Week in Venture Capital. The whole video is worth watching but I've embedded it right at the point where they start talking about seed funding:  

It is a fascinating time for technology VC to say the least. One thing is for sure, it is an industry that is evolving rapidly. I think Mark is right that we'll start to see more natural selection of the industry over the next couple of years where each segment – seed, super seed, A round VC, B round VC, and growth equity – is right-sized given its total market size.

As for the innovation engine, I agree with Fred Wilson that this is good news for everyone. The companies that don't work will fail faster. For the companies that do work, the entrepreneurs will be able raise more money at a later time when the business is worth more, thus they'll be better able to keep control of their company. The seed investors will fail a lot too but will get handsomely rewarded for their big risks when a few of the companies become winners. Lastly, the VCs don't have to make as many early bets so they eliminate more risks and can better deploy capital to the likely winners. Again, good news for everyone.

 

The Internet As A Primary Export Industry Of The U.S.

The Fat vs. Trim Startup

While I was away on an unplugged vacation last week, I missed out on a great back and forth between Ben Horowitz and Fred Wilson on the optimal amount of fundraising for a startup, specifically in an economic downturn like the one we're currently in.