In my attempts to engage in angel financing, I have seen the typical concerns that potential angel investors have. Many of these have to do with the investment parameters, and figuring out how investors can get their money back (or returns) - especially given the inherent immaturity of these businesses in being able to outline an exit potential. Investment then gets limited to businesses where investors perceive a high probability of creating a breakout business. Many other diamonds remain in the rough. I have been thinking of ways of addressing this issue so that seed financing is available to a larger base of startups. This should allow for great businesses to “emerge” rather than being “envisioned”.
To start, I am sharing some thoughts on a potential investment structure that should allow this to happen. There are several other elements to making this successful, besides the investment structure, and I will talk about some of those over next few weeks. In the meanwhile, comments and critiques are welcome on this - both from entrepreneurs and angel investors!
TheFunded has published what it believes should be a standard termsheet in venture financings. Their argument is that the following balances the rights and incentives of investors and founders well, and the negotiation should be limited to valuation and amount being raised. Interesting point of view.
These are all commendable efforts and in my view, in the right direction. The issue arises when certain provisions are more valuable to one party than other (due to differential view on the business, different degrees of experience etc) - so in some cases, founders may be optimistic to not care about participation, but may want higher valuation. Or, the VCs may perceive certain additional risks and may want protection against those. Such deal-specific characteristics encourage “trade-offs” amongst terms - a la “if I have to offer a higher valuation to be competitive in the deal, let me add more participation”. A negotiation process in the end is about trading off what is less valuable to oneself for something that might be less valuable to others.
Would love to get thoughts from the readers on where they tend to fall on this debate.
Here is a short presentation that outlines the information that we, at Canaan, like to see in business plans. It is also a useful tool to think about what questions one should try and answer, besides just ensuring that a certain format is used. Personally, I don’t fancy paper copies much, especially when all of the audience is in one location, but other than that, this is a good starting point for discussions.
Well, this came out of a comment on our fund announcement post. Someone asked, what do we mean by a great team. While it is almost impossible to provide a precise definition of the same, I would like to offer some things that we look for. Every team might not have all of them, but these matter (in no particular order):
Hunger and passion, sense of purpose driving the specific business
Relevant experience and execution capability
Alignment of objectives - focus on scale, profitability and value creation/realization
Team dynamics and ability to work together
Leadership qualities such as driving change, hiring and developing top talent
Value system match - Integrity, Intelligence and Intellectual honesty
I could elaborate on each of these, and that would make up a book. I do realize that I might have walked into a minefield with this, but feel free
I would go so far as to submit, working for a VC-funded startup is more like having any other job, than true entrepreneurship where you actually are your own boss. Entrepreneurs / CEOs answer to a Board. There is a compensation committee that decides how much you make. You get fired and washed out of your equity stake based on the VC’s whims. This may be perfectly legitimate at times, since not all entrepreneurs scale to become good CEOs of larger companies. But often, these decisions are gut reactions, not legitimate, and entrepreneurs get slaughtered due to the VCs’ lack of experience or seasoned intuition.
Personally, I have found this topic of what leads people to entrepreneurship fairly interesting. For some it is the ability to create something truly big. For others, it might be the money. And for others, being one’s own boss. The last one is certainly not the one with which you want to chase venture investment. VCs, whether experienced or otherwise, are fairly driven by the economic incentive, and hence by their desire to maximize their economic opportunity in a startup. As entrepreneurs, you need to be (a) aligned to that objective, (b) be able to protect your own objectives.
Sequoia Capital makes visible what they look for, both in a company and in a business plan. It is rare to find an A-list VC being this open - this is a great resource, especially for first-time entrepreneurs.
Nishith Desai is an international lawyer and tax consultant and I recently caught up with him to find out about tax, law and strategy in India. This is a two-part interview. In Part-1 he talks about his entertainment law practice (clients include Amitabh Bachchan, Disney, Shekar Kapoor and others) and about Venture Capital in India. Specifically, he talks about the Mauritius route that many Venture Capital firms have used to do business in India.
In Part-2 we talk about venture capital and the various mechanisms and structures through which capital comes into India. What are the challenges of bringing capital into India? What are the various pass-through mechanisms that are available? Nishith set up one of the first trust-based pass-through mechanisms in India between AIG and IF&FS. What does he think of the 2007 budget and Finance Minister Chidambaram’s provisions for VC and investment and pass-through mechanisms in India? We also asked Nishith if there is a bubble in India — you’ll have to tune in to find out what Nishith thinks about that.
With the flurry of venture money pouring into India, the other class of investors that are equally upbeat is strategic investors and corporates. I have met a few entrepreneurs who have received “investment offers” from these investors, and especially in absence of any pure financial offers, the option seems compelling — “they will put in the money, and then also help me build a business!”. Few things to consider before you take that offer:
- If the corporate investors are going to add significant value to the company, its good to quantify that value and test waters before you jump. Work on a few customers jointly and see if this partnership is working, and intended benefits are being achieved. If it is, the partnership can translate into a strategic investment.
- Objectives of strategic investors vary. Some like to invest in businesses that improve overall demand of their products and services - and they are ok taking minority stakes. Having a minority strategic investor with an operational partnership is also a good potential exit route. Others look at immediate consolidation, i.e. majority stake. While there might be promise of buying rest of the shares at a later point at a higher valuation, remember that you will never get the best value through this route.
- Sometimes, strategic investors will impose conditions on future rounds of financings, or have a first right of refusal on exit, and such other terms. While some of these sound benign because they are apparantly on the same valuation that anyone else is paying, remember that if an investor knows that their offer can be taken to another party which has right of first refusal, this investor is probably not too keen to make an offer anyway. So be careful of such terms, and how the exact process will work so as to not deter other potential investors.
In summary, if you are landing up selling the company today (for whatever value), you should know that is the case!
Had a couple of very hectic weeks with TiECon and couple of our partners visiting India. The opportunity to go around, see 10 “shortlisted” companies with some of my partners last week gave a good sense of contrast between what is expected in a mature venture system like the valley, and what is available here. One of the things that stood out was the lack of detail on pitches. What is interesting is that most of the missing detail did not seem to be a function of articulation, but of ignorance - people who had missed the details had not thought about those aspects. Also, most of the people who had missed details had not operated in those markets before. Nine out of ten presentations had no competitive analysis whatsoever — some more mentioned competition but with a dismissive tone.
I have noticed some of the same contrast in my visits to valley pitches. And if I may draw a parallel, I have seen similar lack of detail in corporate environment here in India — VP level plans and presentations get approved often without sufficient level of detail and analysis.
In terms of our education process for entrepreneurs on venturewoods and elsewhere, we have long focussed on “what all to cover” which again leads to a shallow view of the plan — entrepreneurs look at a question, and answer it at a high level, and they are done. We need to start putting more emphasis on the level of detailing. Maybe if someone can share their pitches, we could do a critique. I have a lot of, what in our view are, good and bad pitches, but I dont have the right to share any of them… Any volunteers?
US-based entrepreneur-blogger Fabrice Grinda strongly recommends that any entrepreneur - even if he/she is a “former investment banker or someone with significant M&A experience” - should use a banker when selling a business. (I think this applies when raising Private Equity/Venture Capital as well.)
From Fabrice’s post:
(Avoiding conflicts with the buyer) is the single most important reason to use bankers. Negotiating a sale of a company is one point in time at which your interests are not aligned with those of the buyer. It is very easy for the negotiation to turn acrimonious.
The sale of the company is not the end game, but only one step in its development. You will have to work with the buyer for the foreseeable future and must thus maintain a good relationship with him.
Whether negotiating the price or the details of the stock purchase agreement (SPA - representation and warranties, etc.), I always let my lawyer and bankers take the lead in the discussions. This way I can blame everything on them – they are greedy and difficult while I am the reasonable guy willing to make compromises.
Speaking from the context of a US-based VC, Brad Feld thinks entrepreneurs should use an agent if they raising late-stage capital, but go direct if they are raising funds for a start-up.
From Brad’s post:
Many early stage VCs - especially those that are in saturated geographies and see a lot of deal flow – don’t pay much attention to deals that are promoted by an “investment agent.” I know a number of folks who simply “hit delete” on an email (the virtual equivalent to tossing the physical PPM – the document most agents insist on putting together – in the trash.) In the early stages, the entrepreneur is by far the best fundraiser for his company and there is a knee jerk negative reaction by many VCs against early stage deals that “require” an agent. At the early stage, an entrepreneur is much better served by finding an advisor (or set of advisors) or angel investor that has good VC connections and fundraising experience who can get actively involved in the company as advisor, board member, consultant, or even chairman.
Later stage companies and larger capital raises are a different story. The universe of later stage investors is very dynamic – consisting of corporate (strategic) investors, high net worth individuals, private equity firms, and hedge funds – in addition to later stage VC firms. Many firms enter and exit the market regularly for a variety of reasons (e.g. a number of hedge funds have recently started doing what traditionally look like late stage / mezzanine VC deals). An agent who is active at raising later stage capital will typically have some relationships with folks currently in the market, can run the drill of identifying the primary suspects for the entrepreneur, and can help manage what is typically a more complicated and less structured financing process (e.g. there often isn’t a clear lead investor in a later stage deal.)
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