There has been multiple studies suggesting that more and more businesses are relying on bootstrapping / angel money to start their business and are not too keen on the venture capital, at least in the initial days. A part of this is because of the decreased cost of starting a company and lower development costs because of the open source tools AND the other part is because of the keenness of entrepreneurs to have more control of the company – for as long as possible.
The question to be asked here is: Why are entrepreneurs worried about VC investments, when the VCs truly bring in much more value than just the money?
Guy Kawasaki has a great post on The Venture Capital Aptitude Test (VCAT) that created quite a buzz in the blogosphere. He writes his thoughts on the right time for a person to become a venture capitalist and points to a test that can help you figure out your VCAT. He stresses on the fact that one should become a venture capitalist after they have had the shiitake kicked out of them.
I agree. It is very hard for an entrepreneur to trust a VC who doesn’t have the necessary background in the activities that the entrepreneur is carrying out and the experience in having run (or be a part of) a startup. Somebody who has never answered the board from a management team’s position almost always never understand how is it to run a company. So, while it is important to have people in your board who are independent Directors and aren’t involved in the day-to-day running of company, it is also important for the management team to be able to respect them. The respect comes automatically when the entrepreneur knows that the board member can (and does) empathize with the issues / challenges faced in a company and yet can give open and critical feedback.
Generally speaking – I am quite neutral about my impressions about Venture Capitalists. In fact, it’s been much more on the positive side than the negative side, based on my interaction. But it’s baffling to know that most companies (funded and not-funded) I have talked to have not-so-good things to say about the VCs. On the other hand – everybody have good things to say about angel investors.
Am I just plain lucky (and I have interacted with VCs who would clearly fail the VCAT)? Or is it that Guy Kawasaki has over-generalized his test? India has its own unique problems. On one hand – we need serial entrepreneurs who have been ‘successful’ in the past and not just the 1st generation entrepreneurs AND on the other hand, we need Venture Capitalists who have been entrepreneurs before.
Unfortunately, I can not think of more than just a few names when it comes to people who have successfully build even a USD 50 million plus business in the last many years. There are people who have successfully exited on a valuation of less than USD 10 million dollar business but I am not sure if I can term them as being ‘really successful’ or not. But this is a never-ending process where more entrepreneurs will exit out of their venture in case of acquisition – what will be interesting is how many of them chooses to start again and how many becomes VCs? Of course – there are other options as well, based upon the interest and the exit valuation.
Originally posted at my personal blog.
- Why are entrepreneurs worried about VC involvements? - December 6, 2006
Curious – the angel doesn’t have to ‘exit’. They can retain the equity without further investing. But if they do want to exit, you or the VC can buy their equity at the current value of stocks. Know that their 17% after VC round will not be the same as the money they initially put – as the company valuation will increase over time.
Of course – there are other ways also – which can all be baked into the contract.
Dear adamb,
Thanks a lot for the example.
But then how does one give “exit” to a previous investor? (in the example you have taken, the angel investor ends up holding 17% stake)
sorry for being offtrack to everybody else-
curious_mind:
Lets say that you value your sweat equity (called pre money valuation) before you take any angel money at $100. You take $50 from the angel investor. The valuation of the company after the angel investor is $150 also called post money valuation. Therefore, after the financing, the angel investor ends up with 33% because ($50/$150)
Now later on you need another $150 and then take that money from the VC, then the stake for all the players become:
You- (100/300)=33%
Angel- (50/300)=17%
VC-(150/300)=50%
this is a very simple example where you assume same valuation across the angel investor round and the VC investor round. the key thing to remember in most VC financing, the money that VCs put in do not go to previous investors but to the company itself.
in reality, there are all sorts of complication such as differing valuations across rounds and other terms (Liquidation preferences, participating rights, protection against down round etc….) that make the VC contribution more like debt than equity (i.e. convertible financing than straight equity financing)
I think generally VCs are good guys…sometimes the one off partner gives whole industry a bad name.
Alok and other experienced ppl,
Sorry for going a bit off track here (Ashish). But I want to understand a bit about how an angel invetor’s exit would work.
I am not a finance person and a first time entrepreneur so please pardon me if the question is dumb.
Say an angel investor picks us 33% stake in my venture and wants an exit when i go for next round funding from say a VC, how would the finance structure of my company work out. (lets say VC wants 51% stake)
1. Who would finance the angel investor’s exit ? I mean if the money for his exit is coming from the VC money then would the VC in effect be purchasing his 33% stake and 18% from me.
2. If the money from the VC has to come in first (which would be the case if the exit is being financed with VC’s money) and then how would things work out ?
Please help me out on this one.