Editor’s note: This post is part of Mark Suster’s This Week in Venture Capital Show, which addresses hot topics in the world of startups and VC.
We received so much positive feedback from our This Week in Venture Capital show walking through valuation calculations & term sheets that we decided to do a Q&A show this week to address topics that entrepreneurs want to learn about. We will continue to do more of this.
If you want to watch the show click the image above or this link, but if you want a quick read – here’s a summary (oh, and if you’re wondering – Jon Stewart copied me – not the other way around):
1. @tevye2009, Q: “can you briefly explain why it’s best to get a small valuation when getting investment.” A: It’s not best. The best thing to get is a “right sized” valuation. People assume that I’m biased because I’m a VC and think you should always get the highest valuation possible. This is wrong.
I explain in the video what happened in my first company (e.g. on the entrepreneur side of the table) when I raised at too high of a price. I eventually needed more money. The A round was done in February 2000 (end of the bull market) and my B round was done in April 2001 (bear market). As a result I had to do a down round. Down rounds are psychologically really difficult on companies and can make it harder to do later rounds.
So don’t raise money at a cheap price, but don’t get too far ahead of yourself either. Pricing high also takes exit options off the table. In the video I also covered why you shouldn’t raise too much money too early in your company’s existence. We also discussed how to deal with pricing in angel rounds and a strategy I advocated in my “social proof” blog post, which is to price your initial angel round really low and get in the best possible angels as a way to get momentum in the company. This question runs from about minute 2 – minute 8.
2. Mike Stern (wasn’t sure which one so leave a comment if it’s you): Q: “is it possible to sell your startup without venture investment if the company has big traction and a large user base?” A: Yes. In fact, far better if you haven’t raised venture capital. People buy companies for 3 primary reasons: 1) they want the management team / talent 2) they want the technology or 3) they want the market traction (revenue, customer base, profits, etc). People also buy for defensive reasons or ego but that’s a different story. But the key is that if you want to sell your company you need to have active relationships with potential future buyers. We discussed that at length in this TWiVC with Michael Montgomery. But to the question – it is much EASIER to sell your company if you’ve never taken venture capital. Angels have a much lower threshold for returns than do VCs. This is minutes 8-11.
3. Mark Jeffrey – Q: “Is it more traditional to do your ESOP (employee stock option plan) before or after your angel or Series A funding?” I got on my soap box on this topic. I talked about the need to have a restricted stock plan for your earliest employees. This has HUGE tax benefits to those that join early. See this chart to show you just how much – around 2x the taxes. The downside is that people need to buy their stock. But if you do this early (pre VC) then the price points are pretty low. I talked also about 409a valuations and why common stock purchases cost less than preferred stock purchases.
But most importantly I lectured founders that you can’t avoid the admin of setting up your ESOP. Do it early. I’ve heard every excuse in the book and you’d be surprised how many people put this off. You’re not screwing me – you’re screwing your fellow employees. The longer you wait the higher the price they’ll have to pay and the less time the clock will be ticking on long-term capital gains tax. Bad behaviour but prevalent. If you’re working at a startup and the founding team is promising that they’ll “get around to creating an employee stock option plan” soon – demand it now. Minutes 11-16 in the video.
<< we then discussed the need to do trademarks on your company and your key brand names. We told the horror story of the company that originally owned the URL groupon.com and lost it due to not having a trademark. we thanked our sponsor, LegalZoom, for providing trademark services cheaply >>
4. Q: “If you have a term sheet on the table how should you leverage with other VCs?” A: You need to SUBTLY let other VC’s your speaking with know that you have a term sheet. The best way is if they hear from third parties but if you can’t manage this it’s OK to tell them directly. Just say, “listen, I don’t want to pressure you but I wanted to let you know that we received a term sheet that we’re considering. We think we can take a couple of weeks but in case you were interested I wanted to be sure that you didn’t find this out at the last minute.” I discussed the need to be careful of Gym Salesman VCs and “exploding” term sheets. I also gave some tips on how to politely but successful stall the VC pressure to sign your term sheet quickly. I think this section is so important that anybody raising VC should at least view this section. There’s some stuff here that I even prefer not to put into writing. Minutes 18.30 – 26.30.
5: Q: “What’s the best way to get a VC’s attention in an email” – I’ve written about this topic so more in depth is here on How to Access a VC as well as I Emailed a VC and Never Heard Back – What Now? First advice – don’t respond to a VC website that says “submit your business plan here” – if it’s read at all it will be read by an intern and likely be filtered before it reaches a decision maker. Second – don’t send unsolicited emails to VCs. I get them all the time and I try to respond to as many of them as I possibly can. But one of the things that VCs look for is how you get access to us. In the era of social networking if you can’t figure out how to get intro’d to me you probably aren’t cut out to be an entrepreneur. Tough, but true. So in the video I talked about the “stack rank” of intros: portfolio companies, entrepreneurs, lawyers as the main ones and other investors as the secondary way. Never cold. Never. And I talked a lot about persistence in the video. Starts at minute 41 – a very worthwhile piece to listen to.
6: @marklanday Q: “Do you make personal angel investments and if so what are your criteria?” I talked about the rules GRP has set up for allowing angel investments (has to be in an area we don’t typically invest, in a company that doesn’t have the ambition to build a big business or a company that GRP has turned down. We don’t want to compete with our LPs. I have a link on my blog to the angel deals I’ve done, which is here. I also spent a bit of time talking about why I think angel investing is a mug’s game. I typically do it just to support entrepreneurs I like, to learn about a space (you learn from the inside not by reading TechCrunch) and to build relationships with other investors. To make money as an angel I believe you need to do at least 20 deals and have deep enough pockets to put wood behind 3-4 of them that succeed more than others. If you want to understand why – check out the video starting at minute 49 or so.
7: Q: “Should I take an investment from a family member?” A: No. Not if you don’t have to. If you are thinking about angel investors please read this piece I did on Angel Funding Advice. I also did a piece on how to think about pricing on angel deals. But quicker answer – here’s your stack rank: 1) knowledgeable entrepreneurs who have made a lot of money, are prolific angels, know other angels & VCs and know your industry / space 2) same as 1 but don’t know your space 3) know your space but don’t have hugely deep contacts. But they do have money and they are realistic about angel investing. 4) business people in general who understand angel investing 5) doctors & dentists (metaphorically) who are realistic about angel investing. Most are not. 6) friends & family. I know everybody tells you to start with F&F but here’s the thing. Most likely your venture will fail (most do!) so why burn out your family & friends unless you have to. Obviously if they are very wealthy or they fit categories 1-4 above I’d have a carve out. Anyway, it cover this at length in the video around minute 57.
In the video we did a lengthy discussion on “the return of enterprise software” talking about companies: Atlassian, Jive Software, KickApps, Yammer and SquareSpace. Most importantly we talked about my good friends at Okta who were financed by Andreessen Horowitz. They have a great user proposition and a phenomenal team. Check ’em out! I talk about the company in the video. I think this section started around minute 27 but not 100% sure.
We covered the week’s M&A deals: Playdom and Kongregate and why Disney and GameStop made the acquisitions.
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