Venture Capital

Startup Investor Relations 101

startup-investor-relationsOnce a startup founder has raised outside capital, regardless of stage or amount, it is time to think about building a lasting relationship with his investors. Here are my top four tips:

  1. COMMUNICATE regularly with each investor/director by sending a monthly progress/update email. Spend 30 minutes detailing all your accomplishments, challenges and go-forward plans. You don’t want to wait until your next board meeting or until they email you asking what the hell is going on.
  2. ASK each investor/director for help each month. Think about how each investor/director can help you – perhaps with a product launch, a candidate for employment or a business development deal. If you keep them busy they will be a LOT less likely to get in your ‘business’. One of two things will happen – you will get much needed help or he will hide from you.
  3. MEET (in person or via phone) with each director PRIOR to each board meeting. Show him your agenda and ask him if there is anything he’d like discussed at the meeting. If there are controversial issues to be discussed determine where he stands. If he’s on your side enlist him to meet one-on-one with directors who might not be on board yet PRIOR to the board meeting.
  4. DOCUMENT each interaction with your investor/director. The day after your board meetings email an overview of what happened and what decisions were made to each director. You will approve the minutes at the next board meeting, but you’d be surprised how time can change your perception of history. Do the same thing EVERYTIME you engage with your investor/director – a quick followup email detailing what was accomplished and what everyone has committed to do is VERY important.

Let me know if you have any ideas to improve your investor/director relationships.

My First Startup Board Meeting

your-first-board-meeting

The other morning I was reading about Brad Feld’s first board meeting where he asks the reader if they remember their first board meeting. I remember mine vividly.

It was in the late nineties, I was in my late twenties and I had just raised $11M for my first venture backed startup, LayerOne. The venture capital firm had two seats and I controlled three. They were located in New York so we held the meeting on the phone. The first topic of discussion were option grants we needed to make to a few advisers who had helped me along the way. I had promised the options and they were terribly material; however, the two VC board members objected STRONGLY to the grant.

Remember, this was my FIRST board meeting and I was an arrogant twenty-something who raised $11M for an idea and a prayer. The younger of the two VC board members attempted to coach me on the board call explaining that all of our votes should be unanimous and that we shouldn’t have contention – especially this early in our new relationship. I explained that I had ‘PROMISED’ the grants and that I couldn’t imagine not honoring my commitment. Ultimately we granted the options.

This was one of many mistakes I made as a first time CEO. In retrospect I should have tabled the matter and talked to each director privately, explaining the situation and asking for their support. I just assumed since I had three votes on the board I could do whatever I wanted – I was dead wrong. You need the support of your board and getting them comfortable is vital to the success of your company.

Raising Money in Dallas is Easy?

Dallas-startup-weekI had the opportunity to drop in on the opening ceremony for Dallas Startup Week 2015. During the first panel Michael Johnstone of the Mark Cuban Companies was asked why it was so hard to raise venture capital in Dallas and instead of agreeing with the premise of the question he argued that it wasn’t really harder to raise startup capital in Dallas versus San Francisco. I’ve been thinking about it and I’m starting to think he might be onto something.

Case in point, the other day I met a couple of founders at my StartupMuse office hours and listened to them talk about their mobile application. They’ve been working on it for two years and they’re struggling to raise outside capital. After asking the pair about their personal lives and determining they could easily pick up and move to the Bay Area I immediately told them they should move – that was the ticket to startup funding. The next week one of the founders dropped in on my office hours for a second time and we started playing with the actually mobile application – it was horrible. It was then that I realized moving to San Francisco would be a HUGE mistake for this company. Ironically, I imagine it would be EASIER to raise money in Dallas for this particular team – their deficiencies would be glaring in the Bay Area.

Optically, when you read TechCrunch, the startup publication of record, you’re reading about 90 Bay Area startups for every Dallas based startup so you might naturally assume it is easier for startups to raise money there. The truth might be very different.

10000 SFO Based Startups (unfunded)
1000 SFO Based Startups (funded)
10% funding rate

1000 DFW Based Startups (unfunded)
100 DFW Based Startups (funded)
10% funding rate

These numbers are simply for example, but I hope you get the idea. There are simply far fewer startups in the Dallas area seeking funding. I would imagine that for every 100 startups running around in the Valley there is just one here in Dallas. This is just conjecture, but I wonder if it is actually EASIER to get funded in Dallas? In the Bay Area EVERYONE is starting a company and very few of them are getting funded. In Dallas most everyone is NOT starting a company so those who do are the exception not the rule. Perhaps it is easier for Dallas startups to get attention because they look more like black swans than white ones.

In fact, I am the poster child for Dallas based companies raising venture capital. I have attempted to raise startup capital exactly three times. First with LayerOne (total investment $30M+), then with ShopSavvy (total investment $7M+) and finally with ViewMarket (total investment $10M+). In each case I was able to secure the initial funding as well as follow on funding – I really wonder if I would have been as successful if I was in San Francisco.

I am 100% certain that I am not certain whether or not it is harder for Dallas companies to raise venture capital, BUT I am certain raising money is hard. I do, in fact, believe that most of the companies that aren’t successful at raising capital aren’t successful BECAUSE of their product and team – NOT their location. Good products and teams WILL find investment capital regardless of location.

Convertible Preferred Debt Sucks for Startups

The other morning one of our investors, Dave McClure, created a twitterstorm when he went on an 18 tweet rant about convertible debt. You can read it here or see it below. It got me thinking about convertible debt and how much it can suck. First, for those of you who are unfamiliar with convertible debt I’ll briefly explain how it works.10

Lets say you and your co-founder have starting building a mobile app and need a little money to get it across the finish line. You are likely too early for venture capital so you start looking for an angel investor. You find an investor who is willing to invest $250K, but you’re not sure how to value a company that in reality is hardly a company, lacking revenue or traction. You could argue it is worth NOTHING. You could also argue that is could be worth BILLIONS in a few short years. If the investor is interested in giving you $250K he believes the latter. Many entrepreneurs, instead of getting into a difficult valuation discussion at this early stage, decide to defer it by offering the investor something known as Convertible Debt.

convertible-preferred-noteConvertible debt is basically a loan that converts into equity, usually, upon a future equity financing at a discount of around 20%. Convertible debt, usually, includes a Cap – a maximum valuation for the conversion – early stage deals seem to have a $5M Cap. Dave was complaining about the fact that he’s seeing startups demanding higher and higher Caps – $8-12M. He’s responding by asking for 2X liquidation preference in the event the company is sold BEFORE conversion. I’ll argue that he’s right, but that we’re getting to a point where it almost never makes sense for the investor or the entrepreneur to do a convertible debt deal.

Let me recap why you THINK you want a convertible note:

  1. it takes less time to close
  2. the legal documents are easier and cheaper
  3. you defer the valuation discussion (reducing the amount of time needed)

First, I’ll argue that early stage deals are so straight forward that you can get an equity deal done as easily and quickly as debt deal. Second, most securities firms, assuming they think you’re going to be successful, will do your first equity raise for $5,000 (the same price for the convertible debt). Finally, you’re going to haggle about price ANYWAY. The investor is going to set a maximum valuation for the conversion – usually $5M and you will want to set a minimum valuation in the event a conversion event does not occur – usually $3M. Um, your company is worth about $4M – why not just agree now and issue the investor stock? You avoid the discount. You avoid the interest. You avoid all of the possible downsides of convertible debt. Oh and in the event you sell your company before your next round you don’t have to pay your investors that 2X liquidation preference Dave was ranting about.

Of course, if you can raise convertible debt WITHOUT a cap (or a very high cap – say $12M) you should. Most convertible debt deals don’t have control provisions or board seats – you’ll be in total control of your startup. The reality is that high cap or no cap convertible debt deals are almost unheard of today. In my view the ONLY other reasons you might consider raising convertible debt is if you will be raising money from several investors – getting four or five angel investors to agree on a price might prove itself too hard and the bounded box of a max/min Cap might help get them across the finish line. Additionally, with a convertible note you don’t have to set the amount to be raised – if your first investor agrees to put in $100K you can take it and close and then as the second investor agrees a few weeks later to put in $250K you can it and close and so on.

I used to be a big proponent of convertible debt – we financed ViewMarket and ShopSavvy with convertible debt – but I’m fairly convinced that you might as well just raise equity instead.

Lots of people have opinions on this topic:

Ted Wang, Yokum Taku, Mark Suster, Fred Wilson, and Paul Graham.

Exploding Termsheets are Evil

exploding-termsheetLast year my co-founders and I got a termsheet from an investor here in Dallas that had a 48 hour deadline. I’ve never taken ‘exploding termsheets’ very seriously and didn’t really pay attention to the clause. We sent the offer to our lawyer and the first time he could meet was 50 hours from the start of the deadline – again I didn’t imagine the investor (after having spent weeks looking at our deal) would seriously pull the offer if we were two hours late with our response.

In the meeting with the lawyer we decided we needed to negotiate a few points and I texted the investor and asked him to email a document we could edit. He responded by saying the offer expired. He said he would consider extending the deadline if we would agree to take it ‘as-is’, without any changes. I was flabbergasted.

After that exchange I knew we were done. My partner insisted on negotiating the deal with the investor and ultimately he did agree to let us make various changes to the offer. But at the end of the day the investor showed his true colors in a single text message – I knew I could never be in business with him.

If you’ve received an exploding termsheet you have two choices. You can ignore it or you can talk to the investor and explain you’re going to need more time. Some very obvious reasons are that you need:

  1. Time to review with your co-founders
  2. Time to have your lawyer review the termsheet
  3. Time to check some references on the investor

At the end of the day the investor, by including a short deadline, is signaling a lack of confidence. If he was confident with his offer he’d happily let you ‘shop’ it around town. Fred Wilson describes how he does it – find guys like Fred to invest in your company and avoid the exploding termsheet.

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