Babbling VC

It's Not About Paychecks. It's About Equity!

I've often made the dating reference when it comes to VC's and entrepreneurs. Well, there's one further point which I want to make clear, although to many it's obvious. After we invest, we want to eventually sell our stake. Be it via an IPO or a trade sale, we eventually want out. This means that our premise for investing is taking the money we initially invest and increasing it tenfold or better. You're scratching your head asking yourself why is Paul writing this? It's obvious! Well, not to everyone. We are not looking for businesses which get to break even and then flatline on their growth. We want the hockey stick. We want companies "swinging for the fences". We NEED companies looking to be market leaders. Otherwise, we simply can't generate the returns necessary to make our investors happy. 

Too many pitches I hear (most often in Germany) are too conservative in their thinking. Don't get me wrong. I am not saying go out and make wild claims to make me happy. What I am saying is that you need to have a business case which makes me want to get in on it no matter what. I am not happy investing my money so you can test the market to see which of three or four models gets you to a nice paycheck. It's not about paychecks. It's about equity. 

Equity is where it's at when it comes to venture. You want a piece of a big pie. I want a piece of a big pie. It's not about earning dividends for me. It's not about earning money for you (at least not short-term). What we together have to do is grow a business which sells itself. The buyer chases you and not vice verse. When this happens, we all generate the type of returns necessary for venture capital backed businesses. Everything else is otherwise just a series of bad dates. 

Why Are There Simply Deals We Won't Do

I'll keep this one short but it answers a question often asked. As is probably the case with most VC's and their LP contracts, there are industries we can't invest in. Very simply put, we won't invest in gambling, porn, first-person shooter games and anything having to do with alcohol, drugs or tobacco. All LP contracts vary but it's pretty clear why some of these areas are taboo for VC funds. 

Hence, if your company is in one of these industries, you will most likely have difficulty finding a venture fund to back your business. Note that I am not making any judgement on these industries and if you argue with me about this when asking to pitch me, it's a dead-end. I can't get around these rules in regards to my fund. Some VCs' contracts are a bit more lenient, i.e. they can invest in the gambling segment and have non qualms about first-person shooter games. This may change ever more in the future but they exist. 

Finally, a new area where we are having trouble putting our money to work is segments which reek of a scam. Arrington just went on a rant about the social gaming segment and I agree with many of his points. We are therefore ever more critical of business cases where a grey area exists and customers can be misled into contracts or payments without knowing. I have to admit I've been seeing more and more of these deals the past couple of months. I predict we'll be seeing ever more of this crap with the growth of Facebook, Twitter and other social networks and respective monetization attempts. Even if there are some legitimate business cases there, anything reeking of scam is going to get passed over by VC's. 

As in any profession, most VC's are full of shit!

I read the following line in Paul Graham's essay:

"The reason VCs seem formidable is that it's their profession to. You get to be a VC by convincing asset managers to trust you with hundreds of millions of dollars. How do you do that? You have to seem confident, and you have to seem like you understand technology."

I don't mean to imply with my blog title that all VC's are idiots. Simply put though, even if they are, they sure as hell can hide it well. It's funny how much that sentence from Paul's essay stuck in my mind. Having recently been out in the market gauging LP appetite for venture capital funds, that fact couldn't be more accurate. When raising money as a VC, you're selling yourself and your partners. The VC's themselves become the product. Unfortunately, many VC's manage their portfolio as well with this "game-face" on. Hence, as an entrepreneur you'll probably think they're an idiot. I've caught myself on occasion making this mistake and proving that I'm full of shit on that occasion. I regret it every time!

At the same time, I think we're seeing a major shift in the market right now when it comes to early-stage venture. This is the phase when old-school VC's simply won't continue thriving. You have to be ever closer to the entrepreneur when investing in companies and you have to know how they tick. That's why you've seen a whole slew of guys establish themselves as the players in the past couple years: Brad, Fred, Paul, Mark, Jeff and so forth. Not necessarily everyone in the new group was a serial entrepreneur but they've always been close to the entrepreneur. These guys aren't going out raising funds on the back of "game-face". Sure, you present yourself professionally to your investors and it's not easy for anyone. Yet, the new breed is letting their performance and actions speak louder than their Powerpoint presentation and smile. These are the guys who I look to for inspiration!

What does this mean for you as an entrepreneur? I think it's pretty simple. Don't get blown away by brand names. As always, when it comes to raising venture capital, you're entering into a relationship with one person. Statistically, the chance of running into someone who is clueless is pretty high. Do you homework!  

A VC's Perspective: Blogs I'm Reading Now

I bang out a post like this every now and again as it needs updating. I read a bunch of blogs every day but there are always a couple I come to first. These are usually the core of my reading and tend to drive what else I read as I discover new ones via links in posts. Below is the core of blogs which make up my daily reading now. Tune in 12 months from now to see if this list has remained the same:

A VC

Fred's blog has been on this list for a long time. I am presuming it'll remain on this list for a while longer. I simply like how Fred writes and the best part of his blog is the comments sections. Obviously, Fred is writing things near and dear to my heart (my business heart that is). As he's mostly focused on early stage investing, I get a good perspective on the things Fred is dealing with. I mean this in the best of ways but Fred's a bit stale right now. If you've been reading his blog long enough, topics get a bit re-hashed. I know this to be the case as I also blog. The benefit with Fred is that he always comes back and usually stronger. Hence, I stick around because he's consistent in his ups and downs.  

Chris Dixon

Chris does a splendid job of giving an entrepreneur's perspective. He's new to my list as I only recently discovered him via Fred's blog. His opinions are fresh and related to the issues companies I am investing in now are dealing with. He's direct with his posts and usually hits the nail on the head. I hope he keeps up the pace and quality of writing which I've seen the past couple of months. 

Mark Suster - Both Sides of the Table

Mark is also a recent addition to my reading list. I can't remember where I found the link to him but I'm glad I did. I've recently met him when out in L.A. and in addition to writing an awesome blog, he's a good guy. A former entrepreneur (two solid exits) now turned VC, he's speaking from both sides of the table (hence, the blog title!) He's banged on solid post after solid post this year and I recommend him to every entrepreneur I run across. His focus is US centric but he's also worked in Europe so his background is quite unique to the US VC scene. 

Andrew Weissman

Andrew's is another blog very recently added to my list. He writes great stuff though. He's a part of Betaworks and is obviously therefore angel focused. He doesn't write as often but I've enjoyed his most recent posts quite a bit. I wish he'd pick up the pace a bit and as I've experienced before, he may tail off. This would be a shame though because I'd love to regularly read about his experience with things being done via Betaworks. 

Equity Kicker

Nic is a blogging machine. He's a UK based VC and has perspectives that relate to the same continent I'm on. (There aren't many by the way!) He's a long-time VC having worked for a couple funds throughout his career and is also a great guy whom I bump into a couple times a year. Nic's blog is interesting because it has a VC's perspective but he writes about everything. He doesn't just stick to one area and I like that approach.

Coconut Heads

I literally just found Rob's blog a week or two ago. He writes with a focus on entrepreneurship but about all kinds of things, with a very technical take on it. The focus though is business, finance and critical thinking as he says. I literally went through ten posts or so after landing on his blog the first time. Great stuff to be found here.

Brad Feld

Brad's been at it forever. I've had the pleasure of meeting him a couple of times as well and he's just a really nice guy. I like his early-stage focus and his "screw what you think" approach to how he does stuff. I've been reading his stuff actually longer than Fred I believe. Actually, I'd say he used to have top-notch in terms of when I started but Fred took that spot at some point. I think eventually Mark may be leading ahead of both of these guys but that's just some ranking for my perspective. It's kind of funny that the three guys whose blogs I like the most are also the three guys whom I admire the most in the business and look to as examples for how I'd like to do things. 

As I've said, I read much more than just this. Yet, this is the core for now. I hit each of these blogs when a new post comes up. This is an ever-changing list. Last time, Marc Andreessen was on the list. He doesn't write much anymore so I don't bother following it. It's a shame but this is life in the blogging world.   

Here's How My VC Timeframe Works (as oppossed to yours!)

This is less of a rant and more so a service announcement. It's become clear to me that often, entrepreneurs expect a VC's day to revolve around them and their wishes. I'm referring very specifically to the time from when said entrepreneur sends in his business plan until next steps happen. I'm going to generalize a bit but want to give you an idea of what happens with your business plan once you submit it to a VC fund. I've put in general timelines:

Day 1 through Day 5:

Now I am presuming you've read my other posts about how to get your business plan in front of a VC. I won't go into those specifics again. So, let's presume you've just mailed your business plan to me or it's made it's way to my in-box via proper channels. Depending on how much time I have, I will take a quick scan of your executive summary. Preferably you've had someone I know pitch your idea to me and make the contact. This way, I generally know what your business case is. My initial scan is to determine which investment manager in my fund I want to put on this deal with me. Every VC partner usually has a favorite in their team whom they tend to work with more than others. We have three different IM's and each has his strengths. We try to match them up with the deals we pursue or vice verse, work on the deals they source. So, the investment manager is determined by me and he receives your business plan (or was your key contact and your internal champion when it comes to me). It goes into a pile of other business plans he is reviewing/working on. I determine what priority this business plan gets. If I'm hot for the deal, I'll tell them to get on it immediately. If I'm not too hot on it, I'll ask that I get feedback in a couple days. One way or another, I also want his opinion on it and need it as the IM will take a much deeper dive into the case, reviewing the market, reading about the product and technology and giving me an extensive view of what you're up to. I like to listen to my IM's opinions and thoughts. They can and will sway me. These are guys often much smarter than myself on many issues. Remember this when figuring out how to get to a partner. 

Day 6 though Day 12:

If the IM and I decide we want to pitch the deal to our partners, the real process starts. Our IM will dive into a due diligence. This isn't the extensive full on due diligence we need to invest. This is the due diligence I need to pitch to my partners that I want to pursue this deal. You'll be invited to our offices to pitch the IM and myself. We'll review the market, start talking to people we know to get feedback, we'll play with the product (if possible) and we'll review the numbers for a sense of validity (or sanity). Since we pitch a bunch of deals across three partners at our weekly partners' meeting, you may not be able to get in the door right away. It usually takes at least two weeks for us to discuss the deals amongst ourselves. We're then pretty digital on our decision. It's a yes or no. If yes, then the real due diligence starts. If it's a no, the IM and I determine whether we want to give one last push but usually a deal is then dead. Our goal is to be fast here to make "go, no-go" decisions. Scheduling of meetings here tends to be the biggest time drag.

Day 12 though Day 20:

Once we start pursuing the deal, we'll schedule a meeting at your offices. We try to spend at least one day (usually more) with you and your team, getting to know about the management and employees. We'll want to go much deeper on the questions which remain open. At the same time, we'll be doing research on our end and preparing a termsheet. At this point, we tend to move at your pace, meaning we work around the entrepreneur's schedule to get time with them. If you involve lawyers at this point for the termsheet, that 12-20 range up there can expand quite a bit. Nevertheless, we try to push to stay within this timeframe so as not to lose momentum. Finally, we schedule a pitch at our offices to my other two partners. This is for final approval to do a deal. If you get approved at this meeting, I have the "go" to close the deal without further involvement of my partners. They'll be kept informed as to what's happening of course, but I'll be driving the deal from here to close (or break-up). Make sure to try to get this meeting done as early as possible, since in our case, this is a key step to having the process continue moving. 

Day 20 though Day 40:

In a realistic scenario, most deals take two to three months at least. There is no rule to this as we've done deals in two weeks from start to finish. We've also had deals take significantly longer than 6 months. Each case is different. Some deals also have significantly more competition and this obviously changes many things. During days 20 to 40 we're usually negotiating the investment documents, completing our reference calls and market analysis, interviewing potential key hires and basically tracking how you run your business and whether you're delivering on things you promised. 

This is a rough estimate of how much time it takes. Like I said, each deal is different and I've left out the nitty gritty. This is simply how it works for us. Some VC's do things in a different order. Basically, every VC is going to have the same parts to the process but will take longer on some things and less time on others. We try to keep the negotiation short. Draw this out and things get sloppy. We don't like to rush our due diligence though when not necessary. This is where we're learning as much as possible about your case and you. Yet even here, at times there just isn't that much to look at since we're usually in deals pretty early. One way or another, I hope this helps to give you an idea of what to expect when starting the discussion process with a VC. 

Note: "days" referred to above are business days!

Build Your Company for the World, Not Your Mom

Note: this is a very Europe oriented post!

It's pretty simple. Build your company to be big. Go for broke! Try to win it all! Mom is always going to like what you do so even if you suck, she'll be nice and love you anyway. The business world is not like that. I understand the need for people to be humble and demure. Yet, please do so in other lines of business. In VC backed companies, you need to deliver returns that are above and beyond the norm. This is expected. I'm measured by the same standards as you are when it comes to my returns. 

I understand that people are scared right now and not only entrepreneurs are thinking safe. Lots of VC's have crawled back in their shell and basically moved away from risk. It's very unfortunate though when I get a pitch and hear that someone wants to be the best in a small market or a small geography. It's not enough to just be big in Germany or France or the UK? Sure, there are a few that were able to get big enough in just one country. We actually had a couple in our portfolio and they were very successful exits for us. Yet, it's better to go big and in a worst-case scenario just be the market leader in your country. Could be worse! But what's the worst-case scenario if you're just trying to win the German or French market? Get my point?  

Don't Pay Your VC "Closing" Fees

Jason just ranted about angel groups charging fees on his blog. Go take a look if you haven't read about this topic. He gets a hat-tip from me for taking a stand on this. At the same time, here in Europe I've run across "closing" or "consulting" fees from VC's. This, in my opinion, is just as bad and as an entrepreneur you'd be foolishly throwing away money. It seems like these fees are disappearing but I am sure they still turn up every now and again.

Why are these dumb? Well, first of all, as an LP I'd be pissed about my money being spent this way. What actually happens? Well, it's pretty simple. The VC invests an amount into a company. Let's say 10 million. Right after the investment, the company is required to pay said VC the above mentioned "closing" or "consulting" fee which used to be somewhere around 3%. So, what's happening here? Well, the VC is basically taking out money up front on a deal without having done anything and he's already collecting maintenance fees from his LP's to cover these costs. If you have a VC arguing to you that there is a reason for you to pay the costs of his due diligence or whatever with this fee, be wary. He's lining his pockets with this cash. Now don't mistake this with legal fees or other fees incurred during the due diligence. Most VC's will set an amount in the termsheet (or shareholders' agreement) which is required to be paid. This is for external, third party providers such as lawyers or accountants. Make sure you cap this amount, usually at about 25k. But if you pay the 3% or 300k in my example, you basically have 300k less to grow your business. It's actually even foolish of the VC in regards to his investment case as the company ends up with less money. 

As I said, these fees have been disappearing for a while. The one large European VC who used to charge this has stopped investing in venture deals altogether. I could foresee though some scrupulous groups implementing these again down the road. I was just as surprised to see these angel groups charging fees but realized I had seen this in Europe. As Jason wrote in his post, if you can't find VC's (or angels), you either didn't do enough work to grow your network or your product/team just isn't that good. No matter the case though, don't get suckered into paying unnecessary fees. Solve the real problem of tweaking your team and/or product and investing the necessary leg work to get the right contacts. 

Think Wisely About Your Business Angels

You often see advice on picking your VC. I've written often about this topic. Yet you hardly ever see much about angels. Sure, it's even harder to get angel money than it is venture capital. But nevertheless, you should always consider the consequences of raising money and the person who gives it to you. It may have longer lasting consequences than you ask for.

I've been noticing quite a few "spats" over the last couple of months, very often involving business angels or something having to do with them. I'm sure this is nothing new but it's become quite obvious as of late. Lots of angels are in a poor situation be it because of the recession or poor investment decisions in the past. Actually, it's probably both but some have it worse than others (kind of like the VC's). Those angels who pursued "spray & pray" strategies have a lot of investments which they will never realize a return on. This makes them quite nervous and also unpredictable in your decision making process. If nothing else, they are so busy firefighting that they simply won't have time for you. In general, very nervous or preoccupied investors never make for good support. Oftentimes, in-fighting breaks out which does nothing but deter your start-up from being successful. It also becomes an every man for himself situation and this obviously isn't optimal. Early on, you need all the focused help you can get.

Even worse is that lots of angels have been burned. For example, here in Germany you have at most a 10 year phase now of visible angel investing. There were angels before but these were mostly high net-worth individuals who dabbled here and there, usually within their industry (typically not tech if 10 to 15 years ago or earlier). In the late 90's though you had lots of folks making quick money on the bubble. Many of them went into angel investing thereafter. Actually, I hardly know of any entrepreneurs who exited back then who didn't do some form of angel investing after a successful exit. These weren't necessarily highly experienced managers. They were out to make a buck and didn't necessarily play fair. After what is now a fairly long period, many have already been weeded out. Yet, quite a few remain and due to their behavior they may be caustic to your fundraising process. You definitely need to avoid this as there is nothing worse than not getting meetings with investors simply because of whom you have in your investor syndicate. 

There are great angels out there. I am happy to have seen many of them establish themselves over the 10+ years I've been in venture specifically here in Germany and in general in Europe. These are the guys from whom I receive a majority of my dealflow. They are out there and if you talk to VC's, you should ask them who they know and like. I quite often steer really early stage guys to angels whom I respect. This is a win-win situation as they get a good deal and I know down the road, I may have a better chance of investing in that business. In general, business angels aren't necessarily the easiest people to find and approach. If you ever are planning on launching a business with angel money, start the process early of identifying them and finding out how they tick.

Your VC Must Really Suck

At least that is what you'd think was the case for most start-ups. The past couple of months I've been seeing quite an upswing in posts bashing VC's. Not only are the VC's themselves being abused, so is their performance. Fortunately, this reminds me of 2000. After the Internet bubble burst, VC's were the bad guys. They were the ones caught up in irrational exuberance. Their business model was broken and they were all finished.

Well, fast forward 9 years and let's take a look at what we have. The industry has significantly consolidated. Less new funds are being started and lots of the ones out there are running on fumes. Venture partnerships are structured over ten year periods hence the next couple of years are going to be brutal, especially for funds started in 2000 or later. Nevertheless, we are returning to normal.

The upswing in the number of funds was a one-time event back in the late 90's. There were so many funds out there in 2000 that it wasn't a sustainable level. Hence, the market is correcting and we are coming back to a normal number of funds in the market. You'll have far less funds in Europe when compared to the US but both geographies are seeing a significant decrease.

Back to my original thought. If your VC is still around, has 10+ years of track record and has raised multiple funds, they'll probably be around for a while longer. Yes, the industry is changing but players have established themselves in their respective markets. Those who survive do so because they deliver returns. Are there assholes out there who manage to somehow continue to survive? Yes, there sure are, as is the case in every industry. Is it to be believed that the majority of VC's out there though are crap and not worth taking money from? Well, that's up to you to decide if you're raising money. As I've written before, no one forces you to raise money from VC's. Should you believe all the bad press on venture capital? Well, take it with a grain of salt. Educate yourself and don't depend too much on the people whining online about how bad things have become. The best funds are still out there banging out good deals.

What Kind of Deals am I looking At

I've been asked the past couple of days where I see opportunity in terms of spaces to invest. Well, I wish I had an all-knowing crystal ball but I don't. So my best guess based on what I've seen the past 12 to 18 months and where I am focusing most of my attention is as follows:

I still believe the mobile sector in general is solid. We see that the growth of smartphones is continually speeding up and ever more people are accessing the internet via mobile. With flat data rates coming down in price and 3G networks expanding, you have a perfect opportunity for innovation. I am still bullish on this sector, although we've often seen ideas where we believe it may be too early. When it comes to innovation on the mobile, I am looking for things which solve large problem with simple solutions. Without giving up too much information, I have a couple deals in the pipe right now with cool ideas. In short, with the amount of time I see people around me daily playing around with their phones, I can't imagine some of the bigger exits not coming from this space.

I've said it before and I'll say it again. Customer service and customer retention are hot, whether someone is hyping it or not. I believe some of the best opportunities out there to innovate are around helping companies deal with their customers, deliver them the best possible service and make sure they don't leave. As examples, I love what Zappos does, I'm excited around the prospects for GetSatisfaction and I like the idea behind Spotfire software (owned by Tibco). Unfortunately, I am seeing too few exciting businesses in this space out of Europe at the moment.

Another space which I believe is improperly addressed to date is location based services. Once again, I may sound like a broken record on this one but I have faith. I want services delivered to me based on where I am. Unfortunately, I'm kind of tired of all these "see where your friends are" apps. They are interesting to an extent but there just isn't a business model. At the same time, I want a service that for example knows I'm at the train station or in the subway, which pushes information to me on routes and timetables based upon my previous travel activity. I'd love a service which tells me where people go to eat after having eaten at the restaurant I'm sitting at. Sense Networks are definitely on to something with their Citysense application. Track other peoples' activity, learn from it and fill me in. These are things I am willing to pay for.

There you have it. Hope this helps for those of you who asked. This is where I am focusing my search and am most excited about ideas coming out of these three areas. Nevertheless, I may be totally off on timing, hence I continue to track other areas opportunistically.

UPDATE. I did leave out one space which I was just asked about and that's cloud computing. Yes, in general I am looking at everything "cloud" but I find the segment too broad at the moment and can't say I've narrowed down where I'd place my bets. Further, I believe cloud encompasses so much of what's already out there. It reminds me a lot of cleantech a year or two ago. Everything and anything COULD be cleantech as long as it had a certain angle. I feel that is the case now for cloud computing. So, am I looking at it? Yes but with a very critical eye. Seems like a lot of repackaging is taking place at the moment.