Tuesday, July 19, 2016

Portrait of an Artist

In my professor role, many of my students look up to me (rightly or wrongly) as a teacher, mentor, advisor, confidante, and friend.  I'm not always comfortable being put in that position, but have grown to enjoy that role as I've gotten older and (and perhaps although highly debatable) wiser.  Two weeks ago, I lost my Dad, who had played all of those roles (plus many more) for me.  I've spent the past two weeks thinking about my Dad, sharing stories, digging through his office, and reading notes from friends and colleagues letting us know how much he meant to each of them.

Philip Bennet was an incredible man.  My parents had been married for over 58 years at the time of his sudden passing on the 3rd of July.  He had two amazing careers, spending 40 years at the IRS, before becoming an accomplished artist in his last 20 years.

Me and Dad on a snowy winter day (late 1970's?)

When I was younger, I often wondered why my Dad stayed in a largely unappreciated role with the government, when he could have moved to a lucrative law firm or corporate tax position.  Having graduated from Wharton, I'm sure I was trained to think in terms of optimizing financial outcomes.  However, over the years, I realized he was doing work that challenged him, was living life on his own terms and was very comfortable with who he was.  This truly struck home when my brother connected with a close colleague of my dad's, who he had worked with at a couple of different times during his career" In his condolence note, he wrote:

"When I returned in the 1980's as Commissioner, I found to my delight that your father had not changed but only had become more experienced and wiser.  The Commissioner's office can be a lonely one.  But with the assistance of folks like your father, I had a wonderful time while I was there.  The IRS itself can often be a thankless place to work because if the IRS and its employees do their jobs well, about the most they can hope for is respect and once in a long while, trust.  Your father was someone whom I respected and trusted the most.

His innate goodness and desire to do the right thing and find good solutions to tough problems were his hallmarks.  He is the type of person I think of when I recall how good the folks of the IRS were and are.  He was the consummate professional, and I truly believe our country is better for his service."

Upon retiring from the IRS, he embarked on a second career as an artist.  He had dabbled in art in high school and as he neared retirement, he began sketching and creating watercolors on summer vacations to Maine.  However, rather than continuing as a hobby, he took classes at the local junior college and began experimenting with different mediums and styles.  He continued painting landscapes but his focus soon shifted to abstract art and printmaking. He had a number of exhibits including a 70-year retrospective in 2012 that covered his work from 1942 - 2012 (including a watercolor painted at age 12, a self portrait in oil painted at age 13, and over 25 other works in pastel, acrylics, watercolor, collage and monotype.)  Below is a sample work titled Organic, a watercolor monotype from 2008 that was part of a solo exhibit at the Old Print Gallery in Washington, DC in 2014 and an excerpt from a review of that show by the Washington Post.

Organic by Philip Bennet (2008)

"'Kaleidoscope,' Philip Bennet’s solo show at the Old Print Gallery, takes its name from one of the artist’s monotypes. Working most often with oil-based inks, Bennet makes one-of-a-kind prints whose vivid colors, layered patterns and sheer energy recall 1950s abstract expressionism. They don’t literally multiply and invert mirrored forms the way a kaleidoscope does. The local artist’s style is freer and more fluid, especially in the handful of prints and paintings that use water-based rather than oil pigments."
He clearly made full use of his analytical left brain and creative right brain. He was a rare man and will be missed by many more than his family.

Toasting his grandchildren (10/2014)

For anyone who has been to a Bennet family milestone event, you may recognize the bottle of Haag and Haag Scotch that my Dad used to toast my niece and nephew at their B'nai Mitzvah last October. My grandfather toasted my Dad with this same bottle at his Bar Mitzvah in 1943. Other occasions included my parent's wedding (1958), my brother's bar mitzvah (1973), my bar mitzvah (1976), my sister's bat mitzvah (1980), my brother's wedding (1990), my wedding (1990), and my sister's wedding (2000) along with other bar and bat mitzvah's of his grandchildren.  We celebrated Dad's life last Friday and decided it was time to finally polish off the bottle. My brother, sister and I together toasted our Dad one last time for being an incredible father and the amazing 86 year life he lived.

One final toast to Dad

Below are the remarks I made to honor Dad at the memorial.

Philip Eugene Bennet
1/6/30 – 7/3/16

How you be?

I don’t know how many times I received that greeting from my Dad but wish I could hear it once more.  That was his standard greeting.  Not the perfunctory and more formal “How are you” but “How you be”.  It was always delivered with a smile and often with a pat on the back and sometimes a hearty laugh.  I think it wasn’t so much a greeting, but a question that he really wanted to know.  He cared.  He was a listener.  He wanted to know what was going on in your life. He wanted to help make everyone else feel as good and happy as him.

How you be?

I’d tell him, “Dad, I’m good but I really miss you.  You wouldn’t believe who’s here! But I’m so glad I got to know you over the past 53 years.  I’m grateful for everything you gave me and that I was lucky enough to inherit a few things from you: your good looks (obviously), your dry sense of humor and your dexterity with the tennis racket”

How you be?

I’ve spent the past two weeks going through Dad’s office and reading condolence notes from friends and colleagues.  Some things that came through were his professionalism, kindness, intellect, inquisitiveness and of course, sense of humor.   People remembered Dad. He was a man who made an incredible impact on so many people - those who knew him for decades and those he only met once.

Going through the office has been a bit of an archaeological dig.  But he left some great clues – for my nieces and nephews, the game I played was luddite version of Pokemon Go.  The starting point was a binder he left labeled “For AB in event of PEB demise” One note in the binder indicated information on his Series I bonds could be found in the top file drawer in a manila folder ¾ of the way back that contained a sheet with dates in reverse chronological order.  In addition to the practical financial information, I found a few other gems.  My dad was a bit of a packrat (something else I managed to inherit). In with a pile of resumes and cover letters (last updated in 1962) was a reference letter dated August 7th 1956.  Lt Colonel Wilner N.J. Nelson wrote “Private First Class Bennet is extremely personable and possesses a lively sense of humor. “  I always wondered if our sense of humor would be appreciated in the military and seems like Dad was able to get away with it.

My dad was probably the last person not filing a 1040EZ to complete his tax return by hand.  If you happened to come by the house between the months of February and April, you’d be sure to see various tax forms spread out across the kitchen or dining room table.  He was not about to trust his taxes to a CPA or even worse, some computer program called TurboTax.  In flipping through the 2015 tax return I noted separate Schedule C’s (profit or loss from business for those of you not familiar with the IRS form numbering and lettering schema) for both Mom and Dad’s art businesses.  Dad had $975 in Gross Receipts in 2015, while Mom unfortunately didn’t sell anything last year.  However, on the schedule C for my Mom next to the $0 gross receipts line, Dad wrote by hand “No paintings sold in 2015 even through she had a well received solo show and exhibit”.  He wanted to make sure someone at the IRS knew that 2015 was an anomaly and to expect bigger numbers in 2016.  He was so proud of Mom!

Being here at Edgemoor brings back so many memories of my childhood.  I practically lived here in the summer as a kid and would often tag along with Dad after he returned from work on the off chance a doubles partner didn’t show.  Tennis was such a big part of Dad’s life and my childhood.  Which brings me to another artifact uncovered on my dig.

In his office proudly displayed was this trophy.  It was rather dusty and the racket broke off long ago.  You can’t read this but it is the 3rd place trophy from the 1973 Parent Child Edgemoor Club Championship.  I was 10 at the time and still remember how happy we both were at knocking off teams with kids 4, 5, and 6 years older.  I think he was prouder of that bronze medal than the 1st place trophies he won on his own.

Tennis was such a big part of dad’s life.  I just love that picture from the slideshow of Dad proudly holding his Wilson T2000 racket with those young guns.  The only people that could hit that damn thing were Jimmy Connors and Philip Bennet. I can picture him holding that racket and hitting one of those wicked backhand slices down the line as he races to the net for a put-away volley.

One of my favorite tennis quotes is:

The depressing thing about tennis is that no matter how good I get, I’ll never be as good as a wall.  

Taken literally, I don’t know anyone who has ever taken a set from the backboard.  Taken figuratively, it means a lot when I think about Dad’s life.  It is natural to compare yourself against your peers.  I don’t recall my dad ever getting down or showing signs of envy.  He was very happy in his own (very large) shoes.  In looking through his correspondence, he had myriad opportunities to take lucrative law firm or corporate tax roles after his initial commitment to the IRS.  Many of his colleagues definitely went that route but he knew he was happy and challenged where he was.

Another tennis metaphor I like is:

"Sometimes it pays to stay at the baseline. There is no place like home. "

For my Dad, Home was so many places. Home was 5912 Kirby Road in Bethesda, the only home my parents ever owned. Home was 65 E. 96th Street in Manhattan, where he grew up with my Nana Lil, Papa Charlie and Aunt Carol  and slept in the dining room of a very small apartment.. Home was Edgemoor. Home was the Old Print Gallery.  Home was Mt Dessert Island in Maine.  Home was wherever he was with his beloved wife and friends.

One final tennis story.  About a dozen years ago, we received an email from dad letting us know that his defibrillator kicked in during a tennis match.  Once he assured me his cardiologist said everything was good, I had one more question for him.  I wanted to know how the much was going at the time he had to quit:

“Steve.  Enjoyed your email.  Tim Coss and I won a very hard first set and were down 3-love in the 2nd when I held serve by angling off a drop shot very close to the net and hitting a passing shot between both opponents at the net on the final point of the game.  That felt really good until I was jolted by the defibrillator.  Love Dad”

I just picked up a racket a couple of months ago after giving up the game 25 years ago.. I remember telling him I had a surprise for him after they returned from their Sicily trip in May. I told him of my return to the courts and could hear how happy he was.  He also had to give some fatherly advice – “Make sure you stretch before you play”

I was really looking forward to playing some short court doubles with Dad when they visited later this month. Mom, I still have that court reserved. Will you join me?

“How you be?"

Monday, June 6, 2016

So You Wanna be a VC?

Opening Day Barron Park Elementary School (9/8/98)

"Make new friends,
but keep the old.
One is silver,
the other is gold.
A circle is round,
it has no end.
That's how long,
I will be your friend."
(girl scout song believed to be adapted from poem written by Joseph Parry (1841-1903) or perhaps Boardwalk Empire if you believe Reddit)

In the picture above, "Make New Friends" was sung by the entire Barron Park Elementary School on its first day as a neighborhood school in 1998.  A fitting song for a new school year and new school. (Side note 1: My daughter with back to camera and her friend to her right in pigtails both graduated from UC Santa Barbara together in 2015.  Side note 2: School started on September 8th.  Yes, after Labor Day!  When summer is supposed to end, not in mid-August like Palo Alto and most other school districts do now.)

I've always believed in the golden rule.  You know, the one you learned in nursery school about treating others how you would like to be treated.  However, in my 25 years in the Silicon Valley startup ecosystem, I've experienced the VC corollary to the golden rule much more often: "He has the gold makes the rules!"  I can just picture Mr. Rogers saying "Children, can you say participating preferred stock with an uncapped 3x liquidation preference and a full ratchet?" Well, maybe so after watching his middle finger salute.

When AngelList first launched syndicates a few years ago, I was very skeptical of the idea of angels taking carry on my investment.  I've always felt that as an angel we should be sharing our best opportunities with each other and follow the golden rule.  I work hard on mine and you work hard on yours and we all win (entrepreneurs, angels, and upstream VC's).  I went back to look at a few twitter exchanges I had at the time and clearly had some issues with the program.

So what changed and why I am now launching a syndicate?
  1. I got over it.  In looking at how syndicates have developed, there have been a lot of positives for both angels and entrepreneurs.  Some syndicate leads have gotten allocations in competitive deals where angels wouldn't have had the opportunity to invest previously.  Some are able to offer better terms (pro-rata rights, lower valuation caps) than an individual could get.
  2. It's great for entrepreneurs!  A syndicate is very effective and efficient way to raise capital.  In addition to the syndicate participants who can potentially add value, AngelList has its own institutional funds that often participate.  In addition, the entrepreneur has only one investment entity on its cap table rather than a long list of individual angels.  This offers many of the benefits of angel groups (larger investment, breadth of experience, single entity) without many of the negatives (long process, lack of transparency, etc.)
  3. I'm still not totally on board with the 15-20% carry most syndicates are charging (still stuck with that golden rule).  This is why I am taking 0% (yes you heard that right, 0%) on my syndicate.  There will still be a 5% carry charged that goes to AngelList, but I'm good with that. They have build a great platform and should be compensated for the marketing, administration, etc.
I'm sure your next question is how can I jump aboard?  Well, the train just pulled in to the station and isn't leaving just yet.  I expect to announce the first two opportunities this month.  You can learn more about the Steve Bennet (aka "ProfessorVC") syndicate here.

Tuesday, December 8, 2015

Does Elon Musk + Peter Thiel = 3 or 1.5

I've written previously (here and here) about the issues with private companies merging in an acquihire or other downside scenario (i.e. one company running out of cash and another with cash but searching for a business model).  Often times those involve trading within a venture capital portfolio or between two venture firms portfolios.

But what about the case where both companies are well capitalized and doing well?  I think we will see more of these in 2016 and beyond as IPOs are still far and few between and unicorns struggle to justify their stratospheric valuations.

One of the first I was exposed to was the merger between Peter Thiel's Confinity/PayPal and Elon Musk's X.com.  Both companies were relatively well capitalized, building peer to peer payments businesses and spending a significant amount of their funding on customer acquisition.  According to David Sacks (PayPal's COO at the time), both companies were involved in a scorched Earth battle to acquire customers (upping referral bonuses to $20) that neither were likely to survive if they continued down that road and the merger solved this problem (although created others).

Obviously, Musk and Thiel both did fine off the eventual Paypal IPO (and even better subsequently with Facebook and Tesla).  Musk was the early winner taking the CEO role (for a brief period) in the merged company and the largest equity stake as well.  Not surprisingly, the merger was highly dilutive, particularly to Confinity/PayPal shareholders.  I was a Limited Partner in Angel Investors II (Ron Conway's angel fund) that was an investor in Confinity.  At the IPO, Musk held a 14.2% stake vs Thiel's 5.6% (Sequoia Capital had 10.7%).

For the LP's in Angel Investors II, the investment ended up returning around 7x (but only 1% of the fund), which was a very good return but not as high as it could've been, and clearly not enough to make a dent in many of the other 150+ companies (most that went out of business) in a portfolio that included candybarrel.com, eRugGallery, and dunk.net.  Luckily, Google was one of the 150 and did ultimately return the fund assuming the LP was smart enough to hold the stock after distribution.

I originally got to thinking about this when I received a 485 page information statement on a previously announced merger between Clean Power Finance and Kilowatt Financial.  I was a seed investor in Clean Power Finance (CPF), which subsequently raised $90M+ in venture funding and  over $1 billion in project and debt financing.  CPF's major venture backer is Kleiner Perkins, who coincidentally, is also the majority equity holder in Kilowatt.  Like CPF, Kilowatt also provides solar financing services to consumers.  It is obviously too early to know whether this will be a successful merger, but I generally prefer to roll the dice with the original horse I bet on.  You also have to wonder about the numerous conflicts of interests involved in a deal where one investor owns a significant stake in both parties.

Another seed investment where something similar happened was the 2010 iControl Networks merger with uControl (yeah not a lot of creativity in naming...).  Kleiner was also the lead venture investor in iControl, which had raised close to $50M in financing at the time (I previously wrote a post about iControl's financing history).  Both companies offered home security and automation services through partners.  iControl had make significant inroads in the security industry (partnering with ADT to deliver ADT Pulse) while uControl had more success with cable and broadband providers.  As an investor, I wasn't very excited at the time due to the dilution and challenges in integrating the two platforms.  Looking back five years later, it appears that the merger was a very expensive partner acquisition strategy for iControl.  By the way, this month is the 10-year anniversary of iControl's Series A financing and I haven't been able to get liquid on a single share.  Hope that changes in 2016...

What does this mean for entrepreneurs and investors?  Here are a few thoughts:

  • Expect more consolidation - While acquisitions of early stage companies often provide benefits to fill in product line, acquire a team, or enter a new market, later stage acquisitions are often a sign that one or both companies got stuck in the red zone and the hope that the combined effort can get the ball across the goal line.  
  • Many acquisition are a Zero Sum Game (or worse) - This holds true for many public company acquisitions as well.  Press Releases always tout the synergistic benefits of the combination, but in reality, rarely are both entities better off.  Typically one comes out better and often both end up in a worse position.
  • Resetting of Liquidity Clock - Similar to raising a large late stage private round, this also increases the combined enterprise value and limits potential exits to either an IPO or very large acquisition.  It takes time for the business to catch up to these market expectations and valuation.  Most never make it there.  I do wonder if we will being to see the rarely used redemption clauses triggered where early investors may be happy to take their money back plus accrued preferential return to close out a fund.
Back to that PayPal merger.  What would've actually happened if Confinity and X.com had continued to battle it out.  One thing I know is that the combined business turned out a lot better than Peter Thiel's original business plan for infrared beaming of electronic payments over Palm Pilots that I unfortunately passed on investing in 1999.  For those interested in an entertaining look back at Silicon Valley history, you can find that business plan here.

Tuesday, July 7, 2015

Do Angel Groups Belong in Heaven or Hell?

"You analyze me, pretend to despise me, 
You laugh when I stumble and fall. 
There may come a day I will dance on your grave"
     — Hell in a Bucket, Grateful Dead

I attended one of the Grateful Dead "Fare Thee Well" shows in Santa Clara last weekend.  I have always admired the Dead's biz model (sorry Friendster/MySpace/Facebook, The Dead was the First Social Network) and music, although I never became a full fledged Deadhead.  In fact, before this show, the last time I saw them in concert was in 1978! The band closed out the first set with a rousing rendition of "Hell in a Bucket" with Phish guitarist Trey Anastasio energizing the crowd with his licks (pic below).

During the set break (perhaps influenced by the large amount of second half smoke consumed), I thought about angel groups in relation to the lyrics above, particularly the "you analyze me, pretend to despise me" line.

In theory, angel groups are great.  From an investors position, you have a number of individuals with a wealth of experience to source, vet, and co-invest in deals.  From an entrepreneurs standpoint, you can get a much larger investment than with individual angels, have potential follow-on support and leverage skills and network of a large investor base.

In practice, it can be much different.  For entrepreneurs, the process tends to be very long with many different players, information requests, and a lack of transparency with the process.  This is the exact opposite of the preferred angel funding round where investors can make a decision over a cup of coffee and a quick "no" is much preferred to a drawn out process.  I often jokingly compare the process of going through an angel group as falling somewhere between a colonoscopy and waterboarding.

A typical angel group process goes something like this:

  1. Entrepreneur submits application to angel group on gust, proseeder, or similar platform.  To do a thorough job, the application can take anywhere from 2-5 hours to complete.  While there is good reason for angel groups to have a platform to share information, discuss opportunities, and track investments, it doesn't do much for the entrepreneur who could simply provide a link to their AngelList profile.
  2. Initial Screen - groups typically have a process to filter applications and may go through an industry group, be done online, or via a conference call or meeting.  The goal is to decide which companies to invite to pitch a subgroup.  It typically can take up to 30 days to get to the initial screen.
  3. Screening Meeting - the entrepreneur is invited to pitch to a screening committee.  The company may have 10-20 minutes to pitch and answer questions, often from investors that haven't reviewed the application materials and/or know very little about the space the entrepreneur is operating.  The entrepreneur typically doesn't know who is going to be at the meeting or in many cases who is at the meeting.  This might take anywhere from 15 days - 45 days from the initial screen to get to the screening meeting.
  4. Dinner Meeting - the full membership (or as many as can make it) typically meet in the evening either bi-weekly, monthly or quarterly.  Here the entrepreneur hopefully has a deal lead and champion in the group who introduces and leads a discussion after 20-30 minutes of the pitch and Q&A.  Many deals get derailed here as members may bring up questions/concerns with the deal champion that aren't answered properly.  Often, these questions are about competitors or something someone read on techcrunch yesterday.  The dinner meeting may be another 15-45 days after the screening meeting.
  5. Due Diligence - after the dinner meeting, members indicate if they are potentially interested in investing in the deal and/or participating in due diligence.  The diligence period can take anywhere from 2 weeks to several months.  During this time, the entrepreneur may have no idea where she stands or how much investment interest is within the group.
Based on the above, the process can take anywhere from 45 days to 6 months and suck up a lot of time and resources of the entrepreneur while exposing confidential information among a broad group.  Contrast this process to sharing an AngelList profile or meeting individually with a handful of angels and you can see why many entrepreneurs cross this funding path off of their list.  

I joined Sand Hill Angels (SHA) in 2005 and at the time we had 10-15 members vs. close to 100 today.  Decisions could be made faster and investment amounts per deal (counterintuitively) were actually higher.  I took a leave of absence at the beginning of 2012 primarily due to the fact that I felt we weren't serving our primary customer group, the entrepreneurs.  I decided to rejoin at the beginning of this year as I missed hanging out with many of the members as well as the opportunity to be the lead investor in financings, which was something I couldn't do on my own.  I was hoping the process would have improved in the interim 3 years, but discovered it hadn't.

Granted, there were ways to get around the process and I managed to lead two financings this year that were completed in two weeks.  One was a follow-on investment and the other was an opportunity that was closing quickly and I shared with the members, set up a single meeting, and was able to get commitments and fund quickly.  However, these financings are the exception to the rule in SHA and I assume more so in other groups.

By the way, SHA is one of the better angel groups (#14 out of 370 angel groups and #2 in value of network by CB Insights).  Many are filled with service providers looking for consulting work and entrepreneurs only figure this out after they pitch.  Others have the audacity to charge entrepreneurs to pitch to the group!  At SHA, every member is an investor and those that don't invest, are asked to leave the group.  It is also forbidden to solicit work or do side deals with the startups.

So, how can this be fixed?  I've got a few ideas:
  • Kill the screening call and screening meeting.  These provide little value to members and entrepreneurs.
  • Increase the number of general meetings to accelerate investments in companies that are ready
  • Only bring companies to the general meeting that have at least a minimum amount of investment committed
  • Increase minimum investment amount per member/per deal.  At SHA (since investments are done through an entity) individual investments can be quite small.
  • Have groups of 2-6 members work together on sourcing and working on diligence.  These would be angel groups with the angel group and would ideally commit to particular deals and bring to the group
I've got plenty more, but this is a good start.  From my vantage point, most angel groups have a pipeline full of mediocre opportunities.  The best ones don't see any benefit in going to the group and the worst get screened out quickly.  There is currently a void in committed lead investors (Hello Party Round) for pre-seed and seed deals and a big opportunity for angel groups to fill this void if they can move quickly.

A parting thought.  It's hard enough to raise money for your startup without having people who don't understand your business pick it apart like a vulture on a carcass. I'd much rather roll the dice with the entrepreneur and laugh all the way to the bank than have a bunch of founders dancing on my grave.

Wednesday, June 3, 2015

Please Don't Celebrate Failure!

Silicon Valley and the venture capital industry were built on taking risks and making big bets on technology, teams, and markets.  It's great that failure does not need to be worn as a scarlet letter as it does in other cultures or Hollywood...(wonder if a pic of Emma Stone will get a few new visitors to the ProfessorVC blog).

I remember back in the day when VC's took risks and would invest in nascent technologies and markets.  Now firms are more interested in piling on a late stage financing for an Uber or Slack after product/market has been de-risked and the only question is whether the sky high valuation will ultimately supported by the financial markets.

For a number of years (or at least since twitter has been around), the Silicon Valley echo chamber has publicly celebrated modest exits or acqui-hires.  However, now, it seems that the pendulum has swung so far the other way that failure is being celebrated.  Every week there is another post about "how we failed".   Medium seems to be the platform of choice to promote your failures.

Here are a few:

I recently had a fireside chat with Dave McClure at SJSU where I questioned Dave about a blog post he wrote on failure, late bloomer, not a loser (I hope). You can skip ahead to the 37:35 mark where Dave lets out the secret that writing about being a loser will get you a huge audience for your blog.

SVCE Speaker Series: Dave McClure from SJSU CoB on Vimeo.

Perhaps, those entrepreneurs are just looking to make a few bucks with google AdSense and Commission Junction while figuring out next career move...

I agree it is good to share lessons learned with other entrepreneurs.  Also, if it is cathartic for you to do a post-mortem for the world to see, I'm not going to stand in your way.  However, where I draw the line is when failures are treated as less than a little speed bump on the road to success.  FAILING SUCKS!! YOU ARE IN THE GAME TO WIN!! EMPLOYEES LOST THEIR JOBS AND INVESTORS LOST MONEY!!

Ok, now it's time to reveal what got ProfessorVC's tighty whities in a bunch.  I received this email from a CEO/founder of a company where I was an investor on April 14th at 8:29 PM:
Thank you for your belief in me and the entire team. We had bold visions for how we were going to upend research and investment in the private market, and we wanted to make that vision a reality. Unfortunately, like many startups, we’ve run out of runway to execute. As of April 15, company will be effectively out of cash.
Yeah, you read that right!  Oops. we're running out of cash tomorrow!! Oh well, we failed...This was with no advanced warning and only bullish statements on company's progress.  It's one thing to be an optimistic entrepreneur but another to be delusional and reckless!  Apparently the entrepreneur (can't tell you who it is but his name rhymes with Saul Pingh) was too embarrassed or arrogant to respond to my requests for answers and more info.  Another investor had to threaten to have his lawyer make the next request before getting a call.  It turns out there was ultimately an acquihire and investors may potentially receive a very small fraction of our investment back.

As an investor, I expect to lose money on many of my investments.  That's part of being an angel investor and luckily the returns on the winners far exceeds the losses on the losers.  However, if entrepreneurs are going to build their companies on other people's money, they need to communicate and work like hell to win!  Sorry, contrary to popular belief among the millennials, there is no trophy for losing (actually, a quick google search shows there is one).

Please don't win one of these!

PostScript: The identity of Saul Pingh was discovered by a DC reporter Chris Bing following in the footsteps of those other DC investigative reporters Woodward and Bernstein...Chris attended the celebration of the acquisition (pic below)

On April 16, the acquisition deal for Disruption Corp. by 1776 was announced. Those pictured include 1776 co-founder Evan Burfield (far left); Virginia Gov. Terry McAuliffe (center, behind podium); 1776 co-founder Donna Harris (to right of McAuliffe); and Disruption Corp. founder Paul Singh (far right). DC Inno photo.

Thursday, March 12, 2015

It might not be a bubble but sure as hell the rent is too damn high!

The above was the opening salvo of a controversial tweetstorm yesterday by my former student and 500 Startups founding partner, Dave McClure (full venom below).

I've known Dave for 20 years and one of my favorite parts about him is that he will always tell you what he thinks and make sure you don't miss anything through creative use of profanity and CAPS.  This tweetstorm really hits home (particularly #4 about founders getting paydays while angel investors lose money), although Dave says it better:

What is also fucked is with small exits $1-$10M, founders may get $1M paydays but angel investors at $5-$10M caps will lose money  
I invested in my first AngelList syndicate about 9 months ago in the authentication startup, Authy.  I started using Authy for two-factor authentication to provide greater security in my digital currency trading.  It was a great product addressing a large market opportunity and was interested in seeing how the AngelList syndicate process worked.  Suffice it to say when I saw the announcement that Authy was being acquired by Twilio less than a year after making the investment, I was initially excited.  As with all M&A exits, there was a round of congratulatory messages to the founder in the Silicon Valley echo chamber.

However, when I read the announcement and saw that the acquisition price wasn't disclosed, alarm bells started going off in my head.  This is often a sign of an acquihire or very small exit.  Also, a private company buying another private company is not a scenario I typically like, although Twilio certainly has excellent prospects and may go public this year, providing liquidity in the medium term. I already own stock in Twilio indirectly through a limited partnership interest in a venture fund and don't need to bet more on Twilio.  I don't know the reasons for selling, but presumably Authy felt their prospects weren't promising as a standalone entity and may have had difficulty raising further financing.  Due to confidentiality provisions, I can't disclose details, but there are many very unhappy participants who invested through the syndicate.

As a refresher, syndicates were introduced by Angellist a couple of years ago as a way for companies to raise funds in small increments from a large number of investors (SEC limit of 99 accredited investors).  Subsequently, they also introduced a platform for individual angel investors and funds to syndicate a piece of their investment in exchange for a carry on the syndicated portion.  Syndicates can either be company led or investor led.  In the case of Authy, it was company led, so the only fees and carry were to AngelList.  Conceptually, the syndication process provides a way for companies to effectively conduct crowdfunding and angels to act as VCs.

While I find the theory of syndicates appealing, particularly for individuals that wouldn't have access to deal flow on their own, I'm generally not interested in paying additional fees and carry when I can invest directly on my own.  If I'm going to pay a fee and carry, would prefer to invest in a venture capital fund, as the investments are being managed by professionals and have a duty to look out for LP interests.

However, I did want to check out the process to see if I might want to create my own syndicate.  It was indeed very easy to review the investment opportunity and fund through a complete online process.  Rather than owning a direct stake in Authy, I became a member of a single purpose LLC created by AngelList to invest in the offering.  The entity invested in the same capped convertible note as other investors.  AngelList's policy is to have the entity vote along with the majority of investors in the company (not the syndicate) when a shareholder (or in this case, debt holder) vote is required.

Once the specifics of the transaction were posted to the members of the AngelList syndicate, there was a heated discussion regarding how the transaction was valued in relation to the valuation cap.  The board decided not to use an external valuation of Twilio's common stock that had been done the month prior to the acquisition, but instead come up with their own valuation methodology.  Of course, this was favorable to holders of common stock (the founder being the largest shareholder) and in addition, the founder received additional benefits in the transaction, presumably at the expense of the debt holders.

Interesting thing about all of this is that one of the primary reasons Naval Ravikant started AngelList was to improve transparency in the investment process (along with access to deal flow).  Transparency became a huge issue for Naval after he felt he was screwed by VC investors prior to his startup (DealTime) being acquired by Epinions. In fact, he took the extra step and filed litigation against two Sand Hill Road firms, something that is rarely done  When syndicates were announced in 2013, I had a twitter exchange with Naval regarding the transparency issue in regards to the syndicate lead's investment.

Given the above, it is interesting that AngelList has been trying to avoid full transparency on the transaction.  I have heard from many investors who think they got a raw deal.  A number of the posts relate to how the Authy board determined the fair market value of the deal consideration, particularly in light of the board being controlled by the founder.  One of the investors in the syndicate says some of his critical posts have been deleted and he has been bullied by someone on the AngelList team.  While it may not be practical from a process or legal standpoint to have the individuals in the syndicate vote on corporate matters, they should be treated with complete transparency on the transactions rather than trying to decipher the hocus pocus on a  deal.

My intention of the post isn't to bash AngelList.  I have been a big fan of AngelList from day one and am definitely entrepreneur friendly.  In fact, I have been on the platform since it's early days as a daily email sharing interesting angel opportunities.  It has definitely grown up and become a major force in the entrepreneurial ecosystem.  However, I will think long and hard before joining another syndicate.

At the end of the twitterstorm is a response from YCombinator's Sam Altman:

.@davemcclure just worry about trying to make 10,000x sometimes, and let founders who work really hard for years w/small exit keep the money
I understand where Sam Altman is coming from in his response and it's fine for him to look at the big picture and accept that for his own investments, but isn't right to expect other investors to be so magnanimous.  Also, in this particular case it is a big ingenuous.  Authy was a YC company, so Sam's firm held a 7% common stock equity stake and benefited from the other angels holding the short end of the stick.  But as Dave says,

the truth of this matter is angels & small investors get FUCKED all the time by high cap debt, & founders don't seem 2 give a shit
If you are interested in drilling deeper in to this tweetstorm or discussing any other entrepreneurial topics, I am hosting a fireside chat with Dave on April 1 (No Joke!) at the new SJSU Theatre on campus as part of our Silicon Valley Center for Entrepreneurship Eminent Speaker Series.  We are also looking to break the current campus record for most f-bombs in an hour.  The event is free and open to the public.  You can register here

Thursday, February 12, 2015

Is the Unicorn Endangered or Extinct?

Before diving in to the topic at hand, I realize Professor VC has been gone for a long time. Although I don't blog for the sake of blogging, I am committed to writing more regularly this year.  In fact, that was one of my New Year's Resolutions for 2015.  My other was going to the eye doctor and I have an appointment for this coming Monday. Nothing like checking off your resolutions in the 2nd month of the year!

My favorite podcast is This American Life, hosted by my business school classmate Karen's brother, Ira.  It is hit and miss from week to week, but stories are well researched, interesting, and often downright hilarious!  One of my favorites is a Little Bit of Knowledge (Episode 293) that has stories on people who believe certain things such as childhood myths well past the age when they should.

In the episode, Kristy Kruger talks about picturing unicorns roaming the planes in Africa as a kid and being at a party many years later when the topic of conversation turned to endangered species:

It was about a group of five to seven people, kind of standing around the keg, just talking. And somehow a discussion of endangered species came up, in which I posed the question, is the unicorn endangered or extinct? And basically, there was a big gap of silence.
I doubt Aileen Lee of Cowboy Ventures believed that a horse with a horn existed when she wrote Welcome To The Unicorn Club: Learning From Billion-Dollar Startups in late 2013, but she probably had no idea that it would become a hot buzzword in Silicon Valley and hit the cover of mainstream business press, Fortune Magazine.

The subtitle on the cover asks the question "At least 80 Tech Startups are Worth $1 Billion or More?  Is this Boom for Real?" Before answering this question, it is good to at least address the B word (no not Billion, but Bubble).  When I pulled the current issue of Fortune out of my mailbox, it reminded me of my reaction to another Fortune cover almost 10 years ago.

When I pulled out the May 30, 2005 issue with Real Estate Gold Rush on the cover and posting the question "Inside the hot-money work of housing speculators, condo-flippers, and get-rich-quick schemers. Is it too late to get in?"  My thought was not whether it was too late to get in, but how quickly one could get out! The article profiled one of the flippers:

"Zareh Tahmassebian is on the way to look at two of his houses in Phoenix. He is lost. Most people don't get lost driving to their own residence, but then, Tahmassebian has never actually been to these particular homes. There are a few reasons for that: (1) He has no intention of ever moving into them, (2) he lives in Las Vegas, not Phoenix, and (3) he owns six other houses--and a half share of seven more--in the greater Phoenix area. "Sometimes it's hard to keep track," he says.  Tahmassebian, just 22, is a big, affable guy who dresses the way a budding young speculator should: black trousers, a blue-and-white-striped shirt, cuff links, a Cartier watch, black suede loafers, and rimless purple sunglasses. The son of Armenian immigrants, he has spent the past four years in Las Vegas working as a mortgage banker, a job that he says paid him $250,000 in salary and commissions last year."
I'm not about to compare the current state of private company valuations to the real estate bubble or even the dot-com bubble.  The real estate bubble was practically a Ponzi scheme driven by greedy (is there another kind?) investment bankers, while the dot com bubble was driven by investment bankers willing and able to convince institutional and retail investors that companies didn't need to have a business model or even a way to exist without relying on additional investment.

No, the question today is not whether these unicorns are viable businesses.  For the most part, they have proven that.  The question is whether the valuations can be supported.  For example, Uber (not a startup but someone should let TechCrunch know) is private and has a valuation greater than 70% of the Fortune 500.

Back in the day, tech companies typically went public at market caps in $100 - $250M range.  Late private and early public investors were richly rewarded.  With companies remaining private much longer today, most of the value appreciation is pre-IPO.  I don't think the intent of the JOBS Act was to have companies remain private longer, but has had this result by increasing the investor limit prior to required reporting.

Former students who are readers of this blog may recall the Amazon IPO case from Entrepreneurial Finance class.  Amazon priced it's IPO in 1997 at approximately $500M (the $18 IPO price was an increase from the $12-$14 range) and first trade was at $29.25 or a market cap of $800M.  It's previous financing round was a little over a year prior to the IPO and was a $8M raise at a $60M pre-money valuation led by John Doerr of Kleiner Perkins.  Kleiner got a markup of approximately 12X at the IPO.  However, the bulk of the gains were earned post IPO as Amazon's current market cap is $175B or a 2,500X increase from the IPO.  If Uber were to go public at its current private valuation, it would have a market cap of $100 Trillion.  No company has ever crossed the $1 Trillion threshold.  That wouldn't be a unicorn.  That would be a unicorn mermaid and cyclops all rolled in one!

Again, we are talking about Amazon, a company that has completely disrupted the business of retail commerce among other things.  We should also remember that Amazon went public at a time (Q2 1997) when many companies were pulling IPO filings because the market was beating up Internet valuations.  In the year prior to Amazon's IPO, 23 Internet companies had gone public at valuations ranging from $63M to $485M, including Etrade ($380M), CNET ($211M), and First Virtual (79M).  At the time of the Amazon IPO, most of these were trading at prices 50%+ less than the IPO price.

Benchmark Capital VC (and former tech analyst) Bill Gurley wrote a post on bubbles a year ago and took a lot of flack for it, but I tend to listen to a guy like Bill who has been around for several cycles and even more so to Warren Buffet who has been around for many more than Bill or I have:

"Warren Buffet has a famous quote, 'Be fearful when others are greedy and greedy when others are fearful.' Using this traditionally contrarian investment mindset, one would certainly tread with trepidation in today’s market. Although we may have not reached the level of observing obvious greediness, there is most certainly an absence of fear. Those that managed companies in 2008 or thirteen years ago in 2001 know exactly how fear feels. And this is not it."
This also gets me thinking of the old poker adage:
 "if you are sitting around the poker table for 30 minutes and can't figure out who the sucker is, it's you." 
I'm a pretty good poker player but can figure out relatively quickly when I'm outmatched.  I don't want to be the last money in or the guy holding the bag.  Recently, I was given the opportunity to invest in unicorns including Dropbox, Lyft, Palantir, and Spotify.  I passed on all.  Not because they aren't excellent companies, but primarily based on valuations.  Is Dropbox at an $8B private valuation worth 4X more than Box as a public company?

For Lyft, it is much more painful.  I was an informal advisor to the founders from the time they were the only two employees.  In 2008, I made an investment offer of $250K for approximately 38% of the company ($400,000 pre-money valuation).  The current valuation of $2B is 3,000X the proposed post-money valuation of that seed term sheet. (igthwghjg2q2g8hu4). Sorry about that.  Just needed a good cry on the keyboard...Logan and John were wise to turn down the offer and continue to bootstrap Lyft (Zimride at the time).  However, I imagine we could've gotten the deal done at a valuation in the $1M range.

Yes, I do believe that late stage valuations are out of whack but remain excited about early stage opportunities.  Also, as the secondary market continues to mature, there will be many more opportunities to get liquid while companies are still private, reaping the rewards that early public investors would've had in days gone by.

Now back to our friend, Zareh, from the real estate flipper article.  I was curious to find out what happened to him.  I couldn't find a linkedin profile, but a quick google search did turn up a number of lawsuits and foreclosures.

If it sounds too good to be true, it probably is.  Just like Unicorns as imagined by a child.