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.

Wednesday, March 5, 2014

Digital Currency and Bitcoinmania. Is ProfessorVC too Late to the Party?

Perhaps if my intention was to be a 49er and join in the Gold Rush and speculative frenzy...Unfortunately as much as I'd like to make a quick buck as the next guy or gal, I've never been very good at timing the market.

For example, I was on the waiting list for close to a year prior to the first Tesla Model S rolling off the robotic assembly line in Fremont.  When I finally bought the car in January, 2013, a single Bitcoin was worth $15. Had I skipped the car and bought Bitcoin instead, I'd have a nice $3.5M (assuming I didn't park it at Mt. Gox) and could buy 44 Teslas, enough for my entire extended family, a few students, and of course, some loyal readers of my blog.  Of course, I would've missed out on picking up the car after the Tesla factory tour (pic below).   I could've used the cash to buy Tesla stock at $33/share, which would now be worth over $600K.

Congratulations to those early miners and speculators who made a killing on Bitcoin.  For the rest of us, it is early days in the digital payments space and fortunes will be made by those starting, investing, and working at companies building payment infrastructure and applications.

We are excited to announce the launch of CrossCoin Ventures today, a Digital Currency Accelerator investing in entrepreneurs building on and advancing the Ripple ecosystem in collaboration with Ripple Labs.  Ripple Labs also announced it's developer portal and support of the CrossCoin accelerator

For those not familiar with Ripple, it is an open-source, distributed payment protocol. It enables nearly free and instant payments to merchants, consumers and developers with no chargebacks and in any currency -- including dollars, yen, euros, and even Bitcoin. Ripple's goal is to make payments just like communications -- global, distributed, instant and free.  Ripple Labs developed the protocol, promotes it's use, supports developers, and builds applications and SDKs to enhance it's utility worldwide.  If interested in learning more, here is a great primer to get started.

Why are we bullish on digital currency and Ripple specifically?  The banking industry is antiquated, inefficient and not built to support many areas of the information economy, including international commerce, financial services for the underbanked, and microtransactions.  Friction and fees are prevalent and we are beginning to see consumer adoption of alternative currencies with Bitcoin the obvious leader.  We love that Ripple works with Bitcoin, traditional currencies, and any other unit of value from frequent flyer miles to loyalty cards and in the future will support smart contracts for the exchange of specific assets. 

Some people make the analogy of digital currencies being at the same stage the Internet was at in 1994.  Huge new Internet businesses were created at that time and one of my partners in CrossCoin, Gary Kremen, invented online dating with the founding of Match.com.  Clearly, we are not alone in this belief as many astute investors including Marc Andreessen, Jeremy Liew, Chris Dixon and Fred Wilson are backing companies in this space. 

If you are an entrepreneur or developer interested in leveraging the ripple ecosystem and looking for capital along with help in launching and building your business, we'd love to hear from you.  Some of the areas we are interested in involve remittance, wallets, analytics, along with other enterprise and consumer applications.  We are open to all ideas. You can find more information and contact us at CrossCoin Ventures.

Friday, October 18, 2013

What's wrong with Academia...

...partly, it might be a guy named Ivgot Tenure (not his real name).  I recently got in a flame war with a colleague in the marketing department that started with one of those emails Deans like to send out recognizing a faculty member who was awarded with an Endowed Professorship.

Ivgot Tenure responded to the dean, entire faculty, and the recipient of the appointment with a screed on another perk for administrators and nothing for peasants (his words) like him.  I generally let these things go, but since this was far from the first one of his rants, I decided to call him on it (see embed on exchange below for the gory details if you wish...)





One important thing to note about the endowed position is that it was funded by a donor interested in the work being done by that professor or the position at the University.  The budget situation for the California high ed system is in bad shape and unlikely to get materially better in the forseeable future. The mission of the CSU is to provide high-quality, affordable higher education.  I won't debate the overall quality here, but the affordable piece is clearly challenged.  State support has gone from close to 100% 15-20 years ago to close to 50% at undergraduate level and much less at graduate level today. My grad school alma mater (Anderson School at UCLA) was getting so little state funding, it said "to hell with it" and declared self sufficiency.

My experiential classes (ELAB and VLAB) require external funding as hard to justify small class sizes.  Luckily, we have donors interested in supporting the work we are doing in entrepreneurship at SJSU.   

Back to my buddy Ivgot Tenure.  Unlike a commercial enterprise, he does not need to produce results.  His job is safe due to our tenure system.  I am a firm believer in the tenure system as it relates to academic freedom.  However, a non-productive byproduct is that it provides a shield that protects faculty members who are not good educators nor producing valuable research.  It is also interesting that Ivgot refers to himself as a peasant when it is actually the non-tenured junior faculty and adjuncts who could make that claim.

At the end of our tete-a-tete, I did what I should've done at the beginning.  I blacklisted Ivgot so I don't have to see any more of his whining.  I'll just focus on teaching and providing my students opportunties to work in the new venture ecosystem and build their own startups.  Hopefully, many will be successful and able to fill some of the growing funding gap in the future.

Thursday, July 25, 2013

Pari Passu or F.U...little guy

Mike Markkula presenting Steve Jobs with first investment in Apple

I recently watched an excellent documentary on PBS, Something Ventured: Risk, Reward, and the Original Venture Capitalists.  It is the story of the founding of the venture capital industry in Silicon Valley and features many of the iconic companies created including Apple, Intel, Genentech and Cisco.  VCs profiled include Arthur Rock, Tom Perkins, Don Valentine, Dick Kramlich, Reid Dennis, Bill Draper and Pitch Johnson (fathers of the industry).  Yup, no women, unfortunately, and industry is still male dominated over 40 years later.

The documentary is well worth watching.  It is both entertaining and a stark contrast to today's venture climate, that is dominated by sharp elbows and the focus on personal gain and self promotion (or the more acceptable term of creating a "personal brand").

Perhaps, I'm becoming an old curmudgeon, but I like the focus on working together to create something really big. This is the feeling you get from watching the venture capitalists talk about the entrepreneurs and other investors in the film.

Pari Passu is a term that was used quite frequently in the early days of the venture industry and even when I got my feet wet in the late '80s and early '90s.  It is a Latin phrase that means "on equal footing" and has been translated to mean "ranking equally", "hand in hand", and "fairly" according to Wikipedia.  In investment parlance, it strictly means that new classes of stock have equal rights with prior classes in terms of liquidation preference, voting rights, etc.

However, I view pari passu as a more intrinsic definition that goes beyond simple legal definitions. I'm a strong believer in fairness (although my daughters may not agree) and investors and entrepreneurs working together as a team to create something valuable to all stakeholders (customers, employees, founders, investors).  Startup outcomes tend to be very binary. The company either fails and provides little or no return to investors or is a success and returns a multiple to investors.  Yes, there are a number of cases in the middle where having a senior or participating preference does make a difference in liquidation proceeds, but I argue that it does very little to overall returns in a diversified portfolio.

I've witnessed a lot of bad behavior by investors recently, along with other examples of greed that stray far from pari passu.  I'm all for transparency, but won't be naming names in this post as I don't want to put some entrepreneurs in a difficult position.  However, I'm sure some of ProfessorVC's readers will recognize themselves or others in these examples.  It's also interesting how a lot of this resembles toddler behavior on the playground from "show me a little more love" to "mine mine mine" and of course, the classic playground bully.

One area I've noticed a lot more recently are angel investors and seed stage funds trying to grab a little bit extra, whether it's warrants for leading the round, advisor shares to go along with the investment, or a common stock stake for just being who they are.  Entrepreneurs are put in a difficult position as they are trying to get a round closed, benefit from having certain investors committed, but at the same time can't feel very comfortable having to tell prospective investors they aren't getting the same deal.  I always ask the question if other investors have different terms and almost always don't invest on principal in these cases.

Another closely related area is that of variable pricing on convertible debt or equity deals where different investors have different caps.  Generally (but not always) it is investors that came on board a little earlier.  As regular readers of this blog know, I'm not a fan of convertible deals to begin with, and it is difficult for me to internalize how value in the company has been created in the two weeks a cap goes from $3 million to $5 million.  I have turned down several of these types of transactions recently.

Seems like my rant is picking up steam now.  I was working closely with an entrepreneur and introduced another angel investor to the company.  We considered a joint investment in the company and the entrepreneur decided not to take funding at the time.  A year or so later, the entrepreneur did raise a round from a seed stage fund that wanted to have most of the round, but the guy I introduced was able to invest, while I got left on the outside.  Company has now raised over $70 million and is growing rapidly.  Yes, the entrepreneur could've worked to get me in the round, but not the easiest position when you are a young CEO raising your first round.  The other investor could've certainly lobbied to get me an allocation.

Another area where I'm not sure I stand is with some of the more formal referral and syndication programs that are emerging now.  Funders Club (which I've written about previously)  recently launched a referral program where angels can receive 10% of the carried interest in a deal they refer that ultimately gets investment from an FC fund.  Since this only impacts the investors participating in the deal through FC, I don't have a big problem with this, although not something I would participate in.  Not sure how much value in just a referral, but also going back to pari passu, I'm just as likely to refer the next opportunity and am happy investing at the same terms on one I refer as one that you refer.

AngelList (which I remain a big fan) also recently launched a syndicate program.  In this program, an angel can ask the entrepreneur for an allocation of the round and then syndicate through AngelList.  It is assumed that the angel has done diligence and will be working with the company going forward to earn a carried interest from others investing in the syndicate.  Effectively, the angel is acting as a VC and works in a similar manner to a pledge fund, where a firm's LPs commit on a deal by deal basis.  I could see potentially getting involved in this type of transaction, but am curious if the investor is committing to the full allocation whether she can syndicate or not.  If it is contingent, then this could provide some perverse incentives.

Finally, I have to bring up some bad behavior by a name Sand Hill Road firm (SH).  An entrepreneur received two Series A term sheets, one lead by an international investor and the other from SH.  The seed round had participation from two venture firms that were committed to doing their pro-rata and seed round was done with a very clean term sheet (1x preference, non participating, no anti-dilution).  SH wanted a senior preference over the seed investors (full disclosure: I'm one) and we tried to push back that precedent was being set for Series B and whoever comes after them, to demand the same, which will negate the value of their seniority at A.  Unfortunately, not everyone follows the KISS principle.  Their response was that we should be happy they didn't ask for a participating preference on top of the seniority.  Lucky us!!

We went ahead and accepted the term sheet, partially due to the fact that they knew the company well from 3 months of diligence, had expertise in the domain, and promised a quick close in 3 weeks from term sheet signing.  Well, those 3 weeks came and went, and they decided they weren't sure about the market and needed to get other partners in the firm on board.  That is VC speak, for get ready to bend over...After several meetings with different partners, principals, venture partners and associates, they scheduled a partner meeting for one month after the original close date to decide if they wanted to move ahead.  They did get the partners on board on the condition that the term sheet is renegotiated at a lower valuation.  Don't know why I'm thinking of Kevin Bacon from Animal House all of a sudden. "Thank you sir, may I have another!"



Just in case you are forgetting at this point, I'm not a pollyanna. It's also not a Rodney King "Can't we all just get along" thing.  I'm a capitalist, a CFO and investor.  I know it's all about capital and using wealth to create more wealth.  However, Wall Street was never an appealing destination for me (unlike the majority of my Wharton classmates) and as much as I snickered, I liked it when VCs started referring to their investments as projects rather than deals. The venture industry has clearly changed and grown since the early days profiled in Something Ventured, but it would be good not to forget all of the lessons shared in the documentary.