Both Sides of the Table


Bad Notes on Venture Capital

Bad Notes on Venture Capital


Posted on Sep 17, 2014 | 0 comments

This week. On the phone …

Me: So, you raised venture capital?
Him: Yeah. We raised a seed round. About $1 million.
Me: At what price?
Him: It wasn’t priced. We raised a convertible note.
Me: With a cap?
Him: Yes, $8 million.
Me: Ah. I see. So you did raise with a price. It’s just a maximum price. You’ll find out the minimum when the next round is raised.
Him: Huh?

Last week. At an accelerator …

Me: Raising convertible notes as a seed round is one of the biggest disservices our industry has done to entrepreneurs since 2001-2003 when there were “full ratchets” and “multiple liquidation preferences” – the most hostile terms anybody found in term sheets 10 years ago. Convertible notes have both features in them but for some reason entrepreneurs don’t understand it. It’s like we need a finance 101 course for entrepreneurs
Him: But when I raised my first round we didn’t know how to price the company. There were no metrics. So a convertible note was easier.
Me: Ok. Well. How will you price the next round? Your A round?
Him: On metrics. We’ll have some proof points by then.
Me: Cool. What proof points? How will the lead determine a value? Revenue multiple? EBITDA multiple? Cashflow projections?
Him: Um. I’m not sure.
Me: There is no rational explanation for valuations of A round companies by ANY objective financial measure. It’s simply what a market is willing to pay based on a future belief that your company will grow and non-linear rates and be worth much more in the future. In finance they call it “terminal value” but the truth is the price is as arbitrary at your A round as it is at your seed round. If we priced it based on any metrics your company would likely be worth less than 7 figures at your A round. Objectively.

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Venture Capital is a tricky industry. If you’re funding the same stuff as everybody else and if you started your activities when the clues were obvious you’re much less likely to drive enormous returns.

When Fred Wilson funded Twitter I guarantee you it wasn’t obvious that it was a billion dollar+++ idea. Far from it. Many questioned whether it could survive under the fail whale, inevitable competition from Facebook, founder fighting, fights with 3rd-party developers let alone become a revolutionary business that could make money. Lots of it. He couldn’t have imagined power users would be global political figures, dictatorships, small factions of people standing up to the Iranian army or every sports figure & celebrity in the world.

It was an early and smart bet.

When the early teams: angels, lowercase capital & first round capital funded Uber they had no idea it would be one of the most revolutionary ideas of our time. I know – I was there when the first people debating funding it at less than a $5m valuation.

Airbnb? Ha. Almost nobody believed and now look at it.

Drones. Bitcoin. Online education. VR. Palantir.

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I wrote a version of this post four years ago but given the hectic nature of today’s tech markets I thought it was worth revisiting and updating.

Canceling meetings is a part of modern day life.  I seem to get so over programmed that if I ever want to have a “break-out” unplanned trip somewhere I seem to have to reschedule meetings. Not fun, but a reality.

People reschedule meetings with me on a regular basis, too.  If done correctly I never have any problem with it at all.

When you do need to reschedule a meeting make sure to put yourself in the other person’s shoes.  Give reflection to what inconvenience you may be causing.  Make sure you’re mentally aware of whether they might have made special plans around your meeting.  Basically, don’t be cavalier about rescheduling meetings.

Let me give you an example.  A couple of years ago an entrepreneur had requested a meeting with me to present his business.  A friend that I respect had introduced me and asked me to meet with the guy.  I always try my best to take meetings like this since my friend had clearly committed some political capital to his friend in saying he could help him get a meeting.

The meeting was set for Wednesday, May 8th at 11am.

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Everybody has a blog these days and there is much advice to be had. Many startups now go through accelerators and have mentors passing through each day with advice – usually it’s conflicting. WTF? There are bootcamps, startup classes, video interviews – the sources are now endless. What is a founder to do?

There are some smart if not somewhat cerebral bloggers I read who say that you shouldn’t take any startup advice at all because it’s too generalized to be useful to your situation. While I have some sympathy with their intent I must point out that their opinions on this are – ironically – startup advice. And not a point-of-view I particularly believe in.

So what IS one to do?

1. Triangulate
I like to use the shorthand “triangulate” to symbolize asking multiple people for their opinions to get a better perspective on the route you should take. Of course triangulation is a mathematics term that is used in sailing and other activities to help you better navigate when you don’t have your bearings. By having the measurement of some known points you can better navigate to unknown points through inference.

I triangulate in nearly every important decision I make.

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Just back from vacation and also some work travel and want to get back to blogging so expect a few posts over the next couple weeks.

During my absence I posted a couple new episodes of Bothsides TV recently. I’ll try to get write-ups shortly but for now here is an overview of my interview with Nanea Reeves – President and COO of textPlus. I could have listened to her for hours as many of her lessons were ones I hadn’t heard before such as how she used online gaming when she was younger as a way of both teaching herself tech as well as learning to lead remote teams.

Just so you know I work directly with Nanea and her arrival last year at TextPlus as President & COO has been transformational for the company. I’m sure I would speak for the entire board and management team in asserting this. I’ll try to do a future blog post on some of my insights in watching Nanea enter the role and how the founders enabled her success.

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