The robots are taking our jobs, folks.

 

 

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In a previous post, I talked about some of the reasons why it might make sense for an angel-backed startup to reject venture capital money, summarizing a great article by Darian Ibrahim.

Here, I want to summarize Prof. Ibrahim’s points about why it might actually be preferable for some angel-backed startups to reject venture capital funding.

Earlier exits

It’s long been thought that entrepreneurs wanted to continue running their startups so they enjoy the benefits of running their own ship.

However, many prominent angels, including Basil Peters, have stated that both entrepreneurs and angel investors would prefer to exit earlier because that results in a greater time-adjusted return on investment.

Also, as many are aware, many entrepreneurs suffer from founder’s syndrome. By selling their companies earlier, such entrepreneurs are able to go off and start their next big idea, instead of hanging around for years pushing a startup to some exit that would appeal to VCs.

Because VCs typically invest larger amounts than angels, they require much higher valuations on exits.  When you also consider that most performers in a VC firm’s portfolio are not that great, you begin to understand why VCs are so dependent on the homerun companies that return 1000x that keep the overall portfolio performance in the black.

Related costs & geographic flexibility

While angels typically invest in equity, VCs often take preferred stock. This adds not only complexity and costs to funding, but can even lead to different incentives for VCs and entrepreneurs/angels.

Finally, Prof. Ibrahim claims that angels have more flexibility in terms of where they live because they are not constrained to stay in Silicon Valley or Boston, as many VC firms are. In fact, some angels can even afford (because they are independently wealthy) to live in places with less dealflow.

Though these two reasons may be viable, in my opinion, I’m not entirely convinced. After all, how many angels actually choose to live someplace that doesn’t have great dealflow? In my opinion, the most compelling reason to reject VC funding is simple: you can get a greater return if you don’t dilute your ownership stake. Taking VC funding means you give up a large chunk of your company (usually anywhere between 30% and 40%) and a few board seats. If you early stage with little traction or cash flow, you might give up even more.

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customer developmentIf you’re an entrepreneur or aspiring entrepreneur, you know that customer development is crucial. You know even more that you have to validate your idea first before you start building. Who wants to build something that no one wants in the first place?
When it comes to customer development, a lot of entrepreneurs begin by asking friends in real life or on Facebook if they like their idea. They might even go further and create a survey and blast all of their friends to fill out the survey, which asks about pain points, the size of the pain points, what other solutions people have tried, and whether or not they like the proposed idea.
These are fine starts but I argue there is a first question entrepreneurs must ask. What is it?

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angel investing venture capitalThe traditional route to financing used to begin with bootstrapping. After bootstrapping got you so far (and assuming you were not able to fund future growth with revenue), you might turn to friends & family and/or angel investors. Then, the old story goes, you got venture capital (VC) money and you were on your way to IPO glory.

That story is not true for software startups today.

According to Darian Ibrahim, one of my favorite legal writers about startups asserts, there are at least three reasons, startups who are angel-backed might actually want to REJECT VC money.

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mark zuckerberg katie perryOne question that comes up a lot is what investors look for when investing in an entrepreneur or a founding team (and, mind you, for the most part investors are putting money into the team, not necessarily the product).

To help put a framework on this, below are some criteria that investors use when they evaluate YOU as a founder. So, without further ado, let’s get to them.

Intangibles

Investors, first and foremost, look at your intangibles. If you’re a football fan, you know that beyond raw athletic power and positional skill, many coaches and scouts look for the “intangibles.” A similar happens when investors are deciding whether or not you are someone they want to invest in. The criteria vary by investor, so it’s hard to pin down exactly what they’re looking for.  I think a fair representation of the intangibles includes (1) business savvy, (2) ability to keep your ego in check, and (3) your appearance.

By business savvy, investors want to see that you are deeply knowledgable about your target market, beyond mere internet research. Do you have a list of contacts in your industry who could be customers, evangelists, or ambassadors? Do you have deep and well-reasoned insights into the future of the market?  If you have previously spoken to an investor about your idea, have you made progress since then? Better yet, have you been able to generate revenue?

Business savvy also includes a certain amount of leadership skills. Investors want to see that you can partner and delegate effectively. After all, n people can get more done than 1 person. Also, are you able to lead and work well with others?*

The next general intangible that investors look for are your ability to keep your ego in check. Regardless of how brilliant you are, you don’t know everything. More likely, you probably do not experience managing and leading a team as your revenues grow exponentially. That’s when you’ll get a lot of “coaching” from your investors. You’ll get straight up criticism about your business, revenues, and management skills. Don’t take it personally.

Finally, this is admittedly somewhat wishy-washy, but investors want to believe that you can look professional. What does this mean? Well, it means different things to different people, but at the end of the day, you need to look appropriately professional for your business and you need to speak and communicate your concept in a way that inspires business confidence.  It’s unfortunate, but in some way you need to fit your potential investor’s stereotypical picture of a successful entrepreneur. That’s one reason, among many, why you need to strategically choose your investors.

 

* n > 1, obviously.

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If you outsource blog content development (or any content development for that point), you have a variety of options from Fiverr to oDesk to Craiglist and everything in between. Often, these arrangements are pretty simple and it’s very unlikely anything will ever happen that would cause you or the contractor to litigate.

If you run a business that has a good amount of revenue and you outsource content development, you might need to enter into longer-term arrangements with your blog contractors. In that case, here are some things you should consider in order to minizethe chances of litigation.

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Every venture financing has to involve lawyers. But not every lawyer is suited for your venture financing.  Here’s the deal with lawyers and what they can (and should) do for your for your venture financing.

Education and Negotiation – An experienced startup lawyer should have lots of VC financing experience. Your VC obviously should have lots of VC financing experience. You know who doesn’t have a lot of VC financing experience? You. That’s where a good startup lawyer can be helpful. If nothing else, she can educate you on the stuff that matters and does not matter. She’ll be able to negotiate  more effectively than a lawyer who has no deal experience. She’ll likely have a good reputation and your choosing her will reflect excellently on you.

Focus – When you get that term sheet or definitive financing agreement (subject of a future post), you’re going to have a million questions. You’re going to (and you should) ask above every word in that document. Some of it will seem like Greek. Honestly, most of it should. A good startup lawyer is going to guide you and get your attention on the stuff that matters.

 

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Capped Fees – A good and experienced startup lawyer is going to cap her fees. If a lawyer doesn’t agree to do this, then you have to question how experienced she is in the startup space. Pre-funding, a startup lawyer may even defer fees until you get funding or waive payment, preferring to get warrants or some other equity compensation.

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angel investorSo you know about the structure of venture capital firms. Truth is, though, your first funding source (besides friends & family or
bootstrapping) will probably be an Angel investor.

Angels usually invest in the very early stages of a startup (also called the seed stage). A little different from venture capitalists, Angels have a more diverse background. Some are professional investors, some successful entrepreneurs, others are well-to-do techies, and some are just rich people with money to burn (kidding, they would never burn that money by investing in you!). They fit the definition of an accredited individual.

Individual Angel investors usually make smaller investment amounts. It varies, but $25,000 isn’t unusual.

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First ever LA Demo Day

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I went to the first LA Demo Day today in Santa Monica, sponsored by just about every top VC firm in SoCal. First impression is that it was really cool. Free admission to give everyone a chance to come, especially those can’t afford inflated ticket costs. Here are some thoughts.

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The Hierarchy of a Venture Capital Firm

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Your friend might tell you he has a connection to a venture capitalist. Great, you think, now I have connection with someone who can get me money. Before you get too excited, understand the hierarchy of a venture capital firm and what that means for you. Not everyone at a venture capital firm has the [...]

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