Diary of a Geek VC

New Fund & New Name: Flybridge Capital Partners

Mon, 17 Mar 2008 00:18:01 -0400

I don’t usually post news about us here, but in this case I will make an exception. I am thrilled to post that today marks the closing of our third fund as a group of investors and the launch of our new name, Flybridge Capital Partners.

Last week we closed a new $280m fund, building on our previous two funds by adding a handful of new investors. We were very fortunate to have great support from our existing investors and as a result, this process went very smoothly and quickly. Our strategy remains unchanged - we are dedicated to being the best active early-stage technology investors we can be. We want to partner with entrepreneurs and help them build great companies.

Naming a company is a very hard thing to do, as most of you startup founders know. It’s very hard to find names that are memorable, meaningful and that possess a simple URL to boot. We think we have accomplished this trifecta with Flybridge. Those of you that are boaters may be familiar with the term - for those who aren’t, here’s a definition:

(n) the highest navigational bridge on a ship, where the captain might go to get a better or different perspective of what lies ahead ...

We think this has great relevance to what we hope to bring as advisors to our portfolio companies. Fortunately, flybridge.com was available and our new web site and email addresses now reflect our new name. Please check out Flybridge Capital Partners at flybridge.com.

A New Lesson for me About Fund Raising

To be completely honest, this was the first time that I have been part of a fund-raising process on the “asking” side. I have supported a number of portfolio companies over the years as they have raised additional rounds of capital, but this was literally my first time making the ask for myself. I have a new found appreciation for what all of you out there go through!

Recession, Taxi Cabs and the Startup Economy

Tue, 11 Mar 2008 03:25:53 -0400

Financial pundits and talking heads are scared to say the “R” word, in part because the psychology of worrying about a recession often drives the downward spiral into one.

I don’t trust financial pundits and talking heads. I trust taxi cab drivers. I am not a frequent cab-taker, but occasionally I’ll take one if I am heading to Logan for a trip or running late to a lunch meeting in Cambridge and can’t wait for the T. I guess I probably take a taxi twice a month, and while 24 samples is not statistically significant, it’s good enough for me to conclude we’re in a recession and have been for a while.

When cabbies tell me their business is down 75% from a year ago, that they’re losing their houses and hording cash to last through the tough times, I can’t help but think that startups ought to follow their example. More on this in a moment.

We have been trying to figure out the impact of the sub-prime mess (Click here for a primer on the crisis) and its affiliated fallout on our startups. The first order effects are obvious to the naked eye:

Expecting that all their customer’s budgets will be cut and under great scrutiny, companies in any sector who depend on selling to large US-based retail banks that had mortgage exposure ought to re-plan their 2008 forecasts and take those plans down.
Expecting that jitters throughout the economy will put greater pressure on earning, enterprise software companies selling into corporate America that are not in the top 3 priorities for CIOs, ought to plan for a very cold year.

The second-order effects on consumer mobile, consumer Internet, video for both and all the other over-heated VC-backed sectors are a little harder to crystal ball.

If Dierdre Six-Pack loses her job, which will she cancel first, her HBO subscription or her broadband?

I bet that this time, it may be a toss up. That being said, too many companies have been funded by guys who look like me banking on eyeballs and strong rates for click-through and CPMs. If ad placements fall or simply stall for Internet/mobile and CPC & CPM’s dive (too early), the results could be very harmful to these little companies who need to show strong progress toward profitability as the runway from their last VC round disappears.

Mind you, I am still very upbeat about the prospects in consumer-focused technology sectors, but think it’s prudent for startups to contemplate direct and indirect effects on their business right now. And take the advice of the cabbies and get some cash into your mattress:

Protect the cash you have on your balance sheet by examining your plan, taking out costs that are just too speculative
If you are in the midst of a VC fund-raising, if you are able, take a little more money than you were planning, even if it means a little more dilution
If you are able to raise money (equity, debt, NRE) do it.

I don’t think this will be a nuclear-winter of the year 2000 variety, but will be more specific to certain sectors. If I am wrong, you have only done the things you should have been doing in the first place.

Anatomy of a Series A Deal: Part III - Term Sheets #1

Wed, 20 Feb 2008 21:48:09 -0500

All right - I admit I have been procrastinating on this post; I wasn’t quite sure how to handle the topic of discussing term sheets. I decided to do the following - first dissect the National Venture Capital Association (NVCA) standard term sheet (available free for download here), and then section, provide some commentary on some term sheet gymnastics you might see out there.

NOTE: I am not a lawyer. What follows is not legal advice and you would be silly to take it for gospel. GET A GOOD LAWYER WHO HAS AMPLE EXPERIENCE HELPING ENTREPRENEURS EVALUATE AND NEGOTIATE A VENTURE CAPITAL TERM SHEET. DO NOT USE YOUR COUSIN ED WHO IS A REAL ESTATE LAWYER. YOU WOULDN’T HAVE A DENTIST PERFORM BRAIN SURGERY WOULD YOU?

Term Sheets Exposed

Probably easiest to follow along with a copy of the NVCA term sheet handy (unless you have already memorized it). The NVCA term sheet is 15 pages long (13 full of real content) and it will take me a while to get through it.

In this first post, I’ll handle the offering terms - really the high-level economic terms that define a VC deal. These are generally the first things on an entrepreneur’s mind, but I am sure you realize the fine print matters and in the case of the standard NVCA VC term sheet, the fine print is about 12.75 pages.

One suggestion as you talk with VCs would be to ask them up front to list exactly how their term sheet differs from the NVCA standard version. They’ll really love it. <grin>

Section 1: Preamble

The first part of any term sheet looks like any standard financial offering memorandum (e.g. mutual fund) with standard caveats and disclaimers. It basically sets the requirements for the company and investors, which is most cases mean the following:
the company has to keep the terms confidential and must not talk with any other investors or potential acquirers for the duration of a “no shop” period, which is typically 30 to 45 days, and
the term sheet is not a commitment of the investors to invest.

This is asymmetrical logic and from an entrepreneur’s standpoint, it can really suck. If you take a term sheet too early before a VC has done enough diligence, you have basically given them the ability to lock you up while they decide if they really want to invest.

There may be extenuating circumstances that convince you to take a premature term sheet, but my advice is to make damn sure you have had a very specific conversation with the VC about (a) what their diligence plan entails and (b) what other conditions to close exist, such as “finding a suitable co-investor.”

It’s important to get as transparent as possible as soon as possible with your potential partner. And if they’re not willing to reciprocate or are insincere in this transparency, run.

The more distinct and fewer in number the closing conditions, the better it is for you; the more nebulous and numerous, the worse it is for you.

Section 2: Offering Terms

These set the critical objective terms of a venture capital investment, including the following:

Closing Date: “As soon as practicable following the Company’s acceptance of this Term Sheet and satisfaction of the Conditions to Closing” - This really should indicate a target date for the consummation of the investment (getting the check) but you can see that the NVCA standard term sheet doesn’t leave a spot to peg a real date. Sounds great, but it all depends on the details as I mentioned above: insist on transparency.
Investors: Indicates identity and amount of investment the investors will commit. Will also specify if a syndicate is already formed or will need to be formed. If the latter, you may see the “suitable co-investor” language, which would be part of closing conditions. Have a discussion about who brings the co-investors to the party. If the VC giving the term sheet demands that you bring the other investor, and is unwilling to make introductions to his/her network, this is another sign that they may be on a fishing trip and you should lace your running shoes up quickly.
Price per Share: For a Series A, this is completely arbitrary and I usually just set it to $1 per share because it makes the math easy. For subsequent rounds, the price per share is critical, because it becomes the true mark of valuation of the company.
Pre-Money Valuation: This is the actual dollar value being placed on the company before the investment is added. It is really important that you understand the fully-diluted valuation of the company, meaning that the VC detail all the items that are included in that valuation - such as new options being created, warrants being granted, loans converted, etc. In order for you to be able to accurately evaluate a deal proposal, you need to be able to view it and any other alternatives in the same canonical form. Remember the mantra of transparency!
Capitalization: This is a simple version of a capitalization table for the company post the new investment and details exactly who will own what part of the company. There are three main constituents: Founders, Option Pool for Employees and those to be hired, and Investors. Things to note:
(Generally) Founders and Employees get common stock, while investors buy preferred stock. Preferred stock has more rights than common stock, at least, but not limited to, “first out” treatment in case the company is liquidated for an amount less than or equal to the total amount invested. More on Preferred stock rights below.
There needs to be balance among the three constituencies, meaning the following.
The investors want to own enough of the company to make it worth their time/effort - in a “true” Series A, investors usually buy between 50-60% of a company. There are definitely variations to this arrangement based on a number of factors such as state of the business (if it’s up and running, bootstrapped by its founders, highly competitive, etc - then the amount of ownership required by investors is likely to be lower). A typical series A split, assuming 3-4 founders*, is:
Founders: 20%
Employees and Unallocated Option Pool: 30%
Investor #1: 25%
Investor #2: 25%

The amount owned by founders, both the total amount and the actual split among founders, is often one of the biggest bones of contention during negotiations with investors. Many founders don’t realize that often times, VCs will take what ever allocation among founders existed and change it as part of their deal terms.
What formula do VCs use to figure out what to “offer” founders? And since the founders founded the company, who are the VCs to change the existing allocation anyway?
On behalf of all venture capitalists, I’ll try and take a crack at this calculus. We want to make sure founders (as well as all employees) have equity ownership that is at least at market rates if not better. We also want to make sure that the allocation among founders is fair and reflective not only of the contributions made to the point in time of funding, but more important, an indication of the value said founders are expected to give on a forward-looking basis.
If some founders are more senior, or have more relevant domain experience, or have more of a history of success than others, we’re going to suggest that the equity allocation reflects these differences. This is usually a hard conversation for the VC to initiate and for the founders to continue amongst themselves.
I have seen many occasions where founders (usually first time founders) have decided they are going to split the founders’ pool equally, disregarding the (somewhat harsh) revelation that all founders are not going to contribute equally to the success of the company. In the cases where I have gone along with this arrangement, it always ended badly, where at some point later, the founders who were contributing more ended up resenting the others with extreme prejudice - long-standing friendships were destroyed and someone(s) left the company. I don’t support the equal founder split anymore, though I guess if the founding team were truly equal in the critical dimensions , I would.
Summary

The sections I have covered in this post are just the preliminaries and what remains to be discussed really matters - in many cases, even more than the valuation and founder allocation. And to make the situation worse, it’s all written by lawyers in legaleeze.

While I don’t think VC-zero (get it, like patient zero) constructed the first term sheet with the intention of convolution and confusion, this is exactly what has resulted. So, I suggest you not only familiarize yourself with the NVCA standard term sheet, but as I indicated above

GET A GOOD LAWYER WHO HAS AMPLE EXPERIENCE HELPING ENTREPRENEURS EVALUATE AND NEGOTIATE A VENTURE CAPITAL TERM SHEET.

Happy hunting.

TechCrunch Boston / MeetUp 11 / Nov 16, 2007 - Update

Tue, 13 Nov 2007 10:59:10 -0500

Just a reminder that Friday night we are hosting TechCrunch’s first ever MeetUp in Boston. The response has been overwhelming and I know that tickets have been hard to find. Hope to see you there!

The event information is as follows:

Date: November 16, 2007
Time: 6 - 11 pm
Location: The Estate (Maps: Google / Microsoft / Yahoo)
Register here through EventBrite, based on availability.

Here’s the post in TechCrunch regarding the event.

Anatomy of a Series A Deal: Part II - Assessment

Mon, 12 Nov 2007 12:17:34 -0500

In part one of this monologue I discussed how VC’s source deals. The second step in the venture capital investment process comprises assessing (I chose this word instead of evaluating, because that frequently gets confused with valuing, which is completely different) a potential investment.

There are two stages to assessing an investment - (1) a preliminary assessment, to determine if some new project (VC speak for deal) is interesting enough to warrant digging in, and (2) a comprehensive assessment, also known as due diligence.

Preliminary Assessment

In general, active VC firms see several thousand business proposals each year and have to winnow this number down to a very small number (in our case 8-10) of new investments. Therefore, a preliminary assessment - a SAT test for startup ideas - is crucial. I mentioned in the previous post that I review each and every business proposal I receive. If I didn’t have a reasonably quick method for first level fit assessment, I might not have sufficient time to make a single investment.

What criteria do we use for this preliminary assessment? I first look for relevant experience and point of view for the problem/solution - “fit.” For example, an enterprise software veteran pitching an HDTV tuner semiconductor idea is likely a poor experience fit and unless there were extenuating circumstances, I would pass on the opportunity.

Other attractive aspects include novelty of the idea, early customer feedback and engagement, and of course advanced development work on the product or service. While none of these are pre-requisites for us to make an investment and conversely, having them (all or part) does not ensure we’ll engage, they do help.

Often, VCs make snap judgments about prospects and turn them down immediately - really a “blink” reaction. It may be because we didn’t really care for the entrepreneurs (based on negative visceral reaction, or credible reference checking), the space, the business model, the level of competition, or any/all of the above. While I would like to think that substance prevails over form, the reality is that a good first impression matters a lot.

What doesn’t help? Here are a few of my pet peeves:

A phalanx of advisory board members. Unless they are REALLY contributing to the company in a meaningful way, which usually only happens with bio/med tech companies, the long long list of advisors seems silly to me. I am sure he’s a great guy, but the identity of your accountant doesn’t make me what to invest in your company.
Powerpoint animations & reveals when presenting. These waste everyone’s time and slow down getting to the meaningful aspects of one’s business.
Chewing gum while pitching. Really. In this day and age I have observed on 3 occasions in the last 2 weeks, people pitching to me while chewing on some Wrigleys or Bubblicious. At least it’s better than Skoal I guess.

I view this preliminary assessment as culminating in a declaration of seriousness to entrepreneurs - or not. In the affirmative, we are saying that we are inclined positively to make an investment and need to dig in deeper.

How long does this take? Usually measured in days or a couple of weeks on the outside, but really depends on immediate reaction (+/-), competitiveness of the deal, geography, and workload. As a rule of thumb, if after a first meeting you haven’t heard from a VC for four weeks, forget about them ...

Due Diligence (Comprehensive Assessment)

IMO, a comprehensive due diligence program is a requirement for VCs making a new investment and I believe it should be a requirement of the entrepreneurs as well. There is no better predictor of how engaged a VC will be on your board of directors post an investment than how seriously they take learning about your business in the first place.

This doesn’t have to mean a slow and painful odyssey; but unfortunately it often is. We strive to be very straightforward in our approach, sharing the high level plan with entrepreneurs - to get their input and feedback and also to be as transparent as possible on the issues that we are considering. That way a team knows how to calibrate progress in a more quantifiable way. A typical diligence program usually comprises many of the following elements:

Team:resumes for founders, key execs and employees, references both supplied by company and “back channel,” spend as much time as possible getting to know the team and vice-versa.
Technology Assessment: architectural evaluation, review of development schedule and status, resource plan, intellectual property review
Market Opportunity Analysis: current state of landscape (if appropriate), customers, partners, suppliers, competitors, sizing of opportunity, go-to-market strategy, exogenous factors that may impact the business in the future, exit analysis
Operational Review: develop perspective on overall company financial plan, capital and resource needs

This type of diligence process involves face to face meetings, phone calls, email, etc.
Some usual questions we hear, include the following.

How long does it take?

It really depends - on the state of the startup, prior relationship with the founders/executives, state of the market, etc. In our experience, from time of “declaration of seriousness” to a commitment (term sheet negotiated and diligence done) typically spans about 4-6 weeks; sometimes shorter, sometime longer.

When does a term sheet appear?

Ideally, we like to submit a formal term sheet when we are done with all our diligence and ready to close a deal. We start discussing terms (including valuation, equity, option pool, key issues) as soon as we get into comprehensive diligence. Sometimes, however, term sheets are submitted prior to the completion of diligence, but this is not a preferred scheme - and shouldn’t be by entrepreneurs, as it ties them up while the VC firm finishes their work.

Next up - Part III, Negotiation of a deal / the term sheet