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Surprising Insights From HubSpot's $35M Mezzanine Round

Posted by Dharmesh Shah on Mon, Nov 05, 2012


The following is a post from my friend and co-founder/CEO of HubSpot, Brian Halligan.
HubSpot just closed its mezzanine round, so I thought I’d share some surprising things I learned during the process. I’m by no means an expert in this field, so these are just the observations of one entrepreneur.

A Surprising Number Of Potential Investors With Widely Varying Value Propositions

My impression is that times have changed in the growth equity game. It used to be that early stage venture folks just did early stage investing, late stage venture folks just did late stage investing, and public equity investors only invested in publicly traded stocks.  What surprised me is that now, it seems like everybody invests in late stage private companies.describe the image

This is certainly not the “official” way to look at it, but here’s the way I ended up bucketing types of investors in my own head.

  1. Typical Early Stage VC Firms with Growth Equity Funds – These are folks like Sequoia, Accel, General Catalyst, Redpoint, DFJ, etc.,  that have typically started new funds with new teams focused only on investing in late stage companies.  They write checks from $15 million to $100 million as far as I can tell, and I think they’re pretty valuation sensitive as a group. They usually want to take a board seat and can add a lot of value in terms of knowledge, connections, and pedigree -- Sequoia led HubSpot’s last round and has been huge on those fronts. 
  2. Late Stage VC Funds – Think Meritech, Adams Street, August, Norwest, Tenaya, Questmark, SAP, and DAG. These folks only do late stage equity and write checks from $10 million to $40 million as far as I can tell. I think they are less valuation sensitive than the traditionally early stage folks. They are typically a bit more arms length in their level of involvement which often translates into a board observer seat -- they seem to follow-on the top tier early stage folks and rely on them for their advice and connections.
  3. Big Check Late Stage Funds – GA, TCV, NEA, etc. seem to only do late stage equity and write checks north of $40 million. I think they are relatively valuation sensitive, but keep in mind I only have a small sample size here. It seems they’ll want a board seat and to be very involved – and they can add a lot of value.
  4. Private Equity Funds – TA, Summit, etc.  are the types of firms I know the least about, but my sense is that these folks do late stage investing and write “biggish” checks. They seem to be wired to buy out existing investors, put in some working capital, and raise debt. This can be a great approach for a company, but it’s probably hard to work for a firm that already has a lot of venture money in it. My sense is that they want to be involved and are value-add.
  5. Public Funds – The last bucket is folks like Fidelity, T Rowe, Janus, Cross Creek/Wasatch, Altimeter, Tiger, and Morgan Stanley. They invest out of public equity funds, seem to write checks from $10 million on up, and tend to be slightly less valuation sensitive (we’ll talk about why below). They are financial investors and do not want to be overly involved, which means no board seats or observer seats for the most part.

That’s my sense of things based on insights from HubSpot’s mezzanine round of funding. If I’ve missed some funds, please do include them in the comments section so we can make this article as useful as possible. 

The Surprising Value Of Public Investors Investing In Your Private Company

We went with public funds -- #5 above -- not private funds for three main reasons that made a lot of sense for us, though they might not make sense for your company:

  1. Public investors tend to buy more of your shares after you go public, while private investors will typically look to sell their shares after you go public.  The venture funds incentive system is set up such that they are supposed to sell the shares and distribute the profits to their investors after a reasonable time elapses following the IPO. My sense is that the period of time between when you go public and when they sell varies widely, and the better the firm’s footing the more likely it is they will hold. Having said that, I think it’s pretty rare that the traditional venture folks actually buy more in the public markets.  It’s important to note that this does not matter if your most likely outcome is a trade sale.
  2. Public investors can “recycle” their capital while most venture funds can’t really do that easily. Huh? If Fidelity gets a 70% return on their investment in your company in a year and a half, they are pretty happy -- they can turn around and reinvest that money into other stocks. If Accel gets a 70% return on their investment in a year and a half, they are actually pretty unhappy -- they need to return that 70% to their investors and can’t really reinvest it. In order for venture funds to make their math work, they need to get a 3X return on their investment. So what? Well, this means that the late stage venture folks will likely give you lower valuations and more “structure” (i.e. participation) in their deals to try to reach higher return levels, while the public folks will likely be more flexible. 
  3. We are generally very happy with our board and were not looking for new members or even new observers. 

Now, that’s HubSpot. Every company is different. Let’s just say, as an example, that you are a travel technology company that’s doing well, but you need some help on the board, some VC pedigree and connections to improve your team, domain expertise, and maybe some money to buy out existing investors and their board seats. In that case, you’d be nuts not to go with, for example, General Catalyst or Sequoia. 

The Surprisingly Common Use of “Structure”

In our A through D rounds, the concept of “structure” did not come up. In fact, when one of the potential Series E investors asked me, “Are you open to ‘structure’?” it caught me off guard, because I didn’t know what it was and didn’t want to seem like a complete rookie. So I said, “Let me check with my board and get back with you.”  That turned out to be a good answer, by the way.

Structure is a fancy word for preferential terms set up to increase the return of the new investor, or limit the downside of the new investor. As I mentioned earlier, private investors typically need to get a 3X return on a late stage deal, and they’re nervous that they will invest money into a company and six months later it will sell for 75% more than they invested. For someone who can reinvest that capital, that’s a great outcome; for a VC, it’s not. In order to protect themselves from that risk, they will ask for participating preferred stock that, for instance, will put a floor on their return of 2X. Given the VC’s incentives, it makes perfect sense, but that is a different type of equity that sits on top of everyone else’s equity that needs to be looked at extremely carefully. It comes in a lot of flavors and can work well to bridge a valuation gap, but can be confusing, so I recommend folks dig in and build the model on how it ripples through.

Another type of structure that VCs put in is a block on an IPO or trade sale of less than 2X (or something like that). This block makes perfect sense for the VC given their contract structures with their LPs, and it might make sense for you -- but you need to go into that with eyes wide open.

The Surprising Importance of Your Series A Terms on Your Mezzanine Round

It turns out that the terms from your Series A are most often cut and pasted into your later round deals. When you compromise on terms in the early stages, you will have to pay the price in the later stages. You generally don’t start from scratch and rehash the terms.

Surprisingly Rational Pricing

The initial pricing interest in our early stage rounds varied widely; but in our mezzanine round, the numbers came in much closer to each other. There are hard public numbers to look at with publicly traded companies and recent acquisitions by public companies. The pricing discussions just seemed much more “real” than the earlier stage deals. 

My advice here would be to get your arms around the public companies for your industry, and where those companies were when they were your size. We built a chart that showed every public SaaS company and what their revenues and growth trajectories were from their early days to where they are today. It was a useful tool in our discussions, particularly when we were getting compared to public companies that were growing at 25% and we were growing at 85%.

Surprising Value of Currency Valuation in M&A

Private companies buying private companies with stock is a tricky business. After our Series D, we acquired another privately traded company called Performable with a combination of cash and stock. The trickiest part of deals like this is figuring out what their stock is worth, and what your stock is worth. The nice part about just having finished a relatively late stage, clean round is that at least our side had a real number to negotiate from. If neither side has a recent number, those negotiations are really tough to sort out.

Those are some of the surprising things we learned in our recent mezzanine round. Am I missing any insights that you have on this topic? Feel free to leave a comment and let me know.

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14 Ways To Be A Great Startup CEO

Posted by Jason Baptiste on Tue, Dec 28, 2010

great startup ceo mark zuckerberg resized 600Everyone thinks that being a startup CEO is a glamorous job or one that has to be a ton of fun. That's what I now refer to as the "glamour brain" speaking aka the startup life you hear about from the press. You know the press articles I'm talking about... the ones that talk about how easy it is to raise money, how many users the company is getting, and how great it is to be CEO. Very rarely do you hear about what a bitch it is to be CEO and how it's not for every founder that wants to be an entrepreneur. I've spent a lot of time recently thinking about what it takes to be a great Startup CEO that is also a founder. Here are some of the traits I've found.

Be A Keeper Of The Company Vision

The CEO is the keeper of the company's overall vision. I'm not talking about the vision for the next few months, but the larger road ahead. The CEO needs to be able to keep things on course for the current quarter to make sure that the large overarching vision of the company can be achieved. The takeover the world vision of a startup usually can't be achieved in one year or even in some cases, like Google, in a decade. It takes a great startup CEO to keep the company on track to achieve that vision. A great startup CEO will often judge upcoming initiatives to see if they fit in as a piece of the large puzzle for the bigger vision.

Absorb The Pain For The Team

A startup CEO needs to be the personal voodoo doll for a startup. They need to be able to take on a strong burden of stress, pain, and torture all while making level headed decisions. You can't have the troops stressing and worrying about the difficult challenges at hand. A good startup CEO will absorb the stress, so the rest of the team can carry on. He also needs to be able to mask this pain and stress. Not that he should hide or lie to the team- I'm not encouraging that. Most of the day to day nuances+stresses of a startup aren't worth having the entire team worry about and the CEO needs to bear that pain.

Find The Smartest People And Defer On Domain Expertise

A startup CEO has a great knack for finding talent. The key is finding people that are smarter than you on specific topics. It might be technical team members/leaders or it might be a new VP of Biz Dev. A startup CEO has to have the ability to find these people and make relatively fast decisions to hire them. They also have to be able to show the fire and passion to convince them to leave what is most likely a better paying and more secure job to join the company. The real key to hiring as a startup CEO comes after the hire. A great startup CEO will be able to trust the hires that they make and defer to them on areas of domain expertise. It's hard to let go, but you have to learn to, especially when the company grows.

Be A Good Link Between The Company + Investors

Whether you want to believe it or not, you are not an investor's only portfolio company. Even if you are a superstar, they have a handful of other companies to help and a ton of incoming potential portfolio companies. A good investor will pick 2-3 new companies per year to work with. A good startup CEO will be a good link between progress, issues, and areas where they need help with investors. A good portion of early stage startups that raise money will have a board comprised of 3 people: the CEO founder, the investor, and an independent board member. You are the lone representative for your cofounder and other employees.

Be A Good Link Between The Company + Product

I have this unwavering belief that the best companies are those that keep a founder as CEO for the long haul. Not because the founders have the right to be CEO, but because the CEO needs to be close to the product vision of the company. Founding CEOs understand this the best and can carry out that same unified vision over time. To fill in the management gaps a great COO, other board members, and heads of divisions will come along. It's a strategy that Facebook has employed and why Apple has had a great resurgence with Steve Jobs at the helm. It's all about keeping the CEO as close as possibly linked to the product.

Be Able To Learn On The Job

Most startup CEOs didn't start out with an MBA or some background in growing a company from nothing to something. The best have an ability to learn along the way and embrace their failures to become a better leader. Zuck started when he was 19 and now 7 years later, runs the most powerful internet company. Don't worry about whether "you're qualified" as it's hard to put typical qualifications on the job. You'll learn the really core stuff along the way. The best startup CEOs will surround themselves with smart mentors to be a sounding board along the way.

No Experience Almost Preferred

It's almost better to have a blank slate of zero experience as a startup CEO. If you come in with preconceived notions and block out the scrappy methods of a startup founder, it actually hurts you. Traditional education often trains you to be CEO or manager for a much larger company, not for a startup of under 50 people. It's a different kind of leadership and company.

Have An Uncanny Ability To Say No

You will be inundated with a list of requests from potential partners, investors, employees, and more. They will all sound absolutely wonderful. As you grow, you will also have the resources to execute more of them. Don't. It's easy to say yes, but so very hard to say no. By having an uncanny ability to say no, you can keep your company on track with the large vision you maintain. It will also keep your team members (notice I don't like to use the word "employees") laser focused and feel more rewarded as they are able to focus on one thing for a good chunk of time. I've seen too many startups sink because the CEO keeps changing what the head of product and engineering should be doing.

Have Some Technical Knowledge And Skillset

A good startup CEO shouldn't be afraid of a little bit of code and a text editor. They don't need to be diving into the source code on a daily basis, but they need to understand the technical requirements. It's easy to say "go build this", but it's a whole other ball game to understand how to build it. What seems simple may be a huge mountain of a technical feat that just isn't feasible with the given resources and deadlines. It can also help lend some street cred with hiring early technical team members too.

Be Able To Break Things Down Into Sizable Chunks + Milestones

Remember that huge unwavering vision that you are the keeper of? Odds are it only makes sense to you and your cofounder. You will need to break it up into sizable chunks and milestones for the rest of the team to understand it. You also need to be able to pick when and where to conquer things strategically. What is the past of least resistance so you can gain traction? What can you do first with your given resources?

Have The Ability To Call An Audible

Nothing goes according to plan. Things fall through, people quit, shit happens, servers crash, and other random things go bump in the night. You're going to have to deal with it and fast. This is a football term:

"Seen when the quarterback goes up to the line of scrimmage, sees a defensive alignment he wasn't expecting, and adjusts by yelling out a new play."

You're going to come up against things that you didn't expect and just be able to call an audible. Launch faster, spend more money here, or even abandon a project.

Can Motivate The Team Through Despair

People love to talk in this business. People love to talk even more when you're company isn't fairing well. A great CEO will be able to take those moments of public despair and keep the company focused. They will be able to debunk the rumors or even approach them head on by keeping the members of the company focused on the bigger mission at hand. It can come in simple 5 minute talks or motivational emails. The worst thing you can do is avoid the situation and be passive aggressive. I repeat: DO NOT WUSS OUT.

Be A Great Communicator

You need to be able to portray the energy and passion that you feel into others...over and over and over and over and over and over again on a daily basis. As a startup founder you need to communicate the vision and hope for the future of your startup to the rest of the world. You need to be able to break down the overall vision of the company into something that mere mortals can understand. You can't speak in crazy technical jargon or industry terms. It needs to be simple, clear, and compelling. You also need to be able to argue your point. Many will pick "fights" with you just to see how strong willed you are. Be respectful, but be very confident in your answer. Often wrong, but never in doubt my friend.

Don't Be A "Fake CEO"

Mark Pincus, CEO of Zynga, makes a strong case for not being a fake ceo. In short, worry about things that produce results, not fame. If it's between going to a conference/doing an interview or completing a deal, get the deal done. Don't "leave it to someone else". You need to get your hands dirty every single day.

By no means is this an exhaustive or definitive list. In some cases, the traits listed above might be counter-intuitive. What are some traits you've seen in great founding startup CEOs? Not the glamorous job you thought it was, eh?

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7 Uncommon Questions I'd Ask A Startup If I Were A Venture Capitalist

Posted by Dharmesh Shah on Mon, Mar 24, 2008


Venture capitalists have a hard job.  The good ones have to pick a small number of investments from a large pool of opportunities, often with minimal "data". 

If I were a VC, I'd  look at a lot of the things that VCs look at today and ask some of the same questions.  What's the market opportunity?  Who's on the team?  What do you think your sustainable competitive advantage is, or will be? 

In addition to some of these common questions, I'd also ask some uncommon ones.  I think it's these uncommon questions that often reveal the heart and soul of a startup.  If I were investing my own money (which I do on occasion), the answers to these uncommon questions would be as important to me as some of the common ones.

Uncommon Questions For A Startup

1.  What is the longest debate the team has had in the last 30 days?  How long did it last?  What did you decide?  How did you decide it?

Motivation: Any great startup team is going to have a set of issues/questions at any given time to which the answer is not obvious.  How a team goes about identifying the tradeoffs and getting to an answer (even if it's not the right one) is revealing.

2.  If your equity/salary was based completely on the accuracy of your projections, what would your forecast be?

Motivation:  Drawing the classic "hockey stick curve" (for users, traffic, revenue, profits, whatever) is just too easy and doesn't tell me anything.  I'd like to know what the startup really thinks it's going to do.  Yes, all forecasts are guesses, but some guesses are more practical than others. 

3.  What's the biggest surprise you've had in the business recently?

Motivation:  There should always be surprises.  Startups should be experimenting and trying new things constantly.  Especially in the early days when lessons are the cheapest.  No startup has it "all figured out" (and those that do, aren't experimenting enough).

4.  If you knew with 100% certainty that you weren't going to be able to raise (more) funding, what would you do?

Motivation:  Sure, it's good for startup teams to think about how to break beyond current limits to build phenomenal companies.  But, great entrepreneurs also work well within constraints that are unavoidable.  The mother of all constraints is a fundamental scarcity of resources -- like cash. 

5.  If you could pick only one non-financial metric to measure the success of the business, what would it be?

Motivation:  Revenues and profits are a great, fundamental way to measure a business.  But, looking at non-financial metrics can often be very revealing.  Shows what people care about.

6.  If you could fix magically fix one, specific problem with the business today what would it be?  What would the likely impact be?

Motivation:  All startups have problems.  It's interesting to know what problems a startup has and how fixing it might create another, non-linear improvement in the business. 

7.  What will you do to find and retain the best people possible for the company?  What do you

Motivation:  More than anything else, the quality of the early team will likely influence the outcome.  I'd like to know what uncommon things are going to be done to draw in the uncommon talent.

If you were a venture capitalist and investing in startups, what uncommon questions would you ask?  If you've raised capital before, what's the best question you've been asked by a VC? 


By the way, are you a startup fanatic?  If so, request access to the free OnStartups LinkedIn Group .  There are already over 5,500 members in the group. 

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Looking For Tech Legends: Is Boston Not Thinking Big Enough?

Posted by Dharmesh Shah on Thu, Nov 29, 2007


Last night, I attended an invitation-only event called "Thinking Big". It was organized by Scott Kirsner who is a Boston Globe journallist and also authors a blog called "Innovation Economy".

Update:  Podcast Is Available Here 

As an introvert, I usually don't like going to these social events (even if they're business/entrepreneurship focused). This one promised to be different because it was much smaller attendance (not the hundreds of people that were at the TechCrunch event held recently) and had at least some structure to the conversation. Besides, I like Scott and think he's doing a really good job drawing out an interesting mix of people at various types of smallish events. This is the second of his events of his that I've gone to (and I really enjoyed the first one, which was a small intimate dinner with a bunch of cool tech/entrepreneurship people).

Here's an overview of the "Thinking Big" session, as described by the organizers:

Are New England's most promising companies getting sold before they have a chance to get really big and really influential? If we're selling our seed corn, as Highland Capital co-founder Paul Maeder suggested recently, how can we cultivate a new generation of companies like DEC, Lotus, EMC, Akamai, Google, and eBay...companies that create entirely new business sectors, grow like crazy, and serve as the hub of new ecosystems?

Scott moderated a mini-panel with Paul Maeder (from Highland Capital Partners) and Michael Greeley (from IDG Ventures). I know and have met both of these gentlemen before -- they're smart and articulate. There's going to be a podcast of the event posted (recorded by none other than the software legend Dan Bricklin who I met for the second time). Dan's cool and very unassuming.

I'm not going to get into the heart of the discussion in this article (too much was said, and the podcast is likely to do a better job). But, will provide some of my thoughts and reactions:

1. Though I think Paul Maeder and Michael Greeley are both very smart and very articulate, they're both currently VCs. It would have been nice to have a current entrepreneur on the panel. But, there was sufficient interaction amongst the rest of the group, so this wasn't a problem.

2. The thesis for the discussion was that we are selling companies too early and that particularly the VCs should take a longer-term view and encourage entrepreneurs to hold on to promising opportunities longer so as to create big, significant businesses here in Massachussetts. I somewhat disagree. Though it would be great to have successful companies here in the area that *don't* sell out too early (particularly to West coast firms), that may not be the best thing for the entrepreneur. If you are a first-time entrepreneur (as I once was) and you have all your net worth tied up into a single company (which you likely do) than even a $100MM or even a $50MM exit is going to be attractive. It's easier for VCs to push for the "big, swing for the fences" type outcomes -- but they have a different risk profile. They have a portfolio of companies to spread their risk. They do this for a living. They've already (in most cases) made their money. Many times, entrepreneurs have not. More to come on this topic later: The point is, in order to encourage entrepreneurs to grow their ideas into billion dollar companies, some changes to the VC/entrepreneurial relationship would help.

3. It's possible that too many promising young companies are being sold too early. The data that the panel shared certainly seemed to indicate that. However, I don't think we're talking enough yet about the potential loss of stellar early-stage entrepreneurs that *leave* the area and migrate to the West coast. before even starting their companies. I've seen this personally happen on a few occasions. This data is much harder to track. We can look at the big, billion dollar West Coast companies and trace them back to see where they came from. But it's hard to track the companies that *should* have been founded/seeded here, but weren't.

4. Frank Moss, the head of the MIT Media Lab challenged the group to better help commercialize the technology and invention that is coming out of MIT. I could not agree with Frank more. MIT produces an amazing amount of intellectual property, much of which never gets used in a meaningful way. Frank asked that investors stop trying to "graze" MIT for the best IP, and instead participate in the risk of R&D to get the best returns. He called for every investor to take 0.1% annually of their fund and invest it in MIT for research and development. Interesting idea. I'd need to know more about the structure that was being considered.

That's about all we have room for. A lot more can be written about the topic. I'll update this article once the podcast goes up somewhere for those that want to hear the discussions. My thanks to Scott and for all the event sponsors. I was humbled by the level of talent in the room. Some really big names in entrepreneurship and technology from the Boston area spending some quality time.

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VentureHacks: Peeking Inside The Blackbox Of Venture Capital

Posted by Dharmesh Shah on Mon, May 07, 2007

For those of you that are regular readers, you know that as a policy, I don't often do site reviews of other startup-related websites -- let alone pour gushing praise on a single one.  But, every know and then, I feel compelled to make an exception.
If you're a startup entrepreneur, head on over to Venture Hacks, read their content and subscribe to their RSS feed.  You'll be glad you did.
Disclaimer:  I don't know Nivi and Naval (the guys behind the site) and I have no personal bias or conflict.  I simply love the content on the site.
The reason I like the site so much is that it provides a rare glimpse into the black box of venture capital (and venture capitalists).  For the most part, the industry is pretty closed and very few (except insiders) really get a glimpse into the details of the process.  The reason is simple:  For those that know enough to write about it, there' s rarely an incentive to do so.  For those that don't know the innards of the business, you're not going to learn much that you couldn't pick up on your own through other sources.  VentureHacks is the rare case where the authors know what they're talking about and are brave enough to actually do it.  As an added bonus, they're witty and edgy too.
5 Reasons to Read VentureHacks
1.  VC Negotiation Is An Art Form:  As an entrepreneur, there are few things more "nuanced" that you'll deal with than raising institutional capital.  Even if you decide not to raise venture capital, a lot of these skills and deal-terms will likely show up in other dealings you have (strategic partners, M&A transactions, etc.). 
2.  The Devil's In The Details:  Most entrepreneurs focus too much energy on the "obvious" things like valuation.  Fact is, there are other, non-valuation terms in the VC deal (vesting, stock option pool, liquidity preferences, etc.) that have a significant impact on the economics of your deal.  It's easy to lure yourself into thinking you should solve for the highest valuation.  But, in most cases, that's sub-optimal.
3.  Great Advice Is Hard To Find:  As it turns out, good advice in the VC business is hard to find.  I would define good advice as a combination of competency (i.e. well informed) and objective (i.e. non-conflicted).  You can get close sometimes (via lawyers, adivsors, etc.) but it's really hard to find great advice.
4.  It's Not Enough To Be Smart: It's importat to remember that regardless of how smart you are, VC negotiation is not just a matter of raw intelligence.  Sure, it helps t have a few brain cells to understand the dynamics of a deal, but a lot is hidden away in the dark corners that you only ever learn by doing it.  It's also important to remember that the VCs do this for a living.  Hopefully, you don't (you're building businessees for a living).  You may be twice as smart as they are, but you're still at a disadvantage.  Try to even the playing field as much as you can.
5.  It's Intellectually Fascinating:  Even if you're not planning on raising funding yourself, I think you might find the whole VC game intellectually interesting.  Further, by getting yourself educated, you can perhaps help someone else that's a total newbie navigate the waters (See #3).
In short, go read VentureHacks.  It's worth the trip.  Nivi/Naval:  If one of you stumbles into this blog article somehow, drop me a line.  As a small token of appreciation, dinner's on me.

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Startup Financing: Questions and Answers From A Recent MIT Panel

Posted by Dharmesh Shah on Fri, Apr 13, 2007


This past week, I was on a panel discussion at MIT on the topic of raising funding for an early stage startup.
Also on the panel was Michael Greeley from IDG Ventures.  Michael was representing the VC perspective whereas I was there speaking primarily from an angel perspective (and alternative sources of capital like friends, family and fools).
Here are some of the questions that came up in the panel.  Since I didn't take notes during the panel myself, this is my best recollection from the two hour session.  Please note that this is not legal advice and if you are raising funding, you should consult counsel on all legal matters.
1.  If I raise capital from friends and family, do they have to be accredited investors?
Generally, yes.  Though there are ways for pool together interests from non-accredited investors, it's usually not advisable as it can get tricky and complicated.
2.  To raise VC funding, do I need to have a complete management team assembled?
Not necessarily.  Many VCs do not mind considering startups that have an incomplete management team.  Some will actually see gaps in the management team as a positive as that is an area that they can help with and bring value to the startup.
3.  How do I negotiate the highest pre-money value for my startup?
Entrepreneurs are often overly obsesssed with the pre-money valuation of their startups.  Though this is an important factor in the negotiations, it is by no means the only one.  Often, non-valuation factors like corporate governance, control and preference issues end up being much more important than the valuation.  Entrepreneurs should look at the deal as a whole and understand the details.
4.  Do investors read business plans?
For the most part, no.  A great business plan will not guarantee funding (or for that matter, even a meeting).  If you find the crafting of the business plan helpful, then you should do it.  But, investors do not generally require a detailed, written business plan. 
5.  Do I need to have formed a legal entity before approaching investors?
It's not required for investors prior to approaching them for funding, but is often a good idea because it is relatively simple and inexpensive to do. 
6.  How do VCs value companies?
This is an imperfect science.  A common approach is that VCs will determine what the company could be worth at the time of an exit (IPO or acquisition).  They then work backwards from there, determining what percentage of equity they need to own to generate the desired returns for their limited partners.  Of course, they apply this approach across a portfolio of investments expecting that a small percentage will generate significant returns.
7.  How do I find angel investors for my startup?
There's no single answer to this.  In major markets like Boston and San Francisco, many angel investors are members of angel groups.  These groups pool together expertise and resources in order to make better investment decisions.  Of course, there are also private investors acting independently.  Generally, you'll want to find investors that have a background in the particular idea you are pursuing -- or, an affinity for it.  Angel investors often invest for reasons beyond just pure financial return.  One common reason is to stay involved in the entrepreneurial process and help entrepreneurs build great companies. 
8.  How do I pick the "right" VC?
There are a number of considerations.  First, you should verify that the VC makes investment in the stage and type of company you are building.  Also, it is important to remember that you are not just picking a firm, you are picking a partner within that firm.  Ideally, you'll find a partner that has made similar investments in the past and has knowledge of your market. 
If you have any other questions, leave a comment and I'll do my best to answer.  Please remember that I'm not a VC, and don't play one on TV.  For content that is much better than this, I strongly recommend Ask The VC by Brad Feld.  It's a great source for information on the VC industry and the process of raising money.

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VC Valuations Are On The Rise: Is Your Startup Worth More?

Posted by Dharmesh Shah on Wed, Feb 21, 2007

News was released today by VentureOne (owned by Dow Jones), which tracks venture investment data.  Venture-backed companies are now getting pre-money valuations (pre-money means the value of the company before the capital is invested) that are the highest they’ve been since the peak of the last bubble in 2000.


Median pre-money valuation of U.S. VC-backed companies reached $18.5 million in 2006 (vs. $15 million in 2005).  At it’s peak in 2000, the median valuation was $25.1 million.  Sounds like valuations are inching back again.  I’m not sure if this is good news or bad news.


Of course, for early-stage startups the information that is much more relevant is what the valuations were for first-round companies.  In this case, the pre-money valuation was $6.2 million vs. the $5.9 million in 2005.


“That’s all fine and dandy,” you’re thinking, “but what does that mean for me?”.  Well, that depends.


For most entrepreneurs, you’re probably not raising venture money – and for those that are, you’re probably not going to succeed in raising it.  Nothing against you or your company (I don’t know you, and don’t know your company), but the numbers are working against you.


So, the question is, if you are not raising money does it help you or hurt you that VC valuations are up?  I find this to be an interesting question.  First, I am going to guess (because it happens to be true in my case), that when VC valuations are up, the price other types of investors are willing to pay (such as angel investors) are up too.  For many of us, that’s good news.  Also, VC valuations can be seen as a proxy for the overall boisterousness (uncanny, I thought I had just made that word up, but it passed the spell-checker) of the market.  


Overall, for no particularly rational reason, I generally feel that the rise of VC valuations (even though I’m not raising VC money) is a good thing for startups.  There’s a small part of me that thinks that since general “market prices” are rising for startups, my startup is worth more too.  But, I could be totally delusional and uninformed.


What do you think?

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Startups: Competing With Venture Funded Rivals

Posted by Dharmesh Shah on Tue, Oct 10, 2006

All of my prior startup experience has been with bootstrapped startups (i.e. no VC funding).  As such, I’ve had to deal the situation where I found myself competing with rivals that were much better funded.  For purposes of this article, I’m going to assume that the competition is another startup (and not a large company with much better funding).  The dynamics of competing with a large company are different and I’ll save that topic for another day.  

There is no pat answer to responding to this situation (if there were a standard answer for anything, it probably wouldn’t be interesting enough to write about anyways).  But, I do have some thoughts on the topic based on some of my own experience – both within my own startups and those that I’ve been involved in.

For example, my first startup, Pyramid Digital Solutions was in a small enough niche that it had little competition in its early years.  But, later, in 1996 we broadened our product offering and pursued a larger market (creating specialized web applications for our vertical within the financial services industry).  Eventually, we found ourselves competing with three other startups that each raised over $25 million in VC funding.  Even for that time, $25 million was a fair amount of money.  One of these startups was a direct competitor and the other two were indirect competitors.  As you might imagine, this had us a bit worried.  We were selling to large financial institutions and were constantly dealing with the issue of a weak balance sheet.  When we were enjoying a competition-free existence, this wasn’t a big problem (the number of alternatives was minimal, and we were clearly the best choice).  With VC-funded competitors, this changed.  Customers are rightfully comforted when dealing with startups that have venture investors.  It removes a lot of the risk from the equation that the startup will die in the near-term.  A lot of the sales we lost were not because we had an inferior product (we didn’t), but because we were a risky bet.

I’ll tell you how all this turned out for me at the end of this article.

Competing With Venture Funded Rivals
  1. Resist getting distracted:  When you first learn that one of your competitors has raised VC funding, it’ll be hard to ignore.  And, you shouldn’t ignore it.  But, you shouldn’t let it distract you too the point of inaction.  It’s important remember that just because they have fresh cash in the bank doesn’t mean that they’re going to be able to do something with it immediately.  But, you shouldn’t dismiss this event.  When a rival raises money, it’s a big deal. 

  1. Talk to your team:  One of the biggest challenges this kind of news has is the potential effect on your team – particularly your management team.  Though it’s possible that the competitor will use some of their new cash to try and lure members of your team away – this is not as likely as you might think.  The bigger issue is that your team may lose faith in your ability to compete in the face of well-funded competition.  Negative morale can become a serious issue.  I would advise having a discussion with key members of your team and keeping them aware of what’s going on.  

  1. Their incentives are impacted:  If a startup raises VC funding (particularly when it’s a large amount), the management team’s equity interest dilutes.  In the short-run, this will have little impact (because the team is still basking in the glow of the new cash).  But, as time progresses, you will find that it may get harder and harder for the team to be motivated as the chances of them making any real money have gone down.  For example, by raising $25 million, our competitors basically raised the bar for what type of valuation they would need to exit with in order to see significant cash at the time of a liquidity event (acquisition or IPO).  Based on the terms of the VC deal, they may have needed to exit with valuations exceeding $50 million for it to deliver significant cash to the founders or management team.  Once the going gets tough (and it usually always does), the team will figure out that the likelihood of a big exit is low.  This shifts their incentives. It’s important to keep this in mind.  This is one of the best things about a bootstrapped approach.  Even if you make a modest exit, you still make a fair amount of money.  This keeps the founders motivated the whole way through.

  1. Don’t compete on price:  One of the things your better funded rivals will likely do (very quickly) is focus on building market share at the cost of revenues and profits.  This manifests itself in two forms:  a decrease in price or a an increase in what is provided.  For example, if you’re selling into the enterprise market, your competitor may give away free services, customizations or implementation projects.  These can be expensive, but they can afford it.  It’s generally a bad idea to try and match their price and/or terms.  You won’t be able to outspend them (without raising capital yourself).  You need to find a different strategy.

  1. Determine market validation:  One potential piece of good news when a competitor raises funding is that it may be a sign of validation for your market.  VCs are generally very smart people and would normally not invest large sums of money unless they saw at least the potential for a large market opportunity.   This could be good news for you (particularly if you’re looking to raise funding too).  

  1. Check out the investors:  It is always a good idea to learn as much as you can about the investors that funded your competitor.  What other companies are in their portfolio?  Who’s the partner that is sitting on the board?  What is her background?  One of the biggest impacts a VC can have on a startup (outside of the cash) is the network and contacts that they bring to the table.  If the VC is well connected within your industry, you may see your rival closing some deals that you’ve had a hard time getting done.

  1. Be cautious of partnerships:  It’s possible that you’ll consider forging partnerships as a way to respond to the new market threat.  In fact, you may even enter discussions of partnering up with one of your rivals that just received funding.  Though you should always look objectively at such opportunities and judge their potential value to you, I will share one thought.  In my 12+ years of experience in startup-land, I have found that crafting a partnership that actually delivers value is very, very difficult.  Usually they end up being grossly asymmetric (one party needs/wants the partnership much more than the other) and as a result ends up not creating the outcome that was originally planned.  Not sure why that is, but it’s just been my experience.  Your mileage will vary.

This is obviously a difficult and complex topic (so it’s hard to provide any real definitive tips or guidelines).  Hope the above has helped.

As for my own story, I am pleased to announce that it had a happy ending (for us, not our competitors).  One startup shut-down completely.  One of the others scaled back considerably and ultimately shifted back into a consulting company.  The final one was put up for sale by the VCs that funded it.  I ended up being the winning bidder and acquiring the technology assets as part of the auction (and ended up paying considerably less than the capital they had spent to build their product).  Net result:  We essentially won that battle.  Not due to brilliant strategy or execution on my part, but I’ll take the win anyways.  I’d rather be naïve and win, than brilliant and lose (most of the time).
Moral of the story:  Just because you’re running a bootstrapped startup doesn’t mean that you can’t compete effectively with better funded rivals.  The key is to think through the implications and not get too distracted.  Chances are, even a smart competitor won’t use the cash as wisely as you fear.  Your goal is to survive the short-term because life usually gets harder for them in the long-term.  

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Why It Takes So Long To Raise VC Funding: The Emperor Has No Close

Posted by Dharmesh Shah on Fri, Aug 25, 2006

If you’ve ever attempted to raise VC for a startup, you likely know that it is a long process that takes months.  One thing I’ve found particularly intriguing is that outside of bubble-like times, the average time it takes a deal to get done (and money to exchange hands) doesn’t seem to change a lot.  Though many other industry sectors have shortened the delivery time of their offering in reaction to the fact that we live in a fast-faced society where timeliness trumps other factors, the VC industry doesn’t seem to have changed a whole lot.  Dell can ship you a custom computer faster, FedEx can deliver a package quicker and home loans can be approved more rapidly than what we have ever known before.  But, VCs still will take months to work through a deal and write a check.

My fundamental question is this:  Is the investment return a VC generates for its limited partners correlated somehow with the time spent in due diligence?  The reason I find this question interesting is that there is a sneaking suspicion I have that VCs, like other people, form very quick decisions on whether a startup is or is not funding-worthy.  If this is the case, and they’re forming their decisions early-on anyways, it seems inefficient to spend inordinate amounts of time on due diligence – as it likely will not change the original decision often-enough.  So, I asked VC friends as to why they do this.  Why spend months on due diligence if it is not likely to change the outcome?

The answer, paraphrased from VCs, goes something like this:  “It takes some amount of time to get “comfortable” with a startup before we write a check.  Not all of this time is spent doing deep due diligence.   A lot of the time is just spent letting the deal “bake” in our (the VCs) minds.  Often, it is during that “think” time that we’ll come up with insights into the business and market that we would not have otherwise.  Sometimes, it’s simply a matter of getting educated on the space, educated about the founders, etc.  Often, during this “due diligence” time (where often, not that much due diligence time is being spent), we’ll come up with good reasons not to do the deal.  These reasons would not have occurred to us in the early conversations.”

This actually makes pretty good sense.  If the VCs are not having to invest all that much time/energy in “deep” due diligence in the weeks and months that pass, and they do indeed “discover” things that cause them to filter out opportunities that are later determined not to be of sufficient value, then it seems that VCs should do exactly what they’re doing.  Why close a deal in days or weeks?  You sometimes have a small risk of losing the deal, but since everyone else behaves this way anyways, there’s little that an entrepreneur can do to accelerate the process.

From an entrepreneur’s perspective, the situation looks something like this:  The VC will likely make a spot decision (within a day or two) as to whether you’re worth even investing the time in.  But, you’re not going to get a direct “no” (I’ve written about this phenomenon before).  But, from the time that they make the mental decision to invest, they are looking to leave themselves enough time to talk themselves out of the deal.  If they fail to talk themselves out of the deal, they’ll close it. During this time, where there is no possible way they’re going to reach a “close”, VCs are likely to ask entrepreneurs for deeper, more exhaustive information.  The frustrating part is that not all of these requests are so they can learn more about the company, which will influence their decision.  .  Some of it is simply to ensure there is adequate time for them to talk themselves out of it.  Unfortunately, it’s hard to know the difference, you have to respond to all due diligence requests as if they are somehow going to change the outcome.  Such is the life of an entrepreneur raising money.

Interesting Idea From Left Field:  What if a new VC came along that offered entrepreneurs a quicker, less painful process to raise capital for their startup?  Would this VC be able to attract a better class of entrepreneur?  Entrepreneurs that would rather focus on their business and customers than on raising capital?  Or, would this new VC be doomed to failure because they were not allowing themselves sufficient “bake time”?  Could some of the risk be mitigated by having a “probationary” period for the capital.  For example, in a $4MM round, the VC has the ability to retract up to 90% of the investment within 90-120 days if the deal isn’t what they thought it was?  This kind of approach will likely never occur, but if you look at entrepreneurs as the “customer”, then I’m pretty sure there are a pool of customers out there that would like more rapid “service” than they’re getting now.  Will we see innovation in the VC sector anytime soon, or is it by design immune to the need for change?
If you are a VC, or play one on TV, would love to hear your thoughts on this.  What am I missing?

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How To Watch A Startup Presentation

Posted by on Mon, Aug 07, 2006

This article is in response to an excellent article Paul Graham posted recently titled “How To Present To Investors”.  If you are the founder of an early-stage startup and expect to pitch your company to angels or VCs someday, I highly recommend the article.

Paul’s article was motivated in part by the fact that Y Combinator (the early stage investment firm in which he is a partner) is hosting an event called “Angel Day”.  On Angel Day, the current crop of Y Combinator  startups (companies that he and his partners have funded recently) will be pitching to a group of potential investors.  I’m scheduled to attend this event, as one of those potential angel investors.

Having been on both sides of the fence (heard pitches and given pitches), I have come to realize that many articles have been written to provide advice to entrepreneurs on how to make effective pitches to investors.  What hasn’t been covered much is the reverse:  what investors should do to maximize the value they get from startup pitches.  Hence, this article.  To keep myself focused, I’ll pretend I’m writing to other attendees of the Y Combinator Angel Day presentations.  However, most of these tips should apply equally well to other similar situations.

How To Watch A Startup Presentation
  1. If You’re There, Be There

Nothing surprises me (or irritates me) more than having people attend a startup pitch and them mentally “check out” within minutes.  A popular activity is checking email on a Blackberry.  Assuming that this activity is not intended to convey some sort of importance (I think most investors are not that insecure), I can only guess that this comes out of a force of habit and a short attention span.  My advice:  If you thought the meeting was worth your time to go, you are being inefficient if you’re not engaged.  Even those with the best pattern matching algorithms in the world need some inputs into those algorithms.  If you’re there, be there.  You’re wasting your time otherwise.
  1. Learn Something

It is entirely possible that the pitch you’re hearing is of absolutely no interest.  It may be an idea that you don’t like, a category that you’re not interested in, etc.  However, I think it’s important to remember that the best startup founders have spent a lot more time thinking about the problem.  In the case of Y Combinator companies, they’re not only building products to solve a problem, they are likely part of the larger target market.  These are the early adopters and people keeping their pulse on technology.  As such, there are lots of important things to learn about the state of the industry and where things are headed.
  1. Keep Things In Context

I’ve seen a number of startup pitches where someone in the audience asked one of the standard questions.  The most common being:  “That’s great, but how are you going to make money?”.  Though business models are certainly an important factor, in the first pitch (and particularly in a format like the Y Combinator presentations) it is unlikely you’re going to get a thoughtful and productive answer.  So, unless you’re there purely to rationalize why this is a terrible startup and why you’d never consider putting money in – try to remember the limitations of the format and context.  If you have to ask questions, ask ones that will actually tell you something useful.
  1. Focus On The Problem And The Solution

Many startup presenters have little or no formal experience pitching to anybody – let alone a group of smart but cynical investors.  So, don’t judge the quality of the startup based on the polish of the presentation.  In fact, at this stage in the game, if the pitch is really, really polished it could be a mild signal that one or more of the founders cares more about the pitch than they do about the problem.  I tend not to penalize startups for having good presentations, but it’s also important not to penalize them too much for having mediocre ones.  Let the passion for the problem shine through.
  1. Give Back Something Useful

Many startup founders (particularly the Y Combinator ones) are early in their careers.  They’re working hard to solve a problem they care about.  The ones I have met are genuine entrepreneurs.  Though you may or may not like the current idea, I think it is important to support those pursuing their dreams and taking the entrepreneurial leap.  Be candid, but be constructive.  These are really smart, hard-working people willing to listen and take input.  Though the investment may not make sense for you, it doesn’t mean that you can’t help in some way.  If you’re an angel investor, chances are that you were in their shoes once too.
  1. Be Courteous and Polite

This is likely going to be the most controversial item on the list.  Many investors need to remind themselves that startup founders are people too.  (Though in some cases, I think investors don’t discriminate – they’re equally discourteous to everyone).  I’m not sure why, but I’ve found that people investing their own money (angels) are usually more courteous and polite than those investing other people’s money (VC) – but that’s a topic for another day.  

I look forward to seeing the Y Combinator companies later this week.  If you’re one of the startups presenting – or one of the investors attending, drop me a note. 

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