ProfessorVC

Would a Dart Board Provide better VC Returns?

2010-02-26T13:42:00.000-08:00

For those of you that are regular visitors at ProfessorVC, I apologize for the long hiatus over the holidays and beyond. I know there are at least a few of you as I received several emails this week along the lines of "no new posts since November???"

Well, I'm back. Was amused to read about Right Side Capital this week. They have raised a fund to provide seed funding of $50-$250K to 100-200 start-ups. Rather than going through their networks or targeting specific sectors for deal flow, they are going to rely on an algorithm to select companies. The formula will be based on the founders' experience, schools they attended and other background information to gauge the likelihood of success. This certainly gives new meaning to "drive by investing" which became popular in the late 90's....

My first reaction is incredulity that limited partners would buy into this idea. Of course, when 10-year returns for the entire venture capital asset class is about to drop below zero, drastic measures may be in order. Seed stage investing is all about the team, so there may be something to this idea. For firms that don't have access to the most successful entrepreneurs, trying to predict an individual or individual teams success rate based on experience, personal attributes, intellect, etc. might very well be a good way to find some promising first time entrepreneurs. This is not far from the Y Combinator model, except they put a lot of time and energy into working with the entrepreneurs. With 2 or 4 new investments per week that Right Side is projecting, it will be challenging enough to remember the names of the entrepreneurs in their portfolio, let along help build companies.

This got me thinking about the debate over serial entrepreneurs and whether success breeds success or complacency. My colleague, Anu Basu, Director of the Silicon Valley Center for Entrepreneurship at San Jose State, recently completed a paper on this topic, "Does Experience Matter? A Comparison Between Novice and Serial Entrepreneurs" Her research shows that there is a positive correlation between prior founding experience and new venture performance due to stronger and more diverse social networks, access to capital, reliance on collaborators and other factors.

While this is not surprising, it would be interesting to look at returns provided to venture capital firms from novice and serial entrepreneurs. Serial entrepreneurs would be more likely to have larger personal investment in the company, have taken outside investment at higher valuations and possibly less open to taking big "bet the company" type risks.

Of course, given the state of venture returns, perhaps randomly picking from a stack of business plans would provide as good or better results than an entrepreneur selection algorithm or detailed due diligence. I recall that the WSJ used to run a contest in stock picking between investment analysts and selection by darts. The random selection fared quite well against the analysts and now the contest has shifted to readers vs. darts. The darts seem to be doing quite well over the past few years...

Can Entrepreneurship Be Taught?

2009-11-19T16:34:00.000-08:00

I attended the annual LP meeting for a venture capital firm this week and got into a discussion about the above question. Seems like a good question to ponder given that I spend several hours each week as a professor of Entrepreneurship.

At a high level, I definitely agree that being an entrepreneur and being in school don't necessarily mix. Most of us know of Exhibits 1 (Bill Gates) and 2 (Mark Zuckerberg) from Harvard, but I have met dozens of other successful entrepreneurs who felt a greater need to get going on an opportunity than to wait around to complete a degree.

However, for most of the rest of us, the analytical skills honed in college or grad school, along with the opportunity to network and explore different fields prove invaluable later. With that in mind, I created a new course at San Jose State last year, the Entrepreneurship Lab (E-Lab). The seminar course combined an internship at a start-up or venture firm with classroom learning and sharing of experiences. There was an application and interview process to be admitted to the class so I was able to have a diverse group of students with varied educational and work backgrounds. Business, Engineering, Computer Science, and Design were all represented.

I'm teaching the class again this coming semester and held an information session for prospective students this week. I had several of the students from E-Lab I come to share their experience with those interested in applying for E-Lab II (went with the Super Bowl numbering scheme to see if I can convince the powers that be to make this a permanent part of the curriculum). I was blown away by some of the testimonials of how the course was a career and life altering experience for the students. I realized that opportunities like this are so rare and students don't get enough of this type of experiential education.

Here are a couple of quotes from the students:

"The internship provoked by thinking and challenged me to pursue my interests with more drive and determination. The opportunity provided by the [E-Lab] has been truly inspiring. And now I know exactly where I want to spend my time"

"This internship truly provide me an entry point into the private equity world. I am still not certain about exactly what I would like to do for the next 30 years, but I am certain that it will have something to do with funding/valuing/investing in start-up companies."

I think something else they liked was that there was no final exam, since in the real world, you are judged by the market and investors rather than on a grading curve...Instead, we spent the designated exam time with a final debriefing of the semester at Gordon Biersch brewpub (see below)

Special shout-out to Dan Gordon, founder of Gordon Biersch, who has been a great supporter of our entrepreneurship program at SJSU and is hosting my Entrepreneurial Finance class at the brewery next week.

If you are interested in getting involved in the E-Lab, there are a few opportunities. If you are an SJSU student, the priority application deadline is December 10 and you can find more information and an application here. If you are interested in hosting an intern, we will be accepting employer applications in December and January for internships beginning in February. If you are interested in sponsoring the course, would love to hear from you as being part of a state institution in California provides its own special challenges.

Now back to the question at hand. Entrepreneurship can be taught, but the jury is out on whether you can teach someone to be an entrepreneur. However, I've seen a number of students not find their entrepreneurial DNA until exposed to the content and guest speakers in the entrepreneurial program. That's enough to keep me teaching!

Watch Out for the Red W(h)ine

2009-10-20T14:47:00.000-07:00

I have been following the rallying cry of entrepreneurs with some amusement over the past couple of weeks in response to a blog post by Jason Calacanis, "Why Start-ups Shouldn't have to pay to pitch angel investors." In fact, I was cornered by a member of this camp at our recent Sand Hill Angels annual social event at the Wine Room in Palo Alto (great place, by the way). I was afraid if I didn't answer the question of whether Sand Hill charges entrepreneurs to pitch properly, I might be wearing a very nice pinot.

I've written about the practice of charging entrepreneurs in earlier blog posts and it is not something we would ever do at SHA. However, the individual above was adamant that we should have a PR campaign to let the entrepreneurial community know that we don't participate or support this practice. I laughed and said that our web site made this clear and we may have even put a brief posting to this effect on our twitter feed. I'm also a strong believer that your track record and reputation are your most valuable assets in the venture community. This is not something that can happen overnight by putting a press release on the wire.

However, this is a great question to ask at the front of the process. I have put together a list of questions to ask your angel investor group contact:

Do you charge any fees to present or during the due diligence process?
How many investments have you made this year? Last year? Average size?
How many of those investments are initial investments? Follow-on?
In how many of those were you a lead investor?
How many do you have a board seat?
What percentage of your members have made an investment in the past 12 months?
What percentage of your members are not active angel investors (i.e. service providers)?
Do you invest as a fund, single purpose entity or as individuals?

This is not a comprehensive list of questions, but certainly a good start? At Sand Hill, we are very active and often lead investor and Series A board representative. We made 12 investments last year (5 new and 7 follow-on) and are on the same pace in 2009.

For those who do charge, should you avoid them like the plague or burn at the stake? I wouldn't go that far, but certainly fair to determine what you are getting for your limited amount of cash. Here is a list of questions I'd ask:

How much is the fee?
When are we obligated to pay?
What do we get?
Are you a broker-dealer? (Note: Finders fees are illegal in California for non broker-dealers, not sure about other states)
Do you have any service provider members? Do you charge them a fee?
If you do charge, why are you you charging me for the privilege of being added to a telemarketing list? Shouldn't you be paying me?
How many companies have paid fees in the last year?
How many of these have received investment for your group?

I don't think it's time to hang all angel investors in effigy, but remember that due diligence goes two ways...

Survey says VC's invest on Gut Instinct

2009-09-24T13:04:00.000-07:00

Nope, the above quote isn't from Richard Dawson on Family Feud, but similar to a headline that caught my attention on the front page of the business section of the San Jose Mercury News this morning. Not that it was surprising, but that it would be news worthy of this placement. Once I got past the headline, I realized, that Scott Harris had the same reaction to the survey that I did.

He was citing a survey done by John Paglia at Pepperdine University. Harris writes "'Gut Feelings were cited by 67 percent of 185 venture capitalists surveyed, while [discounted] cash flow analysis was cited by 43 percent" as techniques used in analyzing potential investments. It struck me that the 43 percent number for DCF was really high, but if a sizable chunk of the VC's surveyed are late stage, would make more sense. Or perhaps, that is just my west coast bias to
think nobody pays attention to DCF.

I decided to go grab the survey to see if there was more. I pulled the report and buried in table 28 on page 35 is the data cited in the article. The data makes a lot more sense if you look at the entire table. I'd break down into two separate pieces - financial analysis and business/market analysis. On the financial analysis end, you have multiples far and away the most common valuation method over DCF, Simulation and Option analysis. I've never heard of a VC running Monte Carlo simulations on possible outcomes. Either the company is going to be successful, wildly successful or will fail....I always focus on the business model and assumptions, but there are too many unknowns to put much faith in the future cash flow projections.

On the other side, you have Market Analysis (96%) followed by gut (67%). This brings up the age old question on whether you are investing in markets or teams. If you've got a large growing market, solid team, strong competitive position and compelling solution, you'll move forward with diligence, which can range from going with your gut to doing detailed projections, numerous reference calls and deep market analysis.

Let's get back to the topic of gut investing. I was a limited partner in Angel Investors, LP, Ron Conway's fund in the late 1990's. They clearly went on gut and were often accused of drive-by investing, but that has to be the only way to invest in 200 companies over a 3-year period. Luckily, Ron's gut told him to get as much money as he could in to Google, which saved the fund.

I just finished reading Malcolm Gladwell's Blink.

Blink starts with the anecdote of the Getty Museum's $10 million acquisition of a rare Greek statue dating from the 6th century BC. They spent 14 months researching the authenticity. A geologist spent two days examining the statue with a high-resolution stereomicroscope and removed a sample and "analyzed it using an electron microscope, electron microprobe, mass spectometry, X-ray diffraction, and X-ray fluorescence." The conclusion was that it was indeed old.

However, when several experts in Greek sculpture viewed the sculpture, they were all able to see immediately that that it didn't seem right, but couldn't necessarily articulate why. Turns out they were right and the statue was fake. Whether this was gut, natural intuition, or some other subconscious analysis from years in the field, it doesn't matter. The point is their opinions weren't clouded by any vested interest or lengthy analysis.

Certainly, a corollary to VC's who have seen hundreds or thousands of start-ups and can often tell within the first 2 minutes or 2 seconds whether an investment is even a possibility.

Back to the survey. One other chart worth noting is the the expected returns from various private capital providers (Banks, Asset based lenders, Mezzanine, Private Equity and VC). From the chart to the left, you can see that the 42% expected return of VC is clearly an outlier on the graph.

Of course, if you look at the Cambridge Associates data ( graph at the bottom left) comparing venture capital returns of top quartile vs. median funds, you'll see that over the past three decades, the median fund has never returned over 40% and that the returns have been 0% over the past ten years. In looking at that data, if I'm a VC and promising LP's a 42% return, my "gut" might be telling me to to find another job when the fund is done.

Burn Rate

2009-07-22T11:07:00.000-07:00

The burn rates of my portfolio companies is certainly top of mind right now, but that's not what this post is about. Not yet anyway...Things may change by the end.

Ever wonder what your ops guy is doing when he's not obsessing over your site's health 7x24. If anyone still carries a beeper these days, it's him. Well, our VP Operations at Fliqz, Daniel Marcus, dabbles in creating writing and music when not managing our data center.

His specialty is short fiction of the sci-fi variety, but has also authored numerous papers in the areas of applied math and computational physics, if that's your thing. Since I'm not a fan of any of those genres, I have been looking forward to the release of his latest work, Burn Rate.

A quick synopsis from the book jacket blurb:

Ross and Lori Williamson are living the Boomer version of the American Dream. Ross is a Silicon Valley entrepreneur, battered but still standing after the Internet collapse. Lori has quit her upscale corporate law job to make pottery, study martial arts, and start a family. Unable to conceive, they hire Annie Day as a surrogate to bear their fertilized egg to term. Annie has a few skeletons in her closet, including an ex-boyfriend desperate for cash and on the run from the Italian and Russian mobs.

It is hard to tell the bigger villain - Microsoft (aka evil empire), the vulture capitalists (aka Sand Hill Road) or the Jewish kid from Brooklyn who after some problems with gambling (what kind of nut bets on the Knicks?) and drug dealing (to pay off the stupid bet) takes up kidnapping and murder. Once you get past the stereotypes (of the first two anyway), this is a very funny and entertaining read and a great page turner to take to the beach or pool on one of these hot summer days.

While there are certainly better books that chronicle the highs and lows of starting a company, Burn Rate does raise some interesting issues on the personal side of entrepreneurship. The protagonist, Ross Williamson, is struggling to finance his company and hang on to his team during the process. His angel investors are tapped out and the VC's aren't biting. He convinces his wife to let him take a second mortgage on their home to give Tesseract a few more months of runway.

While credit cards, second mortgages, and personal guarantees are all common methods of early stage funding, they can certainly put a strain on marriages and personal relationships. When he receives a lowball acquisition offer, he must decide between protecting his hide and leaving his team hanging or rejecting the offer and rolling the dice on a better outcome.

I won't spoil the end of the story, but wouldn't bet against the good guys....Now back to hunkering down and figuring out how to deal with the burn rates in the portfolio.

Can you start a company on $10K?

2009-05-30T11:09:00.000-07:00

Nope, not another post on boostrapping, although certainly a big part of this question. We held our annual business plan competition at San Jose State this month and first prize was $10,000. While difficult to do a lot with, there are a number of non-pecuniary benefits in addition to the cash.

First prize went to one of my students, Ryan Guerrettaz (giving the winning pitch below), for his college notes sharing service, Rate-the-Test. I think it's a great idea, although one of colleagues starting calling it Cheating.com and StealtheTest.com. One way to look at it is to level the playing field for those students not in fraternities where old (and probably sometimes current) exams are in the filing cabinet.

This is a much bigger idea than that and is really about helping students succeed. Particularly at a school like SJSU, where a large percentage of students are working part or full-time while taking a partial or full load of classes, time is a precious commodity. As a professor, I would also be very open to loading my materials to a site like this both to help students and to share with entrepreneurship faculty at other universities.

Ryan was actually working on another business plan for my class when he came to discuss this concept with me a few weeks before the business plan competition. He was concerned that he wouldn't have enough time to do a good job on the business plan in such a short time and asked me to advise him on whether to proceed. As a part-time academic, I had to pontificate and give him the scholarly answer, which was "Why the Hell Not??". He worked over 50 hours the final three days, saw his girlfriend once in three weeks and blew off other activities, but beat the midnight deadline by a few minutes.

Rate-the-Test was selected for the semi-finals, which gave him a couple of days to prepare a pitch deck. He did an adequate job presenting and barely made it to the final round. However, this gave him a full week (or 30% of the time already spent) to focus on the presentation and feedback from the semi-final judges. By the morning of the finals, he was ready, gave an excellent presentation, and responded to the judges questions with well thought answers.

Back to the question at hand. Certainly, starting a company on $10K is not easy, but it can provide a great start and the motivation to move ahead. In addition to the first prize, he was also given office space at the Plug and Play incubator for the summer and get to spend his days with other entrepreneurs and investors.

However, it will be under a different name as it may be hard to get profs to cooperate with a site called Rate-the-Test and the service will offer much more than previous exams. I look forward to seeing my students using this service in the fall semester. Also, if it turns out he neglected his girlfriend too much while starting up the company, he'll certainly have the opportunity to meet plenty of co-eds as he hands out flyers for the site on campus. With $10K, certainly can't have a marketing budget to do anything but guerrilla marketing.

Bootstrapping 101

2009-03-10T11:41:00.000-07:00

I moderated a panel discussion last night on one of my favorite topics, bootstrapping, as part of our Silicon Valley Center for Entrepreneurship Eminent Speaker Series at San Jose State. One of my colleagues, Joel West, beat me to the punch with a summary of the program.

We had a good mix of experts on the subject:

Jon Fisher, serial entrepreneur, blogger and author of Strategic Entrepreneurism
Gustavo Alberelli, director of Kennet Venture Partners that specializes in investing in bootstrap companies
Ilya Ronin, a former software engineer and SJSU alumnus who is one of the three executives of bootstrapping Marpo Kinetics (an exercise machine company)

Gus shared the strategy of Kennet, which is a unique breed of venture firm, sitting in between early stage Sand Hill Road VC's and late stage/private equity players. They have a standard presentation on bootstrapping, which they present around the country. Kennet has a white paper on that summarizes why bootstrapped businesses are the best. Another interesting related point that he made was that only in Silicon Valley does this message seem to fall on deaf ears, although maybe not now! In other parts of the country, this is business as usual:

Identify a customer need
Build a product
Sell the product

In the valley, the knee jerk reaction is to start with the powerpoint deck and look for the venture capital drug....

Jon Fisher purposely avoided raising venture capital in his ventures. His latest venture, Bharosa, was sold to Oracle for a 6X multiple in 3 years to his angel investors, a sweet close to triple digit IRR. His goal in building the company was to spend 3 years building value and find a good home for the engineers and product. In this case, a win-win for everyone, except perhaps the VCs who didn't get the opportunity to participate. Certainly not to say they couldn't have raised more cash and built this in to a bigger company, but was nice to have the option of going either way and doing what was right for the founders and employees.

Finally, Ilya Ronin, shared the Marpo Kinetics story, a true bootstrapped garage start-up. The three founders shared a vision, built the exercise machines in the garage, and knocked on doors at health clubs, attended trade shows, and worked the phone to get initial sales. We don't know the end of the story, but they have built a real business with hundres of machines sold to gyms all over the world along with government contracts for military purchases.

In this economy, all entrepreneurs are going to hear a lot of "no's", but time spent going after customers rather than investors should provide a higher return on investment. Of course, assuming you are successful in the first, the latter will certainly be an option in the future.

The Most Important Venture Capital Statistic

2009-01-20T07:33:00.000-08:00

A couple of headlines caught my eye in this morning's VentureWire:

Deals Slow As VC Feels Economic Chill
Web Video Platform Fliqz Gains $6M In Series C Funding

The funding news and general condition of the economy has been no secret and certainly wasn't a surprise that venture funding in the fourth quarter was the lowest level in four years and most expect the decline to continue at least through the end of 2009. The latest statistics from VentureSource show 554 financings in Q4, down from 620 in Q3 and 718 in Q4 2007. Total amount raised fell from $7.5 billion to $5.5 billion quarter over quarter. First round median investment size fell to $3.8 million and $4.2 million for the year, which is the first time it has been below $5 million since 2001, a sign that capital efficiency will be even more important than it has.

Of course, the most important funding statistic to an entrepreneur relates to one specific company, and whether there is sufficient capital available to build and scale his business. On that front, I take pride in the second headline with news that Fliqz, where I am CFO, just closed on $6 million in Series C financing. From first hand experience, we certainly felt the market conditions and the funding process was much more difficult than anticipated.

I'll share a few points about how we were successful, but most of the credit goes to Benjamin Wayne, founder and CEO of Fliqz, a passionate, strategic and tactical executive. The funding search began the day after Labor Day and continued throughout the fall as the environment continued to worsen, and resulted in a term sheet the day before Thanksgiving.

Here are a few takeaways from the process:

Extend Runway - As we planned out our investment process last spring, we realized that there were still a number of areas we needed more proof points and the optimal time to raise capital might not be for another 2-3 quarters. We decided to raise some venture debt as an insurance policy and extend our cash runway. We drew $1.5 million from Lighthouse Capital Partners, which ultimately became critical to our balance sheet and they turned out to be a great partner as we worked through the equity financing process.

Evaluate Business and Financing Needs - We initially went out seeking $10 million in financing, but listened to the prospective investors and watched the market. Mid-way through the process, we took another cut at our business plan and built a model where $5 million would be sufficient to get us beyond breakeven. This brought in a new set of prospective investors and required a lower investment from the lead investor as our existing investors were committed and on board.

Don't miss Plan - This may seem obvious, but I've seen a number of CEO's shot for missing the first quarter's numbers after going public, which is a great way to shrink your market cap well before the lock-up period is up. Same principle here. Prospective investors have a free look to see how you execute under the gun. At Fliqz, we met or exceeded the sales plan every month during the due diligence process.

Look beyond the usual suspects - With Mohr Davidow Ventures, one of the premier Sand Hill Road firms already in the company, it would have been easy to focus on a short list of other top tier firms with long track records in the valley. However, as we soon discovered, many of these firms were forced to hoard capital for existing portfolio companies and focus most of their time and energy on deciding which ones deserved these reserves. Some were also dealing with issues of limited partners struggles with capital calls and asset allocations. With that in mind, new funds are a great place to focus. Without all of the legacy issues, they have the capital and time to seek, evaluate and actively work on new opportunities. Our lead investor, Triangle Peak Partners closed on a $170 million first fund in late 2008.

Of course, timing and luck are still a big part of a successful capital campaign, particularly with these market conditions. Many companies that have raised capital are going to need to spend it wisely to win and others will be forced to bootstrap.

Speaking of bootstrapping, this is always a subject near and dear to my heart and I'll be moderating a panel on the topic on March 9th as part of our eminent speaker series at the Silicon Valley Center for Entrepreneurship. More on that in a future post.

Why didn't I think of that??

2008-12-18T09:08:00.000-08:00

Great ideas can come from many places. Some result from years of work and/or education while others are a result of trying to identify a unique solution to a consumer or business problem. Of course, there are those that are completely ridiculous (think Pet Rock). We recently had our Neat Ideas Fair, which is my favorite annual event of our Silicon Valley Center for Entrepreneurship at SJSU.

The NIF (in it's 5th year), is essentially a science fair for entrepreneurs. A science fair conjures images of excited middle school kids standing in front of their poster boards explaining which type of paper decomposes the fastest or in my daughter's case, the longevity of chewing gum flavor. Not sure whether she was truly interested in the answer or just thought it was a great way to get her parents to buy her a big stack of gum.

Many entrepreneurial programs feature a business plan competition, which is a great exercise. At SJSU, we also have a business plan competition in the spring, which ideally allows the students to build a viable business model around their NIF projects. However, the NIF forces the students to focus on their idea and ability to communicate it's need, kind of like the Demo conference is all about the product.

The NIF brings together students from all parts of the university (business, computer science, mechanical engineering, design, life science, etc.) to share their passions and projects. Some have developed working prototypes, while others are still at the concept stage and only on posterboard. I really enjoy the collaboration among students in different parts of the university and the excitement of talking about their ideas and thinking through the business potential, particularly for the non-business students.

One of my favorite projects from 2007 was a solar power wetsuit. This was a collaboration between students in industrial design, electrical engineering and business. This team had a working prototype of the first solar powered wetsuit using nano-solar technology. They had done a lot of research talking with surfers and divers, as well as working with O'Neill, one of the leading wetsuit design and maufacturers.

Some of the most popular projects from this year's NIF were:

I.C.E. - Solar thermal collector that functions as an ince generator to provide cooling through a building
Tenebra - device with cryptological communication protocol that revolves around a cheap hardware random number generator to enable consumers and businesses to communication with military-grade protection
Snack Caddy - Reusable tray for carrying snacks and drinks at the movies or other events

You can see a description of these and other projects at the NIF site.

Here are a few of the budding entrepreneurs that I chatted with at the event:

Jeff Gibboney, a graduate mechanical engineering student, developed a battery operated skateboard for cruising to school or work. This new mode of transportation included a go-kart wheel, a motor and battery pack from an electric scooter, and sensors from a Nintendo Wii.

Manija Ansari is an undergraduate business student (currently in my Entrepreneurial Finance course), working on a social entreprenurial venture. She has developed a new twist on the micro-lending concept. Unforgettable treasures will provide micro-loans to third world crafts artists to enable them to build their business and will also market their wares through the Internet. She is planning on starting the business upon graduation.

There were a number of green projects at the NIF, including environmental studies major Alan Hackler's Zero Waste Solutions. Alan's concept is a foot pedal operated sink (to save water) that automatically separates compostable and other waste. While many people would have a hard time doing without a garbage disposal some municipalities have banned the use due to the impact to the water treatment systems.

Man Camp

2008-11-13T12:00:00.001-08:00

Just returned from a golf trip to Bandon Dunes, Oregon. We played a Ryder Cup style tournament with 16 guys (the motley crew to your left) over 3 days and 72 holes, with a few drinks mixed in. Waking up Monday morning with a golf hangover, I remembered I hadn't had time to prepare for my class that afternoon. This got me thinking about the business model that Mike Keiser has built at the resort and a lecture began to form in my head.

One of the guys on the trip referred to Bandon as Man Camp. If you haven't been, it is difficult to describe the allure. The location is remote (a 3-hour drive from Eugene and over 4 from Portland, with not much in between). Mike Keiser (the founder of Recycled Paper Greetings) had a vision to create a true links experience in the US.

As described by Stepen Goodwin on the book jacket to Dream Golf, The Making of Bandon Dunes, "Bandon Dunes would be a 'pure' golf experience, pitting the golfer against the elements, allowing the land to dictate the course, banning the use of carts, making the golfer feel as one with both nature and the game. To achieve that goal would take a great amount of planning and hard work, the struggle of man against nature in shaping the land into three courses that would become the Bandon Dunes complex. Convention wisdom said it was impossible. And even if he built it, would anyone come to this remote Oregon outpost?" Well, built it he did and they have come. Less than 10 years from the opening of the first course, the $150 million investment has been recovered. And the courses are all ranked in the Top 25 courses open to the public by Golf Digest, with Pacific Dunes (#2), Bandon Dunes (#7) and Bandon Trails (#21).

So what is about the business model that is so successful:

Focus on your core target market - The original marketing plan for Bandon Dunes is as simple as they come - "Great golf + great food + great people = marketing plan". They have done a great job of serving the market. Although I've seen a few brave women, the resort is full of middle to upper income middle aged guys who love serious golf. The offering is all about golf and camraderie - get there, stay on site, traditional golf, multiple courses, excellent pub food, and of course, the Bunker Bar (complete with poker, pool, stogies, and a bartender that will stay as long as necessary). No spa..yet, but I hear one may be in the plans. A gift shop with nice jewelry is adjacent to the front desk so you don't forget that important purchase prior to checking out, to help with the permission for the next visit. This is not surprising from a greeting card guy, who realized that $5 is expensive for a Valentine's Day card, but incredibly cheap compared to the price if not purchased...

Manage seasonal demand through pricing - Weather on the Oregon coast can range from gorgeous to downright nasty and can change from one of the other in a matter of minutes. While pricing never approaches Pebble Beach, it can be very expensive during peak season and more difficult to justify to the spouse at home. Both trips I've made have been in early November when prices are reduced by 50%. For the true golf fanatics, the second round of the day is half-price all year and the third is free. Also, if the weather gets really bad, they offer a full refund voucher good for your next trip - all about customer retention.

Grow organically - It took ten years of planning to get the first course open and nobody had any idea how many golfers would come. Once the first course opened, ground was broken on the second (Pacific Dunes). Several years later, Bandon Trails opened in 1995 and the fourth course (Old Macdonald) is scheduled to open by summer 2010. Certainly there must be a temptation given the success to grow faster or target other segments, but Keiser is committed to staying true to the vision, and making sure everyone can get in 36 holes in a day.I can't wait to go back, which is clearly goal #1 in the list of critical success factors if anyone is still following the business model tangent.

I'll leave you with the 11th hole at Pacific Dunes and a link to Dream Golf if you are interested in more of the Bandon Dunes story:

CFO's - More Guardian, Less Angel?

2008-09-26T15:48:00.000-07:00

Just received this month's issue of CFO Magazine (yes, I know, it should be a very exciting weekend) and found an article I was interviewed for a couple of months ago. The article, "More Guardian, Less Angel" discusses how CFO's add value to angel groups by helping to kill deals. I spent most of the time with the reporter talking about Sand Hill Angels and how we add value to the start-ups and entrepreneurs that we partner with, which is why I just have a small mention in the article.

It is certainly true that we can pick apart the financial projections or pour through contracts, legal and financial diligence, but none of those areas tend to be the most important areas in deciding whether to make an early stage investment. No company's future ever matches their projections and it is the assumptions and how the entrepreneur understands the market and sees the opportunity evolving that we care about.

As I am quoted in the article, it is easy to pick holes in a business plan. It is certainly good to take an analytical approach to any investment opportunity and many venture capital firms and angel groups do an excellent job of diligence. However, at the end of the day, your gut can tell you a lot more about whether to make an investment or not. How passionate are the entrepreneurs about their business? Can they recruit and get others excited? Do I believe they can succeed? Does the business model pass the smell test?

While no real data exists on returns in angel groups vs. individual angels, I often wonder which is the better way to invest. I enjoy my colleagues at Sand Hill Angels and like investing as a group as it enables us to lead investments, take board seats and have more influence. The downside is the groupthink mentality, which can work in both directions, killing deals and also creating a bandwagon effect. In a lot of our deals, there is often a tipping point where the deal will either move forward or die.

Even though I am an active member of an angel group, I often advise entrepreneurs that they may be better off raising money from individual angels rather than groups. A lot is based on how much money they are raising, terms being sought, entrepreneur's experience, stage and total funding required for the business. I'm going to do some more thinking on this topic and write another post sometime in the near future.

Brickbreaker - Mindless Amusement or Viscious Addiction

2008-09-16T14:12:00.000-07:00

I am not sure how this relates to venture finance or entrepreneurship, but I'm sure I'll find some connection along the way. Perhaps, it's that old joke:

Q: What two industries call their customers "users"?
A: Technology companies and Drug dealers

While the fall semester is in full swing, summer doesn't officially end for another few days. Still a good time to revisit what I did over my summer vacation. One thing I spent too much time doing was playing Brickbreaker, the only game that is part of the standard blackberry deck. Brickbreaker is an incredibly mindless game that can be played in spare moments on line, at airports, during boring conference calls, etc. For those of you fond of 1970's nostalgia, the game is similar to the Atari game, Breakout, that was a sequel to Pong. I recall playing this on one of the early Atari systems when I was a teenager.

The object is to knock down rows of bricks by hitting a ball with a paddle that can be moved by the wheel on the device. You start the game with three "lives" but can accumulate many more as you play and advance through the levels. After 34 levels, you start again at level 1 and continue. The game can be stopped and started at any time. In those spare moments, I manged to keep the same game going for several months over the summer and reached a score of 509,090 when I decided it was time to quit and let my remaining lives (somewhere north of 100) die.

The other interesting feature of the game is that you can submit your high score through the device and see where you rank on the list. My score was #471. It did not show how many scores were on the list, but given the number of blackberrys in the market, it has to be a big number. But that begs the question, Who are these other 470 people? Do they have jobs? How much abuse can the wheel on a blackberry take?

I didn't find the answer to any of these questions, but did run across a blog, Brickbreaker Conquest, that shed some light on the question. Here are a couple of those folks:

I’ve been playing my current game for about a month now. My current score is 1,376,500 with 378 lives remaining. My goal is to get in the top ten and then kill myself off. I’m spending way too much time on this thing and frankly has been an addiction worse than crack! Somebody help me! Seriously, I am having a blast knowing that I am going to be in the top ten in the world pretty soon!

For all you that can’t believe the scores out there, it is possible. I recently broke through the 2×34 level barrier. It took a few months of practice. Once you get past the second round, there are no more bragging rights. Actually the more points you boast, the more you should be scorned for frittering away your life. The game isn’t challenging and becomes boring, a way to pass time only. So if you’ve made it past the second round, pat yourself on the back and forget the game. You’ll be better for it. ps my score is currently 303,070 with 59 lives (no cheats used). Sigh….. This %$#^%$ addiciton!

Back to my point at the beginning of the post. I'm still not actually sure what this says about new venture opportunities, but there are a few points that came to mind:

Stabilitly of mobile platform - Can you imagine using your PC and not having it crash once in several months? Maybe if you have a MAC, but I've never gotten that kind of stability out of my PC.
Perhaps there is an opportunity in games for the non-serious gamer. I do have one investment in a company that has developed a platform for in game mobile advertising - Greystripe. They also run a site, Game Jump, that offers free games for mobile devices, many of which are similar style games, such as Tetris, Lego Bricks and Solitaire.
Finally, in Brickbreaker, the game becomes increasingly more difficult as you work through the first two series of levels, but once you pass in to the third series, it becomes very easy. Maybe this is trying to say that once you reach a certain level in an organization, work becomes easy and boring and it's time to leave and scratch that entrepreneurial itch...

Ok, I admit it. After a couple of weeks off, I have now started another game. See you at the twelve step program.

Where did Summer Go?

2008-07-31T19:05:00.000-07:00

It's been a while since my last blog post...It happens every year, but the speed at which summer travels relative to the rest of the year catches me by surprise. I enjoy the 90 day respite from teaching that runs from late May through late August. It still feels early in the summer, but I realized that my first class of the semester is only a few weeks away and my department deadline for the syllabus is tomorrow. Time to get to work. Guess it's not only the students who procrastinate...

I actually enjoy the process of pulling together a selection of materials to create a complete course on Entrepreneurial Finance. Last year, I tried out a custom textbook through one of the major publishers, which seemed like a great way to go. I assembled textbook chapters, Harvard Business Review articles, cases, and notes to pull together my own textbook. It was kind of fun to add each case and see the price of the book adjust on the fly. I was able to come in around $100 and assumed with the bookstore mark-up, it would still be under $125, not outrageous for a text. However, the cost to the students ended up at over $140.

After apologizing at the first class of each semester, putting materials on reserve at the library and finding a more economical way to get just the cases, I vowed to find another solution for next time. This year, I'm giving University Readers a try. So far, the service seems great and the price is a lot better, in large part by cutting out the bookstore. This wasn't an option with the publisher I used last year (more about that later). Students order directly from University Readers and get access to the first 20% of materials online while waiting for the book to arrive at their door.

This whole process got me thinking about the textbook business model. A 2005 report by the Government Accountability Office indicates that textbook prices have outpaced inflation by more than 2-1 over the past two decades and account for 26% of tuition and fees at four-year public universities and nearly three-quarters of costs at community colleges. The producers of the content (professors) get very little of the price, new editions are constantly coming out with added bells and whistles that most faculty and students don't want. These new texts reduce the value of used books, while publishers and the bookstores reap the rewards, 64.3% and 22.4% of the sale price, respectively, according to the National Association of College Stores. Competition in the retail chain is limited as off campus bookstores have a difficult time accessing the required texts and don't typically have a complete selection for the students.

A bill pending in Congress would require publishers to sell "unbundled" versions of the books and disclose book prices to faculty in their marketing materials. Both good steps, but competition, more choices (including online, subscription, rental and other new models) will do more than regulation.

Of course, students could certainly take this in their own hands. Randy Stross, a colleague of mine at San Jose State, wrote an interesting piece on the textbook business in his Sunday New York Times column, "First it Was Song Downloads. Now It's Organic Chemistry." He describes college students as the "angriest group of captive customers to be found anywhere" and that "students who create and give away digital copies are motivated not by financial self-interest but by something more powerful: the sweet satisfaction of revenge".

One of the shrewdest groups in the music business and way ahead of their time was the Grateful Dead. Similar to the textbook business, the music business BN (before Napster) was controlled by the labels. The artists received very little of album sales, but kept concert and merchandise revenue. The Dead developed an avid fan base (aka Deadheads) who attended mutliple shows on each tour and traded bootleg tapes of their favorite shows. While the Dead did nothing to discourage the pirated music, they actively protected their trademarks to prevent unlicensed merchandise.

Let's hope that students, after graduation, saddled with debt from the high cost of tuition and textbooks aren't on the street reciting lyrics from the Dead's Touch of Grey

"I know the rent is in arrears, the dog has not been fed in years
It's even worse than it appears, but it's alright"

Is it the Horse or Jockey?

2008-06-06T08:07:00.000-07:00

It seems appropriate to have this discussion as Kent Desormeaux grabs Big Brown's reins and goes after the Triple Crown tomorrow at Belmont...There is an age old debate in the venture business on whether it is better to bet on the horse (business/market) or the jockey (management team/founders). Hans Hvide at the University of Aberdeen Business School just published a paper, "The Horse or the Jockey? Evidence from Nascent Firms where a Founder Dies" in an attempt to quantitatively answer this question.

Hvide analyzed 6,800 companies that started between 1996 and 2003 in Norway. Out of the 12,500 founders of these firms, 181 (1.7%) die at some point between starting up the firm and the end of 2005 (Hvide 6). This leaves a relatively small sample. And there were certainly many other founders that were figuratively "shot" by their board rather than literally kicking the bucket or left on their own to pursue other opportunities.

As you might guess, the results were inconclusive. The 6-year firm survival rate was 60% for dead founders and 61% for live founders, while the average Operating Return on Assets was 6% for dead founders vs. 8% for live founders, but neither are statistically significant (Hvilde 15). Some conclusions were that the founders role is more important in the very early stage in the creation of the horse and as the visionary and as the company moves beyond this stage, becomes replaceable. This obviously depends on the "horsepower" of the founder, but speaks to the differing skill sets required in starting vs. growing the company. Of course, this would be obvious to anyone who has been in the start-up ecosystem for any length of time

This led me to think through some anecdotal examples of the companies that I have invested in or been on the management team that have had successful outcomes. In most of these cases, the founder relinquished the CEO role within the first 18 months following institutional funding, but remained in a critical technical or visionary role, often as the company's external evangelist. In the cases where the founder has remained as CEO, this has not been their first start-up.

I typically advise the founders of my companies to be open to being replaced as CEO and to remember that a company can have a number of CEO's over it's lifespan, but not founders and that is the best title to have on your business card. Of course, that doesn't mean being sent off to Siberia. Upon taking the CEO role at a venture backed start-up, one of my friends got this word of advice from the VC investor, "Your CEO now. Do whatever you want with the founders". Basically, I invested in them, but they are your problem now.

Back to the Triple Crown and wishing Big Brown and Kent Desormeaux success tomorrow. I'm not a big horse racing fan, but do remember the glory days of the 1970's when we had 3 triple crown winners in 5 years, including Secretariat who was the first horse to claim the triple crown since Citation 25 years earlier. Who would have known we would have to wait at least 30 years for another. I'm still a little sad at having to turn down an invitation to see Secretariat run at the Preakness, but it happened to fall on the same day as my brother's Bar Mitzvah.

What does it take to be an Angel Investor?

2008-05-29T11:35:00.000-07:00

This is often a tough question to answer. To the SEC, it means that you are an accredited investor and To the man (or woman) on the street, a minimum qualification would seem to be an interest and ability to invest in early stage ventures. However, that is not always the case as there is no qualification to set out your shingle as an angel investor or form an angel group. I often wonder if saying you are an angel investor is the 21st century version of being a consultant in the early 1990's after the corporate layoffs, a euphemism for someone without a real job.

I attended the ACA Summit in San Diego earlier this month. I ran into a friend who was wearing a nametag from another angel group and I inquired as to why she had never shown an interest in joining Sand Hill Angels. Her response was that we required our members to make investments and the other group didn't....Silly us, with that kind of a requirement. I think this sentiment has given angel groups a bad name. An entrepreneur will pitch their business plan to what they think is a group of angel investors and will get a number of follow-up calls afterwards, but they are pitches for services not investment interest.

The ACA is an interesting organization and is providing support in a number of ways to its member angel groups, from public policy, networking, sydnication, and best practices. The National Venture Capital Association (NVCA) was also represented at the conference and is forging closer links with the ACA. In fact, there are some members of both groups, as a number of angel groups have raised funds (that is an entire discussion that I'll leave for a future post).

Academically challenged

2008-05-06T09:51:00.001-07:00

My colleague, Joel West, wrote a blog post yesterday responding to an article in the Financial Times on the looming shortage of b-school faculty. In the post, he raises the age old question of whether business students are better served by traditional academics or those with current, practical business experience. Obviously, you can't just have one or the other...At many b-schools, the faculty with the highest student ratings are rarely the ones with the best record of publishing.

In the post, he mentioned that while he feels I am a lynch pin (Thanks, Joel!) of the entrepreneurship program, I depress the academically qualified ratio. Not immediately grasping the meaning, I assumed that if I'm considered academically unqualified, I must be academically challenged. This sounds like a politically correct term for "stupid". However, when I checked into it, it just means for accreditation purposes, I am "PQ" (professional qualified), not "AQ" (academically qualified).

Thinking back to my b-school experiences at Wharton and UCLA, the best profs I had were a mix of AQ and PQ. However, the academics that were in the group of the best spent a reasonable amount of time in industry and consulting. The lecturers tended to be consistently excellent in the classroom, because they were teaching because they enjoyed it rather than a requirement as tenured or tenure track faculty. The money clearly isn't the driving force!

I have been teaching on a part-time basis for over ten years and enjoy the interaction with students and faculty. However, as an adjunct, I don't have to get involved in any of the politics (and very little of the bureaucracy) of academia. This reminds of a comment from the VP Engineering at one of my start-ups, who is a Brit with a dry sense of humor - "I used to teach at university, but then I realized I didn't like the students". Luckily, that isn't the case for me....

Baby's All Grown Up

2008-04-11T10:22:00.000-07:00

It's been a while since my last post and it appears I missed the entire month of March. Not to worry, I was busy working on closing the Series B financing for iControl Networks. We ended up raising $15.5M, led by John Doerr of Kleiner Perkins.

This got me thinking about my role in helping companies grow up. I started working with the founders of iControl at the concept stage, prior to the first $100K of angel financing. For a while, it seemed like we were constantly walking along the edge of a cliff and had several near death experiences. In fact, for a good laugh, I just went back and checked our accounting system, and at the end of one quarter in 2005, we were down to $143 cash on the balance sheet. The CEO and I ended up funding the company ourselves until we were able to scrape together a larger angel round.

Now, the company is poised to change the home security industry, one that is in dire need of change. However, my role changes and I am moving from CFO and member of the executive team to cheerleader and advisor. It is not unlike watching your children grow up. With two teenage daughters, I am becoming quite familiar with the changes as your babies become toddlers, pre-schoolers, enter kindergarten, middle and high school. My oldest won't be off to college for a few years, but will probably happen in a blink of an eye.

At times, I do miss being part of a team that takes a company from infancy all the way to IPO and beyond. I have been tempted at various times to join one of my companies as full time CFO, but have decided that is not in the best interest of either party (me or the company). As the company grows, it is more important to have a CFO that is both strategic and skilled in process, rather than a "seat of the pants" entrepreneurial CFO. I personally enjoy the earliest stages and building a portfolio of start-ups and entrepreneurial teams.

The cheerleader role isn't all bad. Anonymizer, a company where I was an early investor, advisor and board member, just got acquired by Abraxas Corporation for a very nice multiple. Rather than home security, these guys are helping with our nation's security. Anonymizer raised a small amount of equity and was able to build a business that became very profitable. It took almost a decade from the initial investment, but in the end, worked out well for all involved. Come to think of it, this will help pay for those college tuition bills that will be coming....

4 Lessons of Entrepreneurship

2008-02-26T19:40:00.000-08:00

For golfer's, Ben Hogan's Five Lessons is a classic. While the golf courses and equipment have certainly changed over the five decades since this was published, this tutorial is still relied upon by professionals and amateurs worldwide.

As I mentioned in the previous post, Jeff Fluhr (founder of StubHub) recently stopped by my Entrepreneurial Finance class to share his 4 Lessons of Entrepreneurship with the students. I was glad to see he didn't try and upstage Mr. Hogan by adding another one.

Do you have the right make-up to be an entrepreneur? You need to be true to yourself and many people aren't cut out to take the personal and professional risk associated with being an entrepreneur. There are going to be a lot of tough times and perseverance is essential.
Challenge the Status Quo - StubHub entered an industry dominated by a couple of large players who had a vested interest to block the legality of their business of providing a marketplace for the sale of tickets in the secondary market. In the early days, Jeff spent a lot of time with state legislators to get beyond the stigma of "ticket scalping" and change regulations. He definitely had a lot of people tell him that it couldn't be done.
Go with Your Gut - This certainly goes hand in hand with challenging the status quo. Jeff founded StubHub during the dotcom bust and funding for consumer Internet companies was disappearing rapidly. His gut told him the opportunity might not be there in a year and he dropped out of business school to launch the venture. He raised less financing than originally planned but was able to launch the site and was running a business by the time his classmates graduated 9 months later.
It's Ok to Exit a Little Early -StubHub was experiencing great growth and hitting it's metrics when Ebay acquired the company in early 2007 It is quite possible that Jeff could have gotten a higher price for the company by waiting, but felt there were a number of benefits to exiting when they did. Besides the natural fit with eBay, he wanted the buyer to feel good following the acquisition and certainly the investors in StubHub were happy. All of this only helps for the next venture.

Here's another bonus lesson. Be passionate about whatever it is you are doing. Any start-up is going to be all consuming and will require a lot of personal sacrifices, so make sure you believe in what you are doing. Dan Gordon, founder of Gordon Biersch, came by my class this week. Prior to founding the brewery, Dan spent five years studying beer in Germany and not the way most college students partake in this particular study. He was the first American in 30 years to graduate from the 5-year brewing program at the Technical University of Munich, the highest technical degree in brewing engineering. Upon graduation, he knew he wanted to open a German brewery restaurant in California and the passion and determination drove a lot of the early success. Brewing a great beer certainly doesn't hurt, which the students got to taste at the brewery after the class.

Buyer's Remorse

2008-02-12T17:28:00.000-08:00

Wikipedia (where else would you look....) defines Buyer's Remorse as "an emotional condition whereby a person feels remorse or regret after a purchase" and "a natural human reaction, rising out of a sense of caution". I certainly remember the feeling after buying my first house. The feeling is fleeting and then you go about making the house into your home.

I have noticed this same feeling when making a venture capital or angel investment. While spending time with the entrepreneurs and championing the deal through the group, you tend to become emotionally attached. Of course, rigorous diligence is performed, the team is challenged, and assumptions are tested. Once the point is reached where you want to move ahead, we put the sales hat on and convince our partners about the incredible opportunity that we are lucky enough to be able to invest on the ground floor. However, once the deal is completed and the wire hits the start-ups bank account, all the warts seem to jump out. In most cases, the entrepreneur hasn't hidden anything, it is just buyer's remorse kicking in and the realization that the hard work is beginning. As early stage investors, our goal is to eliminate as much risk as possible with the least amount of cash spent.

Of course, the opposite of buyer's remorse is exercising too much caution and not making an investment where your gut was saying yes. I've found that the opportunities we let pass often stick around longer than many that we do. I started thinking about this yesterday when Jeff Fluhr, founder of Stub Hub spoke at my San Jose State class. I first met Jeff about 8 years ago when he was finishing his first year at the Stanford GSB and was beginning to raise money for a business plan he developed for a secondary market ticket exchange. This was the beginning of the dot com bust and getting a consumer deal through the partners at my venture firm was next to impossible. I liked the founders and considered making a personal investment, but ended up passing.

However, I was glad to see they were able to raise financing and launch the service. I used it as a buyer and seller on a number of occasions and rooted from the sidelines for their success against the Ticketmaster, state regulators and others trying to knock them down. Jeff was able to build a profitable company and a successful exit when Ebay acquired Stub Hub for $300 million early last year. Jeff shared some entrepreneurial lessons with the class and I may include in a subsequent blog post.

Of course, I'm not the only one to feel this way. I was listening to a podcast recently on Venture Voice with legendary VC Tom Perkins. When asked the question about the worst investment he ever made, he turned it around to mention the one that got away, Apple. Kleiner Perkins had looked at a few other computer start-ups and weren't interested, so didn't even take a meeting with the Steves. Bessemer Venture Partners lists an anti-portfolio of investments they passed on that includes Apple, Ebay, Intel, and Google.

Now, back to that house in Mountain View, California. Hard to believe you could buy a nice house like that in the Bay Area for only $300,000....

Is the Grass Really Greener on the Dark Side?

2008-01-27T12:47:00.000-08:00

The spring semester of my Entrepreneurial Finance class starts tomorrow. During the next four months, we will examine over a dozen entrepreneurial ventures from a diverse mix of industries - technology, service, food & beverage, and fashion. We will also look at a variety of financing methods including venture capital, angel investing, licensing, franchising, roll-up, venture debt and my old favorite, bootstrapping. One thing that strikes me every time I teach the course and in my investing activities is how much easier it is to critique someone else's idea than build your own. In addition to the case study analysis, the students also have the opportunity to develop a business model and financial model for a new concept, which always proves a lot more challenging.

I think this same concept plays into what I've seen happening a lot more in the venture community: partners at VC firms jumping back into entrepreneurial ventures. There used to be a fairly standard career path in the venture capital industry. After a successful career in a technology leader (Intel, Microsoft, Cisco, etc.) or one or more exits as a start-up founder, you were enticed to become a partner on Sand Hill Road, or as some call it, jumping over to the dark side. With a limited number of these opportunities and 10-year fund cycles, there wasn't a lot of transition among partners in firms. In fact, most partners that left VC firms either cut back to a non general partner role and/or to personal investing and other activities.

However, over the past 5-10 years, we have seen a lot of changes in the make-up of firms, expansion and consolidation in number of firms and partners leaving to join other firms or more interestingly, to start companies or join other start-ups. I thought about the differences a lot when I spent several years as a venture partner. I had been considering moving towards a full time role as a VC, but decided I enjoyed the company side better and participating as an active member of the team rather than strictly an advisor, coach and board member.

Perhaps, this is partially driving some of the jumping across the table, but certainly the performance metrics of funds and individual partners has also played a key role. An argument can also be made that money remains the key driver and given the increasing competitiveness in the VC business in both raising funds and investing, that start-ups are now seen as the more lucrative route.

I'm going to continue to follow the paths of entrepreneurs turned VCs turned entrepreneurs again and see how it evolves. As an angel investor and start-up CFO, I should have a good vantage point.

Touched by an Angel

2008-01-17T16:21:00.000-08:00

I think the title of this post is a TV show, but fitting as there has been much debate in the venture community as to the whether angel investors are good or bad for entrepreneurs and VCs. What would the VC corollary to Touched by an Angel, be. Well, you can certainly peruse The Funded for some descriptive terms for investors.

I was on a panel earlier this week with several other investors from Angel Groups in the Valley. The panel was a typical Silicon Valley shmoozefest hosted at a law firm with about 75+ attendees. A partner from the law firm (sponsor, covers the drinks and food) tosses out some softball questions to the panelists, the audience chimes in with Q&A and finally, culminates with the meet and greet where the panelists are flooded with business cards and pitches on the next great thing, which is often very similar to the last great thing. My facebook can beat up your facebook....

The theme of the event was angel investment trends for 2008. One of my comments was that we would likely see more institutionalization of angel groups and syndication of deals among groups. We have already seen the institutionalization of groups evidenced by the growth of the Angel Capital Association (ACA), which counts 265 angel groups and 10,000 individual members, up from probably a handful a decade ago. At Sand Hill Angels, we recently switched our IT infrastructure over to Angelsoft, which built a specialized application for angel groups. While currently free to angel groups, their business model revolves around aggregating the angel investment data.

Speaking of angel investment data, the Kauffman Foundation funded a paper on Returns to Angel Investors in Groups written by Robert Wiltbank at Willamette University and Warren Boeker at University of Washington. According to their research, overall returns on group-affiliated angel investments average to a 2.6X return on investment after 3.5 years. If my math is correct, this is approximately a 31% IRR, which has to beat individual angel investments on aggregate and venture capital returns over the period of the study (1990-2007). I found this data quite interesting and wonder how representative it actually is as most angel investments are not reported.

Back to the panel. There were a couple of comments by other panelists that I found interesting. One group charges entrepreneurs "an administrative fee" to present to the group. Mind you, this is not a $20 fee to cover printing nametags and making copying an executive summary into a book. It is several thousand dollars, which is a lot of cash for a struggling entrepreneur in search of seed funding. Just seems that the guys with the money shouldn't be charging the guys who don't have any....One of the other panelists mentioned that they don't charge the entrepreneurs, but do require them to spring for lunch at a follow-up meeting. I found this amusing as well, but presume the entrepreneurs get to choose and can bring PB&J sandwiches. At Sand Hill Angels, we won't charge you to pitch and will even spring for the food!

Another comment which probably deserves more discussion is around valuation. One of the panelists mentioned that they have gotten very valuation sensitive (nothing wrong with that) and like to purchase preferred stock rather than invest in convertible notes. Again, I see nothing wrong with this, although entrepreneurs often prefer convertible debt as it defers the valuation discussion and leaves the Series A price for the venture firm to set. He also said they typically only invest at a $1 million pre-money valuation or less. He then went on to say that this type of financing was good for the entrepreneur (vs taking VC money) because they got to keep more of the company.

This got me scratching my head and ready to open up a debate. However, there was not any interest on the other side in debating me in front of the group of entrepreneurs, so I'll have to do it here. Valuation at this stage is clearly much more art than science, but I subscribe to the splitting up the pie school of thought. There needs to be enough equity to go around for founders, early investors, later investors, and employees. We typically invest at pre-money valuations between $1 - $5 million, with the sweet spot somewhere in the middle.

At a $1 million, pre-money, with an investment of $500K, that would leave 67% of the company for the founders and initial option pool. Let's say the company hits it out of the park with that $500K and can now raise $10 million at a $15 million pre-money valuation. Keeping this simple with no employee option pool and just founders and investors, investors would hold 60% at this point (20% for angels and 40% for VCs) and founders would have 40%. Under an alternative scenario, entrepreneurs go for VC funding to start and raise $4M at a $4M pre-money. For the next round, assume pre-money stays at $15M and amount raised is $6.5M for a total of $10.5M of funding in both scenarios. Now the investors have 65% (35% for first round and 30% for second round), while founders have 35%. I guess you can make the argument that the founders keep more of the company under the take angel money at a $1M pre-money valuation, but the stars need to be aligned and it is much more likely that initial VC funding in the angel scenario would be at a lower valuation with significantly more dilution. I'm sure I lost all of you, but I feel better now having completed the analysis.

I guess the moral is, make sure you know where the angel is touching you.....ProfessorVCs office hours are now closed. See you next time.

Who does this ProfessorVC think he is?

2008-01-17T15:10:00.000-08:00

Ok, so I think I'm the last guy in Silicon Valley to start a blog. I've thought about it for the past 5 or 6 years and finally decided to do it this afternoon. I'm so late hopping on the train that we are probably pulling into the station. I put up my Bodega Partners web site in 1995 and it served its purpose for a number of years, but I just didn't spend the energy to keep it current and finally just took it down last month.

I thought I'd just go with a simple blog name like Steve Bennet, but wasn't available on Blogger so I had to come up with something else. The first thing that popped in my head was Start-up CFO Guy, but that didn't quite roll off the tongue. ProfessorVC was the second name and being impatient I just typed it into the blog creation tool and before I could think twice, it existed in cyberspace. I mentioned the name to my wife and you she thought it made me sound arrogant. I next tried it on my 14 year old daughter and she said it was completely lame. Of course, she thinks most things I do are lame.....

I thought about the name some more and I do spend much of my time teaching entrepreneurship and coaching entrepreneurs. I have also been a VC and am currently actively angel investing as a member of Sand Hill Angels. For now, I'll keep it, but will certainly solicit comments and suggestions for a better name.

In the blog, I plan on sharing my opinions (I generally have no shortage of these) on venture capital, angel investing, teaching entrepreneurship, and anything else that strikes my fancy. First post will be about a panel I was on earlier this week with several other angel investors.