Archive for the 'venture capitalist' Category

Are you giving equity to your VC to get their advice?

This post comes after a discussion through comments with Fred Destin on one of his recent posts. This is something I’ve been thinking for a long time, and I just thought it may be time for me to put this on paper: Nothing in the way term sheets are crafted creates an incentive for any of both parties to value advice from investors.

Let me just state first that I’m not saying that some VCs or BAs are not adding value to companies they’ve invested in. I know Fred and he’s definitely a nice fellow and very proactive investor, he’s for example participating in a lot of initiatives like Seedcamp. But, my point is that VCs or BAs are best viewed as pure financiers with the incentive structure put in place through current shareholder agreements: Their added value is in putting money in the projects that will be providing the best returns – with or without them on board.

Today, once the money has been committed, there is no incentive for the entrepreneurs to listen to investors’ advice – entrepreneurs are not paying for it. Furthermore, there is no incentive for investors to put extra skin in the game – if they do, other investors will benefit from these freebies on the same terms than they will.

OK, we regularly do see some investors providing extra help. But for me, their incentive belongs to either empathy or reputation management (providing value now to get a discount on future financing rounds with other startups). The carried interest, that is often cited, is not actually a hard incentive. Investors will receive it, whether or not they were really instrumental in the success of the company. Sure, investors have an incentive not to let the company fail, but the way to “fix” a company is certainly something that is not widely shared between entrepreneurs and investors, and I don’t think entrepreneurs see them as advice they have paid for when they issued equities.

So my whole point to entrepreneurs is that they should not expect particular help from VCs or BAs. Sure, they will get some “free” advice, but like everything that is free, you may like it or not, it may even have a lot of value for you, but you can not complain on the quality.

I’m actually thinking that we need alternate incentive structures so that entrepreneurs do pay for advice that have value for the project. There is a problem of assymetry in information products like advice, it is that you don’t know the value until you’ve consumed them, and when you’ve consumed them for free, you have litlle binding to pay their full value. My current thinking is that alternative currencies may be a good way to solve this problem: You can imagine that projects will be able to issue local currencies that will be backed someday by actual shares of the profit. But this is another story, a subject for another post…

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Heading to San Francisco for first BarCampBank of the Year

I’m packing my things to be ready Wednesday morning when I fly to San Francisco. Next week-end there will be BarCampBank San Francisco, first BarCampBank of the year, and quite an unsual event because of the wealth of startups that will be represented there: Wesabe, Mint, Zoppa, Zecco, just to name a few who confirmed their presence here, and I hope a lot more will drop-in to join the mind-shaking debates we can anticipate.

I will use the opportunity to discuss with all the brilliant people there a couple of projects I’m currently working on:

1) creating a virtual incubator for FI-startups

In the spirit of P2PVenture, I think there is an opportunity to create a virtual space where entrepreneurs, professionals and investors can mingle and co-develop projects up to the point where some of the professionals can join the project and investors finance it

2) creating a FI angel investors network

One of the components of the previous space could be a virtual angel investors club dedicated to the FI-business. I’m thinking of maybe setting up such a club in a near future

3) organizing a FundCamp FinTech

While launching FundCamp is one of the main action of P2PVenture.org right now. I’m also thinking of organizing a FundCamp dedicated to FinTech. I also see this as an opportunity to boot-strap the 2 previous points.

4) setting up a FinTech venture fund

This is a rather longer term project. There are not so many venture funds dedicated to FinTech and I believe there could be an opportunity to offer real value along the money a dedicated FinTech venture fund would invest in FI-startups.

As you see, quite a lot of things to discuss and get feedback on. Hopefully, critical mass could be assembled on a couple of these subjects and we could see something taking off in a not too distant future.

LendingClub secures $10M in Series A

LendingClub just announced that it secured a Series A round of $10M from Canaan Partners and Norwest Venture Partners. Seems like things are really accelerating and VCs are pouring more and more money in new financial startups.

 We spotted LendingClub at BarCampBank a while back and put them on our Bank & Finance Watch site. Seems like we are going to live a rapid increase in the number of startups we’ll follow on our site and witness more and more funding for a selection of these.

Should I give an arm and a leg to the VCs?

Bringing VCs on board can be an emotional (and sometimes traumatic) experience. It always seems that you’re giving a lot for what seems little in return: cash. Using simple maths may prove a powerful tool to set some context before taking the dreadful decision of accepting foreigners’ money. In this case, we can rely on the notion of discount rate to shed some light to the debate.

 Let’s first take the theoritical case of a startup doing a seed round of €500k on Year 1, a first round of €2M on Year 2, a second round of €6M on Year 3, a mezzanine round of €2M on Year 4 and a brilliant exit of €30M on Year 5. If VCs use a discount rate of 50% to define the shares they want with a target exit of €30M, they’ll dilute you from 100% ownership to 91.5% after seed-round, 71% after first round, 39% after second round (ouch!) and leaving you 35.1% ownership of the company after mezzanine round (where we keeped a 50% rate for the sake of simplicity). So you’ll end up with €10.5M in Year 5.

Not bad! But wouldn’t have you been better not taking VCs’ money and maybe take 10 years to exit with 100% of the final €30M? This is where using discount rate can bring some rationale to the decision. Let’s forget all the details of the different rounds that were there just to set the stage for: am I better owning 35% of the exit value in Year 5 or owning the entire exit value in Year 10? This is where it all depends on your own discount rate. If your own way to assume the discount you apply on years between 5 and 10 is below 23.3%, then you should go all on your own and shoot for the big prize; just be prepared for a long, long trip. If it is above 23.3%, then settle for the “quick” route and pocket the %35.1 percent faster (still 5 years).

 When we compare this 23.3% with the 50% of the VCs, it could seem obvious that the decision should be: pocket the money on Year 5 and then,..become a VC. In fact, the 50% holds only for specific projects: The successful ones. VCs invest in a portfolio of projects and as the old saying goes: Out of 10 invesment, 5 go down the drain, 2 become zombies (projects with no exits), 2 give back less than what was disbursed and only 1 is a superstar offering the famous 50% or above. All in all, a fund is very happy if it can provide an Internal Rate of Return (IRR) above 12%. So you could assume that you’re finally better off keeping your investment in your own startup and make it blossom at a rate superior to 23.3%. But remember that your investment is tied to one “single” project, and that the risk is exactly what is making the transition from a discount rate to an IRR.

In fact, from an option point of view, it is always very positive to get cash out sooner than latter. What the little example illustrated was just that faster exits are actually made possible by the cash that the VCs bring in: this provides the acceleration needed to reach more rapidly the way out.

So when taking the decision, remember the paradox: Giving an arm and a leg can help me run faster.

VentureCamp in Rome

VentureCamp logo

I just discovered this initiative: a BarCamp on Venture Capital in Rome. Quite a pleasant prospect!!!

I hope all the success for this first VentureCamp. Depending on the date (late May / early June at this time), I may join the event to enjoy Rome and I’m sure lively discussions on the subject of venturing. I would also use the opportunity to promote some of the projects we’re having at the BarCampBank and in particular the P2PVenture project.

Should you give your valuation on your first date?

I was participating the other day to a project presentation session at a Business Angel club. The different presentations were all finally presenting some slide where you could find the money they need (a good point) and some valuation (a bad point). Let me give a fatherly piece of advice: “do not give your valuation on the first date”.

 This special moment of seduction where entrepreneurs meet potential investors is definitely a first date. You may engage for a long time as partners and you must surely take the female approach of being very selective on the gene pool and the means of survival that you want for the baby that “you” will be carrying. So be very seductive, be plain open on what you need, but do not spoil this first getting-together with valuation. The risks that you take is that you could deter some potential investors that have a lot to offer beside money. Second, in a good negociation, you must try if possible not to be the one giving the first price: if your valuation is silly and you find someone ready to talk with you, chances are they will never go for the long stand or are plain stupid. In the case of professional investors like VCs, this can be even considered as a faux-pas, VCs will use their own valuation mechanisms to come to a price and you’ll have small freedom to maneuver beside playing several potentially suitable partners one against the others.

 So do not rush things. Dress your idea up for the event, give your number at the end of the first rendezvous and wait to see if you convinced a smart investor or two to try to know more about you,… and be ready to get rid of the indecisive ones.